An ongoing revaluation of the U.S., and its place within the global order, is shaking up asset values and allocations too, says Desjardins Group.
In a report published Thursday, the firm’s analysts note that investors are rethinking their exposures to various asset classes in the current environment. “It’s difficult for U.S. assets to behave like safe havens when the source of global uncertainty is made in America,” it said.
Against this backdrop, “fixed income is having a harder time hedging equity risk, and investors continue to hunt for linkages to commodities, both direct and indirect, to manage portfolio volatility,” the report said. “These shifts are less about ‘Selling America’ and more about monetizing the new macro.”
In global equity markets, this is expected to translate into a rotation away from the “fully priced” U.S. equity markets to other regional markets, including Canada — which Desjardins said is “positioned to outperform” and to supply diversification.
“With tighter linkages to commodities, the TSX has seen its correlation with other major equity indices decline,” the report noted, adding that Canadian equities should continue to benefit from their exposure to natural resources this year.
It’s forecasting a 12.5% return for the S&P/TSX index this year, outpacing expectations for U.S. equities.
However, the S&P 500 is still forecast to deliver a 10.5% return this year — as, despite high valuations, “American companies continue to exhibit superior margins and stronger cost discipline, providing better downside protection when growth softens.”
As for fixed income, the asset class’ role in portfolios is evolving too, the report said.
“Higher interest rates have restored bonds as a source of income, but that has come alongside higher volatility. Investors can no longer rely on fixed income to remain a stable hedge to their equity risk,” it said.
“High inflation — and inflation uncertainty — tends to be associated with positive stock–bond correlations and higher bond volatility. Today’s environment is trending in that direction,” it noted.
In this climate, diversification within the asset class is becoming more important, the report said, as uncertainty about the future for monetary policy has risen.
“Investors are currently overweight U.S. debt markets, but look for that to gradually change,” it said.
Canadian government bonds “should benefit in this environment, especially in the long end,” the report said, adding that longer-duration U.S. Treasuries will likely underperform Canadian government bonds this year.
Additionally, the ongoing weakness in the U.S. dollar is an increasingly important consideration for investors too, the report suggested.
“Investing in U.S. assets unhedged has become extremely risky,” it said — as a weakening dollar can undermine foreign investors’ returns on U.S. assets, when those returns are converted into a stronger local currency.
“Investors aren’t rotating away from the U.S. so much as repricing what matters in a world of risks,” the report concluded. “After years of overweighting U.S. assets, market participants are rethinking exposures amidst what Prime Minister Mark Carney has called a ‘new world order’ of shifting alliances and trade.”