I look back on the commentary from winter 2022 at which time everything appeared to be smooth sailing, little did we know at the time Russia would start a war which was the beginning of a rough ride in markets.  There was nowhere to hide last year as rising interest rates also created a tough year for bond markets, causing 2022 to be one of the worst on record for balanced investors. 

Inflation has peaked as oil prices have pushed lower and the pandemic-related global supply chain disruptions have largely normalized. After several months of central bank rate hiking (at one of the quickest paces in modern history) overnight rates appear to have peaked in Canada. The US federal reserve may have more room to hike but is expected to peak in spring 2023 and markets are already pricing in lower rates in later 2023 to help brace for the highly anticipated recession.

Interest rates are not expected to stay at the current rates for long, markets have already priced in lower rates in the future. Further evidence of this can be found in the GIC market, in December all GIC’s (1 to 5 years) had rates above 5% compared to today all rates are below 5%. Not only that but if you invest into a 1 year GIC the rate as of Jan 27th is 4.9% compared to a 5 year at only 4.21%. This makes for an interesting predicament as an investor needs to consider locking in higher rates for longer vs a higher rate in short term but reinvest risk of not knowing what rates will be at in a year from now. This also makes for a timely opportunity in the bond market, as interest rates drop the price of bonds will go up. For example several bonds today trade below par ($100) giving the investor an opportunity to buy them at a discount. When you purchase a bond at a discount, say $97 today, a portion of your return will be a capital gain. Since a capital gain is only 50% taxable vs interest income 100% it gives the investor a higher after-tax yield (more in your pockets!), especially for those in a higher tax bracket. I don’t see the window for this opportunity being available for long.

Changes

We anticipate 2023 to continue to be volatile but also expect the worst of equity markets to largely be priced in already. Most economists forecast equity markets to finish 2023 in-line with where we started, emphasis should be tilted towards higher quality dividend paying stocks which your portfolio is built with. The businesses in your portfolio are resilient, high quality and have the ability to weather a mild recession and continue to grow earnings in the years ahead. We have a lot of conviction with this exposure in your portfolio however; bonds do present a timely opportunity. With higher yields today than we’ve seen in several years and the opportunity to increase in price as interest rates drop. Your portfolio has increased the exposure to bonds which allows us to focus on protecting capital and maximizing interest through both higher quality investment grade bonds and higher yielding bonds.

Asset Allocation Guide 

This publication provides guidance and direction on asset allocation from the Canadian Investment Committee, including updated thoughts and recommendations for various asset and sub-asset classes. It can be used to help investors tilt their own strategic asset mix in a direction that reflects the 12-18 month investment view at RBC wealth management.

Cheers!