Asset Allocation Quarterly
The Economic Expansion: To Be Continued….
In this publication, we discuss our outlook for the global economy and outline our tactical asset allocation recommendations for the next 9-12 months. 2022 has started off with a bang, literally with the Russian invasion of Ukraine. This follows a record year in 2021, with global real GDP growth soaring +5.9% or ~2x the long-term trend. Moreover, as we look ahead over the next 9-12 months, we see more uncertainty/risk to the expansion than we did at the beginning of the year, including but not limited to: 1) The Russian invasion of Ukraine and the rise in geopolitical tensions (US/NATO vs. Russia/China) not to mention global sanctions on Russia - a major commodity producer; 2) divergence of central bank policy; 3) stubbornly high inflation; 4) new COVID-19 variants and lockdowns (e.g., China); and, 5) a significant slowdown in China. In this environment, we suggest investors diversify across equity asset classes, styles and sectors. Within fixed income markets, we suggest investors consider US MBS, and stick to lower duration securities, with a preference for Canadian/US corporates over sovereign debt given the recent rise in corporate spreads.
Key Takeaways:- It’s complicated…a more uneven recovery than we had originally expected. While global real GDP growth has been revised lower, the brunt of the revision has largely been concentrated across several Asian, Emerging and European economies, while commodity oriented regions and North American developed economies have experienced quite the opposite. Amid all the uncertainty, we believe capital will flow to the “cleanest dirty shirts in the laundry” over the nearterm, which from a Canadian investor’s perspective means Canada and the US markets. Both economies are set to grow by +3.8% and +3.1%, respectively, in 2022, above the 20-year trend of ~1.8%.
- Everything is still uncertain. The lasting economic impacts from the Russia/Ukraine conflict and China lockdowns are still very uncertain. The range of expectations includes everything from a global recession to a high growth/inflationary outlook supported by substantial fiscal spending/QE globally. Everything should be clearer in a couple of months, but now in early April, diversifying across asset classes, styles and sectors makes a lot of sense until the outcome of these exogenous events is more clear.
- Inversion = recession is imminent? The US/Canadian sovereign yield curves (measured as the 10-year yield minus the 2-year yield) have inverted, causing a buzz in the media over the possibility of a recession. While every recession in the US since the 1980s has been preceded by an inverted yield curve, not every inverted yield curve led to a recession, as there are many more temporary inversions than there are recessions. Also, the 10-year yield minus the 3-month yield represents a stronger indicator of a recession, and it remains positively sloped with a spread of +194bps.
- Asset allocation recommendations. We continue to recommend an overweight allocation to equities, which, relative to cash and fixed income, continues to offer a more compelling risk/reward profile for medium-/long-term investors. Also, given relative valuations and the current earnings outlook, we suggest an overweight allocation to the cyclically sensitive S&P/TSX versus the tech-heavy S&P 500 index.
