Michael: Hello everyone. Welcome to Portfolio Manager Views. My name is Mike Augustine, head of fixed income and Asset Liability Management. And I'm delighted to be joined today by Hafiz Nordin, a senior active portfolio manager. So, Hafiz, 2026, I feel like we've been shot out of a cannon, so let's get right into this. So maybe to set the stage.
Davos. All the world leaders in a room. Prime Minister Mark Carney steps up and makes a speech. So, I jotted down a couple of things he said. There has been a rupture in the world order. It is the end of pleasant fiction and the beginning of a harsh reality. Intermediary powers like Canada are not powerless. If you're not at the table, we are on the menu.
Right. So, let's sort of step way back. Right. And maybe we could talk about some stuff that's on the menu. So obviously, we've started the year. There's activity in Venezuela. So, if we think about other countries like Mexico, we think about Colombia, maybe we think about Canada, there could be implications there? Iran, right? There's civil unrest. There's talk of U.S. intervention.
There's the ongoing war by Russia on Ukraine. You can think about Taiwan and some of the South China Seas activity. And then more recently, Arctic sovereignty. Right. So, a lot of things if we pan back and we think about the macroeconomic environment, right. You, when we start to think about fixed income and given that background, what are your initial thoughts and how are you feeling starting the year?
Hafiz: Right. Yeah, I know it's been feeling exhausting, right, to sort through all that. So yeah, I think when we tried to, reflect on a lot on a lot of the team discussions we've been having to start the year. There's a clear implication for Canada around the energy sector. And so, there was obviously a big equity story there where there's a lot of volatility in energy related equities.
But when you look at the bond market and if you look at the bigger corporate borrowers in the Canadian market, they're largely the pipelines. And what we saw there was that the prices for bonds for pipeline companies were actually pretty stable throughout all of this. So, I think that's kind of a good thing to sort of reflect on that.
The business models of the biggest borrowers in the energy sector are generally still intact. And so, I think that's sort of a good thing to sort of reflect on. But I think what you pointed out around you, looking at what's happening Davos and Greenland in particular, the market reaction, there has been much more broad based.
It has only just been energy related, but sentiment has really deteriorated a lot around, in equities as well as in fixed income. And so, I think there's definitely reflects worries about tariffs coming back into the picture. And I think that obviously it has implications around inflation and has implications around, what's arguably our rich valuations in equities and in corporate bonds.
So, I think I think that's something that's we have to take headline by headline. But I wanted to add one thing, which was that there's one topic there that didn't get a lot of headlines but actually mattered a ton to the fixed income markets. And that was Japan. And it's not so much a geopolitical event, but it does point to this idea that fiscal sustainability is still going to be a really important theme and arguably one that could persist more than the, the constant noise around geopolitical risks.
And what happened there was that there's a lot more concerns around how much Japan, the Japanese government, intends to borrow. And is that sustainable when they already have a debt to GDP of 250%. So those are the bigger picture things that we have to look at. And, to start the year, certainly some bad ism, a lot of volatility in equities and crypto.
But if you were a holder of 30-year Japanese government bonds, I think at one point your total return was down 7% in a matter of a few days. So those are the kind of moves that we were looking at and thinking, that's what we really have to watch out for, particularly the fixed income market.
Michael: Yeah, it's interesting because we often don't think about sovereigns as having credit risk. But let's come back to that. You talked about inflation and obviously last year tariffs were front and center. When we think about inflation in central banks and what we'd expect them to do. there's a lot of other factors, obviously, that we've talked about on the desk, we've got aging demographics, so we've got a lot of people leaving the workforce. We've had shifts in immigration policies in many countries, and that's sort of diminishing entrance to the workforce. I don't think we can do a podcast without talking about A.I. Right. And the productivity there is also impacted is sort of, if you think about inflation, I mean, productivity, the relationship with inflation.
And then if we're also thinking about inflation, I'll start to think about Fed independence. And there's a lot going on there and the sort of headwinds and tailwinds and we could tie these back to inflation and maybe central bank actions. So, if you think a little bit about what this means for central banks and what we're thinking for the year, maybe if it's rate cuts at the short end or to your point, what's happening in the long end with sovereigns, like how are you thinking about that?
