Good morning, everyone. Thanks for joining the Outlook 2024 edition of our Market Update webcast. With me is Kevin McCreadie, AGF's CEO and Chief Investment Officer, and AGF Portfolio Managers Stephen Way, Tristan Sones, Tom Nakamura, and Stephen Bonnyman. I'm David Pett, editor of the AGF Perspectives blog. Before we begin, I need to cover off a few administrative items, as always, related to our virtual event platform. Today's presentation will last no longer than 60 minutes. Those joining us live can submit questions any time during the presentation by opening the Q&A icon found along the side of the presentation screen. Questions will be addressed near the end of the webcast. Additional resources for this session can be accessed in your attendee hub at the top of the page, under the Resources tab.
Finally, please note, CE credits may be available for members of our Canadian audience. Okay, last week, we released our annual Outlook publication, and that includes contributions from each of you. And I'd like to spend the first half of today's call discussing what might be in store for investors in the new year, and then we'll open it up for questions from the audience in the second half of the call. To start, let's get into the economy and monetary policy. One of the biggest questions facing investors, if not the biggest, is the direction that monetary policy will take in the new year.
Later today, the U.S. Federal Reserve is expected to leave its key lending rate unchanged, which would further fuel the idea that the rate- hiking cycle of the past two years is finally done, and that rate cuts may be drawing near. Kevin, let's start with you. My first question is a simple one, but perhaps not simple to answer: What should investors expect of U.S. monetary policy next year?
Yeah, David, thank you, and thank you, everybody, for joining us today. I think next year will be a different year. Obviously, if you go back the last two years, 2022 was an aggressive rate hiking cycle. Right? We went from near zero to north of, w e ended up here north of 5%. In 2023, it was less aggressive, but still the fear was it was going higher, and we certainly weren't cutting any time soon. And there were a number of head fakes throughout the year about that, right? Which is, when does the Fed end, pause, turn into another hike, et cetera. But obviously, the pace was very different than 2022. 2024, is gonna be one, I think, of more of no longer how high, it's gonna be about how long and when.
The when now becomes: when do we need to begin cutting rates? So the narrative is gonna change. It will still be the main backdrop that will drive all markets, will be what Fed policy does, and obviously, Fed policy will be dictated about how quickly they feel inflation is finally tracking to target, and then second, where the economy is in terms of its potential. So we also have talked many times on this call that 18 months of rate hiking that we've been through, there's a lag effect to that, which things are starting to show up now in terms of just where the economy starts to soften in parts of the labor market and other things which are linked to this inflation trend.
So I'd say the narrative changes as we move into 2024 from where we were in the last two years, but very similarly will impact markets in terms of the tone and the when.
And then in terms of when we get into rate cuts and the number of rate cuts that we might expect in the new year, which is obviously a big thing that investors are asking themselves right now. You mentioned a lot of that will stem off of where the economy is headed. Can you maybe break down maybe some of the scenarios, and maybe we can start with sort of this idea of a soft landing and what that might do to monetary policy, in particular in the U.S., Kevin?
Yeah, maybe I'll come back to maybe if we start six weeks ago. Okay? Six weeks ago, the Fed met, and it's a coincidence that they'll be meeting today. At that time, they basically talked and consistently talked about, maybe it's time to pause. Maybe we don't need to keep going. And that was because they felt that financial conditions had tightened because the bond market had essentially done the Fed's work for it. You saw short rates, you saw 10-year rates move up. 10-year went north in the U.S., almost no`rth of 5%. Two-year was well above 5%. Since that six weeks, we've had a few data points that have shown up mildly weaker, jobs reports mildly weaker, inflation reports mildly weaker, or less hot. But I'd say mildly, not dramatically.
But you, you're seeing markets now pricing in this idea of a soft landing, repricing bond yields. Again, a drop in yields, a 10-year now from where I said north of 5% to something this morning, 4.15%, and we saw 4.10% earlier in the week. That's a dramatic move. Equity markets, same thing, pricing in now that maybe we're done raising and maybe we can achieve positive economic growth and slowing inflation, and the Fed can just cut rates into that, right? And so you've propped up both markets now on this idea of the soft landing. It seems, again, a little bit premature when you look at the bond market pricing in what looks to be almost 4 cuts next year from here in that backdrop. So we're saying growth is gonna stay positive. The market is saying this.
Growth is gonna stay positive, and inflation is gonna cool, and we're just gonna start cutting rates into that, and we're gonna cut 4 times . You're gonna get some data from the Fed today, in their post-meeting. You'll get this thing called the dot plot, which some of my other colleagues can talk about, Tom and Tristan. Which will tell you what the 17 Fed governors think about where they should be thinking about the level of rates and the pace of those cuts next year. That may disappoint markets, but it seems inconsistent to say soft landing and cutting rates 4 times at this juncture.
And then, maybe I'll just bring in the others. Stephen Way, starting with you, what's your thought in terms of, you know, where rates are going to be? There seems to be this anticipation that they're going to be several cuts next year. What's your expectation on that front?
