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Welcome to Advisor To Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Avery Shenfeld, chief economist at CIBC.

I think many of us welcomed the Bank of Canada’s decision to leave rates on hold at its latest meeting. It’s clear that inflation is not where they want it to be, but the economy has clearly also gone into a stall in growth. We’ve had very little growth really over the last six months or so, and that should over time take care of the inflation issues, so they want to avoid overdoing it.

You have the governor saying that he doesn’t see the need for an outright recession to get inflation under control. And since we’re now in a period, basically we’re as close to recession as we can be with virtually zero growth for a while, I think it behooves the Bank of Canada to now sit back, wait for those, that slower growth to open up some slack in the economy and bring inflation back to target.

The Bank of Canada is driving a car where you have to turn the steering wheel several blocks ahead of where you want the car to turn, in the sense that they raise interest rates today, or in the past year and they don’t see the full impact on the economy for a few quarters. And the impact on inflation actually lags a bit behind that because you need to run a slow economy for a while for the unemployment rate to drift up, for wage and price inflation to start to decelerate. And so I don’t expect the Bank of Canada to move on interest rates as long as we continue to see this soft patch for growth, as long as there are signs of slack opening up in the economy, that should leave them confident that with enough patience, lower inflation, that is, will follow.

The bar to start cutting interest rates as opposed to merely leaving them on hold is quite a bit higher. The Bank of Canada would first of all have to see some signs of greater slack in the labour market. The bank points to the tightness in the labour market as a clear impediment to getting wage and price inflation under control. So we’ll need to see a somewhat higher unemployment rate, likely a bit above 6% for a while. And some signs that wage inflation is starting to slow before they would cut interest rates. And they might even need to see some actual progress in getting core measures of inflation down.

I don’t think they’ll need to see headline inflation all the way back at 2% because perversely, one of the things that’s going to stand in the way of that is that the inflation measure includes mortgage interest costs and high mortgage rates are actually adding to that particular component of inflation. But they’ll be looking at other metrics of inflation that strip out some of that impact of higher mortgage rates and they’ll need to see some progress in other measures of inflation coming at least closer in line with the 2% target before they cut.

It does look like the high inflation numbers that we saw a year or so ago are now firmly behind us, and that’s not really just a Canadian story. We’ve seen inflation peak and come down in the U.S., in many European countries, and part of that is not really that the central banks raising interest rates caused that. It’s that some of the earlier inflation was tied up with supply chain difficulties, emanating initially from the Covid pandemic and workers being absent, Chinese factories being shut down. And then also the war in Ukraine that initially caused a surge in oil prices and world grain prices. And what we’ve seen is broadly speaking across the good sector of the economy, that inflation has melted away as factories returned back to normal production schedules as Russian oil didn’t in fact get cut off from the world the way it was feared after the start of the war in Ukraine. And even Ukraine managed of course to ship more of its grain to global markets as well.

So that’s brought inflation down everywhere in the world. The problem is that the last mile of this journey to lower inflation is really the one where we need to go through a period of slower economic growth globally in order to bring down things like services, prices, and other parts of the inflation story that remain still above the kind of temperature readings that the central banks are looking for.

The fact that central banks around the world, not only in the U.S. but in Europe and Australia, have collectively been raising interest rates, all of course for the same reasons as the Bank of Canada in an effort to slow growth and contain inflation in their countries. Those interest rate hikes are in fact a helpful hand for the Bank of Canada in its task to slow the Canadian economy. For one, on the inflation front, it has helped cool the temperature of some commodities, things like energy prices, that feed into Canada’s CPI. Slower global growth will do that. But it also means that the market for Canada’s exports is also slowing, helping to moderate growth and therefore inflation pressures in Canada.

We’ve seen European growth slow to a slow crawl and perhaps even some recessions in some parts of Europe. The U.S. of course, is one exception, their economy really hasn’t slowed in 2023. But the Bank of Canada can take comfort that with interest rates as high as they are now in the U.S., they can look ahead to a slowing in that economy and therefore a cooling in the market for Canada’s exports south of the border. So all told, higher interest rates in the rest of the world have perhaps taken a bit of the pressure off the Bank of Canada to continue to raise interest rates here and cool the domestic economy because our export prospects are slowing and that should help us on the inflation front.

We’re now in a watchful waiting mode, like the Bank of Canada, like the Federal Reserve, and we’re looking for two key developments. One is that in Canada we don’t really need a further slowdown. The one we’ve already got would seem to be sufficient to do the job, to take the steam out of inflation. So we’re mostly watching to see how that slowdown translates into a cooler labour market, into a cooling in wage pressures, and down the road some softer core inflation readings. In the U.S. it’s a bit more of a mystery at this point why the U.S. economy has yet to respond very much at all to higher interest rates. So really we’re waiting to see that some of the sectors that have slowed, including housing and the resale market and the slowing that we’re seeing in corporate lending in the U.S., that those do translate into a broader slowdown in the American economy to put the Federal Reserve on hold as well, and then take the wind out of U.S. inflation.

So less concern here now about Canada, it does appear that our economy is slow enough to get our inflation problem behind us at some point. And we’re hoping to see a moderation in U.S. growth, not an outright recession, but a slowing sufficient so that we gain comfort that U.S. inflation will also come down in 2024.

We expect the U.S. to lag behind Canada in terms of when it ultimately starts cutting rates. In fact, there’s still a risk that the Federal Reserve will hike another time given the fact that the U.S. economy hasn’t materially slowed yet in the face of interest rate hikes that have been similar to Canada’s but haven’t slowed the consumer sector in particular. And the fact that the U.S. economy is weathering the storm of high interest rates much better in Canada also leads us to a view that it will take longer then for high interest rates to produce enough downward pressure on American inflation for the Federal Reserve to join the Bank of Canada in easing interest rates in 2024.

We do expect to see some rate cuts in the second half of next year in the U.S., but probably starting a quarter or so later than where we would see the Bank of Canada moving, which would be sometime in the second quarter. And likely fewer interest rate cuts, that is a shallower path to lower rates in the U.S.

Simply put, the American household sector is not as sensitive to higher interest rates as the Canadian household sector. They’re not as indebted. Their mortgages are locked in for 30 years. And so the American economy won’t be as early in needing some relief from lower interest rates as the Canadian economy is likely to be.

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Craig Jerusalim, senior portfolio manager, Canadian equities at CIBC Asset Management.

Equities, especially dividend-paying equities that Canadians hold so dear, are getting severely punished as of late, and that’s largely due to the relative rise in bond yields.

The problems we see with rushing into these securities indiscriminately is the fact that we are just so early in this current economic cycle, and central banks are likely to continue with their hawkish commentary, even if we are in the final innings of interest rate hikes.

The reason for this, the need to remain hawkish, is the desire to ward off any re-acceleration of inflation, and avoid the boomerang that was experienced in the 1970s as inflation came down the first time. In any case, rate cuts are unlikely to materialize until more pain is felt, causing inflation to slowly head back towards central bank targets, and unemployment rates to slowly rise.

The good news is that we need not wait for bond yields to go back to zero before we see separation in the stronger, higher quality security that have fallen alongside the overly or poorly positioned lower growth funds. In fact, we’re unlikely to ever see interest rates back to zero outside of another black swan event like Covid.

What’s an investor to do?

In a stagflationary environment, you want to seek out companies that have low leverage, have strong pricing power or sustainable competitive advantages, have good growth characteristics, and reasonable valuations. The low leverage is obviously due to the rising cost of debt payments. The strong pricing power is to ensure that companies can pass along the inflationary cost to their own customers in order to maintain margins. The growth is relative to the scarcity of growth in a slowdown and starting valuations do have an impact on future expected returns.

Well, it is often a good trade-off to pay up for quality. We just don’t want to be overpaying for tomorrow’s growth today.

There are a few sectors that stand out with these characteristics, including the waste sector, self-storage, property and casualty insurance, and energy, and many other one-off companies that have become the proverbial babies being thrown out with the bathwater.

As for dividend-paying stocks, the key there is to examine sustainability of those dividends. And more importantly, to seek out the companies that can grow those dividends over time, as a way to separate themselves from their weaker peers, as well as from fixed income and money market securities whose interest payments are at best stagnant and offer no protection against inflation.