Hafiz: Yeah. Yeah. And so, to your point, I think the inflation outlook feels very muddled, right, because there's these big dynamics around, you mentioned tariffs, causing noise, but immigration and productivity and A.I. are big ones that we have to monitor. I think what I would say is that the good news is that with all of that, the market's still pricing in a fairly stable outlook for inflation.
You can look at market pricing for inflation using inflation protected bonds. And for, in that market, we're seeing about 2% as still being priced in for a long-term inflation. So, when the market digests all of these things, it's still landing around there, which is I think a good story. But that can change. Right. And I think, the learning from last year at least is that with when it comes to tariffs, yes, they matter a lot for goods prices, but we can kind of treat that as a bit of a one-time tax on companies that are importing in in each region or that's applying tariffs.
So, I think and you talked about immigration policy. To me, that's the that's the area we have to kind of focus on in terms of how it plays out and the risk that it can pose. We're generally seeing in Canada and the U.S. and generally globally a move towards lower levels of immigration in some countries, even net negative immigration.
And so, the concern there is does that lead to shortages in labor leading to higher wage prices? Those are the types of trends that could cause a broad-based increase in inflation. So, we have to look at the data. I think for now at least, Again, the data is showing a reasonable story where in Canada we ended last year kind of 2.4% year over year in terms of our CPI in the U.S., the CPI is about 2.7.
So that's not bad. It's above the target for central banks, but it's close enough that it's allowing central banks to be a little bit more, staying around their neutral stance for central bank policy rates. And so, I think that's that support being supportive for the economy is supportive for equities and by extension, supportive for credit spreads, we've seen credit spreads come in a lot. So, yeah, I think, when we and maybe on that point, thinking about corporate bonds, I know from when we talk about our fixed income outlook, credit is front and center when it comes to the outlook. And it's been a very good story the last year in terms of seeing, credit spreads tighten and total returns are pretty, pretty solid.
So, Mike, from your perspective, though, as you kind of look out the next year and in corporate bonds particularly, how is that kind of feeding into your outlook?
Michael: Yeah, I mean, it is interesting to sort of think back to last year. I mean, we saw FTSE TMX returns, sort of 2, 3% saw IG corporates four or 5% higher yields, six, 7%. So, kind of bonds doing what they're supposed to be doing. Right. It is interesting because obviously our credit center of excellence, we spend a lot of time doing fundamental research and the fundamentals are good, IG issuers had good earnings we have seen upgrades to downgrades sort of come off the boil, but those numbers are still really good as well. So, financial conditions are good, the regulatory environment seems to be shaping up on fiscal monetary stimulus. So, we seem to be firing on all cylinders and going into the year there should be this tailwind.
So, it gives us optimism about credit markets. We are mindful of technical, though. So, to your point, we had record issuance last year and we're expecting even more issuance this year. So, we also have to be mindful of how well that issuance has been received by the market. If we're getting too much in one sector or too much at one time, that could cause credit spreads to widen out a little bit.
We're also mindful of some things that are going to go on. For example, free trade is going to be renegotiated this year, so there could be some volatility, but the demand has been there. All yield buyers are there. Absorption of just net issuance just from maturities and coupons is going to be quite supportive of credit as well.
So, I think sort of stepping back, really, we like credit like the fundamentals. We're mindful of the technicals. There could be some widening out this year. And I think widening out in credit spreads or that incremental compensation on corporates over sovereigns is really something we can lean into. And we may spend more time thinking about sectors obviously with everything going on geopolitically, like it's not going to treat every sector the same.
And then also we won't have dry powder, right? And I mean, we spend a lot of time thinking about when we lean into credit. And having that dry powder is important, whether it's in IG, high yield, or even the private markets, too. So, I think we're set up well and I think it all kind of goes back to sort of doing the fundamental research.
It's funny, when I think about credit, we spend a lot of time thinking about North America, and I know Canada is sort of 2% of global GDP. So, there's a lot of opportunities outside of Canada. So emerging markets were sort of the darling of 2025. And I know you spend a lot of time thinking about that Hafiz. So, what are you thinking going into 2026?
What are your expectations or are you finding or thinking about opportunities in that space?
