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Darrin Pickett joined the RBC GAM Global Infrastructure Investments team in January as a senior manager. Darrin will play a leadership role in the launch of the RBC Global Infrastructure Fund LP, including the execution of the fund's investment and asset management strategy, and will work closely with external co-investment partners to execute the fund's mandate. Previously, Darrin was head of infrastructure asset management for a large, global real assets investment manager.

Leah Patry, an institutional portfolio manager at PH&N Institutional, left the firm at the end of March; her responsibilities have been assumed by other members of the team.

Irene Fernando and Sarah Neilson, co-managers of the PH&N Canadian Equity Value Fund, will be assuming full responsibility for management of the fund effective July 1, 2023, taking over the remaining sectors from Doug Raymond and Stu Kedwell. Both Irene and Sarah have been members of the RBC North American Equity team for more than a decade, and have had responsibility for security selection within the fund for the past two years. Doug and Stu will remain as co-heads of the team and are retaining their other portfolio manager responsibilities.

Recent developments

For the ninth consecutive year, PH&N Institutional was honoured to receive the Greenwich Quality Leader Award in Canadian Institutional Investment Management Service¹, which recognizes the top three Canadian asset managers for “delivering superior levels of client service that help institutional investors achieve their investment goals and objectives.” We are especially humbled to be the only manager to have received this honour each year since the award’s inception.

Market updates

Indices performance comparison as of March 31, 2023

Source: RBC GAM, FTSE Russell, S&P, MSCI

Markets rally as rates hikes pause, but market volatility ensues

Markets rallied at the start of the first quarter on the back of optimism surrounding a pause on rate hikes. However, the rally gave way to significant market volatility toward quarter-end amidst signs that rate hikes were having an economic impact as cracks emerged in a few parts of the banking system.

Equity markets witness renewed volatility

Source: RBC GAM, MSCI World Index as of March 31, 2023

There has been much to cheer from a macroeconomic standpoint in recent months. A few of the positives include the performance of the labour market and consumer spending, China’s reopening, Europe’s economic resilience in the face of an energy shock, and marginally easier financial conditions. Moreover, U.S. job creation continued to run at a heady pace and even accelerated in early 2023. Canada’s experience has been similar, and unemployment rates across most of the developed world have declined to levels not seen in decades. However, we believe the massive and sudden surge in interest rates over the past year is almost certain to cause economic pain. Signs of weakness are already discernible in the housing market, rising goods inventories, diminished business confidence, and scaled-back capital spending. Moreover, there have been some troubles in the banking sector recently.

The recent collapse of a few U.S. regional banks illustrates the extent to which tighter monetary policy can cause worrisome financial contagion. Global banking witnessed further turmoil with the collapse of Credit Suisse, which was subsequently taken over by UBS Group AG. Despite assurances and timely intervention by governments and financial regulators, concerns about the health of the global financial system persist in the aftermath of these stunning developments, and investors continue to be wary. We assign an 80% chance to a U.S. recession materializing, and expect that it will occur in the second half of this year.

Recession signals point mostly to "yes" or "likely"

Note: As of Jan 2023. Source: RBC GAM, Bureau of Labor Statistics, Office for National Statistics, Statistics Canada, Statistical Office of the European Countries, Haver Analytics

Though inflation continues to remain above target, it continued on a downward trajectory and the main drivers that contributed to the inflation surge have now all reversed. Namely, the commodity shock has waned, supply-chain bottlenecks continue to improve markedly, and excessive monetary and fiscal stimulus have been curtailed. Moreover, businesses’ pricing power may be fading and home prices have begun to fall. Given these conditions, we forecast a faster-than-expected decline in inflation. Nevertheless, a myriad of counter forces could keep inflation uncomfortably above central banks’ targets. These factors include a tight labour market and low productivity growth. Although our base-case inflation forecasts appear reasonable, there is an unusually wide range of possible outcomes. These range from inflation remaining too hot to, alternatively, inflation abruptly converting to temporary deflation.

Inflation remains elevated in major economies, but turning lower

Note: As of Jan 2023. Source: RBC GAM, Bureau of Labor Statistics, Office for National Statistics, Statistics Canada, Statistical Office of the European Countries, Haver Analytics

After pursuing aggressive rate hikes over the last year in an attempt to counter high inflation, central banks eased their stance in the first quarter by either keeping their rates unchanged or increasing rates by less than what was witnessed in 2022. However, signals from central banks were mixed, with some, such as the Bank of Canada, indicating that they have reached the finish line after considerable effort, while the U.S. Federal Reserve (the Fed), the European Central Bank, and the Bank of England hinted that modestly to moderately more tightening lies ahead. However, as inflation ebbs, central banks will ultimately be in a position to take their foot off the brake. Though interest rates are unlikely to return to prior lows, it makes sense that a structurally low interest-rate environment gradually reasserts itself given elevated global debt levels, demographics, and a low speed limit for economic growth. More generally, the recent increase in interest rates has highlighted certain vulnerabilities.

