Modest growth and falling interest rates allow for cautious optimism in 2024

Michael Sager: This time last year, we were emphasizing the elevated risk of a recession and stretched valuations across most major developed market equity indexes. The concern was that factors would drive a significant downward correction in equities. This led investors to turn to defensive hedges.

Fast forward to this year and we’re in a different world with steady — if unspectacular — growth in the US expected to support earnings growth. Rate cutting cycles are always beneficial to equities. True, the anticipated cutting later this year may be slightly less than some hope, but there should be cutting. So steady US growth and a global interest rate easing cycle give us cautious optimism for equities, at a time when many investors are running with excess cash.

Michael Sager: Selectivity is going to be key. Identify the markets with the most attractive fundamentals. Avoid taking a carte blanche approach. We see a couple of interesting ideas currently. One is Canada.

If you go back three, four months, in our tactical positioning we were underweight Canadian equities. We’re now neutral. The valuation of the Canadian market is broadly in line with its historical average. And that's really setting us up for decent long-term performance.

Emerging markets is the other idea. There are some really attractive opportunities in Latin America and in Asia — outside of China. So, if you look and apply a rigorous fundamentally focused investment process, and avoid the markets with still stretched valuations, it should prove beneficial. Cautious optimism is definitely the way to think about equities.

Michael Sager: I think it’s a similar story. Cautious optimism. Certainly, the outlook for core sovereign bond returns has improved substantially compared to a couple of years ago as a result of the backup in yields.

A good way to approximate your expected annual fixed income return over the long term is to start with current yields. At current levels, these suggest an average annual local return of 4% for a US 10-year treasury, and a little less for a Canadian 10-year bond.

It was easier to allocate back into fixed income from excessive cash holdings a couple of months ago, before we had the strong bond rally. Nonetheless, if we're looking at long-term opportunities from a starting point of having an excess allocation to cash, then the expected return to core sovereign bonds is an attractive one.

You know, we still do have a small probability attached to recession. That's just the way the world is. There's always a small probability. So, if we're incorrect and the outcome is weaker than we expect, bonds are going to be a good hedge. So, whether it's a return to diversification or just good hedging practice, bonds are offering a good opportunity.

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