Yeah, I mean, I would say that it's unlikely, based on what I can see now, that we're gonna get, you know, several, like, 4-6 rate cuts. I think maybe 4 rate cuts are priced right now. And I'll just go back to the soft landing commentary, because if you go back in time over the last 75 years, there's only been three or four soft landings that we've experienced after a Fed period of rate hikes. It's much more likely that we get some type of a recession, a mild recession, a more severe recession. But in general, if you go back to the mid-1950s, there's been 13 Fed tightening cycles, and in 12 of those cycles, you've had an earnings recession.
In 10 of those cycles, you've had an actual economic recession. So, we can talk about, you know, how many rate cuts there's gonna be, but I guess you have to be careful what you wish for, because if there are a lot of rate cuts, that probably means the economic environment is dire, and the outlook therefore, for earnings, is not gonna be that great. So we really have to be careful what you wish for. And I think and hope is not a strategy either. I think based on the data, based on experience, it's more likely that we're gonna get some modest, a few modest rate cuts and, kind of a mild recession, as we go through 2024.
That would be my kind of ongoing thesis right now in the United States anyway.
And David, can I add one thing to Steve's point? Just be careful for what you wish for, because I think Steve is absolutely right, which is, we may be wishing for it, and as the data weakens, but inflation may be still hot or warmer than where people want it to be. They may not get the rate cuts when they're pricing them into the market, and that may be a market disappointment for both bonds and equities. Because the market may be demanding you cut rates now, and the Fed may be, and other central banks, we can talk about them as well, may have the same stance, which says, "Not yet." And that's that disconnect that I think in the beginning part of the year, for sure, we would have to worry about, mostly in the beginning part of the year.
Tom, I'll go to you next. But it seems to me, if I'm reading this right, that the markets are almost wanting it all kind of thing. They want a soft landing, and they want a bunch of rate cuts on top of that. Tom, what's your sense of what we might see next year from the U.S. Federal Reserve first, and then maybe we can get into some of the other central banks around the world?
Yeah, I do agree with what Steve and Kevin said in terms of what we have for the Fed. Tristan and I were talking about this, and you can almost look at the rest of the world and see, you know, some that are kind of in the same predicament that the Fed will be in. And then you have other central banks that are, you know, in a different situation. They have their own economies that are at different phases of their economic cycle. So maybe I'll focus on those two to start. And the one thing that kind of strikes me is we have Bank of Japan, and I think that's clearly, like, a topic on its own, and we can spend quite a bit of time there.
But we know in Japan, they've been dealing with a lot of deflationary episodes, as well as some pretty strong structural headwinds in terms of the demographic profile, to really grow that economy and to create a period of stable, positive inflation. And I think that's where, you know, the Bank of Japan, their central bank, has been really struggling and weighing the pros and cons of exiting their Negative Interest Rate Policy and their Yield Curve Control, against the risk of falling back. Because if they do fall back into a period of strong disinflation or even deflation, I think it really shatters the confidence that's been slowly building up over the past few years. So I think that remains a challenge.
Our team, we've been pretty consistent over the course of the past year or so, that the Bank of Japan will be slow and very steady and very, very predictable about how slow and steady they will be in terms of normalizing that policy. We think that will continue into next year. Really, the data doesn't really support them going a whole lot faster than that. Similarly, we have economies like, I guess you can kind of lump in the U.K., but you know, our focus is on the ECB, where you do have a more kind of classical situation where, you know... I guess the good news is the ECB has rates to cut now, which is a change than where, where we were pre-pandemic.
But they are also an economy that continues to struggle with their, you know, again, a headwind in their demographic profile. You have kind of a structural issue in terms of their fiscal, their ability to stimulate their economy fiscally. And then they are more exposed to softness in the Chinese economy than some of the other major economies. So I think there, you know, we do expect easy policy to be more likely to come than in the Fed or in North America in general. So we do think that that plays a role in thinking about rates globally. And I know Tristan probably has some thoughts about some of the other central banks.
Yeah, go for it, Tristan, maybe you can start with Canada and then maybe get into EM as well.
For sure. Yep. Yeah, in terms of Canada and select EM countries in Latam and Eastern Europe, I mean, they're also in the mix for cuts in 2024. I mean, when we look at Canada, you have an economy that outside of January of last year has really not grown in real terms. The effect of higher rates has really taken its toll on the end consumer from a spending standpoint, and also inflation has been elevated also because of those higher rates, with mortgage costs being embedded in the CPI. And so you have, like prior comments, 4 cuts almost priced in for Canada for next year. One even starting in Q1, which seems pretty unlikely at this point. I mean, you have core inflation running in the mid threes.
And so, you know, despite all that, you're probably gonna see the Bank of Canada cut before the Fed does, but how aggressive can the Bank of Canada be in a Fed higher for longer scenario and with core inflation still running well above target? So, probably gonna see, you know, the Bank of Canada be probably pretty steadfast, at least to start the year. And maybe if CPI does come down, because as the mortgage cost component comes down with the move that we had in November and partly in December, you might see that actually come down fairly aggressively, and maybe give them some cover to do, like, an insurance cut.
