Sell equities, buy corporate bonds for high returns: Earl Davis
Canadian stocks and bonds have rallied as investors bet on interest rate cuts as soon as next spring, but experts say the Bank of Canada is leaving the door open to future hikes in a bid to rein in market expectations.
The central bank kept its overnight lending rate at five per cent for the third consecutive decision on Wednesday, but said it “remains prepared to raise the policy rate further if needed.”
Earl Davis, head of fixed income and money markets at BMO Global Asset Management, said he believes the Bank of Canada chose not to push back against the bond rally in its decision language in an effort to avoid creating further market volatility.
“The easing that we’re seeing in the bond market actually is stimulative to the economy, to jobs and to housing,” he said in a Wednesday television interview.
“The reason why they don’t want to come out more forceful, and I think this is the right tone that they have, is they don’t want to add volatility to the market.”
Davis said that while the bank continues to keep further rate hikes on the table, they’ve now adopted a “loose-hiking bias” in part to prevent a mass bond sell-off.
Jules Boudreau, senior economist at Mackenzie Investments, said the Bank of Canada is also trying to avoid a repeat of the beginning of this year, when markets saw the “tame rhetoric around rates as an indication that it was done hiking.”
“This caused financial conditions to ease and provoked a rebound in growth, inflation and the housing market. The Bank had to reverse its pause in June … it won’t risk such an outcome this time,” he told BNNBloomberg.ca in an emailed statement.
Davis said purchasing bonds can protect investors against an impending economic slowdown as high rates work their way through the economy.
“People now have an ability to monetize their profits in stocks, in equities, and go into corporate bonds,” he said.
“You get still get a great yield pickup, you're higher up on the capital curve, which means it's safer in case the economy does dramatically turn, and you're in a better position to earn yield going forward.”
The broad-based bond rally has included both investment-grade and high-yield bonds. Davis said he would advise sticking with investment-grade, because he views those bonds as safer to hold near the end of a quantitative tightening cycle.
“It has much higher interest rate coverage, by definition, and that's where you want to be,” he said.
In terms of overall portfolio management, Davis said that the recent price increase in cryptocurrencies presents a good opportunity for crypto owners to convert them into safer investments such as corporate bond ETFs.
“I view cryptocurrencies the same way I view stocks. It's a risk asset, and given this accelerated rally, it's a great time to convert that into (investment grade) corporate bond exposure,” he said.
Davis also suggested that investors in oil should consider recent geopolitical events as an indicator of the risks associated with investing in the industry.
“Oil gets impacted by geopolitical events (and) there's still a significant amount of geopolitical risk, so that's what will impact oil and that's another wildcard to the upside of inflation for 2024,” he said.
Davis added that bonds are typically ahead of the market when it comes to predicting rate cuts or hikes, but added that he’ll be watching data from the first quarter of 2024 to see how stock prices will ultimately fare in the face of a potential economic slowdown.