What’s dovishness got to do with it?

Equity markets marched higher for another month as global central banks reaffirmed their dovishness on interest rates

What’s dovishness got to do with it?

Equity markets marched higher for another month as global central banks reaffirmed their dovishness on interest rates. As a result of the continued strength, North America’s major indices completed their best quarterly performance since 2009. It was a broad-based rally as asset prices rebounded from the lows we saw at the end of 2018. With the first quarter in the books, the S&P/TSX Composite Index is up 12%, while the S&P 500 and Nasdaq have gained 13% and 16%, respectively.

Markets remain increasingly focused on interest rates. The dramatic reversal by the US Federal Reserve to back off of its planned rate increases sent bond yields lower and risk assets higher. Fed Chair Jerome Powell put on a brave face as a hawk for a few months, but recently he has fallen into place amongst the doves.

Fears of a global recession have been dismissed, for now. The return of a low-yielding market has brought back TINA (There Is No Alternative) for income-starved investors. Once again, central bankers appear ready to extend the global economic cycle by keeping rates lower for longer. An inversion of the yield curve is typically considered a predictor of recessions; this time around, it’s being seen as an anomaly.

The Canadian market and economy appear to be on increasingly shaky ground. Western Canada is still dealing with a broken energy sector and the long-expected housing slowdown is starting to show signs of materializing. Calls to short the Canadian banks are back. It has been a popular trade in the past and it may be again. Whether or not it will work this time remains to be seen.

Looking at markets on the whole, there hasn’t been much change since the Fall, despite the sell-off and recovery. We aren’t at new highs in equities and earnings growth is slowing. What will it take to push higher? A China trade deal would be a start, as tariffs have slowed the Chinese economy and that is beginning to affect Europe.

Globally, profit growth has slowed. Buybacks are keeping the market going and a strong US dollar is the biggest risk to growth. A profit recession is a very real possibility, as the strong gains experienced last year due to tax cuts will make for difficult year-over-year comparisons.

Going forward, sector leadership will be important to watch. If rates remain low, defensive sectors that typically pay a yield will see a flow of funds. In a low-growth environment, investors will pay a premium for scarce growth, which could keep software stocks in a favourable position.

With the recent strength in markets, investors have chosen to believe central bank accommodation will trump slower growth and delay a recession. This sentiment could change very quickly to become more fearful, but until then ‘don’t fight the Fed’ is back and should be obeyed.

Ideas with Purpose

Purpose Core Dividend Fund (PDF) is quite different from most other dividend funds, thanks to its sector cap. This discipline has been a driver of recent outperformance. The Fund runs with a much smaller allocation to financials than the typical dividend fund (particularly in Canada) and much larger exposures to traditionally defensive, yield-generating sectors such as consumer staples, healthcare and utilities.  PDF is designed to outperform in the type of environment we see on the horizon.

Purpose Multi-Strategy Market Neutral Fund (PMM) generates returns from equity, currency and commodity markets, with aggregate performance that moves largely independently of equity and fixed income benchmarks. Because the Fund has the flexibility to swing from fairly aggressive to very defensive posturing, it has the potential to be highly accretive to portfolios, particularly when markets are volatile and generally under pressure.  PMM adds much-needed diversification and improves a portfolio’s overall risk/return profile.

— Greg Taylor, CFA is the Chief Investment Officer of Purpose Investments

All data sourced from Bloomberg unless otherwise noted.

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