Business

Investors refuse to accept higher rates are here to stay – and that’s a problem for financial markets

Published

2 years ago

August 14, 2022

Traders work on the floor at the New York Stock Exchange in New York, on Aug. 10.Seth Wenig/The Associated Press

With interest rates rising, and rapidly so, the driving force that dictated decision making in financial markets for the past fifteen years is dying out. In a flash, disoriented investors have been exposed to a new world, one that demands dramatically different expectations for what constitutes a decent return.

Yet for all that’s changed, it can be tough to accept the era of ever-lower rates is truly over. Deep down there may be a tacit acknowledgment of changing winds, but it is often coupled with denial about what this all means.

The hope, it seems, is that the damage has already been done. Technology stocks have been clobbered, and house prices have finally started falling in Canada. But the undertow generated by rising rates is hard to contain, and for that reason it will likely ripple through financial markets, hitting everything from private equity to blue-chip stocks.

Such a sea change can be hard to grasp. Since the 2008-09 global financial crisis, investors of all stripes have grown accustomed to ever-falling interest rates. By July, 2020, the yield on the 10-year U.S. Treasury bond, a benchmark for financial markets, had dropped to a paltry 0.52 per cent.

The trend was so absurd, such a deviation from historical norms, that it even spawned a new mantra: “lower for longer.” Investors learned to accept that rates would stay low for longer than once thought imaginable – and it lasted for so long that it became the norm.

And now, in just seven months, it’s all changed, after scorching inflation and geopolitical earthquakes forced a paradigm shift. In July, the Bank of Canada raised its benchmark rate by a full percentage point, something not seen since 1998. The Federal Reserve hiked its own by 0.75 percentage points a few weeks later.

The reaction since has been quite bizarre. The Nasdaq Composite index for one, a barometer for growth stocks, is up 23 per cent from its June low. Investors seem to think the worst is behind us, and they’re happy to return to the way things were.

The reality: It is highly likely that there is no going back, at least not for quite some time.

“Many economists, strategists and investors are thinking the world hasn’t changed – that we’re in a normal cycle,” said Tom Galvin, chief investment officer at City National Rochdale, a subsidiary of Royal Bank of Canada with roughly US$50-billion in assets under management. He disagrees. “We are in a new era.”

This summer, Mr. Galvin put out a paper that spelled this all out, explaining why the new mantra must be ‘higher for longer.’

“Inflation will be higher for longer than we anticipated, interest rates will be higher for longer, geopolitical tensions and uncertainty will be higher for longer and high volatility in the economy and financial markets will be higher for longer,” he wrote.

Of course, Mr. Galvin is only one voice, and everything in economics and finance is so chaotic right now that it’s near impossible to call anything with 100 per cent certainty. In Canada, inflation is at its highest level in nearly 40 years, yet unemployment is at a record low. That isn’t supposed to happen.

But in the past two weeks a spate of Federal Reserve officials have given public interviews saying much the same.

The day after stock markets rallied this week on the back of news that month-over-month U.S. inflation was flat in July, Mary Daly, president of the San Francisco branch of the Federal Reserve, told the Financial Times that investors shouldn’t be so giddy. While the data was encouraging, core prices, a basket that strips out volatile items such as energy costs, still rose. “This is why we don’t want to declare victory on inflation coming down,” she said. “We’re not near done yet.”

Diane Swonk, chief economist at KPMG, can’t quite understand why investors are forgetting what scares the Fed the most: inflation. One of the central bank’s biggest failures in the past 50 years was allowing U.S. inflation to grow out of control – or ‘entrenched,’ in economics parlance – in the 1970s, forcing the Fed to eventually take drastic action to bring it back in line.

“This is a Fed that remembers the seventies,” Ms. Swonk said. “Most people operating in financial markets don’t.” Especially not the twenty- and thirty-something retail traders who sent stock markets soaring in 2021.

Fed officials can’t say outright they’ll tolerate a recession as a trade off for squashing inflation, but the eighties is proof they have and they will. “They’re going to raise rates and hold it for a while to grind inflation down,” Ms. Swonk predicts.

Despite the history, there is still speculation in certain corners of the financial markets that the Fed will change course. And there are some recent precedents of doing so. Twice over the past decade, the Fed and the Bank of Canada signalled they were ready to take action to cool the economy, but both times the central banks ultimately backed off. They did so first in 2013, after bond investors freaked out, and then again in 2019.

The big difference between now and then is inflation. Even Mike Novogratz, one of the most popular investors in cryptocurrencies, the mother of all speculative assets, warned in the spring that rates won’t be falling any time soon. “There is no cavalry coming to drive a V-shaped recovery,” he wrote in a letter to investors after the crypto market crashed, referencing the quick stock market rebound after the pandemic first hit. “The Fed can’t ‘save’ the market until inflation falls.”

