Portfolio managers offer outlooks, opportunity sets following CPI print
Canadian investors may rightly feel like they got some relief last week when the consumer price index (CPI) was reported to have risen only 2.9 per cent year-over-year. While it doesn’t make a trend for Canada quite yet, falling below the 3 per cent threshold closer to the Bank of Canada’s target rate has opened the door to potential interest rate cuts coming later this year.
The question, now, is where Canadian equities and fixed income sit. Given the backdrop of a slowing economy, especially compared to the US, where should investors be looking to in their domestic holdings. To answer that question, Thomas Reithinger, fixed income portfolio manager at Capital Group, and Kathrin Forrest, Equity Investment Specialist at Capital Group, outlined the opportunity sets within broad asset classes now and where they see the macro narrative in Canada going.
“Our outlook is that CPI is drifting towards the 2 per cent target, which is quite different [from the US] as the Bank of Canada is under less pressure than the Fed,” says Reithinger, “Therefore it’s probably a higher chance that the Bank of Canada will cut earlier than the Fed, even in a soft-landing scenario.”
While the outlook for rate cuts is potentially more rosy, it reflects a somewhat gloomier overall view of the Canadian economy.
“Economic data continued to be mixed,” Forrest says. “CPI was good news, and in retail sales there could be some light at the end of the tunnel as well, but on the other side of the picture we have the labour market which continues to be relatively strong. Even if participation is down in the context of a growing population, when you look at average hourly wages that continues to print pretty high.”
Wages, Forrest notes, may yet be a lagging indicator and one that will catch up with an otherwise slowing economic picture. She notes that central banks across the globe are paying close attention to wages and employment, but adds that they are comparing nominal wage growth with productivity too. Those factors may yet play a role in determining when the Bank of Canada decides to cut.
So too will the Business Outlook Survey, says Reithinger. He notes that this uniquely Canadian outlook presents some “yellow flags” to the BoC, indicating that Canadian performance is weakening notably compared to the United States. Future sales on the survey are deteriorating towards levels seen in 2008, during the 2015 oil shock, and during the first days of the COVID-19 pandemic. A downturn in those results often predates a downturn in employment by a month or two, which may mean more labour weakness on the horizon.
While that is bad news for the Canadian economy, a weakening labour market gives the Bank of Canada even more cover to cut. Reithinger believes it is too early for Governor Macklem to cut at the BoC meeting next week in early March, but he says that essentially every meeting afterwards is in play. Markets are currently pricing in the first cut to come in July, but it may arrive far sooner than that.
Given that outlook, Reithinger sees some opportunity in Canadian fixed income that the market has not priced in yet. He believes the greatest current opportunity in Canada is in provincial bonds, which he says offer better value on a risk-adjusted basis than corporate bonds. He also thinks that any fixed income allocation should incorporate a global perspective and that US mortgage backed securities look attractive after their exposure to last year’s turmoil at Silicon Valley Bank was dealth with.
Forrest believes asset managers need to be selective on the Canadian market. Broadly speaking she notes that Canadian equities have been strong on absolute terms, but in the past year they have lagged other developed markets. Some of that, she says, is a product of slowing domestic economic momentum, but some of that is a story of global growth given 50 per cent of revenues for TSX listed companies come from outside of Canada.
Canada’s traditionally dominant sectors — namely financials and energy — have been laggards globally for the past few years as well. Tech and consumer discretionary, two sectors that are relatively underrepresented on the TSX, have performed better in recent years. Given that backdrop, Forrest advocates for a more selective approach by asset managers towards their Canadian equity allocations. There are opportunities to be had, but diversification within and beyond Canada will be key to drive performance.
“When we think about our portfolios, with a bottom-up, long-term investment time horizon, we continue to find opportunities in Canada,” Forrest says. “But those opportunities are selective and many of the areas where we find opportunities in Canada look quite different from the index. There are some really interesting companies in Canada, but we find it important to complement them with opportunities outside of Canada, in particular in areas that are not represented strongly in the Canadian market.”
