How higher recession odds have shifted the math for portfolio positioning

'We're optimistic there will be sunshine when we come out of this storm,' says CIO

How higher recession odds have shifted the math for portfolio positioning

The central banks’ fight against inflation is really increasing the chance of a recession, says one chief investment officer.
“The banks are basically admitting that they’re behind the curve, and they need to act swiftly and significantly to fight inflation as it’s becoming a lot more embedded in expectations,” Lesley Marks, Mackenzie Investments’ chief investment officer of equities, told Wealth Professional.

“I think this move and how aggressive central bankers need to be to fight inflation is really increasing the probability that major economies, like Canada and the United States, will experience a recession later this year – and that would not have been our view at the start of the year.”

Marks said Mackenzie’s key themes at the beginning of 2022 – inflation, central bank policy, and China – are still the most relevant for investors’ positioning. But, Mackenzie’s position on positioning is changing because of the economic slowdown and potential recession now coming into focus.

She said there’s now a 50% probability that there will be recession, but Canada may be a bit more isolated from that and experience zero, or negative, economic growth.

“For all intents and purposes, the outcome could be the same because of the importance of the resource economy to Canada, and particularly the energy sector, which has been fuelled by very strong energy prices,” she said. Given that oil prices are still up by about 50%, she said that will translate into more earnings and cash flow growth for a large part of the Canadian economy.

As 2022 began, Mackenzie thought that China was more accommodative on monetary policy than Canada and the U.S., so China would be more of a contrarian player this year. But, it’s commitment to a zero COVID policy and the resultant lockdowns have impacted both the domestic, and global, economies, especially with their impact on the supply chain. That has impacted the inflation picture around the world. While China’s central bank policy is easier than others, Marks said Mackenzie now doesn’t expect it to meet its 5.5% growth rate this year.

While there’s been a lot of talk about bringing more manufacturing onshore because of the supply chain vulnerabilities, Marks said that would take time and also be slowed by the low unemployment rate and lack of available labour in both Canada and the U.S.

Given the increasing likelihood of a recession this year, Marks warned advisors to position their portfolios for a full business cycle, rather than just an expansionary environment, so these also work during a slowdown and recession, which they haven’t really seen since 2008.

Although long duration equities have been the hardest hit assets, she said it could be better to reposition back into them for investors with long-time horizons than buy cheaper stocks that “can remain inexpensive for a very long period of time before you will see recovery.”

Dividends are also an important part of returns, even though dividend paying companies have been out of favor for awhile and the high-growth tech stocks that did well in the pandemic didn’t pay them. “We still really believe in the value of owning high quality companies that pay attractive dividends that are sustainable,” said Marks.

There’s also a growing interest in alternatives, especially since the environment, social, and governance sector wasn’t invested in the top-performing energy sector, so hasn’t done as well.

Marks said the question she now hears most often is: “Are we at the bottom of this correction yet?”

She doesn’t think we’re quite there yet, even though the future markets are pricing in the central banks’ plans to increase interest rates and tighten financial conditions to impact demand, and that still has a negative impact on the equity markets.

“We’re getting very close on what the market is pricing in for the central bank tightening cycle,” she said. “I think it is almost getting to the point where that will become a positive for equities.”

The early major U.S. bank numbers for the second quarter earnings have also been disappointing, which Marks said could men a generally disappointing earnings season as companies start to reflect higher costs for both goods and labor. That could also have a downward pressure for equities.

Finally, even though the sentiment indicators are showing that consumer confidence is down and investors fear a recession, there hasn’t been a negative fund outflow from equities yet. So, Marks said, “we’re optimistic there will be sunshine when we come out of this storm.”