Predicting precisely how financial markets will be impacted by higher rates is hard, but just like unprofitable technology stocks, the asset classes that benefitted the most from the low rate world are those most susceptible to tremors. Private equity and private credit, to name two, are near the top of the list.

When debt was ultra cheap, private equity funds could fund their buyouts for next to nothing. At the same time, passive investing was gathering steam, taking the shine off hedge funds and mutual funds. Private equity, then, became a vehicle for outsized returns.

Earlier this year, Harvard Business School professor Victoria Ivashina wrote a paper predicting a shake out in the sector, arguing that these tailwinds aren’t there anymore. “As the flow of funds into private equity stabilizes and as the industry growth slows down, the fee structure will compress and compensation will shift to be more contingent on performance,” she wrote.

Already there are signs that major investors are moving away from private equity. Earlier this month, John Graham, chief executive of Canada Pension Plan Investment Board, one of the world’s largest institutional investors, disclosed that CPPIB saw more value in public markets than private ones for now. And in a July report, Jefferies, an investment bank, wrote that major money managers, including pension and sovereign wealth funds, had sold US$33-billion worth of stakes in buyout and venture capital funds in the first half of the year, the most on record.

Private debt funds, which lend money to higher risk borrowers, are also vulnerable in the current environment. Money poured into the sector over the past five years because these investment vehicles tend to pay 8-per-cent yields, but that return looks much less rosy now that one-year guaranteed investment certificates pay nearly 4.5 per cent.

By no means are these asset classes dead in the water. The same goes with stocks and so many others. Rates have jumped, and quickly, but they are still low by historical standards.

However, there are many reasons why investors of all stripes should not be expecting a quick return to lower for longer. The latest inflation data is encouraging, but it’s a single data point. Who knows what type of energy crisis Europe and the United Kingdom will face this winter, and what that will do to oil and gas prices.

Inflation also isn’t known to disappear quickly. “It’s easy to get from 6-per-cent core inflation to 4 per cent,” Ms. Swonk, the economist, said. “It’s really hard to get from 4 per cent to 2 per cent.”

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Telus prioritizing ‘most important customers,’ avoiding ‘unprofitable’ offers: CFO

Published

1 day ago

November 8, 2024

Anne Joseph

Telus Corp. says it is avoiding offering “unprofitable” discounts as fierce competition in the Canadian telecommunications sector shows no sign of slowing down.

The company said Friday it had fewer net new customers during its third quarter compared with the same time last year, as it copes with increasingly “aggressive marketing and promotional pricing” that is prompting more customers to switch providers.

Telus said it added 347,000 net new customers, down around 14.5 per cent compared with last year. The figure includes 130,000 mobile phone subscribers and 34,000 internet customers, down 30,000 and 3,000, respectively, year-over-year.

The company reported its mobile phone churn rate — a metric measuring subscribers who cancelled their services — was 1.09 per cent in the third quarter, up from 1.03 per cent in the third quarter of 2023. That included a postpaid mobile phone churn rate of 0.90 per cent in its latest quarter.

Telus said its focus is on customer retention through its “industry-leading service and network quality, along with successful promotions and bundled offerings.”

“The customers we have are the most important customers we can get,” said chief financial officer Doug French in an interview.

“We’ve, again, just continued to focus on what matters most to our customers, from a product and customer service perspective, while not loading unprofitable customers.”

Meanwhile, Telus reported its net income attributable to common shares more than doubled during its third quarter.

The telecommunications company said it earned $280 million, up 105.9 per cent from the same three-month period in 2023. Earnings per diluted share for the quarter ended Sept. 30 was 19 cents compared with nine cents a year earlier.

It reported adjusted net income was $413 million, up 10.7 per cent year-over-year from $373 million in the same quarter last year. Operating revenue and other income for the quarter was $5.1 billion, up 1.8 per cent from the previous year.

Mobile phone average revenue per user was $58.85 in the third quarter, a decrease of $2.09 or 3.4 per cent from a year ago. Telus said the drop was attributable to customers signing up for base rate plans with lower prices, along with a decline in overage and roaming revenues.

It said customers are increasingly adopting unlimited data and Canada-U.S. plans which provide higher and more stable ARPU on a monthly basis.

“In a tough operating environment and relative to peers, we view Q3 results that were in line to slightly better than forecast as the best of the bunch,” said RBC analyst Drew McReynolds in a note.

Scotiabank analyst Maher Yaghi added that “the telecom industry in Canada remains very challenging for all players, however, Telus has been able to face these pressures” and still deliver growth.

The Big 3 telecom providers — which also include Rogers Communications Inc. and BCE Inc. — have frequently stressed that the market has grown more competitive in recent years, especially after the closing of Quebecor Inc.’s purchase of Freedom Mobile in April 2023.

Hailed as a fourth national carrier, Quebecor has invested in enhancements to Freedom’s network while offering more affordable plans as part of a set of commitments it was mandated by Ottawa to agree to.

