3 growth barriers investors can’t ignore

Text transcript

Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

* * * 

Adam Ditkofsky, senior portfolio manager, global fixed income at CIBC Asset Management 

* * * 

In terms of our positioning in our portfolios, with regards to the expectations for the Bank of Canada, we are currently long duration, meaning that we anticipate rates will continue to move lower, as we expect the bank will need to resume its rate-cutting cycle in the coming months. 

Now, if we look at what’s priced into the bond market right now, in terms of expectations for rate cuts, there are no further rate cuts fully priced in for the balance of 2025. But these expectations can quickly change, especially if we continue to see economic weakness that forces the bank’s hand. Right now, the Bank of Canada remains concerned with uncertainty surrounding the U.S. trade war and tariff implications, and more specifically, the bank is concerned with re-accelerating inflation. 

Now, as of the end of June, Canadian CPI stood at 1.9%. But core inflation data points, which exclude the most volatile components, like food and energy, is at approximately 3%. So the bank being on hold has been prudent. But while inflation remains their primary focus for the bank, we can’t ignore that the bank just recently cut their growth outlook for Canada significantly, from an average growth rate of 1.8% to 1.3% this year, and to 1.1% next year. So they may need to provide further support in a stumbling economy. And the current 2.75 for the overnight rate may not be appropriate. 

Now, I break it down into three things. 

The first being unemployment, which now sits at 6.9% and has been rising for the past few years. Anecdotally, it also appears to be getting worse, especially with the tariff uncertainties. Right now, there are roughly 3.3 unemployed people in Canada for every available job in our country. And based on recent StatsCan data, there’s less than 500,000 jobs available in Canada right now. So it’s no surprise we’re seeing wage growth rate quickly drop, and of course, without more labour needs, I expect our unemployment rate is going to worsen. 

The second issue is with the trade war. We’ve drastically reduced our trade surplus with the U.S. to the point that is no longer offsetting the trade deficit we have with the rest of the world. Now, if we can’t quickly improve these relationships or find some substitute markets for our exports, we’ll continue to see merchandise trade deficit north of $5 billion a month, which is roughly 2.5% of our GDP on an annualized basis. So that would be a massive drag for GDP as well. 

Historically, we’ve always thought of ourselves as an export nation because of our raw materials, but unfortunately, that hasn’t been really the case since the Great Financial Crisis. And up until this year, our surplus with the U.S. has offset the deficit with the rest of the world. So trade is painful, and this means that we’ll likely see a contracted economy, at least in the near term. 

And the third being real estate, which in Canada still represents close to 40% of the average household net worth. It has, unfortunately, been stagnant, especially residential markets, with inventories rising and sales not drastically improving. Also, we still have 60% of mortgages coming up for renewal this year, and while it’s not as painful as last year given that rates have come down, we are still seeing refis going from close to 2% from where they were five years ago for mortgages, to now closer to 4%. 

Overall, all three of these aspects — the unemployment rate, the trade situation and the stagnant real estate market — all provide me with confidence to believe that Canada is still very much not out of the woods economically. While the new government will look to stimulate growth, they have also noted plans to cut spending in government jobs. To me, this is all supportive for further monetary stimulus. 

Now, to be clear, our base case is not calling for a recession. But the risks are still very much there, and we continue to expect more rate cuts. And, in terms of our forecast, we’re expecting two to be included, at least until the end of Q2 of next year. 

* * * 

In terms of how fixed-income markets are reacting to the global rate divergence, particularly with the Fed, well, in reality, the Fed and the Bank’s actions have been very similar this year, other than the fact that the Fed has been on pause for longer and their overnight rate is much higher than ours at 4.5%. We’d argue if the U.S. weakens more than anticipated, they have more room to cut rates, especially with rates being well above neutral, and inflation being around 2.5% to 3% in the U.S. 

In July, the Fed left rates unchanged, but we saw that this was not a unified Fed, and President Trump continues to publicly challenge Chairman Powell, threatening to replace him next year. So far, the U.S. economy has been very resilient, but we are starting to see cracks with slowing employment growth, and a modestly weakening consumer. 

So if inflation continues to remain stable, it’s likely we’ll see some cuts this year in the U.S. as well. And if not, Trump could look to replace Powell next year with someone willing to lower rates more aggressively. Currently, in early August, the futures market is pricing in two cuts by the Fed this year, and four cuts by June 2026. We’d argue this is consistent with our forecast where we see four cuts through the second quarter of next year. 

* * * 

In terms of the role of Canadian government bonds in today’s environment compared to corporate credit, well, that role really has never changed. They continue to be a large part of the Canadian bond universe. They represent triple-A securities, or the highest credit quality of government bonds in our country, and they provide reasonable yields for high-quality, low-response securities. 