Dividend strategies rightfully fall out of favour when markets are skyrocketing higher, like they’ve done for much of the past decade. However, dividends become a much larger percentage of total returns when the market’s correct or moves sideways for an extended period of time, like they did in the late 2000 early 2010s. And similar to what we could experience for the next little while.

It is our view that we are in a new normal where interest rates are going to stay higher for longer. If, however, I’m wrong about that, and central banks do begin cutting interest rates faster and earlier than I expect, then we are likely to see a return to some of the higher yielding, higher growth sectors that have recently fallen out of favour with higher interest rates. That would be a return to the telecom sector, the utility sector, REITs, select financials; as well as the companies with long-dated cashflows, so those are typically the more expensive companies in the technology sector that have those long-dated cash flows. There would be a return to those companies. That’s not in our base case. However, even if that interest rate environment doesn’t change, we’re still trying to seek out the relative opportunities within those sectors to be able to differentiate ourselves, regardless of what the macroeconomic backdrop is.

The thesis is that stronger companies with the stronger balance sheets, and the better growth, and the better fundamentals, are able to survive any downturn and are best positioned to thrive once economic conditions improve.

Energy stocks have a lot of analogies to the tobacco stocks of the last few decades. Over the last 30 years, everyone knew that tobacco stocks caused cancer, and that there’s going to be declining trends in domestic markets, picked up by growth in emerging markets; and for many years, those tobacco stocks slowly grinded their way higher. However, when you incorporated the dividend payments on top of the price increases, many of those tobacco stocks compounded returns at close to 10% for nearly 30 years. Those are fantastic rates of return. And we think that the energy sector, the highest quality energy producers, like Cenovus, and CNQ, Tourmaline and Arc, have the ability to compound returns at similar rates.

And our thesis is based on four key points: supply, demand, starting valuations, and even ESG.

On the demand side, we know about the thesis that domestic markets in North America are eliminating internal combustion vehicles, moving more towards electronic vehicles, and that’s going to have a negative demand at the margin for oil consumption. However, that is more than offset by the continued growth in emerging markets — not just China, but India and other emerging Asian economies — such that the demand profile for energy is not going to peak for many years to come.

Then on the supply side, we really had a change in mentality when the price war happened that sent oil below zero for a short period of time. What that changed is investors started demanding that companies no longer be judged based on their growth but be judged based on their profitability. And that caused many of the shale producers to stop their growth-at-all-cost strategies, and that allowed OPEC to once again become the swing producer in oil, meaning that they’re more likely to keep oil in a tighter range over time. There’s going to be a high volatility in short-term pricing; but longer-term pricing is more likely to stay in a $70-90 range, given that OPEC is able to be the swing producer, and increase that supply when oil gets close to $100, and then maybe cut back if oil falls back down to the low $70s if demand warrants it. But it does need more stability in price; and that is very good for the Canadian producers who, unlike the shale producers that keeps putting money into the ground to maintain their production, the oil sands formation is one where these companies had to spend tens of billions of dollars, but now benefit from 50-year mine lives with very low decline rates.

Their cost per barrel today are in the $20-30 range, which means that the excess that they have per barrel is very lucrative; and considering most of them are reaching their debt targets, close to 100% of that excess free cashflow is coming back to shareholders in the form of dividends and buybacks.

Then valuations. Now, we’re off of the trough levels that we saw over the last couple years, but we’re still well below average multiples for many of these producers, even though their balance sheets are much stronger than they’ve ever been, they’re returning money to shareholders, they’re not investing in corporate M&A unless they want to. They’re no longer doing it because they need to. Our thesis is not based on any multiple expansion. Even if multiples stay where they are, it’s going to be the cashflow growth that’s going to result in those dividend payments going up and returns to shareholders.

Then the final point is ESG. You don’t always immediately think that ESG is a reason to own Canadian stocks. However, when you think about carbon-emitting companies and the need to reduce greenhouse gases, energy production is a global problem, it’s not a local problem; and any barrel of oil produced in Canada means one fewer barrels of oil being produced in countries like Venezuela, Nigeria, Iran, Iraq, where not only are the environmental standards much worse, but so are the social and governance standards. So I think every barrel of oil produced in Canada is a net benefit to the world.

Within the financial sector, we’re seeing a big discrepancy between the fundamental go-forward lookout for the banks versus the insurance companies. Specifically the P&C insurance companies, as well as the reinsurance, like Fairfax Financial, Isura, Intact, where the fundamentals really benefit from the hard market that they’re seeing today, which means that they’re able to continue to raise prices. The P&C companies also benefit from higher interest rates because they’ve got shorter duration books, and they’re able to reprice their business faster, and their investment portfolios are benefiting from higher interest rates today.

All to say that relative to the banks, which are very cheap right now, the P&C companies have a much better risk return profile, from our vantage points. Even though the banks are trading at very attractive price-to-earnings ratio, have very attractive dividend yields in the 7% range, we’re just too early in the cycle to be interested in going overweight to Canadian banks.

When you take a very long-term view of the banks, there is nothing wrong with buying a Canadian bank that operates in a strong oligopoly when they’re trading sub-nine-times earnings, 7% dividend yields, and have underperformed for close to three years now. The general rule over the last 40 years is Canadian banks outperformed eight out of 10 years. Given the cheap valuation, and the high dividend yields, and the recent underperformance, it is fine to be investing in these companies for the medium and long-term.

We have to be a little bit more tactical. Given that we are so early in this credit cycle, we’ve only started to see the provision for credit losses start to work their way off of trough levels, but we have a long way to go before those credit losses hit mid-cycle levels and begin to slow down.

Plus, given the higher interest rates, we’re only now starting to see loan growth beginning to slow, and capital-level requirements are only going up from a regulatory point of view, which does negatively impact future earnings potential.

Then with fourth quarter reporting coming over the course of November and into December, we are expecting some significant restructuring charges from many of the banks, which the banks call one-time in nature, but it does depress current quarter earnings only to help earnings in future quarters.

So we think that might be a better entry point, although realistically we have to wait for some of the trends that I just talked about to start to play out before we would get more optimistic on the Canadian banks.

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Welcome to Advisor To Go, brought to you by CIBC Asset Management. A podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

David Wong, chief investment officer, total investment solutions with CIBC Asset Management.

Entering 2023, we were facing a very challenging investment backdrop. We were in a holding pattern waiting for an economic slowdown and expecting the markets to respond accordingly.

Things haven’t been all that bad for asset returns compared to 2022 as we’ve seen 2023 unfold. And so investors can balance stability and growth in today’s economic environment in rather interesting ways. Almost 10 months into the year now still feels like we’re in that holding pattern, and so we would say that there’s no reason to abandon your long-term strategy. Stay focused on the strategy that’s designed to get you where you need to be in the long-term and don’t try to outguess the situation. 2023 is a great case study of why that’s the right approach.

That said, when we look around the investment landscape today, we are seeing some interesting things shaping up.

Interest rates are noticeably higher today than they were at the start of the year. The pain that’s been felt in the bond market so far this year is likely going to be in the rearview, we believe, as the hiking cycle nears its end. So it’s hard not to be attracted to the yields that are available in the market today.

When we see 10-year bond yields north of 4% for a credit risk-free federal bond in the U.S. and Canada, it’s hard not to be attracted to it after a long period in the prior decade where bond yields were under 2%. And we haven’t seen today’s level of yields since the end of 2007.

Now investors are rightly looking at these yields as a bit of a gift horse right now, taking its time to inspect what’s going on in the investment environment before accepting the gift of higher yields. But viewed from a forward-looking long-term lens, we may want to take advantage of these levels as soon as we can.

When we look at the data on Canadian bond yields via the index going back to 1983, when we take the starting yield of the index and look at the subsequent return one year out, we find that the return bears little resemblance to the starting yield. The difference is plus or minus 67% relative to the starting yield. But if we extend out the analysis to the subsequent return 10 years out, we find that the return looks awfully close to the starting yield. The difference is only plus or minus 15% relative to the starting yield. And this makes intuitive sense. As you get closer to maturity, bonds pay you back at par and any short-term price volatility simply goes away. The trick is to avoid the noise that surrounds us every day and stay focused on your return objectives. So if we stay invested and can ignore the short-term noise, there are more attractive return prospects for bonds today than at any point since 2007. That’s something that shouldn’t be easily dismissed just because it creates some discomfort over the volatility in the short term.

