Geopolitical risks and other factors mean markets should brace for 'life after Goldilocks' era, says Mackenzie Investments CIO
Following the past year’s aggressive monetary policy tightening and record-high inflation, one leading Canadian asset managers has issued a cloudy 2023 forecast: tighter financial conditions and an economic slowdown – along with a chance of geopolitical tension.
“Right now, we're focused on two areas of geopolitical risk,” says Lesley Marks, SVP, Investment Management and CIO of Equities at Mackenzie Investments. “One is the conflict between Russia and Ukraine, and the second would be China overall.”
After the Russia-Ukraine conflict first exploded in February, prices of commodities skyrocketed in short order. The surge in food and fuel costs added to the lingering symptoms of global supply-chain pressures, ratcheting up inflation to multi-decade highs across different countries worldwide.
“Inflation came through at different levels in different regions,” Marks says. “This past year, some European countries saw inflation as high as 15%. So I think if we saw a continuation or an escalation in the conflict, we could see inflation persisting for much longer in Europe.”
A protracted bout of commodity inflation across the pond – particularly if Russian actions to curtail supplies of energy and grain continue – would have severe implications for food and fuel security in the European Union. That would make it harder for the European Central Bank to ease up on their monetary policy tightening, which would in turn weigh on the region’s economic growth.
The 2023 Outlook report by Mackenzie acknowledged central banks’ recent signals that they’ll slow the magnitude of rate increases, but cautioned investors against assuming an outright pivot. Projecting a base case of moderating rate hikes, it argued that “higher for longer” will be the predominant theme to watch, with further tightening to come at the start of next year.
“There’s always the tail risk of a nuclear event being instigated by Russia,” Marks adds. “In any conflict situation, it’s very difficult to have good visibility as an investor. That’s certainly not our best-case scenario … it’s hard for us to factor that in investment scenario planning.”
Tensions between the Asian superpower and the U.S. have abated somewhat. But in its outlook report, Mackenzie highlighted that Chinese President Xi Jinping’s two long-term goals for the country – namely high-quality economic growth and national security – could lead to an inevitable continuation in the rivalry between the world’s two largest economic powers.
More immediately, much of the market is focused on the Chinese government’s COVID restrictions, and what impact a relaxation or lifting of those measures would have. Mackenzie’s 2023 outlook noted that easing those policies could cause inflation to remain stickier than expected.
“On balance, the relaxation of the zero-COVID policy will generally be positive for the market domestically in China, and the Chinese consumer,” Marks says. “That will be additive to economic growth in the region, which will likely contribute to an increase in expectations for China to offset the significant slowdowns that other regions are experiencing.”
Looking ahead, Marks says 2023 is set to be the year for income investors. As risks started to pile up over the course of 2022, there’s been a significant correction in both equities and fixed-income investments, including lower-risk asset classes like Government of Canada bonds and U.S. Treasurys.
“We think that next year, in the face of what is likely to be an economic slowdown and potentially a mild recession, will be a very good market for fixed-income investors, where you have a fairly low risk security at an attractive yield,” Marks says. “That’s something we haven’t seen for a very long time.”
Based on its view of a soft-landing or moderate-recession scenario, Mackenzie sees high-quality investment-grade credit as an attractive asset class. The current yields on government bonds, particularly on the short end of the curve, also make them very attractive, Marks adds.
“Based on our view towards an economic slowdown, we think investors should be focusing on companies in the equity space that have high visibility in their earnings, and aren’t particularly economically sensitive,” she says. “These companies typically have excess cash flow and can support a dividend, which would make them compelling investments for equity investors this year.”
While the past 10 years has been defined by chronic underperformance of Canadian equities compared to the U.S., Marks says that dynamic is set to be overturned. As the world turns into a period of “life after Goldilocks” – marked by higher interest rates and higher inflation, according to Mackenzie – it would bode well for Canadian equities relative to more growth- and technology-oriented U.S. stocks.
“There are opportunities in equities outside of the US in Canada, even internationally, in Europe, as well as Asia,” Marks says. “The next little while will be very different from what we’ve seen in the past decade, and we’ll see opportunities to do well as an investor beyond technology or high growth.”
