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Economic Recovery Expected to Continue Amid Inflation Uncertainty

March 4, 2024 10 min 18 sec
Michael Sager
CIBC Asset Management
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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves. 

Michael Sager, managing director and head of multi-asset and currency management at CIBC Asset Management. 

With December’s inflation print for the U.S., both on consumer prices and producer prices, some of the recent improvement in inflation data has been halted, and it’s caused the market to have some reflection. 

And as a result, a lot of the rate cuts have been priced out. To us now, it looks reasonably priced. Yields have backed up as a result, but when we think about long-term equilibrium bond yield, about 4.25, which is where we are in the middle of February, again for a 10-year U.S. Treasury, that looks reasonable to us. 

So, what does this mean for stocks, bonds, and then, a broader asset allocation within portfolios? 

On stocks, we began the year cautiously optimistic. We saw there was opportunities in the market as long as you focused on attractive fundamentals. So, you were differentiating based on fundamentals. We also expected market volatility to pick up a little bit, which again, emphasized the point and the importance of selectivity. Nothing really has changed in that narrative. The U.S. economy has remained robust. Europe, Japan and China have all remained much weaker, and Canada, somewhere in the middle.  

So, as part of that selectivity, understanding economic cyclical strength, longer-term valuations, central bank policy expectations and making sure that they were coherent and consistent with data flow were some of the key criteria that we were looking at. And so, selectivity remains the game. 

Certainly, Canada is one where we’ve identified, we’re broadly in line with long-term fair value. But it’s also got challenges in that the Canadian economic cycle looks quite challenged. The housing market is a headwind, and so you’ve got those push-pull factors. Longer term though, we still think Canada is a particularly interesting opportunity. So, cautiously optimistic, selectiveness based on a really rigorous fundamental analysis. There are opportunities in equities. You’ve just got to be discerning. 

In terms of bonds, long term, the case for bonds has significantly improved over the past couple of years. We’ve gone from 10-year government bond yields close to zero in key developed world countries. For example, on 10-year U.S. Treasury, we’re at 4.31 on the 21st of February. Canada, we’re in the mid threes. Those look to us to be not only consistent with fair value but also relatively attractive returns compared to what you could have got from an investment in a 10-year sovereign a couple of years ago. And then, the expected return on corporates, on high yield and emerging market debt are commensurately higher. Of course, there are risks, but the long-term proposition from fixed income, an eclectic mix of fixed income, is an attractive one. 

And then, finally, on asset allocation, we recommend against trying to time the market. It’s a hard thing to do. Much better to identify long-term goals and objectives, and build a strategic portfolio that over that long term, five, 10, even longer number of years, will deliver outcomes on average. And I have to say, a year or two ago, the narrative was that the traditional balanced portfolio was dead. It was no longer relevant. But if you look at the performance of a fairly plain vanilla balanced portfolio focused on public markets, you don’t have to get too fancy, despite the narrative on shorter and longer-term horizons, that balanced portfolio has handily beaten cash. So, focus on the long term, focus on goals and objectives, and don’t try to time the market or react to every convulsion in market volatility. 

The latest data in the U.S. has given markets, including ourselves, pause for thought, particularly service sector inflation, both rental and other services. They seem to have hit a floor, and if anything, have bounced higher a little bit in the last month or two. And so, we need to see more prints. Are we going to continue the trend lower? Or again, have markets overstated the extent to which central banks will be easing? And so, that’s really the interesting question, because if you look at the U.S. economy, I think the broad narrative is that policy became very tight. The Fed tightened interest rates, increased interest rates aggressively, and policy was tightened. 

But if you look at the labour market, you look at economic growth, both of those challenge that narrative. Growth is strong. The labour market is still tight. So, is policy quite as tight as the market believes? If it is, then inflation will continue to moderate, and three or four cuts as currently priced is likely what we’ll see from the Fed. But if we’re all misreading the extent of policy tightening, and actually, inflation gets another breath, another life, and it bounces a little bit from here, then the Fed is going to have to think long and hard about its extent of easing. 

How has our economic outlook changed over the first couple of months of 2024? 

The answer is not too much. The U.S. economy has continued to demonstrate resilience, driven primarily by strong growth in real household income. Other parts of the world are still pretty soggy. Japan, for example, printed in February Q4 GDP, which was negative, and Q3’s GDP number for Japan was revised to be more negative. So, you’ve got two consecutive negative quarters in Japan. Germany and France in Europe are flirting with recession. China remains moribund despite the efforts of the policymakers in that country to stimulate growth. 

Global manufacturing sentiment indicators do appear to have found a bottom. That’s partly because of U.S. resilience. It’s partly because of Chinese policy stimulus. But again, Chinese policy stimulus is not benefiting domestic Chinese growth. It’s benefiting countries that are attached to China, places like Korea, Taiwan, some of the countries in Latin America. And so, that’s being reflected in the global manufacturing sentiment indicator, which seems to be coming off of its bottom. 

So, that’s green shoots of recovery in the broader global economy. Again, this is pretty consistent with what we were looking for. Now, the question is, are those green shoots going to flourish? Will we see a strengthening of recovery in LatAm, Asia, and a continued robustness of growth in the U.S.? That’s the next stage followed in the second half of this year, we hope and expect, by a recovery, particularly in Canada.