If you’re a long-term investor, you should be pretty excited about it actually, particularly if you’re sidelined in cash right now just because of nervousness over the headlines.

So if interest rates remain high but stable, that would actually be really good for bond returns. It would give us the starting yield back in the form of returns with lower volatility. Permanently higher rates might, on the other hand, create some repricing lower for equity multiples as the discount rate for future earnings would need to be adjusted higher. In that environment having a focus on the bonds of good companies with the ability to withstand higher rates should provide really solid returns.

For equities, it will be important to find special companies that have good business models that can withstand short-term volatility in any sort of repricing. You want to be very comfortable with what you’re owning in that environment as selling low is never a winning strategy.

So this might be an environment where having a close connection with an active manager could help investors contextualize what’s going on and provide the comfort to stay invested and focused on opportunities that managers are able to select out of the volatility.

If rates remain high but continue to increase ever higher and we get a bear steepener with long yields rising more than short yields, that would be a headwind for bonds. In that environment instruments like floating-rate bank loans would likely benefit as they have over the past two years. Over the past two years since rates started going up, floating-rate bank loans have generated returns of about 5.7% annualized while traditional bonds are down almost 6% annualized. So having diversification inside of your bond portfolio is a really good idea to have something working in any extreme outcome, whether rates are going higher or lower.

Now, central banks started cutting rates and if we got a repeat of the playbook from the prior decade where central banks seemingly respond to market weakness with looser monetary policy, that would actually be a very positive environment for risk assets.

However, the central banks have made very clear that inflation is their main focus right now. So the Bank of Canada and the Federal Reserve in the U.S. would need to be more certain than they are today certainly that they’ve got prices under control and that’s a big if. So we need to be prepared for any scenario to happen with a diversified portfolio.

That said, the assets that would likely benefit the most in our portfolio would be the ones that are a bit further out the risk curve, were administered rates to move lower. So think about global small cap or emerging markets and growth equities. Those would all benefit from lower rates. Bonds would also pull forward future returns and get repriced higher in the short term. So it’d be likely to be an attractive return environment for fixed income, at least in the short term.

The assets to avoid in advance of such scenario would be cash, not because cash would necessarily go down in value, but it certainly won’t go up in value, and that’ll be a drag to portfolios in the form of opportunity cost, which is why we recommend investors with a long-term timeframe to stay invested at all times.

Without question diversification should be the core to any investment strategy short of a crystal ball, so we would always recommend it. Prediction is hard. Preparation is relatively easier. That said, when we think about alternatives to diversification, I think really what the heart of the matter is is whether there are things that investors should have in the portfolio that they might not have today or they might’ve forgotten about. The late Peter Bernstein, one of the truly great market observers once said that you aren’t really diversified until there’s something you’re not comfortable with in your portfolio.

And so for many investors, giving up some liquidity in exchange for premium returns can be uncomfortable. But it’s been a strategy that’s been successfully used by many institutional investors who have the ability to do the deep research and identify good diversified opportunities in private markets.

Private credit, for one example, has higher yields than available in the publicly traded bond markets. And in the right hands, the credit risk can be managed very carefully by being selective to borrowers deemed to have a higher likelihood of paying them back. Of course, a good private credit manager wouldn’t put all of their eggs in one basket and would spread their loans around sectors and companies. Private assets are not valued daily by the voting machine of the market, but instead are valued according to predefined pricing methodologies on a periodic basis.

This means that they can be at least superficially less volatile, then they’re publicly traded counterparts. This can lead to an era of mystery about whether the volatility is artificially suppressed in down markets. So investors need to be very comfortable with the manager they’ve chosen and do their homework so they know what to expect in any environment.

One of the key risks that investors should watch out for is that equity market volatility could pick up if an economic slowdown becomes realized, and particularly if it is expected to be a severe downturn.

When we started the year, some gauges of market sentiment were quite bearish. If you look at investors intelligence, which does a survey on bulls versus bears, a ratio of bulls versus bears, the number of bears actually was equal to the number of bulls at the start of 2023. That’s actually quite rare and actually highlighted that investors were on high alert to start the year.

As 2023 proved this caution to be unwarranted we saw the bull-bear ratio reach three, meaning there were three times as many bulls as bears, which historically has preceded large market downturns.

Now that ratio has since come off the peak, but it’s important for investors to not get too complacent because that’s the condition for overreaction to any surprises that might come out of the economy or news flow in general. And one area that we’re watching closely is the impacts of mortgages and the higher interest rates and the impacts on mortgages for Canadian consumers. That’s yet to be fully felt here in Canada, and that could have some big negative consequences for the Canadian economy over the next couple of years. And if the market starts getting concerned in advance of that, it could be a headwind to equity markets.

The outlook for the next several months into the end of 2023 and early 2024, first of all, that’s a pretty short-term timeframe. Six months I would say is a short-term forecast, so take it with a grain of salt. That said, equities have had a good run so far in 2023.

We would be hard-pressed to get as solid of a year in 2024 through equities. Though arguably in the U.S. it’s been heavily concentrated in just seven stocks with the rest of the market having fairly muted returns this year. The headline shows that the U.S. market is up 15% in Canadian dollar terms this year, but if we actually equal weight the index instead of market-cap weighting it, U.S. stocks would only be up about two and a half percent so far this year. So if we focus on the glass being half full, there might be room for some catch up for the rest of the market that could buffer any overheating that’s occurred in the select few stocks.

Bond yields could have room to get lower if we hit a soft patch, something for investors who have been on the sidelines with cash to think about. They’ll be losing out on the opportunity cost of getting capital appreciation in the bond market in that scenario. And one thing that our data shows is over the long-term, the returns of a portfolio of bonds comes very close to the starting yield.

And so with yields at their very attractive levels today relative to any time since 2007, we believe that the long-term focus is something that people should look through the short-term horizon and ensure that they’re focused on the outcomes that they need to get to their investment objectives.

So even though we could see some softness in the economic data as the impacts of rising rates worked their way through the real economy, we would still caution investors to try not to outguess the market as the market has a way of pricing things in advance. So the obvious bad news is already assigned probabilities.

Stay focused on the returns you need over the longterm. Identify an asset mix that will help get you there using the unique opportunities that are available today, and let the power of time and diversification help you prepare rather than predict the markets.

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management. A podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Robertson Velez. I’m a portfolio manager at CIBC Asset Management.

At the start of the rate hikes in 2022, there was a marked change in the direction of interest rates after years of quantitative easing due to fears of rampant inflation in the anticipated Fed response.

The general view was that equity values needed to be brought down because a higher discount rate reduces the present value of future cash flows, so those securities should be worth less relative to cash and bonds. And because technology stocks had higher growth in general, the free cash flow expectations over the long term were a bigger part of the valuation. So, tech stocks were considered long duration assets and were impacted more by this revaluation. And so the whole market declined in 2022, with tech stocks declining even more.

But here’s the question that many investors started to realize was much more important. What is the real impact of higher interest rates?

Here’s my view. If a company relies on debt to finance much of its operations or it is unprofitable and needs to raise money, then higher interest rates mean lower profitability, or in the worst case, it could lead to bankruptcy. And this is the real risk if rates stay higher for longer for most companies. Many large cap tech companies have very little debt, generate significant free cash flow and continue to grow revenues even in a challenging environment. Moreover, they have shed significant costs in anticipation of weakening macroeconomic conditions brought on by the higher rates, so they are now leaner and more competitive. These companies are less impacted by higher rates and had been overly discounted in the selloff.

So, the market recognized this discrepancy earlier this year for a small number of large-cap tech stocks that are very high quality in nature, and they have pretty much driven the broad index returns year-to-date up to now in October.

Another factor that drove returns for a few stocks this year was the introduction of generative AI at the beginning of the year by Microsoft, followed by the strong demand for infrastructure equipment reported by Nvidia.

Many believe it was generative AI that drove returns for some tech stocks this year. My view is that while I do agree generative AI’s potential for significant growth, many of the quality tech names were so undervalued at the beginning of the year that there would inevitably have been some catalyst, whether generative AI or some other technology to drive up valuations.

