A bullish outlook for bonds and growth opportunities in artificial intelligence and the energy transition are among the recurring themes in investment-fund providers’ 2024 forecasts.
“Given current valuations and an outlook for challenging economic growth and diminishing inflation, we believe bonds have rarely appeared more compelling than equities,” according to an asset-allocation report released by the U.S.-based Pacific Investment Management Co. LLC. Best known as a leading bond manager, PIMCO’s offerings include six ETFs listed in Canada.
The PIMCO strategists contend that at current levels, yields of high-quality bonds have historically on average been followed by outperformance over the subsequent five years. By contrast, the current cyclically adjusted price-earnings (CAPE) ratio for equities has tended to be associated with long-term underperformance.
Other strong proponents of the valuation argument in favour of bonds over stocks are asset-allocation strategists with U.S.-based Vanguard Group Inc., the indirect parent company of Toronto-based ETF provider Vanguard Investments Canada Inc.
According to Vanguard’s 2024 market outlook, higher interest rates have led to substantially higher expected returns for fixed income. High rates have also compressed the equity risk premium, which is the expected higher return of equities.
This has led to a dramatic shift in Vanguard’s valuation-driven tactical model, known as time-varying asset allocation (TVAA). From its neutral 50/50 benchmark weighting, the TVAA model portfolio has shifted to 68% fixed income and only 32% equities.
“This position reflects our proactive approach to capturing value while managing risk in a dynamic market landscape,” Vanguard said.
Within the fixed-income market, TD Asset Management Inc.’s asset allocation committee favours a modest overweight in government bonds. It’s neutral on investment-grade corporate bonds, citing tightening spreads that have made these credits less attractive. For the same reason, TDAM is underweight in high-yield credits, and it also expects deterioration of corporate-credit fundamentals.
For Canadian equities, active stock selection can add value in 2024, according to a strategist affiliated with BlackRock Asset Management Canada Ltd., the country’s largest ETF provider known for its broad-market index ETFs.
“The greater uncertainty and dispersion of returns in the new regime calls for a more active approach to managing investment portfolios,” said Tara Iyer, chief North America macro strategist with the BlackRock Investment Institute, and this could include a mix of passive and active products.
High-quality Canadian companies with sustainable business models and low leverage ratios could keep outperforming next year, said Iyer, who is based in New York. She added that Canadian energy companies score highly on quality metrics.
Though fixed income has become more attractive, global equities are expected to revert to long-term averages and outperform bonds over the next 10 years, according to Toronto-based Franklin Templeton Investment Solutions (FTIS). Currently, FTIS’s portfolio positioning calls for overweighting U.S. equities and emerging market equities, while underweighting Canada and Europe.
Despite strong population growth, weak productivity growth remains a headwind for Canada, said Ian Riach, FTIS senior vice-president and portfolio manager, at a Toronto meeting of financial advisors in December. Another reason for caution is Canada’s household debt-service ratio, which is much higher than in the U.S.
Taking a neutral stance on Canadian equities, TDAM strategists said the full effect of higher rates on consumers and the real estate market remains to be seen. “However, strong free cash flows within the energy sector, and relatively inexpensive financials stocks, may present attractive opportunities.”
Meanwhile, according to FTIS, valuations of European equities look attractive but they reflect weak economic data, including negative expectations for economic growth and employment levels. TDAM said international stocks in developed markets, particularly in Europe, continue to face concerns regarding corporate profitability and slowing macroeconomic conditions.
BlackRock strategists are bullish on Japan, which remains its favourite developed market even after strong gains in 2023. BlackRock cites appealing valuations, earnings growth and shareholder-friendly corporate reforms.
As for emerging markets, TDAM said rate cuts in Brazil and Chile create potential for improved economic growth. That, along with relatively low equity valuations, increases the appeal of these markets. But TDAM is cautious on China because of its continued struggles in the property sector.
On the key metric of profitability, the U.S. market still leads, according to FTIS, with return on equity significantly higher than other regions.
History is also on the side of investors who are bullish on the U.S. in 2024, since presidential election years tend to have positive stock-market returns. As BMO Global Asset Management noted in its forecast, since 1952 the S&P 500 has not declined in a year in which an incumbent president was running for re-election.
“Presidents tend to use whatever policy levers are needed to boost the economy, shore up their support, and maximize their chances of being re-elected,” said Fred Demers, BMO GAM’s director, multi-asset solutions.
Additionally, the U.S. is the leading player in one of the key global growth themes: the transformative impact of artificial intelligence on all aspects of the economy. “Technology companies, including the Magnificent Seven, are finding new ways to expand their already-dominant businesses,” Demers said. “Don’t be surprised if Big Tech continues to lead in 2024.”
Another promising global megatrend is the energy transition. In its market outlook, Mackenzie Investments predicted that 2024 will bring continued investment and advances in solar generation and storage, and electric vehicle manufacturing and infrastructure. Carbon-capture technology may also gain prominence, Mackenzie said.
A related theme is climate resilience, said Olivia Markham, a BlackRock portfolio manager based in London, England, who specializes in thematic and sector investing.
“This is the ability to prepare for, adapt to and withstand climate hazards, and to rebuild after climate damage,” Markham said. As examples, she cited monitoring systems to predict floods and retrofitting buildings to withstand extreme weather.
“We already see demand growing for products and services that build climate resilience,” Markham said. “Markets may be under-appreciating how this can become a mainstream investment theme over time.”