AGF CEO says there are reasons for concern – from major pockets of global economic weakness, to poor bond yields and trade wars
Ahead of its July meeting, the US Federal Reserve is approaching a delicate juncture. Having already scared the markets with hawkish language last year, it is now almost certain to cut rates by at least 25 basis points on Wednesday.
It’s a dramatic and relatively sudden U-turn in the face of a weakening economy and trade war that is hurting growth and sentiment. However, AGF Investments CEO and CIO, Kevin McCreadie, told WP that if Fed chair Jay Powell gets it right, he could hand the equity markets a boost and prolong the cycle.
McCreadie said there are, however, reasons for concern given the extensive movement in the markets since the fall. Equities sold off almost 20% from September to December but recovered it all back and broke a new high on the “promise” of a trade deal with China. The latter does appear close, the AGF chief added wryly. The bond market, meanwhile, has slumped. The 10-year US treasury fell from 3.25% to below 2% before hovering above 2%. Put together, there is a conflicting picture that investors need to be wary off as they position their portfolios.
“There is no trade deal we see that’s imminent,” McCreadie said. “And at the same time, we have gone from a fear the Fed was going to raise too many times in 2019 to a 100% probability of a full cut this week.
“If you think about why the Fed is cutting, it’s because the world is weakening and the trade war is damaging confidence and growth, and at the same time we have markets that are pricing it in.
“In the near-term, it’s hard to see how you drive the equity market much higher without earnings. You could drive it higher if the Fed gets really aggressive [with its cuts] but that could scare the market. For example, if it cuts 50 basis points this week, the markets are going to think, ‘what do the Fed know that I don’t?’
“The bond market is telling you it fears a recession and the equity market is telling you the Fed is going to bail you out. One of those things is going to give.”
McCreadie admitted that a July cut seemed highly unlikely last year but that no one predicted the global economy weakening this quickly. He never, though, saw the much-hyped four hikes happening after the Fed slipped up last year by saying it was a long way from the neutral rate, and added that there are worrying pockets of weakness out there, especially in Europe. Germany, for example, has posted “terrible” manufacturing numbers.
Now, investors are waiting to see whether the Fed can engineer a soft landing to prolong this epic bull run.
He said: “I think the equity market could grind higher. The scenario you have to paint in your mind is the Fed could ease enough to prolong the cycle. That will be good for equity markets because if the cycle is prolonged - and I don’t think 10-year yields will move down significantly but they don’t feel attractive - you are going to see people move back to equities.
“The premise to buy equities on this big rally is that the Fed is going to save you but if the Fed is too late on these cuts, then maybe not. We do think the US feels pretty healthy but if you are looking at earnings coming in a little softer because of the impact of the trade war, the warning signs are there.”
McCreadie recommended taking a little money out of equities and bonds so the middle of the portfolio is a barbell of 5-7% cash in a balanced account. Caution is the watchword and he urged advisors and investors not expect a repeat of the past decade.
He explained: “If you stop the clock and go back to 2009, the past decade produced an almost 17% compound return. But if you go back a decade before, 1999 to 2009, with the tech bubble, that was a -3% world. I would suggest, therefore, that we are not going to repeat the next decade, so it’s better to be a little cautious and have money in the equity markets.
“The great thing for Canada is that investors have access to liquid alternatives now and there has never been a better time for people to not only have some long exposure to equities but to own something that gives you a hedge to a downmarket.
“The next few years, until there is clarity around the economies of the world, are going to feature a lot more volatility.”
