Portfolio manager stresses importance of long-term thinking instead of trying to time inflation or market trends
Investors face a dilemma with the next 10 years expected to deliver lower average returns compared to previous decades.
A given target return, therefore, will require greater investment risk, according to Todd Mattina, chief economist and portfolio manager, Mackenzie Multi-Asset Strategies Team. The 60/40 portfolio of U.S. large cap stocks and 10-year treasuries in the past 40 years has returned close to 10% but that is expected to drop to 4% over the next decade.
The solution lies first and foremost in thinking long term and recognising that timing the direction of inflation, long-term interest rates and equity market styles is a challenge even for the most successful tactical trader.
He said: “Popular narratives for the coming year range from a 'reflation' scenario with higher inflation and interest rates to a 'scarring' scenario in which the recovery from the pandemic-related downturn is more gradual with an extended period of low inflation and interest rates.
“There have been many false starts in the reflation and higher interest rate scenario over the past decade, including concerns about the impact of quantitative easing in 2008 after the Global Financial Crisis, the “Taper Tantrum” in 2013 and even the surprise election of Donald Trump in 2016 that raised expectations of a deficit-financed economic boom.
“In each case, the secular bull market rally in long-term government bonds and tech-driven stock markets ultimately prevailed. This time might be different but investors shouldn’t bet the farm on any one economic scenario next year.”
While the Democrats’ win in Georgia and the progress made in distributing the COVID-19 vaccine, uncertainty is still rife, making it a tough environment for the average investor – and even advisor – to navigate. Mattina said investors must seek an asset mix that can achieve a target return over time and that robust assumptions about expected return and risk of major asset classes will be key inputs.
Mackenzie Investments has forecast that 10-year government bonds will provide an average expected return of around 1.5% over the next decade, with China a notable exception of about 2%. Mattina believes that emerging markets dollar debt and corporate credit provide greater return-seeking opportunities.
He also expects EM and China to prove more attractive than the U.S. equity market. “While the U.S. stock markets outperformed in recent years driven by a narrow range of technology stocks, we expect U.S. stock returns will be lower than in other major markets in the next decade,” he said. “Given their more attractive starting valuations, the Canadian, European and small-cap markets are expected to outperform.”
Alternatives also offer investors crucial potential to add value and access to parts of the capital markets that have shifted out of traditional public markets, and have an expected return of 8% over the next decade. Mattina added that liquid-alt strategies with absolute return mandates employ leverage and security shorting in public markets to take advantage of opportunities in both rising and falling market conditions.
For Canada, the portfolio manager expects short-term pain in the first half of 2021 and that beyond this year, medium-term growth with be tied to global reflation and the path of oil prices.
He said: “The Biden presidency is both a blessing and a curse: the US-Canada trade relationship should be normalized, a positive for non-energy commodities and manufacturing, but Biden’s green plan could weigh on the beaten-down Canadian energy sector.”
He warned that the government faces a balancing act when it comes to its stimulus package. Premature withdrawal could hurt the economy, while maintaining the stimulus once the output gap is closed could raise public debt to unsustainable levels.
He added: “An underrated concern for medium-term growth is the sharp drop off in immigration in 2020. If new arrivals don’t quickly recover to pre-pandemic levels, average economic growth could underwhelm.