Maybe that's what we start talking about now, as opposed to insurance hikes, which we were so, so accustomed to the last few years. And then in terms of EM, you've got a good number of Latin American and Eastern European countries that were earlier than most of their developed market counterparts, and really raised rates aggressively because they had to. Inflation, particularly after the start of the war, really shot up. Now you have inflation that's rolled over and is falling in some of those countries, and in some cases, you have very high real rates, particularly in, like, Brazil and Mexico. They definitely stand out.
Even though there is also quite a bit of easing priced into those curves, there is, I think, the scope to see those countries cut, even in a Fed on hold scenario, given how high real rates are. How aggressive they can be, you know, is a question still, but they probably can't start to ease a little bit just because real rates are so high, given how high they raised rates and how far inflation has fallen.
Okay, great. Thank you for that update, Tristan and Tom. Stephen Bonnyman, let me get you into the conversation here a little bit. In your outlook, you talked about the idea that, you know, regardless of what does happen next year with respect to soft landings, hard landings and what direction monetary policy takes, we're probably in a scenario where rates aren't going back down to where they were three to four years ago, right? Investors need to get used to this idea that rates are gonna be, you know, for lack of a better term, higher for longer. Maybe not as high as what they are today, but, you know, much higher than what they had been in the post-financial crisis era.
Yeah, thanks, David. That would certainly be our premise, and sort of reiterating my partners, we've reached a point where the market is comfortable that rates are probably not increasing from here. And the question, as Kevin alluded to, was, you know, how much longer does it take before they fall? And then the second part would be, how far do they fall? And history suggests that it will come, but the market is going to have a fair bit of volatility as we work our way through the process. You know, as an equity investor, what I try and do is anchor my assumptions on the variable that I've got the most comfort in or highest confidence in, and then work to test if all the other variables support that.
That's where the challenge comes out, because the concept of a growth recovery, falling rates and falling inflation, don't all fit together, and really wouldn't make sense all occurring at the same time in the same year. When I look to the real asset space, you know, the concept of a rotation away from the things that have been hurt by rising rates creates an opportunity. We've had a massive level of funds flows into money markets, into yield instruments, and as those start to fall off and as other opportunities arrive, we expect investors, rather than migrating necessarily back into a high growth environment, to start looking for some safer, more stable, but yield producing investments. And that leads you into things like real estate, like utilities.
And then, Kevin, you've talked about this in the past, this idea that, you know, we have returned to normal in terms of interest rates, and that, you know, that, you know, that we're kind of back to where we were before the financial crisis, that kind of environment. Maybe just a comment on that and what that potentially means for investors going forward.
Yeah, I mean, I think what we suffered through the last 18 months, and really 2022 bore the brunt of those rate hikes, right? Was really about how we adjusted f rom near zero so quickly to much higher levels of rates. In 2023, as you can see, showing up in the equity markets was less severe because we actually raised rates at a slower pace. A lot of the damage was 2022, but the damage was about the adjustment, not the level. And these levels of rates, if you go back to a pre-Great Financial Crisis world, so pick 2006, which was kind of pre-going into that softening, you had 10-year yields in the U.S., which were in the mid-4s, high-almost high 4s. Inflation was near 3%.
Mortgage rates were between 6% and 7%, Canada and the U.S. You'd argue that it wasn't so restrictive, and in fact, it was actually pretty accommodative because you created housing bubbles pretty much everywhere. So it wasn't about the level so much as this adjustment that we've been through. So I think that's where we'll go, we will go next, is how we start to feel our way through the levels of things. Obviously, if we're wrong and inflation continues to be ... in core inflation being driven by wages and other things seems hot, and you have to keep raising rates, which is not our forecast, and I don't think is priced into any market right now, that would be a different scenario.
So if you say the short rate is no longer, the peak is at 5-ish, and has something at 6-ish on it, that's gonna be a tougher world, and something we don't see right now. And that would be more where you start to push that. It is a level of things issue, but we think where we settle out here. And even if we go past 2024 and sit there and say, crystal balling 2025, right? Which is more than a year away. Yeah, if you take rates down a couple of points a couple of times there because you've had a recession in 2024, even that level, call it 100 points below where we are here, is pretty accommodative, right?
So I think the range of things is not gonna be the issue going forward, unless we're wrong on inflation. It's really been the pain has been on the adjustment.
Okay, given that backdrop, I want to get into each of your asset class as that you invest in. But, maybe just a quick question about beyond monetary policy and the economy, there's obviously other factors that can impact financial markets. Steve Way, maybe we'll start with you. Are there events or geopolitics on the horizon that you feel like investors need to, you know, be aware of and keep their eye on going forward into the new year?
Sure, sure. I mean, I mean, I think the big thing is the U.S. election, you know, coming up next year. Whether Trump gets back in, or not, and the implication of that, if he were to get back in right now, his polling numbers are very strong. And if he were to get back in, we would assume that the U.S. is probably gonna become more isolationist, and probably, you know, you'd have less support for Ukraine if that war is still going on. Policy towards China would probably become more aggressive, and you might get some tax cuts. So on the business side, Trump could, could do some good things.