So that’s my view of why these small number of quality tech names have outperformed so far this year and are no longer as sensitive to interest rate gyrations because, looking forward, these quality tech names are not really that impacted by interest rates. And looking out over the long term, regardless of what happens in interest rates, I expect that they will outperform the broader market.

In this environment, I would look for quality names in tech, and by that, I mean companies that have high revenue growth, high free cash flow margin, and high return on invested capital. Over time, these factors lead to outperformance because of virtuous cycle of revenue growth at high margins driving high free cash flow that can be reinvested at high return on invested capital driving even higher revenue growth.

So where can you find these qualities in tech companies?

What I look for are companies that have sustainable competitive advantages in their industries. Which can come from, one, opportunities for platform expansion. By this I mean companies like Apple and Microsoft that can grow their platform through user growth or higher pricing because of their strong position in the market. Two, technology leadership. An example of this is Nvidia that has a clear technological advantage in its space. Or three, structural changes in the industry, such as M&A or restructuring. An example of this is Broadcom, that’s grown through many successful acquisitions.

What I would avoid are unprofitable tech companies or tech companies that have significant net debt that is not easily serviceable with their free cash flow generation. In a high interest rate environment, these stocks will continue to be pressured.

Examples of this are many of the small and mid-cap companies in technology, which have very high growth rates, and where we have seen that the price shot up through the pandemic period but have come down and have not really recovered. And the reason is because most of these companies are unprofitable, and they would require injections of new capital in order to sustain their growth. So, I think that there are many examples of these types of companies, and I think at the right point in time, when we do see a change in the environment, they may become more suitable for investment, but at this point, I would tend to avoid them.

If central banks start cutting rates, then I think tech performance broadens out. So, I think tech will still outperform, tech generally outperforms in a lower interest rate environment, but I think that performance broadens out to smaller companies that have more growth than profits, and these companies will start to become more attractive as running out of cash becomes less of a concern. Companies that have a high level of debt service costs will also benefit as lower interest rates will drive up margins.

So, I think what you may be asking is if I would be shifting strategies if central banks start cutting rates. My focus on the science and technology fund will always be on quality as defined by revenue growth, free cash flow margin and return on investment capital. But what may happen, though, is that the opportunity set for quality companies may broaden out in a more supportive interest rate environment and I’ll invest more in the mid-cap and the small-cap names or international opportunities that may have more potential for outperformance as we get into that environment.

The more supportive environment when interest rates start coming down, I think there are many opportunities in the global market where they may present a better upside than U.S. companies. And I think that, in that kind of environment, I think the portfolio would broaden out to include many of these international technology companies.

I think that there is a lot of concern right now that technology may have run up too much, specifically these magnificent seven names, which are the large-cap quality tech names that have outperformed this year versus the broader market.

But I think you have to look at it from the context of where it had been after the big selloff in 2022. Many of these names are just coming back up to where they had been prior to the downturn in 2022, and many have not actually reached those levels.

So I think we have to look at it from the broader perspective of the longer-term opportunity. I had mentioned the generative AI as being a long-term driver of growth, which I believe has still a long leg for growth in terms of the amount of infrastructure that needs to be built out, in terms of the software that needs to be developed and in terms of the services that can be provided by marrying data with large language models and being able to provide that to consumers through generative AI.

So there are a lot of long-term drivers of technology, and I think that there’s still a long runway for growth going forward regardless of the interest rate environment.

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Michael Sager, deputy chief investment officer, multi-asset currency management at CIBC Asset Management.

The first topic to discuss is how interest rates and the broad interest rate environment are affecting currencies. I think there’s two perspectives here.

The first one is that higher interest rates and also wider interest rate differentials between currencies are absolutely a boon for active currency investors. That is, investors who look to add value to client portfolios through taking active positions, long short positions in various currencies around the world. Interest rates are one of the key drivers of currency direction, currency returns. So if you have wider differentials, you have more opportunity to add value. If we look at interest rate differentials today, we are pretty close to two-decade highs. So that tells you that, at least from this perspective, an interest rate perspective, the opportunity to add value to investor portfolios from decision-making in currencies, position taking in currencies, has not been this attractive for a long time.

Second one is a broader macro context. Market participants certainly didn’t expect policy interest rates to rise as quickly as they have over the past 18 months, nor did they expect them to rise to the levels they’ve reached. And I think the same goes for bond yields too. A lot of that rise has reflected resilient growth in the U.S., but nonetheless, it’s now getting to levels or rates and yields are getting to levels where they’re adversely affecting market sentiment, and that in turn is adversely affecting some of the more pro risk emerging market currencies.

The U.S. economy has remained more resilient in terms of economic activity. Both more resilient than market participants expected in absolute returns, but also relative to other major economies. So it’s the U.S. economy that is the primary driver of higher-for-longer from central banks. It’s the U.S. economy that’s driving yields to levels that were not expected even six months ago. And so given that it’s the U.S. economy that’s in the driver seat, this is very positive for the U.S. dollar.

Although we do expect the dollar to be stronger for the next three to six months, one of the most strong currencies, it’s not going to appreciate so much that it has a really significant bearing on economic outcomes. Oftentimes, a strong dollar will impact import and export demand in other countries. A strong dollar will materially impact the outcome that various countries experience in terms of inflation. That’s certainly in play at the margin, but much more important at the moment is just the general tightness of central bank policy around much of the global economy.

Europe is in a recession, and there the European Central Bank has a quandary. Economic activity is weak and weakening, but inflation is converging back to target much slower than expected. So inflation is too high, which is why the European Central Bank is keeping policy tight, higher-for-longer. But that has important implications for deepening further the economic recession.

China has experienced very disappointing economic growth over the last six months related to particularly structural problems in its domestic housing and property market, but also high levels of indebtedness at the local government level. So China is doing something completely different to other major markets. It’s stimulating growth, or at least trying to, via policy easing. So as I say, that’s very different to the U.S., to Europe, to Canada, other developed market economies, where higher-for-longer in terms of tight policy is the norm.

So what can investors do with that information to benefit portfolios?

Well, certainly we think that it’s beneficial to include active currency as an investment allocation within portfolios. Currency markets are very liquid, active currency returns are very diversifying, and active currency mandates are unfunded. They’re implemented via forward contracts that don’t require, in most cases, initial margin payments. So the mandate is very capital efficient. It’s unfunded, which is very different from most other investment mandates.

So what about the Canadian dollar, the loonie? What is its outlook in the next three to six months? Our bias is to think that the Canadian dollar will be weaker against the U.S. dollar over this time horizon for a few reasons. One, the Canadian economy doesn’t look as resilient as the U.S. economy. GDP growth data over the past couple of quarters has been less positive, less strong for Canada than it has been in the U.S. The Canadian housing market continues to look extremely overvalued, and productivity in the Canadian economy has been negative since prior to the Covid pandemic.

Productivity is really important because it’s a key element in the attractiveness of currencies. Their ability to attract capital flows. The most productive economies are the ones that attract the strongest capital flows. So Canadian productivity being negative for a number of years now is not positive for inward capital flows into Canada, which is not positive for the Canadian dollar.

So whether it’s from a more secular trend, that would be the productivity story, or a more cyclical trend, relatively weaker GDP growth, a vulnerable housing market, the outlook for the Canadian dollar against the U.S. dollar is not particularly bright over the next three or six months.

One of the key inputs in that outlook also is the price of oil. Canada’s a big producer and exporter of oil, so in periods where oil price is strong, that’s helpful to the Canadian dollar. And in periods where oil prices weaken off, of course, the opposite is true. Over the past couple of months, we’ve seen some strength in the price of oil, which by itself would’ve been supportive to the Canadian dollar. But if you put it together with all of those other factors, GDP growth, housing, productivity that I mentioned earlier, the net is not particularly attractive.

Going forward, we do think that underlying growth trends in the global economy, including in the U.S., will weaken off. We expect a mild recession for the global economy over the next year or so. That’s not positive for the price of oil. So we think probably we’re at or about the peak for the time being and the price of oil, and we are likely to see a little decline from here. That will add to the relatively negative view on the Canadian dollar in the short term.

