In September, we saw global equity markets surrender some of the gains made since the start of the year, while government bond yields rose significantly. The market reaction may be attributable to mixed economic signals and messages from central banks. Both the Bank of Canada and the US Federal Reserve decided to keep rates unchanged at recent policy meetings, while the European Central Bank raised rates once again. All three have stressed the need for caution when attempting to ensure that interest rates remain high enough for a long enough period to stem inflationary pressures.
Inflation
Despite signs of slowing global economic growth, the Organization for Economic Co-operation and Development (OECD) has recommended that central banks maintain a monetary tightening bias to ensure that inflation returns to its target level. While headline inflation has fallen significantly in the major developed market economies, the OECD warns that policymakers should not ease monetary policy until there is solid evidence that underlying price pressures have eased in a sustainable way.
It should be noted that China's disappointing economic recovery and the recent sharp rise in crude oil prices remain the main obstacles hindering a favorable economic outlook and lower inflation.
Unsurprisingly, Canadians’ excess savings accumulated during the pandemic have all but disappeared. The country’s personal savings rate is close to an all-time low, while credit card debt and unpaid accounts are rising sharply.
Our strategy
With interest rates on the rise, our strategy is becoming increasingly defensive, and we have repositioned our portfolios accordingly, keeping in mind the needs of each client:
- Increasing liquidity to take advantage of opportunities in the coming months;
- Increasing the proportion of bonds to benefit from regular income and more efficient taxation;
- Increasing our exposure to conservative companies with high dividend yields.
As mentioned above, we believe that fixed-income securities should play a more prominent role in our portfolios, as the outlook for returns has become increasingly favorable.
Government of Canada benchmark bond yeilds - 10 years
Yields on the fixed-income component of balanced portfolios have been exceptionally low over the past decade, as central banks have used multiple policy tools to repeatedly reduce bond yields. That being said, market conditions have changed and bond yields have more than doubled over the past three years, making the risk/reward ratio of fixed-income yields attractive once again.
We believe that now is a good time to start adding bonds to portfolios as an alternative to cash. What's more, some of these bonds are currently trading below face value and represent a compelling opportunity to earn interest income and tax-efficient capital gains over the next few years.
For example, here is some recent data from RBC GAM:
strategies exist for increasing a portfolio's exposure to bonds. Among these, we believe that RBC Target Maturity Corporate Bond Exchange Traded Funds (ETFs) represent the most attractive option available today. The current expected returns of these investments are all above 5.5%, and they also offer a tax advantage, bringing us closer to a return above 7% (compared to a Guaranteed Investment Certificate rate). Additionally, unlike GICs, these strategies are liquid, and, therefore, easily accessible at all times.
“The best opportunity to deploy capital is when the situation deteriorates.”
-Warren Buffet
As a source of long-term growth, the role of equities in our portfolios remains unchanged. Market corrections give us the opportunity to invest in the world's best companies at discounted prices. We are always on the lookout for bargains, as evidenced by some of our recent acquisitions such as Fortis, TC Energy Corporation, Enbridge Inc, CVS Health Corporation, Hershey Company and Canadian financial institutions.
We remain disciplined and committed to selecting high-quality, diversified assets for your portfolios that generate solid returns, while focusing on downside protection.
As always, we remain available to answer your questions.
Benoit Legros, CIM, FCSI
Portfolio Manager and Senior Wealth Management Advisor