Welcome to Soundbites, weekly insights on market trends and investment strategies brought to you by Investment Executive and powered by Canada Life.

For today’s Soundbites, we’re asking Todd Mattina, senior vice-president and chief economist with Mackenzie Investments, for his takes on 2023. We talked about the current state of bond and equity markets, and we started by asking how Canada is positioned for the coming year.

Todd Mattina (TM): So, 2022 was a pretty challenging year for the global economy and global capital markets. But in a difficult year, Canada was actually a relative outperformer. We saw energy and food prices worldwide surge, and that contributed to global inflation and even stagflation. But food and energy are top exports in Canada. So, that was a boost to incomes in Canada, giving us a bit of a lift. In addition, while housing activity definitely weakened in 2022, it wasn’t as bad as many economists feared given the dramatic rise in interest rates. And when you look at the hard numbers, you can see that real GDP growth for last year in Canada was estimated at around 3 to 3.25%. And that compares, in the U.S. to something more like 1.75%. So, Canada did relatively well last year.

The state of equity markets.

TM: Clearly, equity markets were under a lot of pressure in 2022. But, you know, since October we’ve seen a dramatic rebound in global stocks. I think investors, just judging by this rebound, are expecting a fairly mild economic slowdown this year, a so-called short and shallow recession. Personally, I’m a little bit more cautious about the outlook over the near term. I would say, historically at least, central banks have needed a much higher-for-longer interest rate to get inflationary pressures back under control. And that’s typically led, unfortunately, to a deeper economic contraction, and more softness in the labour market. So, I think the market may be a little overly optimistic at this stage, Long-term though, I think the equity market has come off the frothy valuations that we saw back in 2021. So, for long-horizon investors, the outlook, I think, is looking quite promising.

The bond market.

TM: We saw a dramatic increase over 2022 in bond yields. Suddenly fixed income is back to a place where it can play its traditional role in a portfolio — the role we’ve all grown accustomed to in a multi-asset portfolio — that is, balancing equity risk. Yields have much more room to fall now if there’s stress in the equity market, and we could see in that scenario a flight to the safety of risk-free government bonds. So, I think the bottom line is that this is a good time for investors to move their portfolios back towards their long-term allocations for bonds in a multi-asset portfolio.

Opportunities in 2023.

TM: The first opportunity we see for this year is to have exposure to inflation sensitivity. This trade will outperform if we see higher inflation than what the market is expecting. And the way we implement our inflation-sensitivity trade is through currencies. Specifically, we’re long commodity- and energy-sensitive currencies, and we’re short a basket of energy- and commodity-importing currencies. We had that trade on through much of 2022, and it performed very well for us. A second interesting opportunity is to be underweight stocks in the near term. If we have inflation that is higher and stickier than expected — and a deeper economic downturn than expected to get inflation back down — then that would generally be bad news for corporate earnings and stocks. And, finally, our third opportunity is to be underweight — or to be short — the 10-year Japanese government bond. Japan’s been fighting deflation for at least two decades, and this inflation breakout has been an opportunity for Japan to achieve and reset inflation expectations closer to their 2% objective. In our view. they’re likely to raise the cap on the 10-year Japanese government bond sometime in 2023. And since yields are almost zero already, there’s little downside to shorting the bond at this stage.

And finally, what’s the bottom line as we start 2023?

TM: For long-horizon investors, I think the most important opportunity comes from staying fully invested, riding the bumps — even the big bumps like in 2022. And for those shorter-term or more tactical investors, the biggest opportunity is, in the near term, to be underweight stocks because the economic slowdown this year could be greater than expected. And that’s going to weigh on earnings. Within fixed income, I’d stay about neutral, given today’s higher yields. That’s a great way to diversify equity risk as well in your balanced multi-asset portfolio. And finally, in currencies, we’re underweight the U.S dollar versus most developed market currencies. I think those are all excellent opportunities.

Well, those are today’s Soundbites, brought you by Investment Executive and powered by Canada Life. Our thanks again to Todd Mattina of Mackenzie Investments.

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