But I think in general, you know, the uncertainty surrounding the U.S. election, whether Biden's gonna get back in, and concerns about his age, if he does get back in, and then the ramifications of a Trump election, and then just the actual election itself. Will it be a peaceful election? Will it be a peaceful handover of power, or we're gonna have a replay of what we had last time, which was just very disturbing. All of that, I think, will lead to a higher level of volatility, particularly as we move through the year and people start to get a sense of what the outcome might be. You know, the best outcome would be probably a split of the Congress between the House and the Senate.
Typically, when that happens, markets are up double-digit, 10 or 11%. Since 1928, that's what happened when you got a split of Congress. But we've got a long ways to go from here to there. So I think that's the major thing I would call out. Outside of the U.S. election, we've got elections taking place in a number of other countries, but they're not as dramatic. You've got the ongoing situation in China from an economic perspective. So, it's really there about their ability to stimulate and grow the economy because, you know, it's been relatively lackluster, and they still have some property challenges that they're working through.
So, we would like to see more coming out of China in terms of monetary and fiscal policy, but it's unlikely to be aggressive. So, China's probably a bit of a wait-and-see environment. And then just what Tom talked about in terms of what's happening with the BOJ, that could have ramifications globally. So those are some of the things I would highlight that both from a macro perspective and non-macro basis.
And then, I can open it up to the rest of the group, but is there anything out there that, you know, do you worry at all about the Ukraine war or what's going on in the Middle East? Anybody, just in terms of what that might, how that might impact markets going forward?
Yeah, I mean, I guess I'll start on that one. I think we've all been a little bit... If you look at the situation in the Middle East, right? We have a shooting war in the Middle East. We have threats to some of the shipping lanes, whether it be the Red Sea or the Straits of Hormuz, where, as Steve Bonnyman would tell you, there's a lot of crude that's transported still. And yet we sit here today with WTI below $70. And that's from a pre-October level of $80-ish, that peaked about $86, $87 a few days after the Israeli-Hamas conflict started, and back down to here. So the energy market is reflecting something else, which is that there is a recession or a clear softening around the world.
I wouldn't take your eye away from the Middle East. It seems to be it's gonna be a more difficult and longer issue for markets, that it may have commodity implications if in fact, things do spread. And I'd say the second geopolitical one is obviously, as Steve touched on the U.S. election, there's a waning desire to fund any of these external events in the U.S., clearly by the Republicans now, and if Trump were to be the candidate, that would get louder. And you've seen it tied up with, and yesterday in Washington, which is really, people more focused internally on border issues in the U.S. and funding for that. So the extent that funding starts to slow, and it won't be just the U.S., it will be Europe as well, for the Ukraine.
You may actually force some kind of a settlement there next year if progress isn't made. So that could go both ways. If not, if you know, if Russia starts to tip the balance and win, that may be market negative for some of those commodities. But I'd say you can't take your eye away from the geopolitical next year.
Okay, let's turn to asset classes now. We'll, given the current backdrop described, my question is: What and where are the opportunities and risks within each of your areas of expertise? Steve Way, let's start with you on the equity front, and then, Kevin, if you have any thoughts on that front, too, please do weigh in. So over to you, Steve, and you can take us through kind of where you're seeing some of the opportunities and risks in the new year.
Sure. So, from a regional perspective, I'll start with where we are most optimistic, and that would be Japan. We've been bullish on Japan for the last at least 12 months. You know, Tom touched on the kind of normalization of the inflationary environment there. We've got inflation now at a 40-year high, and potentially a normalization of monetary policy coming out of that as well, if they end the zero interest rate policy and yield curve control, as Tom referenced. So that's very good because it means more just back to normal environment in Japan. It means consumers are gonna have more money in their pockets if their wages are starting to rise.
And then when you peel back the surface on the corporate side, you see there's a lot of corporate restructuring taking place in Japan right now. A renewed focus on shareholder value creation, increased level of share buybacks, rising dividends, selling off of non-core businesses, at a time when operating profits are at all-time highs. Operating profits in Japan were up almost 30% over the last 12 months, compared to basically flat for the rest of the world. So, we think there's a lot of positive momentum in Japan, in terms of corporate restructuring and in terms of the normalization of the economic environment. Moving elsewhere, in Europe, we'd be more neutral to slightly underweight Europe. We think it's gonna suffer from a period of stagnation.
You know, you could get some cuts in ECB monetary, you know, interest rates later on this year, but we also see risk of margin pressure in Europe. So we'd be a bit more cautious there. And then, in the United States, you know, we do have a positive bias in the United States. There's still a lot of underlying momentum there. Corporates have been able to, you know, trim out their debt. So they're not really at. The large corporates, anyway, aren't suffering a huge amount from higher interest rates.
And, the average stock, particularly average stock in the United States to us, looks much more attractive than some of these, you know, market leaders, which really dominated returns last year. So, the average stock in the United States has really underperformed over the last 12-24 months, and that's where we see the best opportunity. And then finally, emerging markets, we would just be selective in the emerging market environment.
And then, Steve, just quickly before I go to Kevin, if he has any thoughts on this, but just quickly on Canada, just a thought on that.
