Q1: What is your outlook on the global economy?

Global economic growth has been completely determined by modern conditions over the last 2 to 2.5 years. Spike in inflation that happened with the release from the pandemic. We saw a huge increase in interest rates, a historic increase in interest rates.

We had quantitative tightening and also a slowdown in the rate of growth of the money supply. We worked very much with scenario forecasting at RBC GAM, and with the amount of tightening that we'd seen earlier, on a recession and perhaps more than a mild recession was the baseline scenario. But quite surprisingly, as we move through 2023 and into 2024, the economy started to perk up as opposed to slide deeper into recession territory.

Now we did see Germany, Canada, the United Kingdom, come awfully close to what we would technically define as a recession, at least the lightest form of defining recession as being two back-to- back quarters of GDP. We did see that, but it wasn't deep, it wasn't broad. And the U.S. has completely avoided that dip.

We look at U.S. exceptionalism, so how does that explain the outlook for the future and really the difference is, is that we have a longer duration of debt in the United States than we do in other countries. So essentially the medicine that was applied to inflation had a quicker, more dramatic effect outside of the United States than in the United States. And what do you know?

Inflation is now on a proper path towards 2%. So high rates and dramatic drawdowns in the rate of growth, the money supply are no longer required. That means that the economy could recover in the world's biggest economy, the United States, without having passed through the recession that you would generally think would occur as a result of higher rates.

We're already seeing green shoots of stronger growth into 2024 and 2025. Importantly, lending conditions, for example, are becoming somewhat less onerous. We've shifted our scenarios where we had looked for first a deeper recession and then a mild recession. The odds now, I think, slightly favor what's called the soft landing. So, a period of sluggish growth, but low inflation that'll deliver us into 2025.

We're looking for something like 2%, 2.5% growth. And most countries, including the United States and Canada, into 2025.

Q2: What are the current risks to your outlook?

Well, inflation continues to be the key risk of the economic outlook. You know, the Fed and other central bankers are going to have to hold rates higher for longer or even reverse the path towards easier monetary conditions. If inflation, in fact, moves off the path to 2% and starts to head higher, that could happen.

That would mean at least delay easing of interest rates, lower interest rates. It would mean cranking down further on the rate of growth of the money supply or quantitative tightening. These things would probably tip the balance back towards recession. We think it's unlikely less likely it's not our preferred scenario, but it is a possible scenario and something obviously that the market is concerned about.

Every time that we haven't had a sort of a linear decline in inflation monthly towards that 2% target the market has hiccups, so we’re very sensitive to that, I think is the key risk out there. But it's certainly not the only risk with the horrific fighting that we're seeing in the Middle East that has dominated headlines and investors’ attention.

The issues around Chinese growth, Chinese politics are a very, very big concern, as it could ultimately lead to deflation in some scenarios in the in the world economy. Commercial real estate in the United States is a concern as it works through the banking system. So, there's a variety of things that are certainly on our radar. But I would say, number one, we need to continue to bring inflation down towards that 2% target.

Q3: What is your view on inflation?

It's a concern in the market that one of the policy options for the Fed is so called higher for longer and that their concern over really getting inflation down and making sure that expectations do not shift, that rates are held at a punishing level well into 2024. That seems unlikely to us.

The massive increase in interest rates in our models moved them from being stimulative and inappropriately stimulative as we escaped the pandemic through neutral, and all the way to being very restrictive. And the longer they're held at those levels, the more pain is dealt into the economy, and the slower economic growth will be. And we’ll ultimately slip into a recession of some size. And it’s no longer required as long as inflation follows the expected track.

We actually look for something like 100 to 125 basis points or more than one full percentage point cut in short term interest rates by one year out. And that won’t get them even into a neutral level. Right now, what we'd consider the neutral level of interest rates, that level that neither pushes great growth forward or holds it back is closer to 2.5%.

So they started five and a quarter. You get down to four in a year, you still got some weight on the economy, which is probably appropriate but will become less and less necessary beyond 2025.

Q4: What is your outlook for the fixed income markets?

late in 2023? We had seldom seen in an alignment of factors that set up the bond market for the huge move that it had. You had moved interest rates at the short end and pushed out the long way and all the way through a neutral level to a high level, unsustainable level, as long as inflation was going to come under control.

And that's exactly what happened. To the huge amount of bearishness, you had no belief that interest rates would come down. In fact, when we passed through 5% in October, people were looking for a 6% peak. We then had the positive inflation prints. We had the Fed saying that situation was seen to be under control, and we had the huge rally that began and took us actually briefly through 4%.

