A shifting attitude in financial markets that interest rates might stay higher for longer has weighed on returns this year, with investors finding few safe havens between stocks and bonds.
Analysts who spoke to Global News say the uncertainty about rate hike paths for central banks around the world means some portfolios could still stand to lose some value, but there are still some opportunities out there for long-term investors.
A TD Bank report released this week pointed to the rapid rise in interest rates from the Bank of Canada and its central bank counterparts globally as dragging down returns for investors in 2023.
The report said that “swift adjustment” in interest rates has “stunted equity markets,” which sit more than 10 per cent below 2022 highs.
“Interest rates have been affecting everything dramatically, and I don’t use that word lightly,” says Michael Currie, senior investment advisor with TD Wealth.
“For 18 months now, they have such a huge effect on everything we look at, whether it’s real estate, stocks, bonds, you name it — right across the board.”
Higher interest rates affect companies’ access to credit and weigh on consumer spending, so they’re generally seen as a negative for growth outlooks, Currie says.
The Bank of Canada has increased its benchmark rate by 4.75 percentage points since March 2022, with the bulk of the tightening coming last year. In announcing its second consecutive rate hold on Oct. 25, the central bank officials kept the door open to future hikes if needed to get inflation fully back to the two per cent target.
Even though rate hikes have been comparatively muted in 2023, Currie says the fact that the central bank is continuing to keep rates high, with little indication of cuts from policymakers on the horizon, is keeping the pressure on financial markets.
The Bank of Canada announced a “conditional pause” to rate hikes in January, which led financial markets to suspect rate cuts could come as early as year’s end. Currie tells Global News that when rate hikes returned in June and July, it “caught people by surprise.”
“The market doesn’t like surprises and assets are starting to sell off again, unfortunately,” he says.
Businesses also have their own debt costs to worry about amid higher interest rates, notes Colin White, CEO and portfolio manager at Verecan Capital Management.
Like a homeowner gearing up to pay more when their mortgage renews, White says companies will be bracing for their debt rolling over in the coming months, which could put further pressure on their bottom lines.
“The cost of higher borrowing costs haven’t necessarily been completely reflected on all company balance sheets yet,” he says.
‘A totally different environment’
The TD report also blamed higher interest rates for the “worst sell-off in a generation” in bond markets. While bonds are usually a safer position that provide stable returns when equity markets are faltering, the report noted that this doesn’t hold when higher interest rates are causing the weakness in stocks.
Currie says 2023 has so far marked the third year in a row of declining returns in bonds, which means even the most conservative investors are feeling the pain.
“They’re buying (bonds) as a safe, steady income-generating part of the portfolio,” he says. “I think it particularly hits investors when they see the safe part of their portfolio going down on a steady basis.”
Reliable dividend-yield stocks have also taken a beating this year, Currie says, citing shortcomings in industries like utilities, telecom and real estate.
Alternatively, he says sectors that play well with more aggressive investors — like tech — have performed relatively better in 2023.
These are a few examples of how the new higher interest rate landscape should push some investors to adapt their strategy, Currie argues. When even conservative investors are taking losses, it shows the value of having a more diversified portfolio that gives exposure to high-growth stocks like tech, he says.
“In the last 18, 24 months, the environment has changed dramatically,” Currie says. “You can’t stick with what worked in one environment when you’re in a totally different environment.”
Despite their weaker performance this year, Currie isn’t knocking dividend stocks. He notes that if investors are feeling like they’re keen to jump into these sectors that have yielded strong returns in the past, they might be discounted at the current moment.
“Are there bargains out there? Definitely,” he says.
“The only caveat I would give you there is if you really thought rates were going to stay high or continue to rise, they’re not bargains yet.”
Where are interest rates heading next?
While the Bank of Canada has kept its hawkish stance in place — leaning toward further rate tightening rather than easing — recent signs of slowing in the economy have many forecasters arguing the current rate hike cycle might’ve peaked.
This past week saw a pair of data releases that suggested the labour market is softening and the economy stalled in the third quarter of the year. Economists suggested afterwards that the weaker data would keep inflation on a downward trajectory and keep the Bank of Canada on the sidelines.
The U.S. economy has been a somewhat stronger force, however, with the Federal Reserve holding rates this week but also leaving the door open to further hikes.
White says markets are looking for hints from central bankers worldwide, including Bank of Canada governor Tiff Mackelm, for when rate hikes might end or eventually reverse.
“I have this vision in my head that every Tiff Macklem stands up to talk, he walks up to the microphone and he says what he needs to say and he runs back to his office to see what effect it had,” White says.
Given how carefully Macklem and his cohorts are choosing their words to avoid spooking markets, White prefers to look at metrics that feed into underlying inflation to track when interest rates might abate.
“I think that’s a more honest way of looking at it than trying to parse the words or the language that’s being used.”
Signs of weak economic data were indeed welcome news to markets this week.
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BMO chief economist Doug Porter noted Friday that after a 10 per cent correction in the past three months, the S&P 500 was up five per cent on the week and the TSX was heading for its best week in more than a year.
Porter noted that markets are now pricing rate cuts starting in Canada by mid-2024 — a sentiment he said BMO agrees with, though the timeline could be delayed if factors like strong wage growth remain a fuel for inflation.
While the TD report maintains that there might be some “bouts of volatility” in store for U.S. and Canadian equity markets, the bank raised its forecast for annual portfolio returns by a percentage point this week.
White, too, remains confident in the market’s long-term trajectory once the period of higher interest rates passes.
While he says his team is seeing plenty of “opportunity” and discounted companies on the market, individual investors are likely better off not trying to time the market or central bank rate cuts.
“It’s impossible to tell day to day or week to week when that turn may happen,” he says.
“If they’re just investing in the broad market for a long time — just hunker down.”