Uncertainty bolsters home bias

By Vikram Barhat | September 28, 2011 | Last updated on September 28, 2011
4 min read

As equity markets continue to swing wildly in the third quarter, Canadian investment managers looked for safety closer to home, according to the latest Russell Investment Manager Outlook.

The report found sentiment towards U.S. and global markets receded sharply and shifted to favour the Canadian market, especially traditionally defensive sectors.

“This year, it seems U.S. equity sentiment has had an inverse relationship with Canadian equity sentiment,” said Greg Nott, chief investment officer of Russell Investment Canada Limited. “Earlier this year we saw a hot Canadian market, with a subdued U.S. market.”

In the second quarter, given Canadian stocks’ lofty valuations, sentiment toward domestic equity fell abruptly, while 62% of managers described themselves as bullish towards the U.S.

“However, in this latest quarter, Canadian stocks are back in favour as the number of managers bullish towards U.S. equities has fallen 15% to 47%,” Nott said.

The survey found that bullishness towards the Canadian equities market rose sharply from 43% to 57% of managers in the third quarter, while bearish managers remained at 20%.

“This change in sentiment may be a matter of Canadian managers preferring the safety of home as market volatility increases,” said Nott.

Serge Pepin, head of BMO Investments Inc, says the trend unveiled in the survey is consistent with his observation of the current market behaviour.

“Home bias has always been very strong; it’s ingrained in our mind that over the past couple of years Canada has fared better than most of the developed world,” he said. “Home bias has become even stronger today than it has been in the past [with managers] feeling psychologically shielded from what’s happening [globally].”

American markets are of particular concern for Canadian managers. With the S&P 500 down 12%, U.S. stocks have been a disaster this quarter, as investors turned skittish over the softening global economic data and fears of recession. So dramatic was the outperformance of U.S. stocks, experts suggested portfolio rebalancing.

Jack Ablin, chief investment officer at Harris Private Bank in Chicago, was quoted in a Reuters report as saying: “If you’re doing passive rebalancing for quarter-end, that would require investors to sell bonds and buy stocks, especially given the dramatic difference in performance this quarter in particular.”

The market, generally reacting to headlines, may have to brace for worse.

“The situation in Europe may get worse before it gets better, and further deterioration of markets may be necessary before policymakers take the action required to steady the economy and create the conditions for recovery,” said Nott.

Pepin, however, warns Canadian managers and investors to be mindful of the number of opportunities that aren’t presented in Canada, but are found overseas “in certain sectors where we have very little representation.” These sectors include healthcare and technology.

Equities over bonds and cash

Despite recent volatility, most investment managers still want to remain in equities, according to the Russell survey. Bullishness towards cash stands at just 23%, while bearishness is at 40%. In contrast, Canadian bonds are more unpopular with managers (20% bullish versus 67% bearish). High yield bonds didn’t fare much better, with 28% expressing bullish sentiment and 45% describing themselves as bears.

“If that is the view, then interest rates have nowhere to go but up, and bonds ultimately have nowhere to go but down,” said Nott.

Pepin agrees, saying equity markets are down almost 20% from their highs and a lot of companies are on sale at this point. “Our bonds are yielding next to nothing; the upside potential in bonds is way more limited than in equities, not withstanding volatility,” he said. “Managers are seeing cash as a dead or wasting asset as interest rates aren’t going anywhere.”

U.S. not headed for double-dip recession

The survey also asked managers if they believed the U.S. is heading for a double-dip recession; 73% respondents said no, citing slow but positive economic growth, strong corporate balance sheets and profit levels. Nearly two-thirds of respondents mentioned the Federal Reserve’s announcement that it would keep interest rates low until mid-2013. Other factors included weakness in U.S. dollar and declining oil prices.

Despite a declining oil price, energy remains the most favoured sector of the market. Energy bulls fell slightly to 61%, while bears nearly doubled from 16% to 29%.

After the recent market volatility, sentiment toward the gold-dominated materials sector has been muted (43% bullish and 36% bearish).

By contrast, the financial services sector reveals a divergent viewpoint, with 46% bullish and 36% bearish.

“Despite solid bank earnings and dividends, a more bearish view of banks globally may be holding sentiment back,” said Nott.

Playing defence

The study noted that managers were bullish on a number of traditionally defensive sectors such as consumer staples, telecommunications and utilities. The trend likely reflects a desire to own companies with steady, predictable earnings and cash flow as a hedge against continued market volatility.

“We share many of the same concerns as the investment managers surveyed, but firmly believe we are on track for a modest recovery without a double-dip recession,” said Nott. “Between continued accommodative monetary policy and increasing strength of corporate America, we expect slow, but positive growth ahead.”

Vikram Barhat