Positioning for a changing world economy

Volatility and price swings in the offing

Money is in motion as investors scramble to discern and align with the new macro environment. The secular stagnation era of the 2010s – defined by disinflation and low rates and driven by underinvestment and excess savings – is not coming back. In its place is what economist Arthur Okun called a “high-pressure economy,” with above-trend economic growth, a tight labour market, and higher household wages.

Looking back, the largest trend of 2023 was not AI. It was the rush into cash and longer-dated bonds to hedge recession risks and front-run rate cuts. Some $1.3 trillion dollars poured into global money market funds last year.

At the beginning of 2024, that positioning had become extremely crowded and vulnerable to a sharp reversal. As the year has progressed, more and more investors have been lifting their heads above ground and seeing the economy for what it is: strong. The recession camp has been completely thinned out by the powerful surge in U.S. growth, a revival in global trade and, more recently, signs of a trough in global manufacturing

Yet many remain anchored to the past decade, forecasting a return to slow growth and low inflation. This happens in all investment regime changes. People simply have a hard time giving up their investment paradigms.

Looking ahead, our investment team believes that a new cycle is unfolding, led by productive assets in the real economy and underpinned by the unwinding of extreme risk aversion. This, in turn, will incentivize investors to rotate over the coming period from technology-related exposures to a more conventional pro-cyclical theme.

To be sure, enormous risks still exist. We are monitoring them. But the bigger picture is that many investors are not yet positioned for a transitioning world economy, still clinging to the apparent twin comforts of fixed income and U.S. mega-caps. We do not expect this to last. That means huge volatility and price swings beyond surface-level fluctuations as the cycle matures.

Here’s a look at our quarterly re-balance summary.

Cash and currencies

Deploying cash

The opportunity cost of holding cash is increasing, as yields will be pressured lower by central bank interest rate cuts. Simultaneously, risk assets look more attractive as falling policy rates lower discount rates, support domestic demand and tend to drag down longer-term yields. Cash has been drawn down and is now below benchmark in client portfolios.

Lowering U.S. dollar hedge ratio

The U.S. dollar continues to look vulnerable from a medium to longer-term perspective given its rich valuation and counter-cyclicality to global growth. However, on a shorter time horizon, the U.S. dollar should be supported by a widening interest rate differential versus the Canadian dollar, as the Bank of Canada has more imperative to cut interest rates. We have decreased the hedged proportion of U.S. dollar asset exposures this quarter.

Global equities

Maintaining equity overweight

Despite pockets of overvaluation, broadening global growth momentum should be supportive of corporate earnings. Risk appetite has picked up this year, but there is still an abundance of defensively-positioned capital yet to re-enter global equity markets. We remain overweight equity exposure in client portfolios.

Increasing European equity exposure

Europe has struggled in recent years with natural gas shortage fears pressuring up energy costs and a German industrial slump. A more constructive outlook beckons, as credit growth appears to have bottomed, manufacturing PMIs have turned positive, and the European Central Bank has started cutting interest rates. We have increased exposure to European equities this quarter.

Global fixed income

Adding to fixed income exposure

A “high-pressure economy” is not an ideal macro backdrop for fixed income, as sticky inflation and above-trend growth are likely to keep long-term bond yields elevated, thus limiting the potential for capital gains. However, with yields grinding higher last quarter and major central banks embarking on an easing cycle, the attractiveness of bonds has improved. We have moderated our underweight fixed income positioning in client portfolios.

Staying short-duration

Despite the improvement in the overall outlook for bonds, the risk/reward ratio for longer-term bonds remains unattractive. Inverted yield curves in many developed bond markets offer poor risk compensation and are vulnerable to a re-steepening. Short duration fixed income positioning has been maintained this quarter.

David Kletz, CFA, is Vice President and Lead Portfolio Manager at Forstrong Global Asset Management. This article first appeared in Forstrong’s Insights Blog. Used with permission. You can reach David by phone at Forstrong Global, toll-free 1-888-419-6715, or by email at dkletz@forstrong.com.

Disclaimers

Content © 2024 by Forstrong Global. All rights reserved. Reproduction in whole or in part by any means without prior written permission is prohibited. Used with permission.

The foregoing is for general information purposes only and is the opinion of the writer. The author and clients of Forstrong Global Asset Management may have positions in securities mentioned. Performance statistics are calculated from documented actual investment strategies as set by Forstrong’s Investment Committee and applied to its portfolios mandates, and are intended to provide an approximation of composite results for separately managed accounts. Actual performance of individual separate accounts may vary with average gross “composite” performance statistics presented here due to client-specific portfolio differences with respect to size, inflow/outflow history, and inception dates, as well as intra-day market volatilities versus daily closing prices. Performance numbers are net of total ETF expense ratios and custody fees, but before withholding taxes, transaction costs and other investment management and advisor fees. Commissions and management fees may be associated with exchange-traded funds. Please read the prospectus before investing. Securities mentioned carry risk of loss, and no guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.

Image: iStock.com/exithamster