All of that said, much longer term, we think that the U.S. dollar is very expensive, and that the Canadian dollar will recover. But that’s a longer term, one, to two, to three-year view.

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Luc de la Durantaye, Chief Investment Officer, CIBC Asset Management.

Definitely the higher-for-longer trend for interest rates has now resumed, and I say this because it’s been interrupted by the U.S. regional banking crisis and the government debt ceiling between March and May of this year. But interest rates, before that had been, if you look at a chart, interest rate had been on a rising trend since the lows of the pandemic in mid-2020. This rise, the continuous rise of interest rates is the reflection of a very different macroeconomic environment that we had been accustomed to during the global financial crisis.

The new environment, if I can describe it quickly, is one where government spending is very high, considering we have been in an economic expansion. Usually, the kind of large fiscal deficits we see in the U.S. and Canada, even in Europe, is during a recession, not during an expansion. The U.S. deficit will be, for example, more than 6% GDP.

And if you look at the Congressional Budget Office forecast, which is a bipartisan organization that looks at the fiscal deficit and debt projection for the long term, they say the deficits will continue and debt will continue to grow over the coming few years. So that’s one very different environment because after the global financial crisis, governments were actually doing fiscal retrenchment. So that’s one change.

The other change is central banks are engaged in removing their Covid stimulus in two ways. One we’ve seen already, they’ve raised their policy, Fed fund policy for example, one of the fastest tightening that we’ve seen. And that’s because we have high inflation, which was not the case after the global financial crisis. And they’re also engaging, and this is what pertains also to the long end of the bond market, is they’re reversing their quantitative easing with quantitative tightening. This is really only the second time in history that they’re trying to do this. So they’re letting their bonds mature and that’s shrinking their balance sheet. So you have their removal of an important buyer in the bond market.

The world economy is also engaged in an energy transition that requires enormous investment for new sources of energy like wind, solar, nuclear, et cetera. Investing in renewing old infrastructure, there’s also a need for that and investing in new promising technologies. So there’s a lot of investments.

So this is all occurring at a time when the world population is aging. And what that means is that older generations are not saving, they’re saving less. So when you draw a conclusion, if you look at this picture, the global pictures, we have an imbalance because on the one hand you have less buyers of bonds. Central banks are not buying bonds anymore, they’re either letting them mature or selling them. Individuals are buying less than before because they’re retiring. So on one hand you have less savings and on the other hand you have more demand for investment.

Governments are dis-saving, they’re spending too much, so they’re issuing a lot of bonds. And corporations will be issuing bonds to their investment in that energy transition and technology investments. So you have an imbalance between, you have less buyers of bonds and you have more issuance of bonds, and that’s what creates this imbalance. And that’s what’s pushing interest rates higher. And they will be higher for longer because these are longer term trends.

So that’s the dilemma that we’re in. That’s the new environment that we are in.

How does that affect our outlook for bonds? Well, we’re trying to assess where we are in this repricing of bonds. Part of that depends on your economic outlook. And that economic outlook we have is one where we’re going to continue to, the main scenario we have, we’re going to continue to see a deceleration in growth because you’ve had a rise in interest rates. That is going to continue to impact the outlook for the economy.

And the central banks will not ease at all until they see pressure on the labour market at base. You have to see less wage growth, you have to see a less tight labour market, and we’re not there yet. So you need to see more evidence that deceleration is occurring before they can, one, pause and eventually consider easing monetary policy.

Since the yield curve is still somewhat inverted, you’re not rewarded enough to take on a longer maturity in your portfolio. So if your scenario is one of a continued deceleration in growth, you have an inverted yield curve, you don’t necessarily want to be too far into the spectrum in terms of duration. It’s only if you were to create and construct a stronger economic weakness, like a material recession, then you could start considering longer maturity. But I think the evidence is probably there for at least a continued slowdown. But it’s not there to say that you’re going to be in a recession and therefore you want to enter long bonds at this point.

So again, if you continue with the scenario, if you have a deceleration, you want to continue to stay defensive until the economic outlook of a more pronounced deceleration occurs. So you want to avoid the economic risk. So we’re considering being neutral in terms of investment grade, underweight high-yield, and wanting to look for opportunities in emerging markets.

So there’s a whole world within emerging market, and you have to be very selective. These markets offer much higher rates in a global deceleration environment. And when the Fed starts to signal a pause, that’s going to be a more attractive environment for a number of these economies because they’re starting from very high rate and they have room. Because inflation has come down, they have a lot of room, they have very high real yield. That’s going to create some opportunities in some selective markets.

And some of these countries, funnily enough, they’ve been running fiscal policy much more prudently than a number of developed markets. I’m thinking of Mexico for example, they’ve been running a much more prudent fiscal policy. Indonesia, same thing. So that you have a number of economies that are providing some very attractive real yields at the moment. And as soon as you get a little bit of an easing or plateauing in rates from the Federal Reserve, those are going to be some attractive opportunities.

So in terms of our preferred environment first being more into sort of mid to shorter end, because the yield curve is inverted, you’re looking at being careful with some of the credit side of things like investment grade and underweight, even high yield, neutral on the emerging markets. But looking for opportunities, emerging market bonds. And looking for opportunities as you see the development of that economic slowdown.

About equities, equity is a bit tricky because again, to go back to the basic economic slowdown scenario, there’s a number of markets that you want to understand a little bit what will be the impact on earnings. Because the price to earnings at the moment is relatively high, and you also have interest rates that are providing a lot more competition to equity markets at these levels. So you want to be making sure that you want to be in equities that are going to be able to sustain their earnings, because you already have fairly high competition on the fixed income space, even in the short term, which provide very low volatility relative to equities. And so, you want to see that economic scenario unfold and having that sustainability and earnings before you want to commit a lot more.

So we’ve been underweight in some of our strategies. We’ve been underweight equities in general. We’ve been underweight the U.S. in particular. But again, it’s that unfolding of that economic scenario that you want to see a little bit more of before you want to commit a little bit more on the equity side.

I think the environment for currencies is interesting because, in that environment, there’s decoupling between different areas. There’s decoupling with China and Asia. You see that China is lowering interest rates. A number of countries there have started to, they’re close to their peak of interest rates. Whereas, a number of Western economies are continuing to raise interest rates, and so that creates very different economic cycles.

The currencies are driven a lot by interest rate differentials, and that creates a very wide interest rate, differential gap. So between China, who has China, Taiwan, Japan, and somewhat the Euro zone, which have started to signal that they may have ended their tightening cycle, they offer very low interest rates. And so, their currencies are weakening. So you can underweight these currencies and overweight some of the currencies that are offering very high interest rates. Again, we’re going back to the same ones like Mexico, India, Brazil, that offer a very large interest rate differential.

So that’s opportunities within portfolios that we can take advantage of. Look for unfolding opportunities is what I would say. There’s always fear in this environment where central banks sound more aggressive and that creates maybe a bit of a passive approach by investors. But on the contrary, I think where there are changes in the market, there are opportunities. And we think the coming months will provide attractive investing opportunities.

The tightening cycle for many central banks is coming to an end. It’s come to an end in a number of emerging markets. It’s going to come to an end in developed markets. And in many emerging markets, a number of central banks will have to leeway soon to continue, because some have started to lower interest rates and stimulate their domestic economy.

So each central bank will provide better entry points in the bond market and it will provide attractive opportunities in some of the emerging countries.

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management. A podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Michal Marszal. I’m a portfolio manager focusing on the global healthcare sector at CIBC Asset Management.

From a perspective of the macro-economic impact on healthcare, it is important to remind investors that as a sector, healthcare is rather macro-economically defensive. The vast majority of the sector is represented by pharmaceuticals as well as healthcare services, which typically have a fairly steady demand profile through the macro-economic cycles. However, there are pockets of the global healthcare sector, accounting for about 15% of the total sector, that will have some degree of sensitivity toward macro-economic downturns. And these are typically pockets of medical devices, elective procedures, et cetera.

So, looking today at the changes that have been taking place within the global economy, I think that the most notable developments are from a perspective of overall growth, as well as inflationary trends.

