Searching for Opportunities in an Uncertain Market

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Luc de la Durantaye

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

Yeah, I think the central banks and investors will have to quickly assess the impact in two elements. One is the regional banking crisis that we’ve had and the impact that it has on the banking system. In general, in terms of raising the cost of funding for commercial banks and assessing how far and how much that will impact their ability to lend or the lending intentions in the coming weeks and quarters. And how much that will affect the economic activity versus what central banks will do and how will central bank react. So that’s one element.

The other new element is the most recent cut in production from OPEC and what’s the net effect of that. There’s a growth impact of that, there’s an inflation impact. So, if we tackle them one by one, the estimates for the impact in lending standard, if you will, for commercial banks. Some of the estimates that we’ve seen so far are somewhere around 25 to 50 basis points of tightening equivalent from central banks. So in other words, as commercial banks will reduce their lending because their cost of lending is rising and is rising fast because we’ve seen a very fast tightening cycle. One of the unprecedented speeds of tightening cycle. And that would be equivalent to the Federal Reserve not tightening as much by the tune of 25 to 50 basis points. So, we’re getting perhaps closer to a peak in interest rates from the Federal Reserve.

So there’s a number of elements that derive from that. One is this is more for the U.S., for the Federal Reserve, because so far, again, the estimate is that this is impacting the U.S. more than, for example, Canada or Europe. Because the regional banks are a more American phenomena than a Canadian or European phenomena. The size of this banking impact is bigger in the U.S. than it could be in Canada or Europe. So that’s one element.

The other element is the difference between the expectation of the market, that the market is now expecting interest rate cuts versus what the Federal Reserve keeps hammering that they will keep rates at elevated levels. And I think that the tiebreaker will be incoming data, particularly on inflation, particularly in the labour market. We’re starting to see some weakness in labour data and in services. For example, the ISM services were weaker than expected. Some labour data was weaker than expected, but not enough so far to really maybe close the gap between what the market thinks the Fed should do in terms of many interest rate cuts, and versus what the Fed wants to do which is perhaps raising or at least maintaining rates at current level until the end of the year.

So the impact of that is really a potential additional slowdown or downside risk to the global economy. And that means risk to earnings. And again, there’s a discrepancy between what the market thinks and the actual data where earnings have started to come down but equity markets have been surprisingly, in our view, surprisingly resilient so far given the fact that the recession risk had risen both because of this banking issue and again because of the rise in energy cost at the margin. So to us, the impact of the regional bank situation in the U.S. is leading to tighter lending standards, to a slightly slower economic activity than previously expected, and therefore lower earnings, which is at least from an equity perspective there’s probably a little less upside than before.

Finally, on the oil aspect, it’s difficult because on the one hand, it is a tax on consumption, it’s a higher cost per consumer, but on the other hand also it’s going to sort of help maintain inflation at an elevated level, so it makes inflation a bit tougher to bring down. And therefore, that ties into central banks maintaining elevated levels of interest rates longer than what the market thinks. So we see that the downside risk for the economy and downside risk a little bit to the equity market at this stage.

Well, the interesting part is that there’s a divergence in relative terms with Asia for example, and China, which is they’re closer to their peak interest rates. Asia and China are reopening and stimulating its economy, whereas Europe and the U.S. are still in sort of a tightening mode and they’re still waiting to see the downward impact of the tightening cycle that they have. Whereas Asia, helped by China, is sort of at the early stage of a recovery. A mild recovery, our Chinese analyst thinks that the stimulus is not very strong. China doesn’t have as much room to stimulate, but nevertheless from a relative perspective, Asia might do a little bit better. So that’s one area that we think could be an opportunity. In other words, diversified portfolios into Asia and some of the benefits there.

India is also an area that continues to have strong growth. The central bank there just announced that they were pausing, not pivoting and so that could continue to support growth in India, which is very strong. So, from that perspective, there’s areas in Asia that could be helping in terms of sheltering and providing some return opportunities.

We also have been mentioning that cash provides a good stabilizer in portfolios now that you have high-risk pre-returns with low volatility. But I think over the next quarter or two there might be an opportunity to redeploy that cash as we think the markets will adjust, particularly in the equity market. The market will adjust and provide attractive buying opportunities. But patience and diversification are key here.

Well, we had mentioned fixed income was more attractive this year than last year, obviously. The starting point for yields was higher at the start of 2023 versus 2022. Both from a nominal perspective, so inflation plus real rates were higher. And also, spreads were more attractive in the area of high yield spreads, emerging market debt, local currency provide attractive yields. And in the case of emerging market debt, a number of currencies are undervalued versus the Canadian and U.S. dollars. So that provides a better opportunity, but also helps in balancing out your total portfolio and we still think that there’s some opportunities there.

And again, providing a better balance for global portfolios in order to get better performance while you wait for better equity, better equity entry points.