Yeah, we'd be underweight Canada right now. We do have concerns about the Canadian consumer in the face of the mortgage rollover, you know, refinancing of the mortgage debt. And in an environment where the U.S. economy is slowing, you know, that's not usually good for Canada either.
Okay. And then, Kevin, just anything to add on that? I always struck b y this idea of the breadth of the market, but-
Yeah, I'm encouraged by the fact over the last month or so, you've actually seen with this, with this drop in rates, the market broadening out. That doesn't mean those big seven names, you know, the Magnificent Seven, have to go down. They just may be flattening out here. But the rest of the market started to participate. We keep an eye on something that's called the equal weighted index, which gives every company the same weight. That, over the last month, has actually outperformed the S&P by about 3%. So the headline index gets weighed down, and I think you'll see more of that next year as we get in next year, and in fact, when rate cuts do materialize. So again, those big names don't have to collapse. They just may go sideways here.
And you'll start to see the market reward some of the other names that just haven't participated this year. And that gap is seen referenced between an index, which is really weighed down by those names, and the average stock could really participate in that type of environment.
Okay, great. And then, Stephen Bonnyman, let's get you in here, as well. Clearly, you're investing on the equity side of the equation, but it's much more specific in terms of real assets. So maybe you can just run through kind of how you're seeing your space unfold in 2024, given that backdrop that we've already discussed.
Sure. Thanks, David. Yeah. There are both tactical and secular themes emerging from this, you know, hinged around the concept that rates have peaked and will decline. And that sets up a couple of things. One, we've seen a massive flow of money out of equity markets, out of bonds, into money markets and cash, which is perhaps the ultimate risk hedge. And we've also seen a high level of concentration, leaving sectors behind.
So as the market becomes comfortable that rates are going to decline, or at least as we're seeing now, comfortable that they're not going higher, we're starting to see investors testing back into those sectors that were heavily damaged by the threat of higher rates and rising rates, where, in fact, the damage done to the, the stock price was far in excess of the valuation impact from the rate move that we've seen. So that's gonna lead them back, and I'm not sure they're entirely going to be comfortable with taking on high-risk, high-growth opportunities with a better clarity on the economic outlook. And that starts to lead you into things like the more stable earners and higher yielders. There's also a thematic theme here that sometimes gets forgotten.
When we look at names like utilities, you know, the renewable energy space is going to flow through utilities. Green energy will flow through the utilities. When we think of AI, that flows through real estate data centers. The power that feeds those, you know, comes back from utilities. So there's some thematic growth that sometimes gets forgotten in these spaces. That's one of the opportunities we look at. While we're less bullish about commodities in this environment and a slower growth, I constantly remind people that the commodity spaces had massive underinvestment for the last six years, and that will catch up. The old economy will have its revenge, as the supply tapers off, and we need to build into it. But 2024, 2025, potentially may not be those years.
The one holdout from that I would highlight is the energy space. The contraction in the price that we've seen corresponds almost entirely with the departure of non-commercial money from the space, and does not reflect what we're seeing as an underlying supply-demand relationship. Kevin highlighted geopolitical risk. Well, commodities are where it hits, and the market has been remarkable in the sense of how relaxed it's been about geopolitical risk over the last couple of years. So that remains a serious both an opportunity for the space and a risk for the broader markets.
Okay, thank you, Steve. All right, Tristan and Tom, let's talk fixed income for a few minutes, and maybe a little bit on the currency front as well. So I'll leave it to you who wants to start, but maybe some thoughts on opportunities and risks in your asset class going forward.
I can start with an opportunity, and I think that opportunity is the repricing of bonds that we have witnessed now. The fact that you can sort of get a five- to mid-single digit, let's say, gross yield on a well-diversified portfolio with fairly low corporate credit risk, is now much more competitive versus other classes, other asset classes than we've had in years past. It's been actually a very good credit environment, and if you want to take on and have the capacity to take on more corporate credit risk, you can push that gross yield up to high single digits. So the carry is quite attractive right now, and that carry goes a long way to really contributing to absolute returns in a portfolio and even just smoothing absolute returns.
You know, if we do see, and we're likely to see, some pretty violent repricing of things. I mean, 2023, you saw both stocks and bonds have big swings back and forth as the market sort of priced out and priced in rate cuts for next year. And I think that tug-of-war is likely to continue, but the absolute carry that you get on portfolios can go a long way to helping that client experience. And then I think globally, there's some great opportunities. And I'll pass it over to Tom if he wants to talk about those.
Yeah, I think one of the things we've seen over the past couple of years, like even starting with the pandemic response, was a massive easing that was pretty much, you know, uniform and global. And then once we got past the transient inflation story, saw central banks en masse start to hike and in a lot of cases, pretty aggressively. And I think as we trend, I think this is probably, you know, 2023 might be the transition year, but I think 2024 is really the inflection year, where you start to see central banks maybe start going in different directions and certainly in different speeds. And I think this creates a lot of opportunities for those that are in a have a more global stance.