I think, notably, the North American region has been reasonably resilient. We have seen some pockets of weakness in Europe. And of course, the relatively slow recovery of the China region, from a perspective of overall economic growth, has had an impact on the global healthcare sector, specifically looking at the demand for the discretionary procedures. Here, that was somewhat offset throughout 2023 by the backlog of cases that were worked through post-Covid. So a relatively muted type of an impact. And particularly in Europe, the weakness is then largely offset by the public funded nature of the majority of these types of sub-sectors.

From an inflationary perspective, I think that there are two elements here. We obviously have seen inflation subside, and that’s with respect to the demand side as a reflection of the fact that the demand has been weakened through the interest rate hikes. So that in and of itself mostly had an impact from a perspective of tightening credit conditions. And here, the greatest impact is, as usual, noted in the longest duration assets. So the small and mid-capitalization types of companies, especially in sectors such as biotechnology, have seen credits tightening. That has had some flow through impact on the sub-sectors that are somewhat tied to the financing within these types of various … here, I’m looking at things such as life science and research tools, sub-sector within healthcare. And there has been a notable slowdown.

On the flip side, the positive is the opening up of the supply chains. So again, supply chain constraints have also contributed to inflationary pressures in the past, and these have largely subsided. And that is positive for particularly the broader healthcare technology sector, which is responsible for manufacturing various devices, as well as research tools. And here, that acts as a positive impact on the overall cost of goods. So that is, I think, the totality of what we have witnessed this year with respect to macro economic conditions affecting the global healthcare sector.

Research and development is really at the heart of the global healthcare industry, which has really driven a majority of the value added through innovation. I think that the major pockets of healthcare that are really driven by these types of trends are the global biopharmaceutical sector, where large multinational pharmaceutical companies are heavily investing in research and development activities, continuously trying to advance pipelines of attractive assets. And we have obviously seen over the last decade or so, a tremendous growth within the biotech space. That also provides an inorganic source of innovation for the global biopharmaceutical industry.

And I think looking at the trends here, what we’re seeing is really a steady cadence of innovation, fairly solid progression of pipeline assets across a number of important therapeutic categories. We have seen notable developments in the area of oncology with very advanced treatments. Also, recently, a significant step-up in investments in the area of neurology. And interestingly enough, also a tremendous amount of work now being done in areas such as cell senescence, or aging, with some interesting early developments.

I would also note that the industry is increasingly tapping into the potential of artificial intelligence, augmenting those research and development processes. And that possibly could lead to the speeding up of a lot of the early stage R&D activities, as well as possibly going into the early stage, very early stage discovery phase. And so we possibly could be seeing over the next couple of years, a significant improvement in the overall productivity of research and development in that space, and that really having the greatest amount of impact on outcomes as we look at modern medicine.

Somewhat more of a modest change in terms of the impact of R&D on new product introductions and platform introductions, is what we’re seeing happening in their space of medical devices as well as research tools. The second sector, the research tool sector, being significantly tied to the type of innovation that we’re seeing within biopharmaceuticals, because these are effectively devices that are being used specifically for research in this space. And in these types of sub-sectors, innovation level is more steady, it’s more modest. It’s less revolutionary, more evolutionary. And I think that what we have seen more recently is really a continuation of the trends.

And I would also note that the significant component of the healthcare services space, such as contract research organizations as well as contract manufacturing, also play a very critical role in how research and development is progressing going forward. And these are fairly attractive growth opportunities from an investment perspective because they effectively represent an exposure to the types of trends that I have just highlighted.

Right now, the top picks, as I would probably split them by sector within the global biopharmaceutical industry, some top quality names such as Roche or Novartis would really be top of mind. These companies have very well diversified, high quality-based businesses with underappreciated pipeline assets. And have historically been, really in the top tier in terms of their ability to innovate and advance their pipeline products much more rapidly and with much greater success than their peers.

Within the broader healthcare technology space, I would highlight companies such as Medtronic or Thermo Fisher as again, really well diversified players. Very solid based businesses tapping into durable growth end markets, with a steady cadence of innovative pipeline assets. And within healthcare services within the United States managed care space … which this year has been somewhat less attractive from an investment perspective simply because of the temporary issues with respect to the elevated cost trends. Somewhat of that is tied to what I have mentioned with respect to the backlog of cases that had to be processed this year post-Covid. However, within that, a company like CVS, for instance, represents a very attractive investment opportunity because of its idiosyncratic nature of value drivers.

And within the space of outsourcing of certain services, at topic would be companies such as IQVIA. Again, tapping into some of those really attractive growth trends within research and development. This is a provider of research and development services, so really being at the heart of the innovation engine for the industry. And interestingly enough, being one of the early leaders in adopting artificial intelligence tools to augment those research and development capabilities. And that really being the category leader in that space. These right now would represent really the top ideas within [inaudible 00:08:59] that I think are a really strong setup heading into next year and beyond.

The major risks with healthcare will always pertain to regulatory developments. Investors should always be paying attention to any significant changes within the key healthcare systems in the United States, in Europe, Japan, and China. Some of that pertains to pricing. Some of that will pertain to changes in broader reimbursement, et cetera.

I think right now, given where we are with various election cycles, there may be a significant step-up in the dialogue around possible changes in healthcare cost savings associated with various changes to how healthcare is being ran in various jurisdictions. However, I do not foresee any significant actual developments that will materially change the growth outlook for the entire space.

So while it is important to pay attention to and clearly track any developments that may deviate from this status quo assumption, broadly speaking, we should not be looking at significant types of developments that represent downsides to the space.

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Adam Ditkofsky, senior fixed income portfolio manager, CIBC Asset Management.

Following the Bank of Canada’s decision last week not to increase the policy rate above 5%, not much has changed in terms of our outlook, which leans towards an economic slowdown and a moderate recession.

First, the market was not expecting the bank to hike rates, as recent economic data has been materially softer than expectations, but specifically second quarter GDP came in at minus 0.2% for Q2, well below market expectations, which we’re looking for plus 1.2, and well below the bank’s most recent forecast, which was looking for 1.5%.

A big part of this has been driven by Canadians appearing to be pulling back on spending with retail sales coming in weaker than expected and recent housing activity being softer. So really the question remains, has the bank hiked enough to cool the market, and will inflation, which has been easing this year, continue to come down and normalize around the 2% that both the Bank of Canada and the Fed are hoping to achieve?

Now, if we look at the bank’s most recent comments, they remain somewhat cautious, especially since inflation is still elevated above 2%. So they haven’t ruled out further hikes, but given our outlook, we see them as being close to the end, if not done. A big part of our view in Canada reflects really on the nature of our mortgage system, where most mortgages here renew every five years, leaving Canadians more vulnerable than our U.S. neighbours to higher rates in the near term.

We’re already seeing Canadians pull back. In fact, if you look at GDP on a per capita basis, it’s been negative for four of the past five quarters, with the bank not expecting an improvement until later next year. Canada’s aggressive immigration policy has helped really drive GDP, but at the individual level, Canadians are seeing their net worth actually get worse or deteriorate. To be clear, we’re not saying immigration is bad. We’re simply highlighting that it’s growing faster than our country can accommodate.

Now, I think we have to take into the strong job growth we’ve been seeing, for example, so Canada has added this year more than 300,000 jobs, but unemployment this year has also risen by more than half a percent to five and a half percent. The question we have to ask ourselves, if jobs become less plentiful or start shrinking, will that rate quickly rise if our immigration policies don’t slow? So we argue that the risks of a recession are very real.

Now, in terms of the U.S., the economy has been more resilient, especially since Americans don’t need to refinance their mortgage every five years. They get to lock in rates for the entire life of their mortgage, so they’re less sensitive to changes in interest rates. Still, there are areas of concerns in the U.S. One, pent-up savings from the pandemic are almost used up, and two, credit card debt is rapidly rising, meaning people are borrowing more, with many noting they’re using credit cards to pay their daily expenses. So consumers are running out of steam. But how quickly this plays out will all be dependent on what happens with the job market.

Now, one concern we have is inflation. Now supply chains have normalized and in many regions, rents are coming down, and this is for Canada, but we have been seeing evidence of food prices and energy prices moving modestly higher. So there are dangers that inflation could emerge or stay sticky. We do think inflation will continue to come down over time, but the rapid deceleration we’ve been seeing this year seems to be over. So we think it’s going to stay elevated above 3% for some time.

