At the beginning of 2018, markets were “priced for perfection,” according to BlackRock’s Kurt Reiman, Chief Investment Strategist for Canada, and Aubrey Basdeo, Head of Canadian Fixed Income. Investors looked up and saw blue skies. However, says Reiman, “for returns to be strong, you almost had to have all good news, or great news even. Any bad news could be a catalyst for disappointment – and that’s what we got over the course of 2018.” In contrast, markets today are priced for a more uncertain outlook, which means any better-than-expected news can significantly benefit investors.
How has a year of increased volatility affected investors?
Reiman: Markets have been acting as though there’s something really sinister coming around the corner, based on a rolling series of indicators: a flat yield curve, struggling emerging markets and now falling oil prices. There’s fatigue, too. People are tired of having to read the tea leaves of Brexit negotiations, trade wars, the U.S.–China standoff, issues in the Middle East and populist politics. But that’s missing some of the narrative – that growth is still reasonably stable, recession probabilities are low, and the selloff in stocks may translate into opportunities.
Where do you expect central bank policy rates in the U.S. and Canada to go in 2019?
Basdeo: The Fed and Bank of Canada are trying to land at a neutral rate, which is itself a rather vague destination. The Bank of Canada thinks the landing zone is between 2.5% and 3.5% 1. The Fed is aiming for 3.0% to 3.5% 2. That’s the operating plan going into 2019. The question is, is something going to derail that plan? With data indicating a slower trajectory of growth, volatility in risk asset markets, tightening financial conditions and impacts from past rate hikes on the greater economy, we expect one or two more rate increases from the Fed and one more from the Bank of Canada before a pause.
What areas of the equity markets do you expect to perform well in 2019?
Reiman: We believe it’s too early to get broadly defensive. That could change, and we’re flexible, but for now we’re encouraged by underlying economic fundamentals in areas such as emerging markets where fiscal and monetary policy may further improve outcomes. There’s a nice turn higher in the return on equity in emerging markets, that’s being offered at about a 30% 3 discount compared to developed markets. In contrast to “priced for perfection,” where everything has to turn out well, emerging markets could be an interesting turnaround story if things simply don’t get any worse.
How can advisors position their clients’ portfolios for success in the coming year?
Basdeo: One way to build portfolio resilience is to own higher-quality assets. In fixed-income, where investors were reaching for yield, they may want to reallocate to higher-quality risk assets. In addition, the front end of the curve in Canada and the U.S. is very attractive, with positive real yields similar to longer-term bonds and less interest rate sensitivity.
Reiman: The quality theme is true for equities as well and means favouring companies that deliver a higher-than-average return on equity and have a good cash cushion and low debt. Minimum volatility strategies can also help smooth the ride.
1 Bank of Canada Monetary Report (page 12) as of October 24, 2018 “For Canada the neutral rate is estimated to be between 2.5% and 3.5%”
2 Federal Reserve Monetary Policy Report, Summary of Economic Projections, as of September 26, 2018
3 Bloomberg, as of November 27, 2018. Based on 12-month forward price-to-earnings and price-to-book ratios and MSCI indexes.
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