A deteriorating economic backdrop may finally catch up to equity markets in the second half of this year, with investment managers skeptical of the stock market rally and favouring bonds.

The year began with many economists forecasting a recession in the first six months, predicting slower growth would bite into company earnings. But a strong labour market and consumer spending have defied expectations, leading central banks to indicate that further rate hikes may be necessary.

Mackenzie Investments’ mid-year outlook report notes that growth is slowing in Canada as high interest rates weigh on consumer debt.

“Despite mixed signals, we believe that the rapid central bank tightening and steadfast fight against inflation will continue to weigh on the economy, which will prove to be a headwind for risk assets like equities as the economic slowdown dampens earnings growth,” said Lesley Marks, Mackenzie’s chief investment officer of equities, in a statement.

While the S&P/TSX Composite Index was up 1.7% for the year to June 21, U.S. markets have surged in the first half: the S&P 500 was up 13.7% and the Nasdaq is up more than 29%.

However, Mackenzie said the rally likely isn’t sustainable, with monetary policy eventually catching up with corporate earnings.

RBC Global Asset Management was also wary of the narrow rally in its summer outlook report. Excitement about artificial intelligence has driven U.S. large-caps higher but most major indices are flat or down this quarter, it said.

Even the equal-weight version of the S&P 500 is up only 3.9% for the year to June 21.

As economic growth slows, it said S&P 500 company profits could fall as much as 15% from their peak.

As a result, RBC removed the last of its equity overweight positions and its allocations for stocks (60%), bonds (38%) and cash (2%) are now in line with its strategic neutral position.

“To add back equity exposure, we would want to see an easing of financial conditions, an improvement in economic leading indicators and expanding equity-market breadth, particularly in the U.S.,” the report said.

Mackenzie, meanwhile, is now underweight equities, anticipating a more attractive entry point later this year if the economy slows and monetary policy loosens, setting up an equity recovery.

The asset manager is overweight fixed income, pointing to attractive yields and returns in the mid-single digits. Within the category, Mackenzie is neutral on government bonds, overweight investment-grade corporates and underweight high yield, pointing to risks from tighter financial conditions.

The U.S. regional banking crisis earlier this year may continue to affect loans, and Capital Group warned of the risks to commercial real estate in its mid-year outlook.

Companies continue to embrace working from home and it’s becoming harder to refinance commercial real estate loans taken out at much lower rates, it said. “That could be a growing threat to banks with a large exposure to [commercial real estate] loans.”

While Canadian banks’ commercial real estate loans are small compared to U.S. banks’, the report noted that the big banks increased their loan provision in the latest quarter to cover potential defaults.