So while the central banks are close to the end of their hiking cycle, we expect that they will leave rates elevated at current levels for some time, and we aren’t expecting any rate cuts at least until mid 2024.

So from our perspective, we actually see the outlook for fixed income being very favourable. One, recession risks are rising, inflation has come down and should continue to come down over time, albeit at a slower pace. And central banks are close to the end of their hiking cycle. Plus yields are at the highest level they’ve been in more than a decade, offering very competitive rates to GICs. But not only that, you also get the added benefit of more efficient tax returns versus GICs, as most bonds today are trading at a discount and benefit from the potential of price appreciation as they move closer to maturity.

Also, on top of that, there’s also the potential for further price appreciation should the economy slow further and yields fall. So bond investors could get returns in the range of five to seven percent without even taking any significant duration risk.

Aside from rates, of course we’re watching what happens with inflation, and yes, we are paying attention to food and energy prices. But in our view, we think core CPI is more relevant and it reflects what central banks can control, as really food and energy are more driven by supply and demand factors.

Now, I’d argue in Canada we should also exclude shelter costs, which have also benefited from a lack of residential supply and are impacted by rising mortgage costs, which are up more than 30% year over year. So core CPI at shelter has returned, in fact, to more normalized levels. In fact, most recent data print was seeing an increase of 2.5% year over year, and over the past three months, it’s been trending below 2%.

Now, I think it’s also important that we watch labour data, which yes, is a lagging indicator, but it’s resilience partially explains why consumers, especially in the U.S., continue to be confident with their spending patterns. Ultimately, consumers can continue to pay their mortgage and pay down credit card bills so long as they have a job. Now, from our perspective, though we are seeing some cracks, one, the number of job vacancies are coming down in the U.S. and in Canada. In the U.S. the number of jobs available to the number of people who are unemployed has fallen from a high level of above two times to now most recently one and a half times. And salaries for new hires are coming down year over year as well, according to major recruiting firms. And probably the most important, corporate profits are continuing to fall with the S&P 500 seeing the largest decline in Q2 since 2020. If profits don’t improve, it should cause layoffs as companies look to support their stock prices.

In terms of bonds that look the most attractive, we particularly like bonds in the shorter end of the yield curve, as again, the yield curve is inverted, meaning investors getting higher yields in bonds with shorter maturities that are less sensitive to changes in interest rates.

Now, given our view of a slowing economy, we believe over time shorter dated rates will return to more normalized levels, meaning yields will be lower. So investors in short bonds, call it one to five years, five to 10 year bonds will benefit. Now, we also like short-dated investment grade corporate bonds, with some of the banks and the most liquid investment grade securities offering yields north of 6% for some of these bonds. Now, of course, bottom-up analysis is key to ensure credit fundamentals are sound, so having a strong credit team doing the work with you is necessary.

In terms of other opportunities, we also like private debt securities and emerging market debt in some cases as well, depending on the specific countries. As well as some alternatives as well, because generally in those situations we are seeing spreads being materially wider than some investment grade bonds, and those maturities actually tend to be actually shorter in nature. Specifically if we look at private debt, some of those that we are looking at are involved in infrastructure for energy infrastructure, as well as data centres and the movement of data across the internet across various different internet protocols. So there’s a lot of opportunities in that space that we see being high quality counterparties and offering quite attractive spreads relative to government bond yields and offering increased yield enhancements for our portfolios.

In some cases, even for portfolios that allow derivatives, we also see some opportunities as well because they allow us to focus our carry and shorter dated government bonds, meaning that we can actually go out and buy short-dated, call it one-year bonds, at yields north of 5%. But, we can still get that duration exposure by using derivatives in the portfolio so that we aren’t potentially reducing that hedge against the potential for increased recession risks. So there are a lot of opportunities right now in our purview to really increase the yield within our portfolios, and that’s what we’re trying to do, because ultimately that’s what investors are looking for today.

In terms of bonds that may not provide much yield, we are cautious on high yield as spreads are sub 400 basis points. In times of stress, high yield spreads have been materially higher, meaning they could materially sell off if we see a material slowdown. And given our economic outlook, we are more cautious and have reduced our exposure to the sector.

Now, we’re also cautious on longer dated corporate bonds, not just because the yield curve is inverted, but credit spreads also can move wider and push bond prices lower if recession risks rise. So we’re maintaining an underweight in longer dated corporate bonds.

Ultimately, our view is to focus on shorter dated, higher quality risk assets, which in today’s environment with the yield curve being inverted, the bond market is paying you to do.

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Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Amber Sinha. I’m with CIBC Asset Management, part of the global equity team.

There seems to be momentum building up in the soft-landing camp. So there are a lot of experts, commentators, they have been coming out and seem to be more confident of a soft landing or less worried about a hard landing, whichever way you want to call it.

If that were the case, I have no doubt the impact on the equity markets would be positive. Because despite the fact that we’ve had a strong 2023, there are several questions around what is to come later in the year, et cetera. So if we have more visibility and we just have a soft landing, I think the recession fears will go away, and that’ll definitely be helpful for the markets. What would also happen is inflation would be a lot lower, or at least within the ranges where the central banks want them. That’s a soft landing where inflation goes back to being well-behaved.

If that is the case, then what does that mean? That means the central banks will have an opportunity to loosen some. We could see interest rates go back down.

And that, again, would be a positive for the stock market for a couple of reasons. One is the headwind that the consumers have from higher interest rates will… They’ll see some relief there. And then secondly, lower interest rates are generally positive for equity market valuations as well. This is just an asset allocation thing. So bonds cease to be that attractive. It just puts more of an undervaluation. So interest rates, if they were to be walked down, they would have a positive effect in terms of going away with the headwind that consumers face, and also positive for the stock market valuation. So again, I think we would be surprised if we were to get a soft landing without a fairly positive impact on the market.

Now that being said, I will say that we are not 100% convinced like the other experts that have been talking about it, and there’s some reasons for that. I’ll say, when we’ve had high or troublesome inflation in the past, the solution has always been to create a recession. It’s a recession that was required to bring inflation down when it was getting to very high levels. And right now, what we’ve seen in the last two, three years is 40-year high inflation. So to expect that to come back to the range where the central banks wanted without a recession, it’s certainly not been achieved in the past, so I don’t think we are that convinced.

And I would also add to it that the leverage in the system, consumer leverage, corporate leverage, sovereign leverage, so the leverage at the government level is a lot higher now than in the 80s and 90s when we’ve had bouts of high inflation. So I think it’ll be a difficult one to pull off. But yeah, if they were to pull it off, I think certainly should be a positive impact for the stock market.

How does a soft-landing affect growth versus value?

The growth stock should benefit from lower interest rates. So lower interest rates weigh on valuations, and especially on valuations for growth stocks. The more value names, I would say, initially should do well also, because again, value stocks tend to be more cyclical, tend to be more cyclical in general. And then if you are talking about a soft landing, then, again, there is no recession. There is just a soft landing. So the recession fears that are priced into more cyclical stocks could actually lead to a period of good performance from value also.

We’ve been fairly negative on Europe. Again, in our business, we have to focus on the fundamentals and not get distracted by noise. And the fundamentals make it pretty clear that it’s a tough economic situation in Europe. Despite that the market has been fairly strong, especially since September of 2022, we have had almost a 50% rise in the European stock market, so world leading performance.

You don’t hear it all the time from Europe, but here you go. In the last one year, it’s done very well. So rather than taking that as a positive, that adds to the list of concerns we have on Europe. So despite the fundamentals being shaky, now you have valuations also, which are quite stretched because of the recent strength in the stock market. So what are these issues? I would say economically on any given day, Europe tends to be more vulnerable than North America. That’s just the structure of the economy, level of profitability, GDP growth, et cetera.

So at any point in time, the setup in Europe from an economic point of view tends to be a little bit weaker than the U.S. You also have Germany, which is officially in recession, and the Germany economy is the European economy. Not literally, but it has a very big impact. So if Germany is not able to get out of the recession, it will pull the entire European system down with it. Europe tends to be a lot more vulnerable with respect to energy costs compared to what we have over here. So if you recall last year during the initial breakout of the conflict in Ukraine, the utility prices, gas prices, electricity prices in Europe went up twofold, threefold, fivefold. It was all over the news.

