HSBC GAM's head of portfolio management backs central bank's guidance and warns advisors to temper clients' return expectations for next year
Canada’s economy is in a sweet spot as it recovers from the seismic shock of COVID-19 but investors should not get carried away heading into 2022, according to HSBC GAM’s head of portfolio management.
Derek Massey broadly welcomed the Bank of Canada’s move to end QE last week, noting that its guidance and desire to get away from zero-bound interest rates remain in line with HSBC’s long-term fundamental view. With the central bank clear in its narrative, and indicating rate increases are likely sometime in the middle quarters of next year, he believes the economic data is supporting that direction.
Rather than the exact timing of the first hike, Massey said market participants' main concern is always the pace of the change. Not only does the data have to support each move but markets need to be somewhat prepared. The other caveat is, obviously, inflation numbers, which persist. HSBC GAM sees them as transitory and a result of considerable supply chain constraints, citing improving employment levels as a reason to be optimistic.
Massey added: “I would suggest, within the next six months or so, that Canada's going to look very strong competitively compared to the rest of the world and the transitory effects of inflation should start to reduce.”
With the central bank and inflationary outlook, HSBC GAM has been protective of interest-rate risk on its fixed-income allocation. It’s “way up the curve” with regard to quality in its portfolios, having made that move initially at the start of the pandemic. Massey believes there is plenty of space for high-quality corporate over government bonds, while rate risk is covered by being shorter on the duration curve.
With 52-week highs across a number of different markets in developed economies, Canada is thriving through this expansionary phase of the economy. Heavily weighted towards cyclicals, including energy, materials, and financials, the TSX Composite has performed well year to date. But Massey issued a word of warning, reminding investors that stock markets are forward looking, and should temper expectations for 2022.
He explained: “We've got a dividend strategy, using Canadian companies, that we run internally which has an above 25% year-to-date return. That’s a very outside absolute return. We're targeting dividend payments of 4% and 5% plus a little bit of a market return, so maybe a 7% return for that type of strategy, and we're over 25%, year to date!
“As we've gone through the COVID crisis, and as we look to the other side, we've had tremendous outsize gains in equity performance. Although we think equities are still the place to be, we need to temper those expectations going forward, because we don't think absolute returns are going to be as high.
“Growth coming out of a complete shutdown is very strong and the numbers are exceptional. But as we get into a more normalized economy, those projections need to come down and, in turn, return expectations on equity portfolios need to come down as well.”
With that in mind, Massey believes next year is going to be a challenging one for advisors after a couple of very strong years on the back of low expectations. With the world emerging from the pandemic, the general public are likely thinking returns should continue apace but that doesn’t take into account that much of it is already priced in. He expects more volatility as the impact of the inflation numbers work their way through the economy.
He said: “We're just realizing the shock of high oil prices, or high food prices, for example. Again, those numbers take a long time to work through the economy and through to people's bottom line, so I think 2022 is going to be a year of tempered expectations.
“We’re still looking at good growth as we make our way through this pandemic, with the employment picture improving, and vaccination rates globally also improving. But Canada seems to be ahead of the curve on the vaccination rollout, and given the fact our stock market is highly correlated to economic growth, with cyclicals like materials and energy being a large portion, we're still in a really good sweet spot. But again, I’d temper expectations of returns north of 20% as we go through 2022.”
