Canada Quarterly Investment Outlook - July 2019

Summary

• Goaded by central bank easing moves, equity markets have broken through to new highs. But the simultaneous rally in bonds, with falling long duration yields, continues to suggest a mismatch in views. Equities think economic conditions will improve while bonds do not.
• Monetary easing is a response to creeping weakness in the global economy amid big difficulties in global manufacturing and trade. Trade volumes could now shrink outright.
• The U.S. Federal Reserve’s dramatic change of monetary stance at the start of the year continues to create waves in markets. Interest rate markets have taken the central bank’s view on the risks to the economic outlook and then gone further towards a pessimistic stance.
• The declining term premium, now deeply negative, is a key explanation for such low U.S. long duration yields. This has kept Canadian yields low too. A big reversion seems unlikely.
• Credit markets have rallied with equities, but differentiation within the market shows that there is more than meets the eye. A more defensive higher quality approach to credit risk will help.
• Equity market upside is constrained by weak fundamentals shown in both earnings and valuations. With upside potential now running low, a debate over how much equity risk to reduce and how quickly is timely. De-risking now has low opportunity cost in foregone gains.
• Global macro hedge funds have had a very long wait for market volatility to pick up. It is now happening, but slowly. Returns versus equities should stop disappointing quite as much.
• Which asset classes will diversify and protect in the next downturn? There are lots of ‘if’s’ and ‘buts’ but a view is best taken now to ensure that adequate protective buffers are in place. It will be worth the effort to ask and act now rather than reacting to poor market conditions later.

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