Europe certainly is a lot more vulnerable that way, and the weather was nice last year in terms of a milder winter. But if we do have uncertainties with regards to what this winter is going to be like, I think energy prices just put Europe in a very precarious position. So the rate shock for European consumers is going to be even higher than what it’s for us here. So starting off from a economically precarious position and having to deal with one of the highest rate shocks in the world, again, can lead to any positive outcomes.

And then last but not least, wisdom from the last thousands of years is peace and prosperity go together, and there is no peace there. The conflict continues to drag on. And again, with these conflicts, there’s always the potential for further uncertainties, further headwinds to the economy. And again, Europe, given its geography, is a lot closer to these issues.

Asia stands out as the one we would be willing to back more than in the past. We look at Asia as three kind of separate buckets. One, and the biggest one, is Japan, which is the biggest part. It’s almost a third of the Asian stock market by capitalization. Japan has a big impact on Asia-Pacific performance. And while we’re not overly bullish on Japan, it is probably the only country in the world that has actually wanted higher inflation. And the central bank in Japan has tried a lot to engineer higher inflation over the last 30 years, and they have almost failed. And here we are, we now have inflation because of reasons that are external to Japan’s control. So the Japanese economy with higher inflation can actually come out of this 30 year deflationary funk that they’ve been in.

The other bucket is China. Again, can’t ignore it because of its size. It gets bigger every year. For our global mandates, we do not invest aggressively in China. It tends to be outside our mandates. But again, China does feature some really solid national champions, and those are the ones that we try and learn about, get comfortable with, pick some positions there.

And then the other bucket I would say is Korea, Aussie, Singapore, Taiwan. These are the economies that have more likeness to the west, which means more mature, slower growth, so nothing to get overly excited about. And then the rest of Asia is just fundamentally strong growing middle class type of economies, India obviously being the big one there. But Indonesia, Philippines, Malaysia, Thailand, there’s lots of potential there in terms of people making more money and doing things that they can do now that they couldn’t do in years past.

So like North America also, it’s been strong performance in North America also, but it’s largely come out of a very few stocks or few sectors, technology being the big, big one this year.

There are stocks outside of technology that have lagged, that have really not done well. And these are strong companies, high quality, dominant companies. But today everybody cares about technology and AI. So companies like Nike, for example, has had a very rough go. I was just looking at it this morning, September 8th, 2023. The stock is back below $100 for a company that is the world leader in sports apparel, highly engaged company, sustainable competitive advantage. It’s just the definition of a quality company. And we struggled with the higher valuations in the past, but these stocks are available for fairly reasonable prices nowadays because everyone cares about technology.

So I think outside of technology, North America does have opportunities with regards to some solid blue chip companies that people are just [inaudible 00:08:44] right now.

Text transcript

Welcome to Advisor ToGo, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject matter experts themselves.

Colum McKinley, senior portfolio manager, CIBC Asset Management.

We have seen a period of time here where Canadian equities have underperformed their U.S. peers, but we think there continues to be reasons to be quite positive about the longer term outlook for Canadian equities.

And if you first look at the performance that we’ve seen over the last year to the end of August 31st, 2023 in U.S. equities, it really has been performance-driven by a really narrow market. And there’s been a lack of breadth. And technology stocks or a handful of technology stocks have really driven that performance. If you look at the performance of Nvidia, Tesla, Microsoft, Apple, Google, Amazon, all fabulous companies, all great businesses that are doing quite well in delivering for shareholders, but they have disproportionately driven the performance of the U.S. market. And absent the returns you’ve had here, it’s a very different market when you think about how the U.S. has returned. Yet that performance is embedded in the overall return of the index.

If we look at the outcomes of this at the end of August, the valuation of U.S. stocks is much higher than Canadian stocks. U.S. stocks are trading above their long-term averages while Canadian stocks are trading at a discount to their long-term averages. So the S&P 500 at the end of August is trading at a price to earnings ratio of about 19 times. That’s long-term average over the last 10 years, has traded around 18 times. So it’s trading at a premium to where it historically trades.

And in contrast, the S&P/TSX composite at the end of August is trading at a price earnings ratio of approximately 13 times, and its 10-year average is closer to 15 times. And so we can see the Canadian market trading again at a discount to its historical average, and a meaningful discount to where U.S. stocks are trading today. We think that ultimately gets recognized by the market.

I think the second thing that is noticeable, especially in this low interest rate environment and an environment where investors continue to look for attractive dividend yield, the dividend yield in the Canadian market is basically twice that of the U.S. market. So the S&P/TSX has a dividend yield of 3.3% at the end of August, while the S&P 500 has a dividend yield of 1.5%.

And we know that dividend income is incredibly important to investors over the long term. We think about that as the bird in hand for equity investors. So we like to expose your portfolios to high quality dividend paying stocks that have sustainable dividends and that can grow those over time. And we think investors have been rewarded.

So over time, we expect the valuation differences between the Canadian market and the U.S. market, that those will eventually revert to their long-term averages. And as a value investor, I think that’s one of the key ingredients to thinking about how the U.S. market and the Canadian market will perform over the coming years.

For this to work, for Canadian markets to regain some of this performance, we really need some key sectors, such as the energy sector and the financial sectors, to be a key driver. And we think both those sectors are trading at really low and attractive valuations today. They offer attractive dividends. And we think that ultimately those components will be recognized by the market and drive performance.

So what sectors still provide opportunities in the marketplace today? I think the energy market continues to remain quite attractive for investors. These stocks are trading at below historical valuations. So we think they are continued to be mis-priced assets. They’re generating very strong cash flows. And very strong cash flows generated with today’s current commodity prices. And we also have a constructive view on commodity prices going forward given the supply and demand dynamics around the world.

And third, the management teams in this sector continue to remain very focused on capital discipline. So they’re generating strong cash flows, they’re using that to pay down debt, and the returning excess cash to shareholders. And so we think that this sector broadly remains quite attractive, and one we want to be exposed to for all of our clients.

One of the specific stocks that we hold across most of our portfolios is CNQ. This is a company with great assets, has a very strong management team. They’re generating substantial excess free cashflow and returning that to shareholders. So in the last quarter, CNQ returned $1.5 billion to shareholders, so a billion dollars in dividends and $500 million in share buybacks. And these amounts will go up. The company has committed to using a hundred percent of their free cashflow, returning a hundred percent of their free cashflow to shareholders when they hit a $10 billion debt level. And they’re at about $12 billion today in debt. And so over the coming year, we are going to see more and more of that cashflow being returned to shareholders via higher dividends and more share buybacks.

The other area within the energy space that we think is quite attractive is the midstream and pipeline companies. And these are businesses that have contracted revenues, contracted relationships with the E&P companies, so with strong companies today. And we think that a basket of energy and pipeline companies is going to do quite well for shareholders. And so we like Enbridge, Gibson Energy, TC Energy. All of these stocks very well positioned. They have very highly predictable dividend streams, and current yields in the high single digits.

And so again, in an environment where people are looking for consistent stable dividend income, we think that a basket of midstream and pipeline companies is able to provide that and have certainty in the cash flows and those dividends over the long term.

One of the risks we are watching and monitoring in the marketplace is what I would describe as a broad risk related to the effect of interest rate increases that we’ve seen over the last period of time. And we know that consumers drive a big part of the overall economy, and we have just gone through the fastest interest rate tightening cycle that we’ve ever seen.

Now, generally, when interest rates go up, it has a lagged effect before it begins to negatively impact consumers. But we know that the cost of mortgages, the cost of car loans, cost of consumer loans, they have all risen quite substantially. And we know this is happening in an environment that is already challenging for consumers because of the broad inflation that has been taking place.

Now, there are some signs that inflationary environment is coming under control. But we are monitoring and watching very closely the effect that the rise in interest rates could have on consumer consumption. And again, this could have an impact on a large number of sectors given the overall contribution of consumers to the broader economy.

Now, the key offset to this in today’s environment is the labour environment. So as long as labour markets remain tight, it will help consumers navigate some of the rate challenges.

But I think this interest rate environment and the changes that we’ve seen so very quickly is something that we should be thinking about across all of our portfolios and across all sectors.