So, you know, I think this has been a benefit for fixed income investors in the past couple of years, but I think this coming year might be the year that it really shines through, because you do have economies that are still very slow. You still have economies that are dealing with inflation pressure that have either already normalized policy and have been on hold for several months or others that have only just begun. So I think there's a lot of diversification opportunity when we look around the world without even needing to go into credit or into emerging markets. And I think the emerging market side is also something that looks quite attractive from the fixed income perspective, especially if we believe that the Fed is done hiking rates.
Even without getting rate cuts, I think there are some, some good opportunities there. Tristan highlighted that there are a lot of rate cut expectations, for some of these central banks, but you still get a lot of that carry. And that interest rate differential can be pretty powerful, especially if we're able to manage through this coming year without getting into an episode of, a much more severe slowdown globally, and we're able, able to, sidestep some of the geopolitical risk that's been highlighted here. So I think it's still an opportunity for, for the global side. We think EM i s pretty attractive. And David, you mentioned currencies. I think, you know, 2022 was, was, like, a very, powerful year for currencies.
This 2023 was also pretty good for the U.S. dollar, but a little bit more sedate. I think we, we said hope is not a strategy. I'm hoping for a less interesting and, and less dramatic, year in currencies in 2024. And, and I think one of the things that will help with that is, even though you're gonna get some differentiation among central banks, in their stances, and I, I think that actually helps because, we're, we're going to be in a more, in an environment where, judging currencies based on their interest rate becomes too treacherous for investors, and the focus there will start to shift to longer term fundamentals, and I think that'll help to stabilize some of the moves.
So we do expect the U.S. dollar to be okay next year, but probably not as good a year as we had in 2022, certainly, and probably not as good as we had in 2023. So looking forward to a more differentiated year on the currency side.
Okay, great. So, just a reminder, everybody, that we're gonna get into questions from you right now, so please send those in. Maybe while I'm waiting for a few questions to hit our chat box here, Kevin, maybe quick thought on just asset allocation and how that you see that kind of evolving over the next year. From now.
I mean, clearly, we've had a big move in many asset classes with this drop in rates. Obviously, fixed income has had probably one of the best months it's had in decades last month. Equities have had the best individual month it's had in a long time as well. So it would be natural from here, probably as we grind our way through December, what's left of it, we may not see a big push on markets from here. Obviously, the Fed's commentary today may disappoint or may encourage, right? So that will create some volatility as well. I think you get into January, I think realism sets in, that we've gone a fair bit here in this last short period of time.
We may be in for some give back as we move into the first part of the year in terms of the conversation we just had about are the market's expectations being met about this move to easing, right? Or do central banks just stay firm on inflation and the inflation fight for a bit longer? That will create volatility in the equity market, it will create volatility in the bond market, meaning that rates will move around. We will probably be in a period where now we're no longer that bad news, i.e., weaker economic news is good for equities. It will transition to maybe weaker economic news is probably going to be bad for equities, meaning, you know, things weaken.
If the Fed is remaining a little bit, or the Bank of Canada is remaining a little insistent on holding the line, you could see the fear of profits going down on that economic weakness. I'd say we're gonna transition there in the beginning of the year. From an asset allocation standpoint, you probably wanna get closer to your benchmark on fixed income. We've been creeping our way there. I'd let this rally we've had is probably. I would pause on that, thinking about getting closer here. But obviously, you're at a place now where at the end of that game, in terms of hikes, and we probably are closer to the place of cutting, and that would lead you to getting closer to your fixed income weight.
Within the equity bucket, I think there are pretty good opportunities. They're gonna be different. And again, if you believe you can cut rates at some point next year to spur the economy and demand on, you're gonna be rewarded later in the year, I think. So again, as we go into the beginning of the year, you could expect to see some volatility. So our cash position is, we still have some, it's not as high as it's been before, and as I said, we're creeping back toward the neutral stance on things. And lastly, I'd say we still keep our, we have an equity hedge on in the portfolio that we'll keep until we see that we're actually getting closer to that place where rates are cut.
Okay, great. Let's get to some questions, then, from the audience. Here's one, maybe, for Tom to start with, and then if anybody wants to weigh in, but it relates to this idea if we get cuts in Canada first, with respect in relation to the U.S., what does that potentially do for the Canadian dollar, Tom?
Yeah, I think this is a question that we think about quite a bit here. You know, if you think back through this rate hiking cycle, the Bank of Canada actually was slightly ahead. I think Tristan and I looked at it yesterday, it was 13 days ahead when, in terms of the first rate hike and 13 days ahead of the first or the last rate hike. And in this kind of environment that we've had the past few years, where, you know, people are looking for that trend in terms of carry trade and momentum, yeah, I think the Canadian dollar is probably gonna have some headwinds if they're seen as moving ahead of the Fed. But I think the important thing here is what is the relative economic story going on?
If it's around some of the concerns that we've highlighted here around the domestic picture, whether it's around housing, whether it's around the consumer, that's really Canada-focused and Canada-specific, then yes, I do think that's gonna lead to some Canadian dollar weakness. But if it's around some more global phenomena, so, you know, whether it's supply concerns, whether there are some other commodity-related issues that are causing some softness in inflation and the growth profile for Canada, that might be somewhat tempered because it's likely to feed through to the U.S. and other economies as well.
