Many different investment options on blackboard.Getty Images/iStockphoto
The perennial question facing Canadian investors – where do I invest my money? – has never been more apt against a backdrop of generationally low bond yields, uncertainty about the global economic outlook in the wake of the Brexit vote, considerable good news baked into energy prices, and less forgiving equity valuations.
Canadian equities have outperformed many global peers so far this year on the back of higher oil and gold prices. Policy makers have helped, too. Even before Canadian growth faltered in the second quarter because of the Alberta wildfires, policy makers were already on the scene delivering a mix of targeted spending measures and tax cuts, as well as accommodative monetary policy.
We now see further gains in Canadian equities dependent on economic and earnings growth. Higher commodity prices and slow-but-steady growth in the Canadian economy are encouraging. Canadian stocks' above-average exposure to gold miners gives investors a certain hedge in their portfolio amid heightened geopolitical risk at a time when the U.S. is choosing new leadership and the U.K. is aiming to renegotiate its relationship with the EU. Another potential upside "risk" is that investors could divert some of their high cash balances toward stocks if the Canadian and global economies grow faster than most anticipate.
Another factor boosting the relative appeal of Canadian stocks is the low nominal yields available in the government bond market. For investors seeking income, stocks offering sustained and steady dividend growth are appealing. With 10-year Government of Canada bond yields having fallen to roughly 1.0 per cent, the yield advantage for owning Canadian stocks has grown to more than two full percentage points.
The bond market poses even greater challenges than stocks: valuations are expensive and real opportunities are harder to spot. Globally, yields on government bonds are either moving more deeply into negative territory or falling closer to the zero line as investors hoard perceived safety amid heightened uncertainty. While staying close to targeted risk tolerance levels is of utmost importance, we find value in higher-yielding fixed-income segments, like investment-grade corporate bonds and emerging market (EM) debt, for investors willing to tolerate the higher levels of credit risk.
Amid a global thirst for yield and heightened risk aversion, investors may want to consider owning longer-maturity bonds, to benefit from their diversification attributes. This offers the ballast in a portfolio in the event that storms begin to brew. The risk? With nominal yields at such low levels, any reversal would likely weigh on assets purchased for safety, such as nominal government bonds and defensive equity sectors.
This is why we prefer dividend growth stocks, emerging markets debt, and investment-grade corporate bonds. It is not because they're cheap or without risk, but because they meet one of the most important needs of today's generation of investors: income. In the land of the blind, the one-eyed man is king.
Kurt Reiman is BlackRock's chief investment strategist for Canada