Article 1 - 2023 F

An investment playbook for the new market regime

In some ways, how you allocated your wealth didn’t matter all that much. Given a little time, everything went up. “Your mistakes made money,” quips Kurt Reiman, BlackRock’s Senior Investment Strategist for North America. Last year, we witnessed a jarring reversal: almost every investible asset you could put your money into lost value. Coming in to 2023, many investors remain bearish and we’re likely in for an extended period of uncertain markets.

In the decade following the 2008 financial crisis, it was hard for investors to do anything wrong. Between March 9, 2009, when the market hit its Great Recession-era trough, and December 29, 2021, when it reached its highest point, the S&P 500 Index climbed by 608%, while the S&P/TSX Composite Index rose by 182%, according to S&P Capital IQ.

Your mistakes made money.

“

During the last decade, investors largely moved away from fixed income in search of yield amid a lower-rate environment. That’s changing, says Reiman. “There’s finally yield in the bond market again. You can now construct a short duration, low interest-rate risk, low credit risk portfolio with some short-term government bond and short-term investment grade corporate bonds and generate close to five per cent and that’s not something we’ve seen in decades.*” Hayes calls this moment “a generational opportunity to allocate back into fixed income ETFs,” noting that high-quality bonds today offer what junk bonds yielded a year agoª. “iShares Core Canadian Short Term Bond Index ETF (XSB) and RBC Target Maturity Bond ETFs can be used to access short duration, low credit risk bonds,” she added. With all the market volatility, investors are finding shelter in cash and cash alternatives, which have benefited from the attractive money market and ultra-short term bond yields, Hayes explains. “Ultra-short duration ETFs, which includes high interest savings ETFs, money market ETFs, and investment grade ultra-short term fixed income ETFs, is the top-selling ETF category in the first four months of 2023,” says Hayes. “iShares Floating Rate Index ETF (XFR) and iShares Premium Money Market ETF (CMR) are both ultra-short duration cash alternative ETFs offering very attractive yield with minimum interest rate risk and very high credit quality.”

Bonds are Back

“

Given the continued volatility, investors must stay alert to tactical opportunities, but also keep their long-term strategy in mind, Reiman says. If you agree that inflation will continue to be a factor, consider tilting your asset mix toward inflation-protected securities. That includes inflation-linked bonds but also stocks, which tend to adjust to higher-inflation environments. It also means moving away from duration exposure in the bond market. “We’re cautious on having too much longer maturity exposure,” says Reiman. “You’re not getting paid for it.” Investors might consider sticking to shorter-term and floating rate fixed income ETFs instead. The halcyon days of the pre-pandemic markets are not returning any time soon, but with some judicious reallocation, smart investors can still get ahead. “It’s about finding granularity to help you maneuver through what’s likely to be a lean period here,” says Reiman. “But there are ways to navigate this.” Fortunately, financial advisors and investors now have the tools to be nimble with their portfolios and take advantage of opportunities as they arise. Exchange-traded funds (ETFs) make it possible to get in and out of tactical exposures on a weekly or even daily basis. “You can find an ETF solution to access any asset class in a very liquid way,” says Helen Hayes, Head of iShares in Canada for BlackRock. Say you’re concerned about inflation. You can reallocate money into inflation-linked bonds with the iShares 0-5 Year TIPS Bond Index ETF (CAD-hedged) (XSTH), Hayes suggests. “Ease of use in ETFs allows investors to quickly mobilize in fast moving markets, whether to express a view or position their portfolio to meet their long-term investment goals.”

You can find an ETF solution to access any asset class in a very liquid way

“

Navigating a new regime

Reiman cautions that the stock market may be too optimistic about central banks’ ability to tame inflation without serious damage to the economy and corporate earnings. “Some are applying the pre-pandemic playbook to the current times, and the current times are very different,” he says. “It’s a new regime.” Inflation may be moderating, but it will be difficult to get price increases back down to the Federal Reserve’s 2% target due to structural factors such as shrinking working-age populations, shorter supply chains, tepid productivity growth and heightened geopolitical tensions, he explains. “Inflation will come down, but it’ll get sticky at a level that’s higher than the post-financial crisis average,” Reiman says, adding that “when the Fed stops raising rates they’re going to leave them there at a higher level for some time.”

Navigating a new regime

A generational opportunity to allocate back into fixed income ETFs

“

“We should expect higher volatility and not another decades-long bull market in stocks and bonds,” Reiman says. “We need to be more tactical. We need to be more granular. We need to be more selective.”