Okay, thanks for that, Tom. Okay, next question here is, is it a good time to hold U.S. stocks? So a broad question on that. S tephen Way, you kind of mentioned a little bit of that already, but maybe if you want to elaborate on that, and then if Kevin wants to weigh in as well.
Sure. Yeah, I mean, I think it is a good time to hold U.S. stocks. Clearly, we've had a, you know, sharp rally this year, which surprised a lot of people. But again, we've talked about the narrowness of that rally and how the average stock really hasn't performed. Similarly, small cap stocks really haven't performed here. If we can kind of get through this environment of the rate hikes and the aftermath with a mild recession, I think, as I said earlier, the valuations on some of these on the average stock actually looks kind of in line with this historical average. There could be a bit more downside on valuations.
It's really a function of how much the earnings are impacted by a weaker economic environment. And you know, U.S. companies have, you know, demonstrated that they're pretty good at cost cutting and efficiencies and that kind of thing. So we're not forecasting as severe a drop in U.S. earnings. And so if we come out the other side of this with a slowly improving economy, I think the U.S. is going to be well-suited, U.S. stocks are going to be well-suited to thrive in that environment, particularly given valuations are not extreme. Within the U.S., we think the industrial sector looks particularly attractive.
There's a lot of reshoring that's taking place, a lot of increased capital expenditure, which we think will give order books for these industrial companies a lot of visibility. So we'd be looking to the industrials as one opportunity in the United States in particular.
Okay, let's, let's go to the next question, and this is... I'll open this up to all of you. So the question is: Are the portfolio managers, that's you guys, positioning for a recession? So... And, and how does that even work? Like, how do you, o bviously, we've talked about the possibility of it, but how do you kind of go about with your portfolio positioning if you're, if you're thinking that we are gonna be going into a recession? I don't know who wants to go first.
Yes, maybe I'll start, which is, you know, we have a daily discussion around this in our macro meeting every morning, or our daily meeting, right, which is, again, trying to get us a read on the economy and its pacing. I would say we all have different processes. We have different styles within the firm. But I'd say generically, I think we're positioned for a slowdown and a mild recession. I don't think that we are in the camp that there's no landing and we're off to the races, generically speaking. Again, different processes, different styles throughout the house. That's how I would summarize it, but I'd open up to my colleagues.
Sure, David. I can speak to the real asset side, where we're not positioned or expecting a meaningful recession, but we're leaning to the cautious bias, reflecting the expectation of a high level of volatility for the first quarter and perhaps into the second quarter of next year. So we're holding higher cash balances than we normally would, in expectations of some opportunities opening up, and have been shifting the portfolio from one of a tactical positioning within some of the commodities, to a more broader and more diversified portfolio.
Yeah, and maybe on the fixed income side, I think after a few years of bond funds trying to not behave like bond funds, I think the time has come for bond funds to look and act like bond funds. So we've been more cautious and I, y ou know, again, not looking for a severe recession, but mindful that the risks seem to be skewed towards slower growth. So we are a bit lighter in terms of credit, a bit lighter in terms of some growthier components in high yield and certain emerging market exposures. We have higher duration, so that's interest rate sensitivity, than we've had in several years.
Because we do, we do think that, you know, our bond funds should start to behave like bond funds, especially as Tristan highlighted. We're getting a coupon that is very tangible and, and provides a nice head start on returns. So we do . We are positioned somewhat defensively, and we are looking for opportunities, whether they surface this year or into 2025, where if we do get the market properly priced in that risk, that we would then start to look less like bond funds again and add to credit and high yield and several other areas as those risks are appropriately priced.
Okay. Great. Thanks, guys. That's great answers to a good question from the audience. Here's another question that's, you know, an interesting one. It's: How would you explain to clients that the economy is not the market and vice versa? And the follow-on to this, is there an analogy that could be used? So someone looking for a little bit of help, perhaps, explaining that dynamic, and I'm sure you guys have experienced that yourselves, that you know there is that idea that the economy is the same as the market, and yet they are a little different in terms of how they, I mean, they're reactive to each other, but you know there is a lag.
So, I don't know who wants to go first on that.
So look at last year, David, as a good example. The economy was actually growing fairly decently, and we had a negative equity market, negative bond market, because it was looking forward to the fact that these higher levels of short-term rates were meant to cool demand down. You cool demand down, people stop buying things, profits go down. Profits go down, people ultimately get laid off, so companies defend their profits by cutting labor, et cetera. Those people stop spending, and you slow things down. So the market will look forward. Similarly, now, as the market starts to think about cutting rates because you need to, you need to spur demand, that will drive profits.
You'll see the market move forward, even though the economy may, in fact, be moving into a recession or in one. It'll start to move into the next leg of things. I would argue that, maybe differently, that the sooner we can get on with that weakness and cut rates, the sooner we can start the next cycle, right? Even though the economy itself over here will be actually struggling through it, the market will actually be forecasting the next period of time by predicting that your outcome will be this idea of lower rates, and therefore increasing the ability for people to borrow money and buy things.