Unlike corporate bonds, they offer far more liquidity and are easily tradable, and represent benchmark securities that corporate bonds are priced off of. Even in periods of high volatility, like the early days of Covid and the Great Financial Crisis, government bonds maintained their liquidity, while corporate bonds in some cases, couldn’t be moved as easily. 

In terms of needs in a portfolio, government bonds have always acted as a lower-risk diversifier in periods of market sell off, and that should continue to be the base case. In risk-off periods, government of Canada bonds should generate positive returns as yields fall, so they should continue to act as a low-risk source of income, and increase overall portfolio diversification. 

We continue to hold a significant portion of our holdings in government bonds. 

First, markets are not experiencing the inflationary rates of 8% like we did post-Covid. So we aren’t in a period where we see rates rising drastically. And corporate bonds, like stocks, currently have very expensive valuations, with corporate bond spreads being close to their multi-decade tights, which has caused us to become more defensive in our portfolios. 

* * * 

Right now, we favour investment-grade credit over high yield, especially with high-yield spreads being less than 300 basis points, and their overall yields being less than 7% in many situations. Keep in mind, high yield means lower-rated companies, meaning they are considered to have lower credit quality, and in many cases, have weaker credit fundamentals or are more cyclical. Now, as I mentioned earlier, we’re more defensive in our portfolios, so we’re at the lower weights in terms of our positioning. That doesn’t mean we aren’t buying any high yield, it just means we’re being more constructive on credit investments. 

Bottom-up analysis is key to understanding the risks when we make these investments, and I’m also looking for mispriced securities right now. So key fundamentals, relative valuation and bottom-up analysis are very important to me at this juncture. 

* * * 

In terms of overlooked opportunities in fixed income, we still think that there’s some decent opportunities. If you look in our portfolios, one area that we like in particular is hybrid securities, which have essentially replaced the preferred share markets. These are generally deeply subordinated capital instruments from investment-grade corporate bond issuers, that are expected to be called by the issuers at certain dates in the future, but they can be extended. They tend to offer very attractive yields and spreads higher than levels seen in the traditional bond market, and in today’s market, better than the high-yield market. 

These securities benefit the issuers as they are treated as partial equity by the rating agencies, meaning the credit metrics benefit from their issuance while the companies aren’t diluting their equity. And the advantage to bondholders in our portfolios [is] we get enhanced returns that are currently very attractive relative to the rest of the market on a valuation basis. 

And these aren’t new names to us. These are very well-known names in our portfolios. Think about names like Enbridge, Bell Canada, Rogers, TC Energy, AltaGas. These are just some examples, but all high-quality, investment-grade corporate bond issuers where we’ve traditionally held in our portfolios as well. 

Other opportunities that we see that are also still in less traditional sectors, they include some private debt, data centre real estate opportunities that we like as well, and CLOs. And of course, our investment-grade bond funds continue to be solid alternative to cash holdings, offering attractive after-tax yields, with limited risks to yields rising, as all the funds have fixed maturity dates, meaning investors are protected from rising yields if they hold the funds until maturity.

* * *

This program is intended for Advisor Use Only. The views expressed in this material are the views of CIBC Asset Management Inc., as of the date of publication unless otherwise indicated, and are subject to change at any time. CIBC Asset Management Inc. does not undertake any obligation or responsibility to update such opinions. This material is provided for general informational purposes only and does not constitute financial, investment, tax, legal or accounting advice, it should not be relied upon in that regard or be considered predictive of any future market performance, nor does it constitute an offer or solicitation to buy or sell any securities referred to. Individual circumstances and current events are critical to sound investment planning; anyone wishing to act on this material should consult with their advisor. Forward-looking statements include statements that are predictive in nature, that depend upon or refer to future events or conditions, or that include words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “estimates”, or other similar wording. In addition, any statements that may be made concerning future performance, strategies, or prospects and possible future actions taken by the fund, are also forward-looking statements. Forward-looking statements are not guarantees of future performance. These statements involve known and unknown risks, uncertainties, and other factors that may cause the actual results and achievements of the fund to differ materially from those expressed or implied by such statements. Such factors include, but are not limited to: general economic, market, and business conditions; fluctuations in securities prices, interest rates, and foreign currency exchange rates; changes in government regulations; and catastrophic events. The above list of important factors that may affect future results is not exhaustive. Before making any investment decisions, we encourage you to consider these and other factors carefully. CIBC Asset Management Inc. does not undertake, and specifically disclaims, any obligation to update or revise any forward-looking statements, whether as a result of new information, future developments, or otherwise prior to the release of the next management report of fund performance. Past performance may not be repeated and is not indicative of future results. The material and/or its contents may not be reproduced without the express written consent of CIBC Asset Management Inc. ^® The CIBC logo and “CIBC Asset Management” are registered trademarks of CIBC, used under license.