Firm Updates

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This quarter, Mona McManus returned to RBC Global Asset Management Inc. (RBC GAM Inc.) as Head of the Compliance team and Chief Compliance Officer (CCO). Most recently she led compliance for RBC Wealth Management Canada’s discretionary wealth and trust businesses and was CCO for RBC Phillips, Hager & North Investment Counsel Inc. She previously had spent 12 years as Director, Compliance and Alternate Chief Compliance Officer for RBC GAM Inc., with responsibility for managing RBC Global Asset Management (RBC GAM)’s Canadian compliance team.

Jennifer Schillaci joined the RBC Private Markets team in November as Head, Real Estate and Mortgage Investments, reporting to Michael Kitt. In this newly created role, she works with Michael to oversee both the management of existing solutions and the development of new funds, building out our private markets solutions set and capabilities. Previously, Jennifer had spent 20 years with a leading insurance firm where she had held several senior positions related to real estate fund management and investment execution.

Recent developments

In October, we launched the PH&N Long Private Placement Corporate Debt Fund. The fund invests primarily in a portfolio of corporate bonds issued by way of private placement, including illiquid and/or unrated bonds, in order to pursue additional associated yield opportunities. The new fund builds on the successful track record of the PH&N Private Placement Corporate Debt Fund, which was launched in 2016 and has grown to over $1 billion CAD in assets under management.

Also in October, we kicked off the eighth year of the RBC Mentorship for Women in Investment Management program, pairing 51 mentors with students from UBC, SFU, and University of New Brunswick – our biggest year yet. A collaboration with colleagues in RBC GAM and RBC PH&N Investment Counsel, the program reflects PH&N Institutional’s strong support for diversity and inclusion in our industry. This initiative identifies high-potential female talent from the business school at each partner university and seeks to inform them of careers in finance and investing.

Our Investment Policy team monitors PH&N, RBC, and BlueBay investment mandates to ensure they continue to meet our clients’ needs and continue to seek suitable opportunities in evolving capital markets. Most recently, the team worked with the PH&N Fixed Income team to ensure that certain non-prospectused PH&N bond funds can pursue appropriate opportunities in Maple bonds, as well as illiquid and unrated bonds. As a result, in early 2024, we will increase the maximum allocation to Maple bonds in six bond funds¹; and improve the capacity of seven bond funds² to invest in illiquid and unrated private placement bonds.

Market updates

Indices Performance Comparison as of December 31, 2023 (%)

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

AI continues to drive tech stocks up, but recession and inflation fears remain

Global markets witnessed a comeback in 2023 after a disappointing 2022. Stocks were driven by the combination of a strong economy, higher-than-expected corporate earnings, and the likely end of the U.S. Federal Reserve’s (the Fed’s) rate hiking cycle. Tech stocks were among the best performers, bolstered by the likelihood of rate cuts in 2024 and upcoming trends in artificial intelligence (AI) technologies. Heading into 2024, the likelihood of recession, the trajectory of inflation, and the extent of rates cuts will be the key focus areas.

Markets volatile in Q4, but end up higher

Indexed at 0% since the start of 2023

Note: As of December 31, 2023. Magnificent 7 includes Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla. Source: Bloomberg, RBC GAM.

In terms of economic activity, most developed world economies were able to avoid a widely feared economic contraction in 2023. Inflation appears to be on a moderating path, energy risk associated with the war in Ukraine has greatly faded, supply-chain problems have been largely resolved, and stress in the U.S. regional banking system has eased. However, the macroeconomic picture is not encouraging for the first half of 2024. The war in Ukraine and the conflict in the Middle East can become problematic for the economy if they intensify. The ongoing friction between the U.S. and China is already exerting a mild drag as trade patterns are reconfigured. Furthermore, higher yields reflect still-elevated inflation and contain a risk premium that accommodates enormous fiscal deficits that must be funded, the shift from central banks buying bonds to disposing of them, and greater competition from rising yields in previously low-yielding markets such as Japan and the eurozone.

