Asset Allocation Quarterly
Too Fast, Too Furious
Too Fast, Too Furious accurately depicts the current investment backdrop with soaring inflation (but moderating from the peak), rapid increases in interest rates/yields, whip-saw markets, and a material deceleration in the global economic growth outlook. We believe it is now clear that central banks in advanced economies will raise interest rates even further than our prior above consensus expectations, making the current tightening cycle the most aggressive we have observed in three decades. While this may be necessary to tame inflation, it will come at a significant economic cost. In particular, we see a high probability of a global recession unfolding in 2023, which will be more severe in some regions and milder in others. Moreover, we see the risks of a more prolonged and deeper recession as higher today than at the beginning of this tightening cycle, with the potential for this cycle to end with some unintended and unforeseen consequences. These would be similar to the unforeseen consequences that followed the most recent easing cycle during the depths of the COVID-19 crisis (e.g., record supply chain disruptions, inflation soaring to 40-year highs, labour shortages, etc.).
However, as we look ahead over the next 9-12 months, we continue to expect the level of uncertainty to remain very elevated, which has only been further complicated by the war in Europe and a material slowdown in China. But while we see “few places to hide” amid all the worrisome headlines or “wall of worries” as we like to refer to them as, for longer-term-oriented, patient, and prudent investors, we see many opportunities to invest in today and more to come in the months ahead.
- With interest rates still poised to move higher, a further slowdown in global growth will be hard to avoid. All said, we expect global growth to be much weaker than our prior forecast of 2.5 per cent in 2023 and quite possibly below two per cent. And while this level of growth would meet the IMF’s old technical definition of a global recession, we suspect that global economic conditions will meet newer and more sophisticated criteria too, given widespread increases in unemployment, a likely decline in world trade, and falls in various asset prices. Given the uncertainty, we expect real GDP growth of between -1.0% to +1.5% for the U.S., and -1.0% to +1.0% for Canada, in 2023.
- Equity positioning lowered slightly to neutral – focus on the cleanest dirty shirts. We suggest investors remain selective and well diversified as well as focus on de-risking their portfolios (i.e., close/reduce portfolio blind spots and/or tighten active relative bets). We continue to prefer high-quality and durable businesses that are trading at reasonable valuations, with a preference for value > growth stocks and a preference for the broader S&P/TSX and the S&P 500 index > MSCI EAFE index and the MSCI EM index.
- Raising fixed income positioning to neutral – reducing corporate bond exposure with a preference for U.S. yields. The implication of an upcoming recession is increased credit risk, so we have reduced our corporate bond holdings alongside an increase in quality and defensive positions. Also, in relative terms, U.S. yields are higher across the board than Canadian yields, so we prefer holding U.S. treasury over Canadian sovereign bonds.