Quarterly Asset Allocation
The Seventh Inning Stretch
It’s usually during the seventh inning stretch when baseball fans rise and sing along to the unofficial anthem of North American baseball “Take Me Out to the Ball Game”. It’s also when they take cheering for the home team to a whole new level. But the seventh inning is also an indication that the majority of the game has passed, and if the home team is down, it’s time to cheer hard and pray for the win! Similar to the seventh inning stretch, which marks the 80 per cent point of the game, we believe several economic and market indicators suggest today that most of this economic cycle is behind us. This is perhaps why a majority of strategists and economists are suggesting a recession will begin at some point in 2023. While we are in agreement that a recession is likely ahead for several advanced economies including in Canada, the U.S. and the U.K. in 2023 or possibly in early 2024, we believe it will come down to the bottom of the ninth in terms of the black swan event that will eventually push the global economy into a slowdown – the length and severity of which will depend on several factors. Today, our base case assumption is for a mild recession to unfold in 2023 for North America.
- In the Seventh Inning, but Feels like the Bottom of the Ninth! All said, we expect global growth to be considerably weaker in 2023, with the risks of a recession over the next 12 months rising to ~65 per cent for both the U.S. and Canadian economies. While we are not there yet, North American economies are slowing quickly. Strong labour markets and cooling inflation remain the silver lining heading into 2023, which could prevent a more severe downside scenario.
- Equity Positioning Stays at Neutral – Focus on Getting on Base Rather than Trying to Knock it Out of the Park! We continue to suggest investors remain selective with a defensive posture, as the Fed-led rate hikes are likely to peak sometime in 2023. This, coupled with a softer outlook for the USD, should enable value stocks globally to outperform growth over the near-term, with developed markets (e.g., MSCI EAFE) and emerging markets (e.g., MSCI EM) likely putting up a good showing in 2023, especially as China abandons its zero-COVID-19 position. Attractive valuations and a low-bar for earnings across several markets globally make for a rather compelling case for equities outside of North America. In the U.S., we see lower risks and attractive upside for mid- and small-cap equities (e.g., S&P Mid-Cap 400 and S&P Small-Cap 600) versus large-cap equities (e.g., S&P 500), while we maintain a slight overweight to Canadian equities (e.g., S&P/TSX Composite and S&P/TSX 60). For our S&P 500 and S&P/TSX Composite sector recommendations, please click here.
- Fixed Income Allocation Stays at Neutral, but Consider Adding to the Roster (i.e., Duration) in the Off-season.We advise clients to consider adding duration (through longer maturities) to their portfolios to capture higher yields in the current environment. While we like shorter-maturity yield levels for short-term cash needs, we prefer longer-duration fixed income products for a higher total return. The growing risks of a recession provide less confidence regarding adding to credit, so we continue to suggest that corporate bond holdings be reduced to underweight in total alongside an increase in quality and defensive positions. In relative terms, U.S. yields are higher across the board than Canadian ones, so we prefer holding U.S. treasury over Canadian sovereign bonds.