And I would add that, just to supplement that, ultimately, it's all about earnings and the valuation and the multiples you put on those earnings, right? And the multiple that you put on the earnings is a function of the interest rate environment and the inflationary backdrop. And the earnings are a function of the macro, but also a function of a lot of other things, secular drivers, you know, restructurings or specific company-related factors that are driving company earnings. But over the long run, you know, the S&P 500 index tends to follow profits.
So just keeping your eye on the outlook for profits and what's driving those profits, and then how those profits are gonna be valued in the market, I think is the key to successfully navigating a more difficult macroeconomic environment or a macroeconomic environment that doesn't have a lot of visibility from time to time.
Then, Stephen Bonnyman, just to pick up on something you mentioned earlier, just this concept that, you know, if you get into an economic downturn, that, that sectors are gonna perform a little differently, right? So, you know, there's that cyclical sort of play that comes into, comes into play. Just maybe a thought on that, that, you know, some, some sectors are a little bit more defensive than others, and the importance of maybe mining that a bit.
Sure. And that extends on from the last question, which is a reminder that the market is an auction. And an auction will be a function of who shows up each day, and how they choose to play and what mood they're in. And that affects into the sectors. Investors are constantly looking for, ideally, the best risk-reward profile that they can find, and that will adjust with the market. If unemployment is rising, if risks are high, if geopolitical risk is hard to measure, then your investment strategy will probably lean to things that give you a more assured return, rather than investing in longer-term, higher growth opportunities that are much less visible.
Okay. Great. One last question here, and it's about the USMCA. So the trade agreement, which the interesting thing is that it's gonna be maybe renegotiated. I don't know, maybe Kevin, to start, do you see that as being a bit of an impact?
Yeah, it's not getting a lot of focus right now. In the past, but the pre-USMCA, which was the old NAFTA, was a very long-term agreement. And that framework allowed for companies to actually look at the rules, invest in CapEx, et cetera, to take advantage of trade. This is a shorter-term transaction. It does have a look, a period that will come into play. I believe it's 2025, that has to be re-looked. So what you've seen is not a lot of enforcement, a lot of accusations of cheating on every side, whether it be Mexican autos using Chinese parts, whether it be dairy and soft lumber in Canada, et cetera. So there will be a political issue for sure, and when...
We'll probably be dealing with new governments in two of those three countries by late 2025 into 2026. And so again, I think that will complicate it as well. Expect that this becomes an issue on trade as we move, probably not into 2024, but probably as we get to the later part of 2024 and into 2025.
Okay, great. And then one last question, and then we'll call it a day. And this is for Stephen Bonnyman. Just a question. We've talked at the... In the real assets world, obviously, there's different sectors that you're working with. Can you just maybe describe the geographic sort of element to what you're investing in? Just how geographic it potentially is.
We are, by every right, a global fund. We will invest around the world where we seek the best opportunities. The commodity space, which is obviously a focus for us, has a natural global bias because demand is global. We've invested in everything from Chinese ports and shipping facilities to European utilities to South American fertilizer companies. So we will go out and seek where the best opportunities are within most of the tradable markets.
Okay, great. I think that does it for us, guys. Kevin, maybe just some quick final thoughts and then we'll call it a wrap.
Yep. Thanks, everybody, for joining us today, and I hope everyone here has happy holidays. Obviously, we get into the start of next year, this uncertainty will come back to the fore. As I've said, we've had pretty good moves in most markets here over the last month, anticipating a different stance by central banks. I think the issue for the first quarter of next year will be, do economies continue to weaken, or do data points start to become a little bit more inconsistent, some hotter, some colder, and create this idea that maybe we're not ready to cut rates yet? And I think it will be about cutting rates and how long we stay at these levels. That may create some angst for markets as the start of the year.
I think as the year plays through, the weakness that we're talking about will get resolved with, at some point, either a preemptive cut of rates or one that cuts rates because inflation has trended to target and the economies are weakening, which should give some better market backdrop as we move into the later part of the year. But the first couple of months of the year could be very difficult, just in terms of meeting the expectations that have been put into the market this last six weeks and the moves we've had. So I'd say volatility will be present for a little bit, but the narrative, as we said earlier in the conversation, will start to change as central banks, pretty much all of them, from where we were in 2023.
and so that should start, again, the repricing of things for an environment where we're cutting rates for in demand, et cetera, but probably more later in the spring before you actually see that.
Okay, great. That brings our discussion to a close. Thank you, as always, to everyone tuning in today. On behalf of Kevin, Steve and Steve, Tristan, and Tom, we appreciate your time and support, and look forward to sharing our insights with you again next month. I'd also like to give a quick shout-out to Stacy, Annika, Sharon, and Leah for making these market updates happen every month. Without the work you do behind the scenes, these calls wouldn't be nearly as successful as they are. Thank you for all that you do. Before you go, please make sure to click the Add Session button in your Attendee Hub to register for our upcoming market update events, including our first installment of 2024, taking place on January seventeenth.
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