Finding opportunities in volatile markets

The RBC iShares Tactical ETF Guide highlights tactical opportunities across several investment categories based on BlackRock’s Q2 2023 asset allocation views. It notes that the U.S. and European bank tumult is the latest sign that the rapid hiking cycle is creating financial cracks. The guide emphasizes a defensive approach to equity investing. “Dividend ETFs have been a popular defensive play, providing a source of income and often have reduced correlation to market moves,” says Hayes. “There are many good options: the iShares S&P/TSX Composite High Dividend Index ETF (XEI) gives access to Canadian stocks, while iShares Core MSCI US Quality Dividend Index ETF (XDU) and RBC Quant U.S. Dividend Leaders ETF (RUD) provide exposure to U.S. dividend stocks.” “Another tactic is to maintain equity exposure but moderate volatility using iShares Min Vol ETFs, such as the iShares MSCI Min Vol USA Index ETF (XMU), a fund composed of U.S. equities that have, in aggregate, lower volatility characteristics than the broader U.S. stock market,” says Hayes.

We are making more changes to our asset alloction this year than we have made in any year over the last decade.

“

Read more in the RBC iShares Tactical ETF Guide. RBC iShares ETFs are comprised of RBC ETFs managed by RBC Global Asset Management Inc. (RBC GAM) and iShares ETFs managed by BlackRock Asset Management Canada Limited ("BlackRock Canada"). Commissions, management fees and expenses all may be associated with investments in exchange-traded funds (ETFs). Please read the prospectus or ETF Facts document before investing. ETFs are not guaranteed, their values change frequently and past performance may not be repeated. Tax, investment and all other decisions should be made, as appropriate, only with guidance from a qualified professional. ETF units are bought and sold at market price on a stock exchange and brokerage commissions will reduce returns. Index returns do not represent RBC ETF returns. RBC ETFs are managed by RBC Global Asset Management Inc., which is a member of the RBC GAM group of companies and an indirect wholly owned subsidiary of Royal Bank of Canada. RBC Target Maturity Corporate Bond ETFs (“TMCBs”) have been developed solely by RBC GAM. The TMCBs are not in any way connected to or sponsored, endorsed, sold or promoted by the London Stock Exchange Group plc and its group undertakings (collectively, the “LSE Group”). FTSE Russell is a trading name of certain of the LSE Group companies. All rights in the FTSE Maturity Corporate Bond Indices vest in the relevant LSE Group company which owns the FTSE Maturity Corporate Bond Indices. “FTSE®” is a trademark of the relevant LSE Group company and is used by any other LSE Group company under license. This has been provided for informational purposes, as of the date noted only. It is not intended to provide legal, accounting, tax, investment, financial or other advice and such information should not be relied upon for providing such advice. BlackRock Canada and RBC GAM take reasonable steps to provide up-to-date, accurate and reliable information, and believes the information to be so when provided. Past performance is no guarantee of future results. Interest rates, market conditions, tax rulings and other investment factors are subject to rapid change which may materially impact analysis that is included in this document. You should consult with your advisor before taking any action based upon the information contained in this document. All opinions constitute our judgment as of the dates indicated, are subject to change without notice and are provided in good faith without legal responsibility. Information obtained from third parties is believed to be reliable but BlackRock Canada and RBC GAM and its affiliates assume no responsibility for any errors or omissions or for any loss or damage suffered. BlackRock Canada and RBC GAM reserves the right at any time and without notice to change, amend or cease publication of the information. ® / TM Trademark(s) of Royal Bank of Canada. Used under licence. iSHARES is a registered trademark of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. Used under licence. © 2023 RBC Global Asset Management Inc. and BlackRock Asset Management Canada Limited. All rights reserved. MKTGH0523C/S-2922083

The heightened macroeconomic volatility has also driven BlackRock to favour high quality companies with strong balance sheets, high cash flows and low leverage. The iShares MSCI USA Quality Factor Index ETF (XQLT), for instance, is designed to capture U.S. stocks with this sort of quality factor title. Within this new volatility regime, investors may need to be more tactical than they have ever been. “We are making more changes to our asset allocation this year than we have made in any year over the last decade,” says Reiman, “and we are holding a lot less interest-rate risk and credit risk now, compared to even the beginning of the year.”

* Based on the yield-to-maturity of the FTSE Canada Short Term Overall Bond Index (4.1%) and the FTSE Canada Short Term Corporate Bond Index (5.1%). Data as of April 28, 2023. Source: FTSE, BlackRock. ª Markit iBoxx USD Liquid High Yield Index’s yield-to-maturity is 4.4% as of Jan 1, 2022. FTSE Canada Short Term Corporate Bond Index’s yield-to-maturity is 5.1% as of April 28, 2023.