‘Put your guard up on equities to reduce recession risk’, says PM

A hard recession could start by early this fall rather than into next year

‘Put your guard up on equities to reduce recession risk’, says PM

While many are predicting that a recession could come late this year or early next, one successful portfolio manager thinks it will arrive by fall, so advisors should be exercising caution now.

“Advisors want to make sure that they’re mapping to the appropriate policy and mix, given an individual’s situation. We would not be of the view that it’s time to be taking on more risk,” Garey Aitken, a Calgary-based portfolio manager who manages the Franklin Bissett Canadian Equity Fund, told Wealth Professional. He is also the chief investment officer of Franklin Bissett Investment Management.

“Nor should my more bearish view be interpreted that people should head for the hills and abandon the appropriate mix or strategy for somebody and get unduly cautious because, first of all, people can be wrong. What’s ultimately the most important test is a long-term plan. But, our counsel would be that, whether we’re talking in a fixed income or equity setting, now is the time to probably be cautious and have your guard up.

“We always focus on risk management, but there are times when you’re playing more defence and then there are times where you’re playing offense. For us, this is not the kind of environment, with prices that we don’t think we’re getting sufficiently compensated for, to be aggressive. It’s a time to be more cautious. That’s within the context of still having an equity mandate and being fully invested. There will be a better time to be more aggressive with equity positioning.”

Aitken noted that in the debate over whether there will be a recession, and whether it will be a hard or soft landing, his camp expects to see a recession that’s a little harder than softer. He attributed that to the extent of monetary tightening that has occurred over the last 12 to 13 months and the inevitable lag between the central banks’ tightening and the spill-over into the economy.

While he sees the recession unfolding by this fall, he noted, “It’s pretty unlikely that we can avoid a real economic slowdown and, quite frankly, that’s what the central banks want.”

Unlike others, he doesn’t believe the markets have already priced in the extent of the potential economic slowdown or an earnings contraction for this year and next. So, given the tangible evidence of slowing economic growth, he expects to see more pressure on equities since he does not believe they’re sufficiently discounted yet. He noted that his team is not relaxing its need for proper valuation.

“We don’t want to overpay for things just because we’re cautious,” he said. “We don’t want to end up inadvertently trading economic risk for valuation risks, so we’re delicately threading this needle.”

Aitken is holding with his prediction for a September or October recession because early 2024 would be too long a lag from when the central banks began their tightening. He noted that, while the Bank of Canada only has one lever to pull in interest rates, we’re on the cusp of the U.S. earning season as the Q1 earnings start to be released today, and that will be a litmus test for how businesses fared in the first quarter. By summer, he said there’ll be some indication of how consumers are responding to a year of tighter lending conditions and how that’s impacting inflation. Even though there isn’t a lot of pressure for wages to keep pace with inflation yet, he noted it’s going to be a challenge for the central banks to push that down to their targeted 2%. So, they may have to adjust their targeted inflation rate to 3% or 3.5% for an interim period.

Aitken also noted that the recent zero interest rate policy had, in his view, distorted the equity markets and enabled a lot of risk-seeking behaviour, with things like meme or high-flying growth stocks. While that abruptly changed in late 2021, there has been some bounce-back in that.

“We’re back to an environment where fundamentals are more of a driver of equity performance,“ he said. “I know we’re coming at it from a bias perspective, but we certainly found that was a very unusual and difficult market as an active manager focused on fundamentals when that was such a driving influence. So, if we’re up off the mat and moving away from zero interest rates, then I think we’ll get back into a better environment for active managers who have the disciplines they can adhere to. That will eventually get recognized in terms of what they can do in identifying relative winners and losers in equity markets. So, I think what we saw with interest rates, being near zero around COVID, was the last hurrah for that indiscriminate action within equity markets.”