The cost of telephone services in September was down eight per cent compared with a year earlier, according to Statistics Canada’s most recent inflation report last month.

“I think competition has been and continues to be, I’d say, quite intense in Canada, and we’ve obviously had to just manage our business the way we see fit,” said French.

Asked how long that environment could last, he said that’s out of Telus’ hands.

“What I can control, though, is how we go to market and how we lead with our products,” he said.

“I think the conditions within the market will have to adjust accordingly over time. We’ve continued to focus on digitization, continued to bring our cost structure down to compete, irrespective of the price and the current market conditions.”

Still, Canada’s telecom regulator continues to warn providers about customers facing more charges on their cellphone and internet bills.

On Tuesday, CRTC vice-president of consumer, analytics and strategy Scott Hutton called on providers to ensure they clearly inform their customers of charges such as early cancellation fees.

That followed statements from the regulator in recent weeks cautioning against rising international roaming fees and “surprise” price increases being found on their bills.

Hutton said the CRTC plans to launch public consultations in the coming weeks that will focus “on ensuring that information is clear and consistent, making it easier to compare offers and switch services or providers.”

“The CRTC is concerned with recent trends, which suggest that Canadians may not be benefiting from the full protections of our codes,” he said.

“We will continue to monitor developments and will take further action if our codes are not being followed.”

French said any initiative to boost transparency is a step in the right direction.

“I can’t say we are perfect across the board, but what I can say is we are absolutely taking it under consideration and trying to be the best at communicating with our customers,” he said.

“I think everyone looking in the mirror would say there’s room for improvement.”

This report by The Canadian Press was first published Nov. 8, 2024.

Companies in this story: (TSX:T)

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TC Energy cuts cost estimate for Southeast Gateway pipeline project in Mexico

Published

2 days ago

November 7, 2024

Anne Joseph

CALGARY – TC Energy Corp. has lowered the estimated cost of its Southeast Gateway pipeline project in Mexico.

It says it now expects the project to cost between US$3.9 billion and US$4.1 billion compared with its original estimate of US$4.5 billion.

The change came as the company reported a third-quarter profit attributable to common shareholders of C$1.46 billion or $1.40 per share compared with a loss of C$197 million or 19 cents per share in the same quarter last year.

Revenue for the quarter ended Sept. 30 totalled C$4.08 billion, up from C$3.94 billion in the third quarter of 2023.

TC Energy says its comparable earnings for its latest quarter amounted to C$1.03 per share compared with C$1.00 per share a year earlier.

The average analyst estimate had been for a profit of 95 cents per share, according to LSEG Data & Analytics.

This report by The Canadian Press was first published Nov. 7, 2024.

Companies in this story: (TSX:TRP)

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BCE reports Q3 loss on asset impairment charge, cuts revenue guidance

Published

2 days ago

November 7, 2024

Anne Joseph

BCE Inc. reported a loss in its latest quarter as it recorded $2.11 billion in asset impairment charges, mainly related to Bell Media’s TV and radio properties.

The company says its net loss attributable to common shareholders amounted to $1.24 billion or $1.36 per share for the quarter ended Sept. 30 compared with a profit of $640 million or 70 cents per share a year earlier.

On an adjusted basis, BCE says it earned 75 cents per share in its latest quarter compared with an adjusted profit of 81 cents per share in the same quarter last year.

“Bell’s results for the third quarter demonstrate that we are disciplined in our pursuit of profitable growth in an intensely competitive environment,” BCE chief executive Mirko Bibic said in a statement.

“Our focus this quarter, and throughout 2024, has been to attract higher-margin subscribers and reduce costs to help offset short-term revenue impacts from sustained competitive pricing pressures, slow economic growth and a media advertising market that is in transition.”

Operating revenue for the quarter totalled $5.97 billion, down from $6.08 billion in its third quarter of 2023.

BCE also said it now expects its revenue for 2024 to fall about 1.5 per cent compared with earlier guidance for an increase of zero to four per cent.

The company says the change comes as it faces lower-than-anticipated wireless product revenue and sustained pressure on wireless prices.

BCE added 33,111 net postpaid mobile phone subscribers, down 76.8 per cent from the same period last year, which was the company’s second-best performance on the metric since 2010.

It says the drop was driven by higher customer churn — a measure of subscribers who cancelled their service — amid greater competitive activity and promotional offer intensity. BCE’s monthly churn rate for the category was 1.28 per cent, up from 1.1 per cent during its previous third quarter.

The company also saw 11.6 per cent fewer gross subscriber activations “due to more targeted promotional offers and mobile device discounting compared to last year.”

Bell’s wireless mobile phone average revenue per user was $58.26, down 3.4 per cent from $60.28 in the third quarter of the prior year.

This report by The Canadian Press was first published Nov. 7, 2024.

Companies in this story: (TSX:BCE)

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