Proactive Investors - Canadian equities are likely to continue outperforming their global counterparts in 2023, according to BlackRock Inc (NYSE:BLK), the world’s largest asset manager.
That will continue a trend that occurred in 2022 because of above-average exposures to the highly profitable energy sector and below-average tilts to technology, BlackRock Investment Institute said in its 2023 Global Outlook entitled ‘A new investment playbook’.
BlackRock sees Canada entering a recession early this year as the Bank of Canada’s (BoC) tightening to tame inflation starts to weigh on credit-sensitive sectors, especially housing. It thinks the BoC will stop its rate hikes but only once the damage is clearer.
“Rising debt service costs amid larger household indebtedness could precipitate the policy pause,” BlackRock Investment Institute’s senior investment strategic for North America Kurt Reiman wrote in the report. “We then see the BoC opting to live with some inflation above its target rather than risk even more severe economic damage.”
The report noted that Canada’s housing sector is more rate-sensitive than other markets like the US due to the shorter-term variable-rate mortgages offered by banks, whereas 30-year, fixed-rate mortgages are common in the US.
Pricing the damage
However, it said other important differences in the Canadian economy could alleviate some of the production constraints in the new regime of greater macro and market volatility that is playing out globally.
These include strong immigration trends that could help offset an ageing workforce and Canada’s position as a global supplier of many scarce materials that are a big part of today’s high-inflation environment.
Also, existing legislation mandating a rising price for carbon emissions through the end of the decade could help smooth the net-zero transition.
“But a recession is coming, so we are closely gauging how much markets are ‘pricing the damage’, our first investment theme,” Reiman said.
“This is crucial in deciding how to become more constructive on risk assets during 2023. Another key ingredient to turning more positive on risk assets will likely be a weaker US dollar or at least a plateauing of its strength from 2022.”
Financials and energy stocks
While BlackRock is staying underweight developed market stocks over a tactical horizon given the downside risk to corporate earnings heading into a recession, it said it enters 2023 with a positive view on financials and energy – two heavyweight sectors within the Canadian stock market.
“Both sectors show reasonable valuations and realistic earnings expectations relative to other cyclical sectors,” Reiman added. “Resource sectors, like energy and materials, could perform well if shortages emerge during the net-zero transition or amid a more geopolitically charged world.”
BlackRock doesn’t expect the same ballast from bonds as in years past in 2023, which is why ‘rethinking bonds’ is the asset manager’s second theme for the year.
With central banks unlikely to cut interest rates right away, bond prices may remain under pressure, resulting in stock and bond returns both going down at the same time. Yields may also still rise further to reflect both higher inflation risk and the step-change increase in debt loads during the pandemic, it said.
Living with inflation
“We think markets are underestimating the potential for investors to demand higher compensation to hold longer-maturity bonds or term premium,” Reiman said. “This keeps us underweight long-term government bonds. But we think short-term government debt has attractive yields without the same term-premium risk.”
Under its third theme, ‘living with inflation’, the asset manager favors inflation-linked bonds over nominal government bonds over both tactical and strategic horizons. While the Canadian government cancelled its real-return bond program in November, it noted that investors can access US inflation linkers as a proxy.
It also prefers investment-grade corporate bonds in fixed income, both in Canada and globally for added yield.
“We expect a recession in North America in 2023, but we think the yield advantage over government bonds compensates investors for default risk while balance sheets are strong,” Reiman concluded.