Gaelen Morphet, Executive Vice-President and Chief Investment Officer
We believe that it’s always important to diversify and focus on high-quality, financially sound companies. That’s what we do and it is articulated in our disciplined investment philosophy.
Within our equity framework, our asset mix has remained overweight non-domestic equities, in particular the U.S. Throughout the year, we have been adding more international exposure.
Our underweight in fixed income is enhanced by our bias towards higher-yielding issues. We favour corporates for the yield pick-up and have had solid exposure to high yield.
We expect oil prices to remain range bound due to increased non-OPEC supply and OPEC’s lack of discipline with respect to its production cuts.
We prefer U.S. and international markets. The move in the Canadian dollar, which has more to do with concerns over Trump than it does the Canadian market, has surprised us but we continue to expect U.S. dollar strength. Our view on Canada would change if we had a sustainable recovery in oil, an abatement in concerns about the housing market or if markets took a turn for the worse.
Andy Nasr, Vice-President, Capital Markets and Investment Strategist
The correlation between equity and bond markets remains high. We expect a modest increase in interest rates and inflation, which supports being overweight equities and maintaining a position in fixed income.
We believe U.S. equities are fairly valued, but risk-adjusted returns are still compelling. European equities offer strong growth potential and attractive valuations.
Why are we overweight equities?
We believe equities in the context of real interest rates and inflation are, for the most part, fairly valued and we can still find investment opportunities by focusing on our investment philosophy.
Central banks are targeting relatively low inflation. Given the amount of debt that’s been created over the last decade it would only take a little bit of a change in policy rates before economic growth and inflation could start to increase.
It appears that there is relatively low recession risk in the U.S. If you look at indicators before every recession you can see that there is slack in the current economy. When those indicators get stretched central banks have the impetus to raise rates to cool things down. Given the slack in the U.S. economy and low borrowing costs, it should continue to grow at a moderate pace.
We believe the U.S. business cycle is in the later stages while Europe is in the middle of a business cycle. It looks like the U.S. market is passing the baton on to other countries who have not had significant recoveries since 2008/2009.
Looking at European corporate profit data, our analysis shows profits 35% below where they were in 2007 vs. the U.S. where corporate profits are 35% higher than 2007.
It’s the first time in six years that we are seeing corporate earnings growth that is consistently getting revised higher. Domestically, we should see a combination of multiple expansion alongside earnings growth as things improve.
If things go well in the next two years, the European Central Bank may signal tapering. Money would then get sucked out of fixed income and pushed into equities, which supports multiple expansion and an increase in the value of the euro. We think the euro could increase relative to the Canadian dollar and generate a significant amount of growth potential. In the interim, we are focused on companies that have very little debt.
James Dutkiewicz, Chief Investment Strategist and Senior Portfolio Manager
We believe interest rates will increase modestly and that yields will remain range bound. We do not expect the U.S. 10-year to exceed 3% any time soon. The market is at odds with the Federal Reserve (Fed): market expectations on the pace of interest rate increases is below what the Fed has communicated.
There appears to be greater balance between fiscal and monetary policy. There are diminishing returns from low interest rates from a policy perspective and more emphasis on fiscal spending to support less accommodative monetary policy.
We prefer corporate credit vs. sovereign credit. Corporates should be expected to outperform in a slow but steady growth environment. Again, we have a bias towards the U.S.
We believe the following factors will contribute to the suppression of longer-term interest rates:
GLOBAL DEMAND FOR YIELD
Higher U.S rates versus other developed markets – continues to drive demand from foreign investors
U.S. growth remains modest
Growth in Europe remains challenged
Uncertainty related to grow in China
Policy uncertainty under new U.S. administration
Other geopolitical issues
Fed expected to remain data dependent
Central banks outside the U.S. remain accommodative
The Fed’s outlook at its latest meeting indicates they think the interest rates will be around 3% but there is a difference in opinion between the bond market and the Fed. We believe that somewhere around 2% supports current pricing in the yield curve and that’s where we think yields are fair value at current levels.
Generally speaking, when five-year treasury yields go up, high yield and investment grade tend to significantly outperform the government market. We expect that to continue even though we don’t think five-year rates are going to go much above 2.25% over the next 12 months.
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