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Fixed Income Outlook Improving

July 19, 2022 5 min 16 sec
Luc de la Durantaye
CIBC Asset Management
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Luc De la Durantaye, chief investment officer, CIBC Asset Management.

It continues to be a challenging macroeconomic environment, so investors must build well-diversified, resilient portfolios to make sure they can achieve their goals. But I would say, while the inflationary environment remains uncertain, central banks have been tightening, or the markets have started pricing in pretty hawkish central bank tightening so far and bond markets have started to price a good portion of these risks. So, when we look at the starting point, you can probably expect from a fixed income perspective a little bit better expected returns looking forward than what we’ve just witnessed, because obviously we’ve just witnessed one of the worst bear markets in decades.

So, if you start with government bond yields at 3% plus on the 10 year maturities, the starting point is much better than you had something like 1.5% yield at the start of 2022. So just that is giving you a little bit better outlook. If you look at then investment grade corporate bonds in Canada, closer to or a little bit above 4% high yields offering yields at closer to 6. Assuming that inflation is going to sort of come back down towards 3% by the end of this year, early next year, you can earn a positive real yield. And we didn’t have that for a while. And so, that could be attractive.

The other aspect of fixed income is that now that you have higher yield, it can probably play the balancing role that bonds had typically played in prior cycles. So, I think at this stage you can start [inaudible] at bonds and the more aggressive the central bank seems to be the more in a way, in a way, you’re reducing the inflation getting out of control. And then you see that inflation expectations, for example, in various surveys have started to stabilize. So the market is growing more reassured that, yes, eventually inflation could be tamed and therefore you can tip toe in the bond market.

On the equity side, you’ve had a meaningful correction. That correction has predominantly come from valuation. You’ve had a PE, price earnings, de-rating. And so you’ve moved price earnings from overvalued to sort of fairly valued territory. The question remains, though, at least for the second half of this year, how deep of a recession are we going to get? And so therefore how much corporate profits are going to are going to be impacted? And the jury is still somewhat out on this.

We do think that earnings expectations from analysts are still elevated and they need to be adjusted downwards. So that could be early in this quarter, for example, could be another sort of period of difficult performance for equities. But that’s going to set the stage eventually for bottoming and create opportunities for stock pickers to pick and find good values.

We had been talking a little bit also in prior podcasts of holding cash. I think that’s helped stabilize portfolio. I think over the next six to 12 months, you’ll find opportunities to deploy that cash. So we would kind of say, “Yeah, you do have cash, but look for that cash to be redeployed because you’re likely going to see some opportunities.”

And regionally, when you think about some region, I think global diversification, I’ll make a point on global diversification. Because we’re getting into different cycles, you have onshoring by different countries to protect their supplies, you’re going to get different cycles. Think of it as North America, for example, is now continuing to fight inflation and growth is going to be decelerating. China and Asia on the other hand are starting to stimulate their economy. They’re further ahead in the cycle and you can probably have good diversification by having some Asian exposure as well, because they’re at a different stage in their cycle. And so from that perspective, staying defensive in the construction of your portfolio with some defensive sectors, but also diversifying geographically, in particular in Asia where the cycle will be different.