Investment markets may feel somewhat aimless at this stage of the Covid recovery. Key issues remain unresolved. Are inflation trends transitory or embedded into a long-term rising trend? Can policymakers be expected to continue with a series of encores … more monetary largesse … more burgeoning budget deficits … more guidance? Even while “tapering” is considered imminent and interest rates are popularly expected to rise, central banks are at the same time expected to stand ready to douse any outbreaks of fear and volatility. This latter expectation may be regarded as one of the few immutable truths at this time.
Also, following the earlier rip-roaring economic recovery phases, GDP growth expectations are waning. Interestingly, it is a lack of supplies and jammed shipping lines (amongst a myriad of other factors) that is trimming economic growth; not demand.
Thankfully (or perhaps not) corporate profits have remained strong all the same. For one, companies today have much higher pricing power. Decades of merger activity has allowed industries to consolidate and to concentrate economic power. To illustrate, the computer chip shortages have actually contributed to rising prices for premium automobiles. Due to the insufficient supply of automobiles, not only do customers have zero bargaining power; manufacturers are jacking up retail prices.
As always during such times of conflicting signals, we lean heavily on our investment process. It is a highly disciplined approach, tempered through repressed emotions and long experience. Especially at such times we redouble our focus upon long-term “macro” narratives and themes. Properly constructed, these act as performance guardrails for our strategies. When in doubt, it is best to stick to long-term macro trends. These usually are very durable in their direction, even if the short-term developments may seem jagged or aimless.
What are some of the major themes that we expect to play out over the next three to five years and perhaps longer? For one, U.S. economic reflation will continue. Despite the redoubtable trepidations, the economic cycle has more road to run. This is linked to another theme: Modern Monetary Theory (MMT). Budget deficits are swelling virtually everywhere around the globe, with the exception of China. Given these “high pressures” we expect several more years of economic growth before any serious slowdown may develop. A buttress is that consumer balance sheets are in relatively good shape. Not to be overlooked, however, is that markets are likely to settle into a two-speed (economic) world for a time. This is due to the ongoing pandemics trends around the world.
Lastly, investors must recognize that the central pivot point for future economic and financial trends is the growing rivalry between China and America. With growing demographic challenges, China has only a modest-sized window over which to achieve its geopolitical aims.
Given the various crosscurrents we continue to pursue a barbell approach. On one end we are adding new opportunities and risk, and on the other, selecting assets that are anti-fragile and can act as stabilizers in our diversified global strategies.
CASH AND CURRENCIES
- In previous quarters we had raised cash above benchmark to protect against volatility as soaring market expectations had caught up to (and subsequently surpassed) underlying economic fundamentals, creating downside risk.
- With investor optimism levels fading substantially over the past quarter, we are much more comfortable increasing exposure to risk assets.
- We have deployed cash in client portfolios this quarter; bringing cash (and equivalents) levels back in line with benchmark.
Re-implementing US Dollar Hedge
- We maintain a negative outlook on the US dollar from a mid to long-term standpoint, as over-valuation, fiscal largesse, an eroding yield advantage and counter-cyclicality all weigh on the greenback.
- However, last quarter we felt that a sharp rally in the Canadian dollar had pushed the loonie above fair value (versus USD) and tactically unhedged all US dollar exposure in our strategies.
- With the Canadian dollar rally sharply reversing course during the quarter, we have re-initiated a partial hedge on US dollar exposure in client portfolios.
Increasing Equity Overweight
- Equities remain the preeminent asset class exposure to align with our base case scenario of a multi-year economic expansion.
- As investors scaled back expectations markedly last quarter, there is now potential for corporate earnings to surprise on the upside and stock prices to follow.
- We have increased the overweight equity positioning in client portfolios this quarter.
With our positive economic outlook, we expect a resumption in the “reflation trade” where asset classes with relatively high leverage to global growth outperform.
More defensively-oriented exposures that were previously held to scale back equity risk are thus less attractive in our view.
Accordingly, we have elected to take profits in US utilities sector equities and decrease exposure this quarter.
GLOBAL FIXED INCOME
Fixed Income Exposure Moved Further Underweight
- Fixed income markets are facing some notable headwinds with inflation proving stickier than many forecasters expected and major central banks soon to scale back asset purchases.
- With negative real yields prevalent in most developed market bonds and the potential for upwards pressure on interest rates, our view on fixed income remains downbeat.
- We have reduced fixed income exposure further below benchmark this quarter.
Diversifying Income Generation
The aforementioned pervasiveness of negative real fixed income yields has made our income generation objective all the more critical.
In addition to maintaining existing high-yielding exposures such as emerging markets debt, senior leveraged loans and mortgage REITs, US residential REITs stand to benefit from a peaking work-from-home trend and an over-extended price-to-rent ratio (at a decade high).
US residential REIT exposure has been added to income-oriented strategies this quarter.
OPPORTUNITY INVESTMENT HIGHLIGHTS
Back into Chinese Internet Equities
- Forstrong previously exited exposure to Chinese internet equities as lofty valuations and an increasingly hostile regulatory environment clouded the outlook.
- What followed has been a stunning collapse in share prices, as Chinese policymakers went on an all-out offensive to rein in and regulate the rapidly growing sector.
- Now, with more clarity regarding the policy framework and much more reasonable valuation multiples, Chinese internet equity exposure has been repurchased in growth-oriented strategies.
Initiating Oil Services Equities
While maintaining a healthy skepticism towards the oil and gas sector from a longer-term standpoint, we believe there are tactical opportunities in the space at present.
Companies in the oil services industry stand to benefit as an increasing rig count (from low levels) in the US and falling OPEC+ supply constraints provide a favourable backdrop for demand.
We have initiated a position in oil services equities in balanced and growth-oriented strategies this quarter.
Gross-of-fees performance ($CAD) as of August 31, 2021. Returns for periods greater than 1 year are annualized.