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Why a Defensive Stance Makes Sense

September 4, 2023 7 min 27 sec
Wincy Wong
CIBC Private Wealth
Stormy market conditions
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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.

Wincy Wong, executive director, wealth solutions at CIBC.

In thinking about positioning our portfolios in this current environment, in a word, I would say defensive for the last four months of this year.

Our partners on the technical side would remind us September is always historically very poor-performing month for equity markets. But also on the fundamental side, what we’re seeing is a few things. So while the generative AI theme is one that I do believe is structural in nature, so likely to have legs, there are some concerning signs that we’re starting to see coming from China. Signs that I don’t think we can ignore.

So let’s recall China’s COVID recovery, which was lagged, its economy really watching as the rest of the world moved towards normalcy. And in our view, China really was a catalyst for growth. Really, as economies, developing economies, started to weaken, we could see China really starting to get its gears in order and contribute to demand.

But what we’ve seen recently suggests signs that China’s in fact struggling. So we’re having property developers defaulting on debt payments and filing for bankruptcy. We’re seeing shadow banking companies also struggling with bond payments. A key policy rate has been cut twice in the last three months, and more is likely to come, in my opinion. And weak economic data, which suggests that their GDP targets may need to be revised down further. And that could have some ripple effects globally.

While I acknowledge that the data from China can be opaque at times, we are really focused on the downside here. And so from a positioning standpoint for portfolios, we are going to be defensive in nature.

Both interest rates and inflation have been very topical for quite some time now. We know that investors have been very focused since both the Fed and the Bank of Canada began its rate hike cycle in March of last year. And inflation really stoked higher, in part by Covid conditions and the Russian-Ukraine conflict, which also put tremendous pressure on supply chains and demand in some cases.

So what we’re thinking about in light of higher interest rates, from an allocation standpoint in portfolios, is we’ve been adding to our fixed income sovereign holdings, really at the short end for a yield pickup. We have modestly increased duration as well in the fixed income portfolios.

What we’ve seen is weakness on the equity market side in the interest rate sensitive sectors. So think communication services, real estate, utilities over the past year. And over that period of time, we have reduced some of our weights in some of these sectors, but we’ve also been tactical, right? So adding back when we felt that the market was overly punitive in some cases for some of our holdings, which we think still have the ability to grow in a more challenging macro environment.

From a positioning standpoint, as I mentioned, we are defensive in the near term with a focus on downside risks. So an example of downside risks that we think about is wage pressure. What we’re seeing in North America is really tight labour markets. And so we have been seeing continued pressure on wage growth, which is a pressure that will be sticky. And so one thing that we are watching fundamentally is margin pressure on companies and pressure on profitability, which in turn actually leads to potential increased demand on the technology side, as companies look to look for more sources for productivity growth. So I think that’s an interesting dynamic that we think, ultimately, is a positive catalyst for growth that we’re looking at in the markets today.

We do believe that it may be appropriate to consider higher fixed income weights relative to equities in this current environment. Raising a bit more of your cash levels may be prudent in the near term. It really obviously does depend on your mandate. As I mentioned previously, generative AI is something I believe is structural. Now, things just don’t go from A to B in a direction, but we do think that it has legs. One of the things we’re watching is on the consumer side, we do believe consumer could really start to feel the pressure, and we do think that spending could ease. We’re hearing this from management teams, broadly, for the back half of this calendar year. And so we remain cautious on the consumer side.

And really, just remembering that from a Canadian consumer perspective, they are more interest rate sensitive than U.S. consumers. And so there is a preference for us for U.S. markets over Canadian markets. So that said, I do want to remind everybody that it’s often easy to see the negative risks in the near term, but upside surprises do occur. And they are, in fact, surprises, so to really think about a balanced approach. And that’s the way we sort of think about positioning for our portfolios broadly, is to have a broadly diversified portfolio because we do acknowledge that pendulums swing both ways, up and down.

From a regional perspective, we manage both Canadian portfolios, U.S. portfolios, and then North American portfolios. I would say there is a preference for the U.S. in the near term over Canada. As mentioned, the sensitivity to interest rates for consumers in Canada is much higher. Just think about the mortgage market as an example and how our mortgages function with a reset every five years. That’s something that doesn’t happen in the U.S. So the increase in surprising rate hikes that we’ve seen would have more of a negative impact on the consumer in Canada versus the U.S.

And the other factor I would think about is just the China impact. If the Chinese economy continues to decelerate, as we’ve been seeing in the near term, we think that Canada’s more commodity-sensitive sectors could feel some pressure from a demand perspective. And so there’s some near-term risks on the commodity side for Canadian markets.