Asset Allocation Quarterly

Quarterly Outlook: Playing the Waiting Game

The waiting game accurately depicts the current investment backdrop, as many investors are choosing to defer their investment decisions and await additional information before diving in. The first quarter of 2023 was marked by rapidly changing headlines on several topics including cooling inflation, peaking interest rates and unexpected events in the banking sector, all signalling a late cycle economy. Conventional wisdom suggests the next recession will begin sometime in 2023, 2024 or even 2025. But pinpointing the start of the recession is somewhat challenging, like calling market tops and bottoms. Nonetheless, patient, prudent investors who can hold onto their investments for a longer term are often rewarded with higher returns. We see many opportunities to invest in today, with more expected to surface in the upcoming months.

Key Takeaways:

• Fed and Market on Two Separate Pages. While the Fed remains squarely focused on inflationary pressures, the market is concentrated on the significant contraction in money supply and tighter financial conditions, which will weigh on economic output in the coming months. The market typically gets it right, so we anticipate the Fed will pause, if not pivot, later this year. The timing and type of recession that will be experienced remain a wild card. We believe employment will be critical in determining if we experience a hard or soft landing or perhaps rolling recessions occurring across the economy at different times.
• Equities – Pulling Forward Weaker Growth. We find ourselves squarely in a late cycle economy right now, which typically means lower inflation, lower rates and lower earnings expectations. Against this backdrop, we still expect a reasonably flattish and volatile S&P 500, and although we had expected a better year for small- and mid-cap equities, we believe this will be reliant on this bank event creating a hard landing/typical recession. Similarly, we had expected very little difference in value and growth in 2023, but the harder the recession, the more that growth should outperform. We maintain a slight overweight to Canadian equities (e.g., S&P/TSX Composite and S&P/TSX 60) relative to U.S. large-cap equities. For our S&P 500 and S&P/TSX Composite sector recommendations, please click here.
• Fixed Income – Adding Duration Proves to Be a Winning Scenario. We continue to believe that yields – especially those of longer maturities – have peaked, so we reiterate our call to add duration, or extend maturity, to your fixed income portfolio. We recommend reducing floating rate exposure in favour of fixed interest rates over your investment horizon. We continue to like U.S. mortgage-backed securities for their cash flow generating capabilities, as well as U.S. callable agency securities (especially at prices below par), and U.S. and Canadian government securities. In relative terms, U.S. yields are higher across the board than Canadian ones, so we prefer holding U.S. treasury over Canadian sovereign bonds (FX not considered). The growing risks of a recession provide less confidence regarding adding to credit, so we continue to suggest that corporate bond holdings be reduced to underweight in total alongside an increase in quality and defensive positions. With inflation and inflation expectations on the decline, we do not suggest holding inflation-protected securities of either countries.

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