Financial markets have encountered significant volatility over the last few weeks as investors digested a flurry of impactful events and information. The attempt on former U.S. president Donald Trump’s life and President Biden’s withdrawal from the presidential race shifted perceived election odds and its implications for taxes, regulation, trade, immigration and foreign policy.

Later in July, the deaths of several senior members of Hezbollah and Hamas intensified geopolitical tensions and threatened further escalation in the Middle East. The Bank of Japan’s (BOJ) decision to raise interest rates and taper its bond buying program on July 31^st set off an unwind of the carry trade, a strategy that takes advantage of the interest rate divergence between Japan and other regions.

In the subsequent days, investors became increasingly concerned about the outlook for economic growth as purchasing managers indices (PMI) declined in most major regions (Exhibit 1). Moreover, surprisingly weak U.S. jobs data further rankled markets as the pace of the recent rise in the unemployment rate, even if from a low base, triggered an efficacious recession indicator known as the Sahm Rule.

Exhibit 1: Global purchasing managers' indices

Note: As of July 31, 2024. Source: Macrobond, RBC GAM

Although the economy has slowed, the data continues to favour economic growth over recession. The U.S. economy remains robust with a still-healthy labour market and solid consumer spending. In fact, since the spike in market volatility in the first few days of August, economic data prints such as the ISM Services PMI and weekly jobless claims beat estimates and helped to temper investor concerns that the economy could be headed for a downturn.

In addition, the BOJ’s deputy governor Uchida assured that the central bank would not raise rates when the markets are unstable. After considering all of these developments, our base case continues to be for a soft landing with modest global economic growth and inflation slowing towards central
bank targets.

Sovereign bonds move closer to fair value with recent fall in yields

Global sovereign bonds have delivered terrific returns since late-April as inflation reestablished its downward trajectory and economic data moderated. The pace of the decline in yields accelerated in recent weeks as investors adjusted their recession probabilities higher in response to the weak ISM Manufacturing PMI and payroll reports. The U.S. 10-year yield has fallen 91 basis points in recent weeks, from a high of 4.70% on April 25th to a low of 3.79% on August 5^th.

Exhibit 2: U.S. 10-year T-Bond yield

Equilibrium range

Note: As of August 14, 2024. Source: RBC GAM

As a result, the especially attractive valuations in bonds that existed earlier in the year have normalized and our model, adjusted for positive real interest rates going forward, suggests that the current yield is appropriate, sitting near the middle of the 3.3% to 4.5% range projected over the next 12 months (Exhibit 2). This equilibrium range reflects expectations for the gradual decline of inflation towards our target, interest rate cuts and a soft landing for the economy over the period. In our view, sovereign bond investors are likely to earn low- to mid single digit total returns over the next 12 months.

Closing out slight bond overweight and shifting asset mix to a neutral stance

Considering the balance of risks and opportunities in the shorter- and longer-term horizons, we are removing our slight preference for bonds over cash and shifting our asset mix to a neutral setting. The recent rally in bonds reflects a somewhat aggressive central bank easing cycle and has tempered our outlook for bonds going forward as our model indicates a less obvious case for a meaningful downward adjustment in yields from here, absent a downturn in the economy.

Accordingly, we have closed out our slight overweight in bonds of 0.5% with the proceeds going to cash. We continue to expect stocks to outperform bonds over the longer term, but demanding valuations, specifically in U.S. large-cap stocks, and the diminished risk premium over bonds has kept us from adding to our current neutral allocation to equities (Exhibit 3).

Exhibit 3: S&P 500 earnings yield

12-month trailing earnings/index level

Note: As of August 9, 2024. Source: RBC GAM

We would be more inclined to boost our allocation to equities if we saw a durable rotation in equity-market leadership outside of U.S. mega-cap technology and into smaller market cap, value, international and/or emerging market equities. Our current recommended asset mix for a global balanced investor is 60.0% equities (strategic: “neutral”: 60%), 38.0% bonds (strategic “neutral”: 38%) and 2.0% in cash (Exhibit 4).

Exhibit 4: Recommended asset mix

RBC GAM Investment Strategy Committee

Note: As of August 14, 2024. Source: RBC GAM

Soyez au fait des dernières perspectives de RBC Gestion mondiale d’actifs.

Disclosure

This document is provided by RBC Global Asset Management (RBC GAM) for informational purposes only and may not be reproduced, distributed or published without the written consent of RBC GAM or its affiliated entities listed herein. This document does not constitute an offer or a solicitation to buy or to sell any security, product or service in any jurisdiction; nor is it intended to provide investment, financial, legal, accounting, tax, or other advice and such information should not be relied or acted upon for providing such advice. This document is not available for distribution to investors in jurisdictions where such distribution would be prohibited.

RBC GAM is the asset management division of Royal Bank of Canada (RBC) which includes RBC Global Asset Management Inc., RBC Global Asset Management (U.S.) Inc., RBC Global Asset Management (UK) Limited, RBC Global Asset Management (Asia) Limited, and RBC Indigo Asset Management Inc. which are separate, but affiliated subsidiaries of RBC.

In Canada, this document is provided by RBC Global Asset Management Inc. (including PH&N Institutional) and/or RBC Indigo Asset Management Inc. which is regulated by each provincial and territorial securities commission with which it is registered. In the United States, this document is provided by RBC Global Asset Management (U.S.) Inc., a federally registered investment adviser. In Europe this document is provided by RBC Global Asset Management (UK) Limited, which is authorised and regulated by the UK Financial Conduct Authority. In Asia, this document is provided by RBC Global Asset Management (Asia) Limited, which is registered with the Securities and Futures Commission (SFC) in Hong Kong.

 Additional information about RBC GAM may be found at www.rbcgam.com.

This document has not been reviewed by, and is not registered with, any securities or other regulatory authority, and may, where appropriate and permissible, be distributed by the above-listed entities in their respective jurisdictions.

Any investment and economic outlook information contained in this document has been compiled by RBC GAM from various sources. Information obtained from third parties is believed to be reliable, but no representation or warranty, express or implied, is made by RBC GAM, its affiliates or any other person as to its accuracy, completeness or correctness. RBC GAM and its affiliates assume no responsibility for any such errors or omissions.

Opinions contained herein reflect the judgment and thought leadership of RBC GAM and are subject to change at any time. Such opinions are for informational purposes only and are not intended to be investment or financial advice and should not be relied or acted upon for providing such advice. RBC GAM does not undertake any obligation or responsibility to update such opinions.

RBC GAM reserves the right at any time and without notice to change, amend or cease publication of this information.

Past performance is not indicative of future results. With all investments there is a risk of loss of all or a portion of the amount invested. Where return estimates are shown, these are provided for illustrative purposes only and should not be construed as a prediction of returns; actual returns may be higher or lower than those shown and may vary substantially, especially over shorter time periods. It is not possible to invest directly in an index.

Some of the statements contained in this document may be considered forward-looking statements which provide current expectations or forecasts of future results or events. Forward-looking statements are not guarantees of future performance or events and involve risks and uncertainties. Do not place undue reliance on these statements because actual results or events may differ materially from those described in such forward-looking statements as a result of various factors. Before making any investment decisions, we encourage you to consider all relevant factors carefully.

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© RBC Global Asset Management Inc. 2024

Publication date: August 15, 2024

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