Preserving capital amid uncertainty

Canadian and U.S. stock markets have hit record highs after strong gains in recent weeks, defying economic headwinds and surprising some investors.

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“It’s really interesting when you consider the backdrop that is unfolding for equities as we have moved through 2019,” said  Colum McKinley, managing director and chief investment officer at CIBC Asset Management.

In an Oct. 10 interview, McKinley cited the U.S.-China trade war, Brexit uncertainty, impeachment proceedings against U.S. President Donald Trump and weakening economic data from around the world putting pressure on global equity markets.

Despite these hurdles, the S&P/TSX Composite is up more than 18% year to date, as of Friday. The S&P 500 is up more than 23% over the same period.

“Both markets have done incredibly well for equity investors,” said McKinley, who manages the CIBC Monthly Income Fund.

However, as of last month, he still saw reason for caution.

“While there’s plenty of positive things we can talk to, all of the news at the margin is pointing to things slowing or getting weaker,” he said. “For us that equates to an environment where we want to be very cautious with our clients’ capital.”

McKinley said he’s lowered risk and increased quality across portfolios, while raising cash holdings.

“With a lot of uncertainty in the air, we want to be positive to preserve capital [..] but we also want to eventually be able to take advantage of that volatility. [There] will be some incredible buying opportunities that we want to take advantage of,” he said.

Since October, trade tensions between the U.S. and China have decreased. With the 2020 presidential election less than a year away, many analysts expect Trump to seek at least a temporary truce to boost the economy before Americans head to the polls.

The Oct. 31 Brexit deadline was extended to Jan. 31, boosting the British pound, and Prime Minister Boris Johnson has called a general election for Dec. 12.

Last week, U.S. Federal Reserve chair Jerome Powell said interest rates would likely remain unchanged in the coming months amid “a sustained expansion of economic activity.”

One sector that fits McKinley’s cautious approach is Canadian banks, which he says are well managed and able to weather future volatility.

He’s seen “green shoots” for mortgages and personal loans while commercial lending remains strong. Net interest margins are challenged in a low rate environment, but he said Canadian banks have the experience to navigate them.

Compared to the rest of the market, McKinley says Canadian banks’ valuations are attractive.

“Banks have proven over and over again their ability to navigate uncertainty,” he said. “Over the long term, they’re going to continue to deliver strong dividends and strong dividend growth.”

McKinley has a “large overweight” in Canadian banks including RBC, CIBC and TD, which he said are well positioned outside of Canada.

“I think that each of these banks have incredibly strong franchises,” he said. “They have very strong, deep relationships with clients. They have management teams that understand the challenges in their businesses that are coming. They’re well positioned and well diversified.”

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