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Luc de la Durantaye, chief investment officer, CIBC Asset Management.
In our scenario, we talked about the two alternatives, which is a very narrow strip of the landing for central banks to achieve a soft landing. So that risk will probably be translating into a higher risk premium for equities, which means to us, like a limited upside in equity markets until that outcome is decided. And so that’s one element for equity markets.
Typically when you’re facing a central bank that is hiking interest rates that your yield curve is flattening and growth is decelerating and you have inflation that is at a high level, it’s not an environment… It’s not necessarily an environment that is extremely negative for equities, but it’s the risk that is involved, the high inflation makes it a bit more difficult for a very big performance in equity. So the performance of the last two years, I think we have to forget that for the next 12 months.
I think it’s going to be a low digit, single digit return for equities from here. And within that, you’re probably going to see a good degree of sector differences. What we would look into is, have a bit of a barbell approach where you have some defensive sectors in the composition of your portfolio, as well as having commodities… Some sectors that benefit from higher commodity prices, because there’s still the supply chain, the war in Ukraine, which we assume will not be resolved quickly, will probably keep commodity prices at elevated levels.
So that’s an area that investors should continue to investigate, but also to protect against the more negative scenario, having defensive sectors in the portfolio would also be recommended. So it’s going to be a difficult environment to navigate to a certain degree given those degrees of uncertainties.
Specifically, equity outlook is one that’s going to be challenging. On the one hand, when you have central banks that are raising interest rates, when you have high inflation, that’s typically an environment of higher volatility. You have a risk of recession. So you have to build these risks into your equity outlook. Rising interest rates, decelerating growth, will also probably decelerate earnings growth from corporations. Rising interest rates and high inflation is an aspect that is not necessarily good for valuation of equity markets. And so that’s a bit more of a challenging environment for equities as central banks continue to raise interest rates. And so you have to be mindful of your sector allocation in that environment. On the one hand, you want to have some defensive sector exposure. And on the other hand, you do want to have a late cycle because it’s a late cycle economic environment. So you want to be exposed to late cycle sectors, commodity oriented in this case, that can hold up in this type of environment.