Recession signals point mostly to “yes” or “maybe”: we estimate a 60% chance over the next year"

Note: As at 10/29/2023. Analysis for U.S. economy. Source: RBC GAM

The U.S. economy is theoretically less rate sensitive than its peers due to lower levels of household debt and longer mortgage terms. This advantage is, however, partially undermined by a sharper tightening of lending standards there. Also, the large fiscal boost experienced in 2023 is set to become a drag in 2024. On the housing front, the market has gyrated – first weakening in 2022, then rebounding in early 2023 – and is now softening again. We anticipate an extended period of softness in home prices given poor affordability and high mortgage rates. Up north, the Canadian economy is slowing, with a proper recession still potentially ahead. Consumer spending is wavering as higher interest rates weigh on Canada’s elevated household-debt loads and real retail sales on a per-capita basis are lower than they were a year ago. Though extraordinary levels of Canadian immigration have expanded the country’s population at a blistering 3% rate and provide an important support for the economy, it is unlikely to fully offset the effect of higher interest rates, particularly given the country’s awful productivity performance in recent years.We assign a 60% probability of recession over the next year in the U .S. The probability is slightly higher for Canada, the U.K., and the eurozone. But any recession is likely to be reasonably mild and fairly short, with fewer job losses than normal.

Global inflation has declined but remains elevated

Note: As of Nov 2023. Source: Haver Analytics, Macrobond, RBC GAM

Inflation has fallen sharply from its multi-decade peak in the middle of 2022, and we see further scope for decline. The four original drivers of the inflation spike have all turned meaningfully. The commodity shock has faded, supply-chain bottlenecks have eased, central banks have pivoted from massive ease to restraint, and fiscal stimulus is significantly diminished. At its worst, high inflation was broad based, with the majority of the spending basket rising at an unusual clip, but that breadth is now fading quickly. Goods inflation has vanished. Though service sector inflation remains elevated, it too is past its peak. Given these reasons, we think that inflation can continue moving back toward the central bank’s 2% target, although it may not reach that level by the end of 2024.

After hoisting policy rates at a rapid pace and by an unusually large amount in response to the inflation shock, most developed world central banks have stabilized rates at an elevated level in the range of 5%. In keeping with the theme of elevated uncertainty, there are a number of ways central banks could go from here. Further rate increases are not impossible if the economy were to keep chugging along and/or inflation were to become stuck in the 3%-plus range. Despite that, the odds increasingly tilt toward rate cuts in 2024 – conceivably sooner rather than later, and more cuts rather than fewer. The Fed has signalled that it now anticipates turning to rate cutting in the coming quarters.

Equity Markets end the quarter positive, despite a volatile start

Equity markets were volatile in the quarter, tumbling over 10% in the early part of Q4 as bond yields soared, geopolitical tensions flared, and the economy showed signs of wobbling. However, they rallied beginning November and ended the quarter in the positive territory, driven by lower-than-expected inflation and the increased likelihood of an economic soft landing. The MSCI World Net Index posted positive returns during the fourth quarter and ended the period with a return of 8.66%. The performance was underpinned by the shift in Fed policy from interest rate increases to cuts for 2024. Though such a pivot has been prematurely priced in several times earlier over the last 12–18 months, inflation had moderated strongly enough by end-2023 give the market confidence to price it in once again. The broader market's gains were driven largely by the Magnificent Seven companies: Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta Platforms and Tesla. Looking ahead, the biggest risk to the stock market, in our view, is the near-term path for corporate profits. To the extent that a soft landing for the U.S. and global economy has increasing visibility, stocks could extend their gains. Should the outlook for growth improve and the threat of earnings shortfalls diminish, the rally could broaden out and leadership could shift to non-U.S. regions, value stocks, and small/mid-caps as investors look to the most attractive valuations in an environment of a broad-based increase in corporate profits beyond the first half of 2024

The Canadian equity market ended the fourth quarter in positive territory, with the S&P/TSX Composite Index returning 8.10% but underperforming the U.S. market. Information Technology was Canada’s best-performing sector. Continued economic resilience, robust growth expectations, and a potential for productivity and profits to benefit from AI supported technology stocks over the quarter and the year. Financials and Real Estate also performed well, while the Energy and Materials sectors were among the worst performers. Going forward, equity returns will ultimately depend on the path of interest rates, the severity and length of any recession that materializes, and its impact on corporate earnings growth.