Equity markets gain across the board to begin the New Year

The Canadian equity market ended the first quarter in positive territory. The S&P/TSX Composite Index returned 4.55% in Q1, underperforming both the S&P 500 Index and the MSCI World Index when measured in Canadian dollars. Fears about the possibility of widespread bank failures led to a global sell-off in early March and crude oil also plunged amidst fears that the overall economy was in jeopardy. That said, the situation for Canadian banks is different. Critically, Canada has larger, more concentrated, more diversified, and better capitalized banks relative to the U.S. In the context of current stresses, Canadian banks place a smaller fraction of their assets into long-dated bonds, they mark those bonds to market such that there are no hidden losses off balance sheet, and a significant fraction of the bond portfolio is hedged such that the resulting losses from rising interest rates are manageable. As acute risk aversion faded and further global or regional bank failures failed to materialize, confidence in the economy and stock markets improved. Among the top-performing S&P/TSX Composite Index sectors during the quarter were Information Technology, Materials, and Consumer Staples.

Global equity markets witnessed a full gamut of investor emotions during the first quarter, with early cheer giving way to gloom over stubbornly high inflation and fallout from Fed rate hikes. The MSCI World Index rebounded 20% between mid-October and early February before giving back some of those gains toward the end of the quarter, finally ending Q1 up 7.60%. The rally featured a change in leadership in several areas within the market, which we think could signal the start of durable new trends. Some of the big shifts included a weakening U.S. dollar; the outperformance of international equities versus U.S. stocks; and market leadership among cyclical sectors, small- and mid-cap stocks, and value stocks. Although markets are likely to remain somewhat volatile, we think the bulk of the adjustment in valuations with respect to broader financial markets is likely behind us. Looking ahead, we think corporate profits will present a major challenge to financial markets as slowing economic growth and the impact of rising costs weigh on companies’ record-high profit margins.

Though emerging market equities recorded their second successive quarterly gain, they underperformed developed markets in the first quarter. A difficult 2022 meant that a rebound in equities was to be expected, especially as inflation eased back down from a very high level. The start of the year saw renewed optimism about emerging markets, given the re-opening of China’s economy. Though U.S.-China tensions resurfaced in the aftermath of the shooting down of a Chinese high-altitude balloon in U.S. airspace, optimism about the re-opening of the economy and an apparent easing of regulatory pressure on the internet sector were positives for the market. Going forward, emerging market equities look brighter compared to developed markets for several reasons. These include attractive equity valuations and the expected depreciation of the U.S. dollar, the latter of which is strongly associated with emerging market outperformance. That said, uncertainties about the global macroeconomic environment, notably the likelihood and extent of a global recession, will continue to be watched closely.

Investors uncertain about monetary policy, yields stay volatile

Turning to fixed income markets, bond markets endured a chaotic first quarter fuelled by market sentiment shifts and a mixed bag of investor expectations for the direction of monetary policy, as economic growth and inflation are proving much more resilient than expected.

FTSE Canada Bond Index Sector Returns Q1 2023

Source: RBC GAM, FTSE Russell

In terms of the Canadian fixed income market, the yield of the FTSE Canada Universe Bond Index ended the quarter at 3.95%, a decrease of approximately 0.3% from where it began the quarter and an increase of 1.0% year-over-year. Yields continued to exhibit heightened volatility over the quarter, ultimately ending the quarter lower from where they started. Recent events have shifted the narrative for central bank decision making, and may make it easier for the Bank of Canada to stick to its rate hold commitment going forward.

Inflation has likely peaked in Canada and we expect further easing in price pressures in 2023 and 2024. This along with recent market events should allow the Bank of Canada to maintain the overnight rate at the current 4.5% level through much of 2023 and possibly cut it by the end of the year. Fixed income market conditions have improved since the end of 2022 despite recent turmoil. Credit fundamentals look fairly healthy, especially for higher-quality issuers, inflation has moderated, and global economic growth remains solid. Both short-term and long-term bond yields are likely to decline over 2023 as policy rate cuts become closer to being realized. This decline in yields could deliver attractive returns.

Asset mix

Within our multi-asset and balanced portfolios, we executed two asset mix shifts in Q1. Equity markets remained surprisingly resilient for much of the quarter despite the recent failures of some U.S. regional banks and Credit Suisse. However, while the broad-based equity indices are positive, there has been widespread dispersion within sectors, with gains in index-heavy Info Tech and Communication stocks offsetting large losses in other areas, such as within Financials and Energy. Credit spreads have also widened but, like equities, appear to not have fully priced in the negative macro backdrop. The full impact of central bank rate hikes is unlikely to be felt until later this year. Against this backdrop, our Asset Mix Committee believes that there will be better opportunities to add risk in future and has moved the portfolios closer to their neutral targets by eliminating our tactical equity overweight. It has also reduced risk within the equities sleeve by tactically overweighting developed markets relative to emerging markets.

Recent publications

Corporate Governance – Proxy Voting

Quarterly proxy voting is disclosed for our prospectused funds through the vote disclosure portal on rbcgam.com. The portal can be found here.