Through the first quarter of 2024, many Canadian investors have been shifting to the offensive after sitting on the sidelines last year, according to Vanguard Canada.
“Money’s still going into cash, but a lot more is being put to work,” Mario Cianfarani, head of distribution at Vanguard Canada, said in an interview with Yahoo Finance Canada.
“We think that’s the right call.”
Here’s why experts believe this is a good time for Canadians to reposition their cash into stocks and bonds, and why 60/40 portfolios have become attractive again.
Cash yields are on their way down
Over the last two years, central banks have been aggressively hiking interest rates to help combat inflation. As interest rates rose, investors who had money parked in cash were able to return a “pretty reasonable yield for the first time in many, many years,” says Christine Tan, portfolio manager at Sun Life Global Investments.
But that environment is now changing.
With inflation starting to normalize, central banks are considering cutting interest rates. When that happens, Tan says the returns on short-term cash securities like money market funds will decline.
Compared to the five per cent yields seen in 2023, TD Economics forecasts cash yields dropping to four per cent in 2024, and three per cent in 2025.
“And you’re not going to have any offsetting capital appreciation,” Tan said in an interview with Yahoo Finance Canada. “That’s why it’s a good time to think about repositioning.”
The case for 60/40 portfolios
As a starting point, Cianfarani says investors should consider a traditional portfolio composed of 60 per cent stocks and 40 per cent bonds. Despite a challenging year in 2022, he says talk of the “death of 60/40” was premature. Vanguard’s Canadian home-biased 60/40 portfolio, for instance, posted a 12.49 per cent gain in 2023 after dropping by 11.37 per cent in 2022.
The main reason for constructing a 60/40 portfolio is that stocks and bonds are supposed to have low to negative correlation, Tan says.
“On the fixed income side, that’s your defence,” she said. “That’s your ‘steady-Eddie’ yield, even though for many years it was a very low yield. But perhaps more importantly, that part of the portfolio was supposed to hold in better and even potentially perform positively when the equity — the riskier side of your portfolio — sells off.”
That changed in 2022.
Bond prices and interest rates have an inverse relationship. As interest rates increased, bonds underperformed. And with concerns about the economy, stocks and bonds were “selling off at the same time,” Tan says.
Now that interest rates have peaked, she agrees that 60/40 portfolios should serve investors well through different economic outcomes.
“If we go into a hard landing, like some kind of actual recession in Canada, the U.S., or globally, then bond yields will start playing their protective role,” Tan said, noting that bond prices will appreciate as central banks cut interest rates.
“Now, if we do somehow achieve a soft landing, or no landing, or a deferred landing … the equity side will do well, because earnings will be resilient. And in the meantime, you’re still picking up a pretty good yield on the fixed income side.”
Long-term investors in 60/40 portfolios now have a higher probability of seeing annualized returns of at least seven per cent over the next 10 years, according to Vanguard’s 2024 economic and market outlook. This is driven in part by the fixed-income component, with Vanguard projecting an annualized return of 4.3 to 5.3 per cent for Canadian bonds over the next decade.
“Our internal, time-varying model is skewing a little bit more to fixed income than to equities,” Cianfarani said. “It’s not that equities won’t do well … but bonds yielding something comparable to where equities should yield, you’re getting a better risk-adjusted return.”
Ultimately, investors should consider their time horizon and risk tolerance when determining the appropriate allocation between stocks and bonds, Cianfarani says. A higher percentage of stocks probably makes sense for younger investors, he adds, since they have “time on their side” to weather market volatility and maximize long-term returns.
However, with bonds yielding around six to eight per cent, if you’re willing to take on some credit risk, Tan says 60/40 portfolios can even work for younger investors – especially if they’re saving for major purchases like a car or a home.
‘Don’t put all your eggs in one basket’
In addition to having the right asset allocation, constructing a balanced investment portfolio also means being diversified geographically, Tan and Cianfarani say.
The S&P 500 (^GSPC) has returned around 25 per cent over the last five months, for example. Investors who weren’t exposed to this index would have missed out on significant gains.
But that’s not to say the U.S. will continue to outperform.
In fact, due to stretched valuations in the U.S., there’s an increasing likelihood for greater opportunities outside the U.S. over the next 10 years, according to Vanguard.
“The good resilient markets are trading at a relatively full multiple, and the more cyclical markets that have been more challenged from an earnings perspective are inexpensive,” Tan said. “The way you want to approach that as an investor is to have a combination.”
Don’t avoid a market just because it’s expensive, Tan says. There’s a reason the S&P 500 is trading at a higher valuation than the Canadian and international indices – partly because it’s driven by technology stocks that aren’t linked to the economy, she said.
“So, you want to have exposure to that,” Tan said. “At the same time, you don’t want to put all your eggs in that particular basket because it has gotten expensive, and it won’t take much for a re-rating if expectations start being recalibrated.
“It’s all about diversification.”
Farhan Devji is a freelance journalist and published author based in Vancouver. You can follow him on Twitter @farhandevji.
