In fixed-income markets, a mix of soft production data in Europe and Fed Chair Powell throwing in the towel send government yields sharply down as investors began pricing in rate cuts in Canada and the U.S. Yield on 10-year government notes dropped a full 31bp and 33bp in the U.S. and Canada, respectively. More importantly, U.S. and Canada saw their 3-month to 10-year treasury curves invert, which helped spread fear of the R word. Outside of the bond market, fear was nowhere to be found as oil rose 5.1%, bringing the year-to-date gains to a stunning 32.4%. WTI prices now sit above $60 per barrel, topping the range we had anticipated this year. The loonie lost 1.3% in March but downside was limited by a surprisingly positive GDP report late in the month, which pointed to a bottoming for Canadian economic growth.
Equity-Factor Styles Aligned with Late-Cycle Goldilocks
From an equity-factor style’s global perspective, Quality maintained its leadership in March (+3.0%) as the late-cycle narrative gained traction with the inverting yield-curve dynamics, which is driving equity investors to prefer firms with stable profits and lower financial leverage, features which characterizes “quality” firms. The goldilocks environment also meant pro-cyclical factors such as Momentum (+2.5%) and Growth (2.3%) performed well, whereas the defensive-growth narrative also supported the Low-Vol (+2.1%) tilt. Interestingly, all of these style outperformed the MSCI ACWI benchmark (+1.0%) in March, whereas Value (+0.2%) lagged as the economy continues to evolve toward a greater role for intangibles, which does not score high in a “value” world. In Canada, our favourite late-cycle exposures, Low-Vol (ticker: ZLB, +1.4%) and High-Dividend (ticker: ZDV, +0.8%) outperformed the broad market (ticker: ZCN, + 0.3%).
Yield-Curve Flattening: This time could be different
Since 2014, the U.S. yield curve has been on a steady flattening motion as the economic cycle is ageing and the Fed has made progress (9 hikes!) toward monetary policy normalization, but an inversion is always shocking given its track record at leading recessions. When interpreting the nearly mystic yield-curve’s predictive power, the relationship of the term spread is silent about the fundamental causes which could trigger a recession. Great caution is therefore warranted in interpreting the inversion, especially with the massive central-bank interventions of the past decade, which we believe have caused a compression of the term premium in global government bonds.
Of course, reflexivity alone could trigger the self-fulfilling prophecy of the inverted yield-curve. But every recession has a clear external trigger, and it’s hard to see exactly what that could be.
Outlook and Positioning: Steady Equity Overweight
No significant changes were made to our portfolios last month and we remain slightly overweight to stocks. We are on a more cautious stance regarding the outlook, and respect the inversion of the yield curve, and therefore we have modest portfolio tilts. While many areas of uncertainty have disappeared recently, a central pillar of our bullish investment thesis calls for a re-acceleration of U.S. and global growth in the second half of the year. However, beyond some early positive signs from leading indicators, notably U.S. commercial and industrial (C&I loans) credit growth shown in Chart 3, or U.S. and Chinese PMI indicators bottoming out, the pace of growth is the most important source of uncertainty at the moment for investors, though the upcoming earning seasons could move the macro to the passenger seat.