Rear view of traffic jam with breaklights showing

Investors are in for a challenging year as they try to balance the risk of escalating global uncertainty with the prospect of capitalizing on potentially strong growth in equities markets.

Portfolio managers interviewed by Investment Executive for this story do not plan to make significant changes to their clients’ portfolios. They’re either staying the course while focusing on clients’ long-term goals or taking a more defensive stance to counter the effects of a potential decline in the markets. With only minor portfolio tweaks, the portfolio managers’ stances will remain the same regardless of how close clients are to retirement.

The 2020 forecast includes: a global economic slowdown; the potential for a recession; ongoing trade tensions, especially between the U.S. and China; unresolved concerns over Brexit; growing geopolitical tensions, particularly in the Middle East and, to a lesser extent, in Asia; and the U.S. presidential election in November. (See Storm clouds on the horizon?)

Each of those predictions will contribute to uncertainty in the markets.

With these uncertainties in mind, should clients stay the course, or exit the market and wait until greater certainty returns? Or should you tweak your clients’ asset mix with a focus on quality to minimize potential losses in a market downturn?

Steven Belchetz, senior vice president, business development and client relationships, with T.E. Wealth in Toronto, says a recession in North America is on the horizon, and suggests that “it would happen in the next 12 to 18 months.”

Ian Riach, senior vice president, multi-asset solutions, and portfolio manager with Franklin Templeton Investments Corp. in Toronto, also believes we are heading into recession, but doesn’t know when. “The U.S. has a lot of vulnerabilities,” he says, citing the U.S. budget deficit in particular, which hit a seven-year high on Sept. 30, 2019.

Trade tensions, on the other hand, have resulted in declining industrial and manufacturing activity and deteriorating global trade conditions, thereby exacerbating concerns of a recession and a slowdown in global growth.

“We are currently taking a slightly risk-off stance and are being cautious,” Riach says. He attributes this stance to decelerating economic and corporate data, slightly extended valuation levels and the need for “higher growth to justify current valuations.”

Belchetz, however, is “not worried about short-term swings in the market” and is “not concerned about making tactical short-term portfolio shifts.”

Riach says his firm is underweighted in equities – primarily Canadian stocks – “because cyclical economies [such as Canada’s] tend not to do too well in a global downturn.” U.S. equities are favoured because that market offers better exposure to more defensive stocks.

Riach says his firm also is reducing exposure to corporate debt, but is slightly overweighted in government bonds and cash, which compensates for the underweighting in equities.

“We have been taking our corporate credit down because vulnerabilities in equities will affect corporate credit,” Riach says, “and spreads in corporate bonds, yields [of which] are hovering around 30-year averages, are not as attractive.”

The overweighting in cash is “higher than normal” and a “reflection of market uncertainty.” This position facilitates taking volatility out of portfolios. In the event that market conditions improve, the cash can be deployed, Riach says.

“There might be some opportunity to add longer-duration bonds because rates have really backed up, especially in Canada since summer,” Riach says, adding that although yields on these bonds are relatively low, “the bias to rates in Canada is downward, so there is an opportunity for capital appreciation should rates head lower.”

Riach’s firm holds a neutral to slightly overweighted position in international markets, where, he believes, valuations are more attractive, reflecting the greater risk of investing in these markets. He suggests that rising populism and concerns over Brexit and trade, concerns that have been around for a long time, may already be priced into the market.

Riach is “very constructive longer- term” toward emerging markets (EMs), where he holds a neutral to slightly underweighted position. He says EMs have undertaken structural improvements in areas such as policy reforms and now have greater reliance on domestic borrowing, thereby reducing their risk. He is, however, cautious about the impact of trade uncertainties on EM economies.

Belchetz, on the other hand, says, “Regardless of where clients are in their investment cycle, we are staying the course based on their investment goals and objectives.” He notes that his clients’ asset mixes are customized to their circumstances already.

“We are definitely not market-timers,” Belchetz says. “We could have done something different a year ago, when a recession was first speculated, but it didn’t happen. Our modus operandi is to stay invested according to clients’ long-term plans – and if a recession happens, it happens.”

Riach takes a slightly different stance in setting the asset mix for clients, whether they are close to or far away from retirement. “Each client is unique, with different objectives and constraints,” he notes. “The direction of positioning doesn’t change across portfolios. Directionally, we would move portfolios, but the magnitude of the moves [in each portfolio] would be different.”

For example, if a younger investor had an 80% neutral position, Riach would reduce that position and do the same for an older client who might have a 30% position.

From a financial advisor’s perspective, Prem Malik, advisor with Queensbury Securities Inc. in Toronto, says he emphasizes long-term, goals-driven investing based on clients’ objectives and time horizon, and never attempts to time the market. “I have been burned by sector bias and do not make sector calls.”

However, some clients climb a wall of worry during uncertain market conditions, Malik says: “If clients remain anxious after a review of their objectives, I encourage them to get out of the market and remain in cash.”

Should a recession happen, Belchetz says, sectors such as consumer staples and utilities – in which people would not necessarily cut spending – will continue to perform well. But sectors that depend on discretionary spending tend to suffer. As well, the commodities and materials sectors also could experience volatility.

In spite of uncertainty, there is an outside chance that equities could continue to perform well for an extended period. Riach says monetary and fiscal policies have been very accommodating, so there is room for stimulus.

In a U.S. election year, fiscal and monetary stimuli are more likely. “As long as there is monetary and fiscal stimulus and rates remain low, there is scope for equities to continue to rise and the recovery could extend longer,” Riach says.

The end of 2019 also brought positive economic signals: agreement on the first phase of the U.S./China trade deal; and a majority for Boris Johnson in the U.K. elections, paving the way for the U.K. to leave the European Union. Still, these positive signals do not outweigh the risks of an economic slowdown.