We continue to believe that interest rates will be moving higher as the United States and global economies reopen and central banks slowly begin the process of normalization. Crucially, we believe the Fed will keep front-end rates pinned by pushing out rate hike expectations even as it tapers asset purchases. Perhaps more importantly, investor focus should be on the long end of the U.S. yield curve; in other words, the 30-year yield, which is most at risk of climbing aggressively. Higher rates and a steeper yield curve are likely to produce material headwinds in longer duration U.S. Treasuries and act as a general drag within this asset class, particularly in the near term.

In the longer run, however, we believe market pricing will adjust appropriately to reflect expectations of moderately higher inflation and expect the rise in market rates to slow (but not stop) as we move further along this economic and market cycle. In our view, while the asset class will remain challenged (reflected by our near-term underweight stance), we believe the longer-term expected return for U.S. government bonds has improved slightly relative to October 2020. 

Our overweight stance on EM debt continues to be one of our strongest-conviction views—in both the short term and the long term. From a tactical perspective, strengthening momentum behind the global economic rebound and a stall in USD strength should provide support to the asset class.

We believe EM debt will provide some of the most attractive expected total returns over the next five years within fixed income, thanks to the relatively high level of income returns the asset class offers, coupled with additional support from a weaker USD. Crucially, although we expect interest rates to rise somewhat in the coming years, they’re likely to remain near historic lows. This creates an environment that should drive more flows into EM debt as the search for yield becomes more urgent and the carry it can provide becomes more important to investors. Our conviction in what we expect to be a strong cyclical recovery also supports a solid overweight stance on EM debt, especially since regions such as Latin America are poised to benefit from global growth and rising demand for commodities, which should fare well in such an environment in the years ahead. Finally, we have a slight preference for local currency debt over USD-denominated EM debt, a view that’s consistent with our expectation for the greenback to weaken over the long term.

We expect non-North American developed-market interest rates to lag their U.S. and Canadian counterparts as major central banks such as the European Central Bank and the Bank of Japan appear even more likely to leave policy rates on hold and keep front-end rates contained. The same can be said of the broader economic recovery in light of the pace of vaccination rollout programs (with the U.K. being an exception). However, a gradual return to normalcy will inevitably push European and Japanese rates higher, particularly at the longer end, which will likely translate into headwinds in their respective bond markets. Crucially, on a currency-adjusted basis, we find Japanese fixed income slightly more attractive than European fixed income. 

While we don’t expect the BoC to raise interest rates for several years, it’s important to note that it’s already begun tapering its asset purchases. Crucially, an argument can be made for the BoC to raise interest rates before the Fed, both because of Canada’s higher inflation profile and concerns about financial stability, specifically housing. That said, while the BoC may begin to raise rates before the Fed, we believe it’s likely to do so at a slower pace relative to the Fed, in light of the high levels of public and private sector debt in Canada. The end result is that—some timing questions aside—the Canadian interest-rate profile (across the yield curve) will closely resemble the United States’ interest-rate profile. If the Canadian dollar were to strengthen against the USD, as expected over the longer term, it’s fair to conclude that Canadian debt would be slightly more attractive than U.S. debt—if only marginally. By the same logic, on currency-adjusted terms, Canadian corporate credit could offer marginally higher total returns relative to U.S. corporate credit. 

We have a favorable view of high-yield debt, thanks to its exposure to cyclical risk and the carry the asset class provides in the current low interest-rate environment. In our view, the income return that the asset class offers more than offsets the risks associated with price movements. Meanwhile, from a total return perspective, high-yield debt has one of the more attractive prospects in the fixed-income space. That said, spreads have already tightened significantly, and the outlook for the asset class may be slightly more muted than it was at the start of the year.

From a longer-term perspective, our view of the high-yield space is also supported by the Fed’s (and other major central banks’) recent foray into credit easing, which implies that the asset class could see some form of policy support from central banks in the event of a future crisis.  

In our view, the appeal of investment-grade credit is similar to high-yield debt, which includes the ability to provide positive carry that’s likely to outweigh headwinds arising from higher interest rates and a generally favorable outlook on the back of improved growth. Importantly, from a total return perspective, we think high-yield credits are more attractive than investment grade, but it’s also worth noting that investment-grade debts can be used as a tool for investors to add duration to their portfolios. Within this space, we have a preference for lower-rated credits but also believe it’s important to keep an eye on cross-country opportunities.

Since October, short-term risks that had once threatened to hurt sentiment—from the presidential election’s outcome to fiscal stimulus to the vaccine rollout—have been resolved. These developments, along with ample liquidity and expectations of strong growth, have contributed to the asset class’s strong performance. We remain optimistic about the country’s growth outlook for the next several quarters and therefore remain constructive on U.S. equities. However, our view is tempered by high valuations and the likelihood that excitement regarding the reopening trade could soon migrate to other regions as they catch up to the United States. Moreover, given already robust investor expectations relating to the asset class and the macro backdrop, the bar to positive surprises could be fairly high. Over the next several months, we could well see a more granular, sector-level view emerge that we believe will be critical for any outperformance.

