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Market Opportunities Amid Improving Economic Growth

April 22, 2024 10 min 47 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. I’m managing director and head of multi-asset and currency management at CIBC Asset Management. 

What’s the outlook for global equity and bond markets? 

Let’s focus first on equities. Primary driver there will be the behaviour of economic growth, and certainly growth has been stronger than expected. The talk of a recession a year ago has been relegated to a risk, and quite a small risk, and in its place, we’ve got quite a positive outlook for growth. The U.S. economy has remained resilient, driven by consumer spending. Green shoots of recovery have emerged in Canada, in Europe. The Chinese economy has stabilized. Parts of the emerging markets are improving in growth outlook. A better growth outlook is good for corporate earnings, and corporate earnings, of course, are good for equity performance. So, relatively positive outlook for equity markets. 

There are, of course, some caveats. Geopolitical risk remains elevated. Market volatility is likely to rise as we get closer to fall U.S. elections.  

And then, the more immediate risk is around the stickiness of inflation. Markets had priced quite a lot of rate cuts for this year, for the Fed, for the Bank of Canada, for others. But because inflation is proving stickier, harder to control than expected, the market has revised lower the amount of rate cuts. 

So far, equity markets have looked through that revision in rate expectations, and the fact that interest rates will be higher for longer. They’ve looked through it. They’ve focused on growth and the implications for stronger corporate earnings and stronger profit margins.  

So, so far, so good.  

But if that risk on inflation continues to play out, it’s probably going to become more of a headwind for equities. But nonetheless, a relatively constructive outlook for equities over the next six to 12 months based on our outlook for growth. 

For bond markets, we’ve become much more positive on the role of fixed income in portfolios. We’ve gone from a world in 2020 where, for example, the U.S. 10-year Treasury yield was close to zero. We are now close to four-and-a-half per cent in mid-April of 2024. That’s a great starting yield, because if you think about what’s the long-term return to your fixed-income allocation, the starting yield on a 10-year bond is a pretty good indicator. So, a four-and-a-half per cent yield on the 12th of April suggests that over the next 10 years on average, on a buy-and-hold sovereign bond allocation, you’re going to get a four-and-a-half per cent return. That’s a lot better than it was.  

You’ve also got the diversification benefit. If some of the risks that I mentioned — geopolitics, U.S. politics, inflation, uncertainty — emerge, fixed income has a role.  

So, we’re much more constructive on the core role of fixed income than was previously the case.  

So, net-net, overall, a relatively positive view of the world with some risks. 

Let’s talk about specific opportunities in terms of regions within equities and then sectors within fixed income.  

For equities, we particularly like Canadian equities and the emerging markets. Both have underperformed the broader equity markets, and particularly the U.S. and Europe, over the past couple of years. That means there’s the possibility for some catch-up performance. That’s in the context of an improving cyclical economic outlook. It’s also in the context of valuations for both Canada and the emerging markets broadly being fairly neutral. That compares, for instance, to U.S. large-cap where valuations remain more challenging. So, in terms of attractive sectors in equities, definitely the standouts would be Canada and emerging markets. 

Then for those investors who have the ability to differentiate within emerging markets, we would have a preference for outside of China. Places like India and Latin America would be the focal points, but EM generally will work as well.  

In fixed income, we have a preference for global fixed income currently, versus Canada. That reflects the ability to pick up an interest rate carry or a yield premium on a currency-hedged basis. A small preference for global bonds versus Canada universe fixed income. Then within equities, a definite preference for Canada and the emerging markets. 

Thoughts on the traditional 60/40 portfolio in the current environment. 

Market performance … We think about equity market, the performance there has been quite narrow, focused, particularly last year, on the so-called Magnificent Seven names in the U.S. It’s broadened out a little bit more this year. And in fact, if you look at the Magnificent Seven, only a subset of them have either generated positive performance or performance that has beaten the S&P 500.  

My reason for raising that in the context of a 60/40 portfolio is that there always seems to be a reason and an opportunity to time the market. There’s always a better opportunity, so it seems, than the 60/40 portfolio.  

In reality, market timing is really difficult to do. That includes efforts to enter and exit equity markets on a tactical basis.  

The data has proven that over the long term, a balanced portfolio is a really coherent way for a majority of investors to get exposure to markets and predominantly public markets to get that exposure in a way that delivers their long-term goals and objectives. 

If you think about another example from the recent past — the apparent attractiveness of cash. True. But again, if you compare the performance of cash versus a balanced portfolio, 60/40 portfolio, equity/fixed income, on almost every time horizon, the balanced portfolio has beaten cash.  

Timing sounds good, entry and exit the market sounds good, trying to identify specific themes that will outperform over the next three, six, 24 months sounds a good idea. But in hindsight, the balanced portfolio has delivered in a way that takes emotion away and minimizes the errors that come with market timing. 

I’m very supportive of balanced portfolios that have been designed for specific investors. We have to be cognizant of individual investors’ objectives and constraints and risk sensitivities. But once we understand those, building a balanced portfolio that’s focused on the long term has proven itself able to deliver for a large majority of investors, much more than a theme-based, market-timing approach to investments.