Daniel Straus, director of ETF research and strategy, National Bank Financial

FOCUS: ETFs

MARKET OUTLOOK:

Has the world turned upside-down? The U.S. federal yield curve (10-2 year) is the most inverted it’s been in 40 years. Despite a year of breakneck-paced rate hikes from the Federal Reserve, U.S. stocks and bonds are almost back to where they were in May 2022. Market sentiment is cautiously optimistic but fragile, so equity prices could be vulnerable to negative earnings surprises in the second half of 2023, according to National Bank’s economists and strategists.

Economic weakness is not contained to the U.S.; the Eurozone and China are also suffering from lackluster household and manufacturing demand. The global economy may remain sluggish in the coming quarters.

A spate of regional bank failures weighs on the U.S. outlook. These are few in number but significant in terms of assets affected, leading to tightening of credit conditions; add in political gamesmanship surrounding the fast-approaching debt ceiling, and it makes sense for markets to see non-negligible default risk (reflected in sovereign CDS spreads and the rise in T-bill yields). Our economists are still betting that a last-minute agreement will be negotiated, but it might be too late to prevent a degree of market chaos.

However, the good news is that we’re fairly close to the end of this tightening exercise carried out by central banks around the globe. The Bank of Canada’s conditional pause continued in April, and FOMC tightening might also pause here, after 500 bps of cumulative tightening.

Our economics team has suggested further reducing equity allocation in favour of cash. This increase comes at the expense of U.S. equities. Canada’s ongoing population surge may be putting a floor under the housing market and personal deposits at banks; when you consider the steady stream of labour supply and its effect on GDP growth, it could generate a faster rise in joblessness and ultimately, a faster pivot to less restrictive policy.

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TOP PICKS

BMO Money Market Fund ETF (ZMMK TSX)
Cash is king, as the now $18-billion assets under management in the “high-interest savings account” ETF category would attest. (More than double what it was a year ago from flows alone). Money market funds were lagging for a long time and have been ignored by investors, but because of new dynamics in the ultra-short term segment of the fixed income market, more diversified ETFs like ZMMK might be just as attractive, so we’re highlighting it here.

iShares Core TSX Capped ETF (XIC TSX)
Our economics team, while very cautious on global stock market risk, has tilted their equity allocation towards Canada given surprise OPEC cuts and a months-long timeout on rate hikes from the Bank of Canada. For this reason, we’re highlighting one of our go-to “landing spots” for ultra-diversified, low cost, pure-passive index exposure to the Canadian markets.

Vanguard Conservative ETF Portfolio (VCNS TSX)
In the model ETF portfolios that we publish and track, the “conservative” risk profile has 29 per cent in equities, five per cent in alternatives, and the remaining 66 per cent in fixed income and cash. Similar multi-asset portfolios are available in Canada “off the shelf,” and Vanguard’s closest analogue has 40 per cent in stocks and 60 per cent in bonds. It’s simple, low in cost (MER is 0.24 per cent), and diversified, so for investors who want a relatively safe way to remain invested, this kind of ETF provides an avenue forward.

Past Picks: December 1, 2022

 Purpose Core Dividend ETF (PDF TSX)

• Then: $31.53
• Now: $29.96
• Return: -5%
• Total Return: -3%

 Horizons Resolve Adaptive Asset Allocation ETF (HRAA TSX)

• Then: $11.17
• Now: $11.02
• Return: -1%
• Total Return: -1%

 BMO Discount Bond Index ETF (ZDB TSX)

• Then: $14.74
• Now: $14.49
• Return: -2%
• Total Return: -1%

 Total Return Average: -2%