On a structural basis, the United States has the healthiest long-term economic profile in the developed world; however, stock valuations and an expected dollar depreciation (particularly against other key developed-market currencies) remain modest headwinds for the asset class.

While the asset class is increasingly weighted toward technology, it remains levered to manufacturing and the global trade impulse, which we expect to remain strong over the next few quarters. Recent concerns about the cooling Chinese macro backdrop have affected Chinese equities and caused the broad asset class to lag, but improved market sentiment following an overly negative market reaction could lead to a period of outperformance in China. Meanwhile, markets such as South Korea and Taiwan provide exposure to semiconductors, which should continue to benefit from the global recovery.

In our view, EM equities remain attractive from a long-term valuation perspective. We expect this asset class to retain a robust growth profile and continue to provide an attractive dividend profile throughout the duration of our five-year forecast period. Understandably, a structurally weaker USD could provide a modest tailwind to this asset class

Our tactical view of European equities (including U.K. stocks) has become increasingly favorable as the region moves closer to more normalized activity even as valuations remain low relative to the United States. Meanwhile, continued fiscal and monetary policy support has provided a buffer against the worst of the lockdown-related restrictions, while the region’s manufacturing sector continued to perform well.

We continue to find the asset class attractive from a strategic perspective in terms of valuation and its dividend profile. A strengthening euro and a cyclical upturn over the next four to six quarters could translate into additional modest tailwinds; however, this favorable profile is partly offset by the region’s weak growth profile over the longer term.  

Continued progress on the vaccination front is encouraging, while higher oil prices and a steeper yield curve should continue to support the energy and financials sectors, which make up a significant part of the S&P/TSX Composite Index. While it’s likely that investors could revisit concerns relating to the real estate market and consumer indebtedness in the medium term, we expect the next few quarters to be dominated by excitement relating to the great reopening. That said, any sign that the BoC might be adopting a more hawkish stance could inject some volatility into the market, particularly on the foreign exchange front.

Despite a weaker long-term growth profile, we continue to find Canadian equities attractive for the following reasons: a supportive dividend profile, reasonable valuations, and a somewhat modest tailwind from the Canadian dollar’s expected appreciation.

In theory, Japanese equities should appeal to investors; after all, the asset class should benefit from pro-cyclical growth, a weaker yen, and continued massive monetary and fiscal support. In practice, muted foreign demand meant that returns from the asset class remained somewhat disappointing in recent months—if that changes, we could well experience a period of outperformance.

In our view, structural factors in favor of Japanese equities include inexpensive valuation, continued improvement in corporate governance, and generous share buyback programs, but these factors remain more of an offset to what’s a muted growth profile. From a three- to five-year perspective, we continue to have a neutral view of the asset class, albeit with a mild positive bias.

A recent weakening in key macroeconomic data has led to speculation that China’s growth profile has peaked, causing the MSCI China Index to lag other equity markets over the last few months. We expect this moderation to continue, particularly as the economic recovery transitions from being manufacturing led to more services led. However, a recent shift in sentiment would suggest short-term support for this asset class as it recovers from overly negative sentiment.

We’ve long maintained that Chinese growth will need to decelerate gradually in order to facilitate a rebalancing from its industrial growth model to a consumer growth model. While the COVID-19 outbreak has been disruptive, we believe the official policy response will be meaningful enough to keep China in that pattern over the next five years. As a result, we no longer expect the country to benefit from valuation expansion relative to the rest of the world, including EM. We also expect the renminbi to depreciate modestly over the next three to five years.

We’ve upgraded our views on U.S. REITs, as the great reopening and the improving macro backdrop are likely to be constructive for the asset class. Broadly speaking, we believe that the asset class’s key characteristics continue to appeal in the current environment—it has an income component in addition to offering dividend yields that are more attractive relative to both real assets and financial assets. Crucially, REITs also enjoy low correlations to other asset classes, particularly fixed-income assets, and therefore offer potential diversification benefits.

However, the subsectors within the REIT universe are highly bifurcated—we expect those in the industrial, residential, and data center segments to continue to fare well but recognize the uncertainty confronting those in the retail and office space. In addition, we foresee uncertainty developing in the longer term as household and business preferences evolve over time and believe that could affect the demand of certain subsectors within the real estate complex. For this reason, we continue to have a neutral stance on the asset class despite the presence of several favorable dynamics. That said, while rising interest rates could curb the appeal of the asset class, they don’t—in our view—represent a headwind that would wipe out any potential benefits that REIT investors could gain from the great reopening. 

The faster-than-expected reopening in the United States saw a corresponding rise in car journeys, providing support for crude oil in the short term. We expect to see a similar picture in Europe and other developed markets as they gradually reopen, although it could be some time before EM economies (e.g., India, Latin America) could resume business as usual, thereby preventing demand from spiraling in the near term. Global appetite for lumber, however, continues to outstrip supply due to bottlenecks at sawmills, causing prices to rise significantly in recent weeks.

Equity valuation within the global natural resource space has mainly been driven by the energy component, which could continue. In our view, global natural resource equities are an example of a cyclical play and should outperform global equities at this point in the economic cycle.