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Luc de la Durantaye, CIO and managing director of multi-asset and currency management at CIBC Asset Management.
Our economic baseline is for a scenario that remains slow but economic growth over the next two to four quarters, and the slow growth is because you have ongoing trade tension between the U.S. And China. You have the Brexit that’s not dealt with and might be postponed again and you’ve got geopolitical tension in the Middle East. So that’s a drag on global trade, manufacturing, net exports, and therefore business investment is slowing down.
The good part is that the consumer is holding up, because you still have the healthy consumer across the globe in the sense that you have low unemployment. Wage growth, in fact, continues to advance and that helps stabilize global economic activity but to a slow-growth level.
That being said, there’s a good degree of uncertainty and therefore we have a lower degree of conviction than usual to this scenario. Let me then flip: What are the positive and negative risks? A number of them are surrounding trade.
If, on the positive side, you would have a trade truce between China and the U.S., combined — and this is what is important — combined with some sort of a scheduled rollback of tariffs, that could be seen as positive for financial markets, because essentially you’re removing some of the brakes on trade, on manufacturing and on investments and that will be good for equities. All equities would be, probably, relatively good. The more cyclical and the ones that have been most most effected by that — emerging Europe would probably bounce more than U.S. equities, for example. But all equities would go up and bond yields would [go] back up. You would have a rise in bond yields, and the yield curve — which is currently the three to 10 year, which is inverted at the moment — would probably steepen.
But it’s important to say that a trade truce, that is, with a rollback of tariffs — if you have a trade truce but you don’t have a rollback in the tariffs, that would not be stimulative to the economy. So yeah, the markets might respond positively in the short term, but that would probably not be sustainable because of that.
The other positive risk to the current environment is whether we have stronger fiscal stimulus, where you have fiscal stimulus leeway, and that could also be a positive to boost growth a little bit more than currently expected.
Finally, if you look at the negative side, well, if you have the current or an escalation in the trade dispute between China and the U.S., and/or if you have spillover into a trade dispute with Europe, that would obviously continue what we have seen so far, which is a general deceleration of trade, which affects manufacturing.
But the danger there would be that you would have a spillover into the service economy and into the consumer, where wage growth would slow down and/or growth in employment would slow down and that would increase the risk of a recession.
So what do we do in that environment? Well, we continue to sort of recommend to have a broad diversification in portfolios. Because you have a wide range of outcomes, you can’t be too concentrated into any particular asset class so that’s the one starting point.
The other element to emphasize is keep some government bonds in your portfolio, more Canadian or North American rather than European and Japanese given the negative rates there. You may want to keep some quality into corporate bonds — quality corporate bonds and sovereign emerging market debt. They still provide a yield pickup, and in our base scenario where growth continues at a moderate pace, those asset classes would continue to do OK.
Same as equity markets. I think equity markets could still provide a low single-digit return. But keep some flexibility in the portfolio as we, I think, have said three months ago, six months ago — keep some flexibility in your portfolio, holding a little bit of cash to take advantage of the volatility that we might see will give you some optionality in terms of reallocating that cash to opportunities. And keep gold in your portfolio. In a world of geopolitical uncertainty and stability, then gold is kind of probably going to stay up or move a little higher. And get a little bit of safe haven currencies, like the Japanese yen and the Swiss franc would be currencies that would provide some protection in your portfolio.
In terms of back home, if we look at Canadian equities, well, the gold sector would probably provide a degree of outperformance within the Canadian, so that might help hold up the Canadian equity market a little bit with the defensive sectors. So those would be the areas where, in that sort of environment, we would recommend deploying a client portfolio.