Key tactical changes
- Our tactical weights are broadly neutral across equities and bonds
- Within equities we are neutral across various geographies across the U.S., Canada, Euro zone and emerging markets. While valuations look rich in the U.S., growth concerns will likely challenge geographies outside the U.S.
- Within bonds, we are overweight high-quality credit with a preference to investment grade U.S. fixed income and Canadian government bonds
- We are underweight high-yield fixed income as we estimate the risk-reward ratio of this asset class to be less favourable
Equity and bond markets rallied during the final two months of the fourth quarter (Q4) of 2023. That was in stark contrast to the volatility financial markets experienced in October, when 10-year U.S. Treasury yield spiked to a 16-year high of 5%. But a slew of reports showing slowing inflation and moderate but still growing job numbers injected momentum back into markets in Q4 2024. Also, a clear message from the Fed signaled that interest rates have peaked. Markets then climbed higher and seemed to overcome geopolitical uncertainties.
All this pushed down the 10-year U.S. Treasury yield to below 4% in late December. Encouraged by easing in financial conditions, the benchmark S&P 500 index jumped almost 24% in 2023. Euphoria about artificial intelligence helped the tech-heavy Nasdaq-100 index post its best performance since 1999. After two bad years, bonds found their footing too. The Bloomberg Global Aggregate Total Return Index jumped 10% in the final two months of 2023, its best two-month performance since 1990.
While markets had an impressive run in 2023, we expect economic data to get a bit noisy over the next while. For instance, inflation, which trended down nicely for the past few months towards the Fed’s target of 2%, hit a bump in December. The U.S. Consumer Price Index (CPI) increased 3.4% in December, the highest since September. While services costs remained steady, goods disinflation showed signs of stalling. Markets currently expect the Fed to cut rates as early as March. In our view, this is only possible if inflation continues to fall consistently. That said, we expect the Fed to renew its focus toward growth and full employment in the months ahead.
The U.S. economy defied all recession forecasts and posted robust economic growth in 2023. We think this will be challenging to repeat in 2024. As consumer savings dwindle and nominal corporate profits normalize from slowing inflation, 2024’s growth numbers are likely to be lukewarm. While the U.S. has largely been resilient to rising interest rates, other global economies are struggling to keep up. Our indicators show that the outlook for manufacturing outside the U.S. has worsened. The sector has come under pressure in the Euro Area, U.K., Canada and Japan. We expect manufacturing challenges to pressure overall growth in these regions.
Further, we expect monetary conditions in the U.S. to set the tone for economic growth in other countries. If the Fed doesn’t cut interest rates by as much as expected, this could lead to tighter financial conditions for much of the developed world outside the U.S. and for emerging markets.
Given this scenario, we are largely neutral in our positioning. Our tactical equity and bond weights are close to our strategic weights. Within equities, we are neutral across geographies including the U.S., Canada, other developed markets and emerging markets. Within bonds, we prefer higher quality issues that can withstand credit market volatility. Given the lagged effects of tighter monetary policy, we expect U.S. core fixed income and higher quality Canadian bonds to perform better than risky credit in a scenario of slowing growth. We are less constructive about the conditions in high-yield markets. Despite the historic pace of rate hikes in the past two years, high-yield spreads remain low. We feel the risk-reward from high-yield bonds are disadvantageous and are underweight this asset class.