A look ahead, a look back

Donald Horne sat down with three key portfolio managers to get their takes on 2016, and a look back at 2015

A look ahead, a look back
This is the first part of a two-part article. 

Low interest rates are forcing advisors to look high and low for vehicles that offer maximum yield. In November three experts weighed in on where the opportunities can be found: portfolio managers Sergei Strigo of Amundi Asset Management; Martin Murenbeeld of Dundee Capital Markets; and Lieh Wang of Empire Life Investments.
Strigo: Global interest rates are currently at very low levels, even though we expect the US Federal Reserve to hike interest rates in the near future. However, we do expect the absolute level rates to remain low or go even lower in the rest of the developed world.
In this environment, within the fixed income space, there are very few opportunities for investors to get any kind of meaningful yield; but emerging markets do provide opportunities for high yields.
The dollar denominated bonds, we are at over 5.5% in terms of yield on the main indices (JP Morgan), and if you go to local currency bonds, that becomes much more interesting, with around 7% yield (JP Morgan). If you look at countries such as Russia, Brazil or Turkey, you can have double-digit yields of more than 10%.
Murenbeeld: Advisors will take on more risk, and they’ll go into corporate debt. Government debt is paying very little, and they’ll move up the risk curve, buying Italian or Spanish debt. But that’s not what I would recommend. I myself wouldn’t be inclined to lend governments too much money.
Wang: That has been the difficult question going back five years. Since the crisis, when the banks introduced emergency low interest rates, the traditional instruments for investments – like sovereign bonds – don’t give us much of a yield. The two obvious places to look would be one – in the fixed income market, a step beyond the traditional treasury and sovereign bonds and look at the corporate bond market, which would naturally have credit risks.
And if we really want to step out even further on the risk curve, something like high-yield bonds would be something to look at. But I wouldn’t make that a core part of the asset mix.
Secondly, we look towards stocks. The yield on the TSX currently is 3.1%, and that’s a significant increase from where the yield was 10 years ago. Correspondingly the five-year Government of Canada bonds dropped during that same time frame. I would say high quality blue chip stocks can look to add yield.
The US 10-year rate has decreased since June to about 2.1%. What’s the reaction in the market, and who is benefiting?
Murenbeeld: The Bank of Canada is not going to stand in the way of the equity market. That doesn’t mean it isn’t going to look at the market and say, ‘Oh gosh it’s weak, let’s raise rates.’ Whatever the Bank of Canada is going to do isn’t going to upset the equity market.
Wang: The question really speaks to whether the US Federal Reserve will finally start to normalize interest-rate policy and begin hiking interest rates from zero to 25 basis points. If they were to do that, then the whole yield curve may shift upwards, although it may flatten as well.
In Canada, we’re not close to following along, because our economy is weaker than the US, and a lot of that has to do with oil prices collapsing in the last 12 months.

If you see the US hiking rates and the Bank of Canada remaining on hold, then we’ll likely see currencies move as a result.  The loonie will weaken versus the US dollar, and that will benefit Canadian companies that have revenue exposure to US markets.
We might also see some Canadian companies benefit from higher interest rates in the US – for example, Canadian life insurance companies such as Sun Life and Manulife, can be sensitive to rising rates and specifically to rising rates in the US.
Canadian energy companies may get a bit of a tail wind in terms of sales, as oil is priced in US dollars. And then you have Canadian National or an auto parts company like Magna, that will likely benefit from the currency differential.
Strigo: The fact they have actually decreased is beneficial for emerging market bonds, and we’ve seen a good performance in some of the emerging-market countries. If the Federal Reserve doesn’t hike interest rates sharply, we believe it will be supportive for emerging market debt.
Clearly the countries that will benefit the most from this low interest rate environment will be the countries under some macroeconomic imbalances, high levels of debt or potential refinancing issues, such as Turkey or South Africa.

What’s the forecast for global growth?
Murenbeeld: It is likely to be under 4%, certainly for this year and 4% for next year. There are institutions that put together different models for measuring growth, but we follow the International Monetary Fund’s (IMF) World Economic Outlook composition of world growth, and they are looking at something in the neighbourhood of 3.6% for next year, and 3.1% for next year.
The reason I mention 4% is that we have a chart on which we plot real commodity prices change year-over-year against world growth, and when that growth drops below 4% for a year, the real commodity price chart goes negative year-over-year. It is pretty consistent.
The average price of the two bundles we chart are down sharply in 2015 over 2014; of course depending on how much oil is in the bundle, the decline would be even sharper.
Next year, if commodity prices stay where they are, you’ll have a year-over-year decline for next year.
The good news is, if we follow this simple model, commodity prices could increase a little – so long as it increases at a slow rate, so that the average would still be below the average of this year, but we actually have a very mild rising in commodity prices. And I am biased to that scenario, that we have hit bottom for most commodities.
What we’re recommending is that advisors carefully dollar-average into the commodity sector – not aggressively – just gently start to average. These sectors have been beat up terribly, but our models indicate there is likely to be significant value in these sectors.
Strigo: Rates will go up – but the question is by how much and when. Chances are they will go up in December 2015 or next year. We are forecasting a gradual increase in the US of 25 basis points. But in the rest of the developed world, we are seeing the opposite.

Interest rates are going to stay lower for much longer. The European Central Bank is talking about increasing its quantitative easing program beyond September 2016; the Bank of Japan will also have to do something similar, as Japan’s economy is not doing very well at the moment.
The impact of the US interest-rate increases should be counterbalanced to some extent by opposite trends in other developed countries.
Wang: Globally, I would expect interest rates to stay the same. In Europe and Japan, we are likely to see expanded QE programs that will act as a dampener on interest rates.
What about North American economic growth?
Murenbeeld: Let’s start with the US.
Our outlook for the US hasn’t changed a lot since we came out of the great recession. We’ve been talking about – for the last five years at least – about a 2% to 2.5% kind of economy. It turns out the US economy has averaged 2.2% since then. There are a number of reasons why, and some of these are going to continue forward.
One reason is, the US dollar is too high, and that has two immediate effects – it boosts imports and reduce exports, and it tends to dampen business investment.
Fiscal policy has generally not been supportive of growth. You would, in a different environment, expect governments to have much larger deficits than they’ve had – the reason they don’t is that they’re already heavily in debt, and there’s a political demand that they not go further into debt on the Republican side.
The situation in Canada is to some degree similar. We’re a resource producer, much like Australia, so when commodity prices are down, the Canadian economy feels it quite severely – and the dollar declines. That kicks into action the manufacturing sector. The Canadian economy is a very dual economy – when resources are hot, the dollar is high and manufacturers are screaming; when resources are down, the dollar is down and manufacturers are happy again. That’s the shift you are seeing now.

to be continued...