Emerging market (EM) equities posted positive returns during the quarter but underperformed developed markets. The index was weighed down by a heavy tilt to Chinese companies, which comprise 25% of the index and declined on the quarter. One of China’s main issues following the pandemic has been consumers’ lack of confidence in the economy, leading to increased savings rates and anemic consumption. In addition, the rise in geopolitical tensions with the U.S., which has imposed non-tariff trade barriers such as quotas, has led China’s trade partners to diversify their supply chains. We would expect the decline in EM interest rates over the next year to occur faster than any declines in developed markets, and for the drop in EM rates to bolster the earnings of companies in those geographies. The improved earnings outlook in turn suggests better performance for stocks in emerging markets. Furthermore, some of the largest EM countries outside of China, including India and Indonesia, still have strong potential for urbanization to drive long-term economic growth.

Bond yields fall as a “higher-for-longer” rate environment looks less likely

Turning to fixed income markets, major fixed income indices saw positive performance over the quarter as bond yields fell meaningfully across all terms, fuelled by softer economic data, progress on the inflation front, and a shift in central bank sentiment toward an end to the monetary tightening cycle.

FTSE Canada Bond Index Sector Returns Q4 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 fourth quarter at 3.9%, a meaningful decrease of 1.0% from where it began the period. Yields remained volatile over the quarter, delivering approximately 30 days on which yields on the index changed by more than 0.05%. Most of the outsized moves were a result of declining yields, a reflection of the bond market’s shift in expectations from a “higher-for-longer” rate environment to a monetary easing one. The Bank of Canada (BoC) held its policy rate unchanged at 5% at its October and December meetings, citing growing evidence that past rate hikes are having their intended effect on the economy and inflation

On the inflation front in Canada, headline CPI continued its descent over the quarter, declining to 3.1% year over year in November (down from 3.8% in September and 6.8% a year prior). Overall, higher interest rates have reduced price pressures on a broad range of goods and services. However, shelter prices continued to make up the largest single component of total inflation and are a key contributor to inflation remaining above target.

Asset mix

Within our multi-asset and balanced portfolios, we made two changes to our asset mix positioning, both of which resulted in a small tactical overweight to bonds, at the expense of money market. Yields hit multi-year highs over the quarter, making bond valuations attractive, particularly relative to other asset classes. While recent correlation with equities has been strongly positive, the Asset Mix Committee expects that bonds will regain their defensive characteristics if/when the market becomes concerned about future economic weakness. As such, we believe it prudent to start to build a tactical overweight position in bonds. A separate tactical trade within bonds was also executed, which saw the strategy bring its high yield credit exposure back to neutral (from underweight). This trade sought to take advantage of very attractive yields in high yield credit, which in our view were extremely favourable, given the high-quality risk profile of our high yield strategy.

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.

¹The PH&N Short Investment Grade Corporate Bond Trust, PH&N Investment Grade Corporate Bond Trust, PH&N Long Investment Grade Corporate Bond Trust, PH&N Corporate Bond Trust, PH&N Enhanced Corporate Bond Trust, and PH&N Long Corporate Bond Trust.

²The PH&N Investment Grade Corporate Bond Trust, PH&N Long Investment Grade Corporate Bond Trust, PH&N Corporate Bond Trust, PH&N Enhanced Corporate Bond Trust, and PH&N Long Corporate Bond Trust, PH&N Long Bond Pension Trust, and the PH&N Enhanced Total Return Bond Fund.