Christine Wellenreiter, GLC’s Vice-President, Marketing and Communications, spoke with Brent Joyce, Chief Investment Strategist for GLC in mid-September as he was traveling across Canada to speak with institutional clients and financial advisors. The following is an excerpt from that conversation.
After a volatile summer of market swings, historic bond yield moves and wide-reaching geopolitical developments (such as Brexit, trade disputes, Hong Kong protests and Saudi oil production attacks), we thought it was time to check in with GLC’s Chief Investment Strategist, Brent Joyce, about what’s changed in his market view since the release of GLC’s semi-annual Capital Market Outlook in June 2019.
“Now is not the time to bet big on equities. We support a defensive and diversified asset mix that includes equity exposure, but with an overweight versus benchmark to fixed income as most appropriate to navigate through our forecast horizon.
Given the developments over the past month, we continue to ask the question, ‘What, if anything, has actually changed?’ We see the fundamentals driving the global economy and corporate earnings expectations as much the same as they were a month ago (and risks to both remaining high). What has changed is the recent bond market selloff and equity markets moving back toward, or above, all-time highs. This combination makes for an attractive time to move slightly defensive within the broader context of a mature business cycle. To clarify, we suggest only a slight move. On a risk-adjusted basis, the math justifies a slight underweight to stocks in favour of bonds. For most balanced portfolios, we see this reflected as a 2% to 3% shift out of equities into fixed income.”
Brent Joyce, Chief Investment Strategist, GLC Asset Management Group Ltd.
Christine: I’ve been thinking about how volatile markets have been all summer. Back in June, you warned us that we can’t continue to have a bull market in everything and just expect that to go on. Were you were right? Have things changed?
Brent: The bull market in everything has ended, with a return of volatility in both bonds and stocks. We’ve witnessed a sharp reversal in bond yields since mid-August and a small, short-lived swoon for equites, but equities have since resumed their climb toward fresh all-time highs. It’s these relative shifts for stocks and bonds that’s at the heart of our recent positioning changes.
Certain things have changed to one degree or another, but we are still in a slowing economic growth environment. On the bright side, employment, consumer sentiment and retail sales (by and large) have held up and remain solid support for the economy. Inflation has stayed contained as well. However, three major issues we’ve been watching closely have disappointingly deteriorated since mid-June: the U.S. inventory cycle; China stimulus; and, trade frictions. The U.S. inventory cycle, that was showing signs of a turn, rolled over sharply in August. Recent Chinese stimulus measures are welcome, but may yet prove to be too little, too late. On trade, negotiations have soured and become protracted. Recall that, exiting the G20 meeting in Osaka, Japan, a deal was highly expected but since that time we’ve seen a marked deterioration in the tone. While sentiment has improved over the past two weeks with talks re-starting, point-to-point from June, things are worse off – yet equities are higher today than they were then. We find that difficult to justify.
Bond yields, on the other hand, have just spiked back up after hitting deep lows in mid-August. The combination of these events has tilted the risk/reward trade-off slightly away from stocks toward bonds. The thesis is this: if little has changed in the fundamentals, and we’ve now experienced a 3% drop in the year-to-date returns for bonds, while equity values rose and became more expensive, then it all amounts to stocks being less attractive and bonds being more attractive today versus a month ago.
Christine: Why be more cautious about equities?
Brent: Stock markets are forward-looking. At today’s level, we see them already pricing in a much better economic picture than we feel is justified. Our concern is twofold: the current outlook contains greater-than-normal uncertainty; and secondly, the upside may be limited by the combination of valuations and modest corporate earnings growth.
Current earnings growth estimates, at around 10% for 2020, remain too high in our view, even if a “mini trade deal” is struck. Any temporary deal will not remove the uncertainty for long-term corporate investment decisions and damage has already been done – global supply chains are already adjusting, and it’s unlikely any deal will cover technology firms with national security implications.
We also harbour concerns over the extent to which central banks will come to the rescue – bringing about lower yields to drive price/earnings multiples higher. Successive easy-money tactics might not fix what is essentially a confidence problem. For corporations, access to capital – and its associated cost – is not the issue; rather it’s how to deploy the cash. Share buybacks are slowing and, with all the uncertainty provoked by trade frictions, Brexit and the U.S. election cycle, companies seem reluctant to make capital investments.
To us, the sum of these concerns makes stocks look expensive right now. We don’t think falling (but still positive) earnings growth estimates for 2020 should be met with higher stock price expectations, especially given the uncertainty of the macro-economic backdrop.
Christine: How big a change in positioning are we talking about here?
Brent: Not big. To clarify, we think only a moderate move is warranted. Small gains in equities may still come, but the risks associated with equities have increased. I believe 2019’s biggest equity gains are behind us.
Christine: Are GLC portfolio managers taking that position too?
Brent: GLC’s portfolio managers have been tactically seeking out holdings that play to more defensive positions and/or holdings they see as being able to hold up better than their peers in the current environment.
Knowing the underlying fund managers have been taking care of the more tactical, near-term moves, GLC’s asset mix committee – of which I’m a part – was able to buy a bit more time while the risks were more contained. It served us well. But we now think those risks have continued to move upward, along with stock prices, so we’re reducing our equity exposure and putting that cash to work in our diversified bond portfolios.
It’s not a big change though – about a 2% to 3% move out of equities and into bonds for a balanced fund. It’s at the margin, but the move reflects the fact that, in our view, the improvements in the market’s backdrop are few and limited, whereas key areas have deteriorated outright. In the meantime, stocks have climbed higher and bond yields have corrected to such an extent as to make them slightly more attractive, especially given the role bonds can play from a downside protection perspective should stock markets swoon again.
Christine: So, Brent, given the shift, what’s the key message you’d like to leave?
Brent: Now is not the time to bet big on equities. We support a defensive and diversified asset mix that includes equity exposure, but with an overweight versus benchmark to fixed income as most appropriate to navigate through our forecast horizon.
Don’t get me wrong, holding equities for the long term still makes sense – that fundamental rule hasn’t changed. So, if you have a 10-year time horizon or more, are not risk adverse and aren’t concerned about market volatility affecting your long-term goals, then I would stand pat with a balanced portfolio tailored to those needs. This is especially true if you are benefitting from the stock selection expertise of active portfolio management within each of your funds, where stock selection can tactically position the portfolios to outperform the broad market.
Christine: Thanks, Brent. I appreciate your time and insight.
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This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.