100 basis point decline in interest rates, almost 115 basis point decline in long term interest rates into the end of this into the end of 2023. Now, since then, a bit of sort of gut check. Fed's not going to cut rates that quickly. Inflation isn't going to go in a straight line every month down towards 2%. There's a residual risk to that forecast and yields ticked back up above 4%, 4.25% where they currently sit.

We think that the path to inflation is 2%, even if it's irregular. We think that the Fed will accommodate lower interest rates all along the yield curve by beginning rate cuts in 2024, probably this summer and into the fall, that those rate cuts could accelerate into 2025. And at that point, the yields won't stick at their current level, then move at least to 4% over the next 12-month period.

And if that happens, it generates something like a 6% return to bondholders. It's a pretty attractive view of the bond market over the coming 12 months as it has been over the past four or five months.

Q5: What is your outlook for equity markets?

Since 2022, the world equity market has been very much paced by the huge gains in the U.S. equity market, which in fact has been driven by seven stocks now called the MAG seven. I have to say though, that the signals from the equity market have been highly influential on our own view of the economy.

You know, if we were going to go into recession, the equity market should already be in a bear market and most definitely is not. It's more than AI, of course, it's fueling the market. But this has led gains in 2023. Those magnificent seven stocks heavily exposed to technology and artificial intelligence and all promise up over 80% and another 10% so far this year.

If you look deeper into the list, you look in the mid-cap market, you look outside of the United States and you will see, though, that there have been gains far less impressive than that. But, you know, high single digit, low double-digit gains in 2023 are, above the average. And it's signaling better economic times ahead. I think the problem with the equity market here is that the proof points or the things that will legitimize current valuations for the most expensive stocks, those MAG seven leaders, are becoming awfully high.

In our math, they're looking like a requirement for something like 33% of year earnings growth out over the next decade and they produce 22% of year earnings growth as a group since 2018 or 2019. So, this is not an unachievable issue, but it is a challenging issue that needs to be fulfilled.

By the broader list, earnings are probably going to grow close to nominal GDP and in our mind that's 5% a year and the consensus right now is 10% a year. Now, it's also possible that we could get to that 10% a year and that we're being too conservative. We're watching that very closely. How would you get there? Well, obviously, stronger nominal GDP growth, little bit more real growth, hopefully, and inflation moving back towards 2%.

You could do it that way. It wouldn't take an awful lot. Or you could do it through a slight improvement in margins. Margins have been coming down as the economy slowed with the weight of higher interest rates. If you added 1% in margins this year and 1% in margins next year, yes, you'll come up with the level of earnings that will justify the bull market continuing.

But this is the challenge for the equity market. Aggressive forecasts for growth or margins or earnings growth are now absolutely required to sustain the bull market. We're looking for gains in mid to high single digits for the world's equity markets. We're concerned about that MAG seven. We recognize they have achievable but tough to achieve targets. But we're encouraged by the fact that outside of the largest parts of the U.S. equity market, mostly those MAG seven stocks, most valuations around the world actually remain quite attractive despite the gains that have been posted since 2022.

So, if we could navigate that MAG seven, the economy continues on a growth track and especially if we can improve margins over the next 2 years, this bull market will remain intact. But those are the challenges.

Q6: How have you positioned your asset mix in the current environment?

We're looking for returns, total returns and equity markets ranging from mid-single digits to high single digits around the world. And we're hoping that we broaden out the leadership of global markets to include European markets, U.K. markets and Canada. So, it's not all U.S. and it's not all U.S. large cap because that will breathe more life into this bull market.

We're looking for slightly lower returns in the fixed income markets, say a high of mid-single digits to lower single digits. But we still have a slight nod towards fixed income in our asset mix. We’re running neutral exposures to stocks because of the significant challenges to validating current valuations. We need stronger growth in earnings in order to keep this going.

It is possible but is not an absolute certainty. In fixed income, we're intrigued by the risk reward scenario. We always ask ourselves the what if we're wrong? Or What if we're really right? Really right would be, interest rates fall 100 basis points of the current position. If we're wrong, interest rates rise 100 basis points of the current position.

Well, it turns out it's a 3 to 1 bet rate now, perhaps on a ten-year T bond, if interest rates fell 100 basis points, you’d capture 12% total return. If they in fact rise 100 basis points, which we don't expect, you lose about three and a half to 4%. The difference is the coupon that offset some of that capital loss.

You have better downside protection right now on fixed income that just doesn't exist in equities. So, we're running slightly overweight positions in fixed income despite a bit lower total return expectation. Neutral on stocks, slightly overweight in fixed income, and very low cash reserves.