Daniel Straus, managing director at National Bank Financial Market

FOCUS: ETFs

MARKET OUTLOOK:

The first quarter of 2024 turned out positively for U.S. and international stocks, each delivering 10 per cent in the first three months of the year. Even Canadian stocks, missing the growth-tech names that have been propelling returns south of the border, managed to deliver six per cent after a faltering start. However, recent strength has led the S&P 500 Index earnings yield to fall below the U.S. Federal Reserve funds rate for the first time since 1998. Additionally, core price data from the U.S. shows that inflation is falling but still stubbornly above the two per cent target. Meanwhile, gold has vaulted to new highs despite elevated real rates and an appreciating U.S. dollar. The market seems to be strutting along confidently. But is this confidence misplaced?

National Bank’s economics and strategists believe that economic growth and profitability might surprise to the downside in the medium term. They are maintaining their defensive asset allocation, with equities “underweight-to-neutral,” while fixed income and cash are both overweight.

Among Canadian ETF investors, demand for the U.S. is unabated. Year-to-date, Canadian ETFs gathered almost $14 billion in a single quarter, of which $6 billion went to U.S. equity alone. Although it would take quite a few factors to sustain this momentum for nine more months, at this rate, Canadian ETFs would gather $55.6 billion by year-end, narrowly edging out the $51 billion inflow record set in the gangbuster pandemic recovery year of 2021.

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TOP PICKS:

Dynamic Active Preferred Shares ETF (DXP TSX)

Preferred shares are an interesting asset class that we don’t consider core fixed income, but they are very popular with ETF investors seeking tax-efficient yield. Our strategists in this department are bullish on preferred shares (especially those of the fixed-reset variety) in a “higher-for-longer” interest rate environment. Preferred shares may be due for material re-pricing if a high-rate reality sets in. Because preferred shares in Canada are a potentially illiquid and inefficient asset class, we are highlighting an active ETF whose management team has been able to deliver consistent performance over time.

Horizons Enhanced (1.25x) All-Equity Asset Allocation ETF (HEQL TSX)

Caution advised – this ETF contains 25 per cent leverage, which can amplify the downside. We’re highlighting this ETF as an example of how a very long-term, very risk-tolerant investor might approach diversified portfolio construction. Similar to other “all equity” ETFs that are constructed from other sub-funds, this new ETF from Horizons (soon to re-brand as Global X) achieves 125 per cent global equity exposure via cash borrowing, with all of the risks, interest costs, and rebalancing effects that would entail. However, its performance since launch shows us what the extra gearing can accomplish: lower lows and higher highs.

CI Money Market ETF (CMNY TSX)

Cash, T-bills, and money market investments are exciting again when they pay in the neighbourhood of four to five per cent annually. This ETF holds a mix of ultra-short term instruments that mature in less than 365 days. The adjacent category of “high interest savings” ETFs underwent some regulatory changes few months ago, and since bank treasury departments now have to treat their run-off risk differently, we’ve noticed a slight dip in their yields. Money market ETFs suddenly became competitive, and this is one of the newer products that launched to give investors choice for the “cash line” in their portfolios.