Hafiz: Yeah, no, it's really interesting because if you'd asked me a year ago, we're going to have these massive risks around tariffs and that the U.S. would be getting into all of these unconventional policies and looking at ways to essentially reorganize the world economic order. I wouldn't have necessarily had really strong conviction to say emerging markets would be the outperformer in 2025.
But certainly, that's what is what happened. So, I think it surprised a lot of people. What was really interesting about it, though, is that we saw it in equities and in fixed income where emerging market assets appreciated a lot. A lot of that actually was due to what it called the currency effect.
So, if you were even just in cash in emerging markets and just holding cash and earning interest on your cash deposits in some markets, you were getting interest rates close to eight, nine, or 10%. So, you're getting really strong income from the cash. But then on top of it, when we kind of reflect on everything we said around, the big the big shocks from last year, what did last was a U.S. dollar decline.
And when you have a broad-based U.S. dollar decline, emerging markets tend to do well. And so, you got extra capital appreciation in these currencies. So, like Brazil and Mexico, for instance, were up their currencies alone were up 20% on a total return basis last year, which again, very few people were calling for. So, yeah, so I think it's an interesting set up now in that we haven't, the U.S. dollar cheapened but it's by many measures still overvalued especially versus a number of emerging markets.
So, I think the setup is still pretty decent for EM. But I think that, after the wave of outperformance last year, you have to be a lot more careful in how you select different countries. And it's not just a broad-based allocation. And I think the way to think about it is that there is sort of a bucket of what I call low yielding emerging markets where their local bond yields are maybe 3 to 5%, which isn't really that attractive versus developed market government bonds and certainly developed market corporate bonds where you're getting that, extra hundred basis points of spread over government.
So, I kind of would still prefer to be in corporate, domestic corporate bonds over those low yields. But there are still that there's that sort of sector of high yielding emerging markets. a number of LatAm countries, South Africa is another good example. So, these are these are the types of markets where, again, it's not necessarily just buy and hold forever.
You have to watch the political risks, and you need the research behind it. But you can get those high single digit potential total returns. So, I think, and, when it brings it back to portfolio construction, it's about sizing that right in a diversified portfolio of corporate bonds and about markets, government bonds. And so, it's just about getting that allocation right.
And then the country selection. Right.
Michael: Okay. So maybe bring it all home. So, we've talked about the macroeconomic backdrop, sort of how that leads into inflation and good conditions for credit. We've moved beyond our borders and looked a little bit more global to find opportunities. Maybe just final thoughts on how fixed income fit in this multi-asset portfolio and what we're solving for clients.
Hafiz: Yeah, and I think the role of fixed income has been, there's been a lot of questions from a number of different types of clients of how do I think about it? Right. And especially when there have been, it's still, the memory of 2022 and early 2023 when inflation was a problem naturally is still on everyone's mind.
And I think that's a reasonable, a question mark. And I think what comes back to me is just two things. Fixed income provides income and insurance and for each client it is just a matter of which of those factors are important and how much in the portfolio. But I think that insurance component really has to be taken in the context of what we talked about.
I've been around inflation, which is that if inflation is stable, it doesn't have to be declining, even if it's just stable in a reasonable range around the central bank target, that means that we're in kind of a regime where fixed income can provide insurance. You won't necessarily see it day to day. But when it really matters is when you have the market pricing in a recession and then I’d call it more of a typical recession where you get deflation.
And in that world which isn't priced in in any way right now, because fundamentals are strong from an economic growth perspective. But if a shock were to happen that leads to a recessionary outcome, you'll see equities decline materially, but you'll also see fixed income appreciate materially because we'll see bond yields coming down to, price in more central bank cuts to react to that shock.
And so that's the that's the role that the insurance part of what fixed income offers. But I think what's really critically is that, normally you want to pay. You would be paying for insurance. Yeah. When you look at right now, the yield on a typical fixed income investment grade, find your somewhere around 4%.
Hafiz: That compares to cash rate of two, two and a half, maybe. So, it's not just that you're having to pay for insurance. I think that frame it is that you're getting paid to take out insurance right now with high quality fixed income. And so that to me is the framework that I would think about. And, again, then, it all depends on the time horizon for each client.
But that role, I think, is compelling right now.
Michael: Yeah. No, I like the way you've framed it as income and insurance because I know I spend a lot of time talking to institutional accounts and clearly foundations and endowments, they have income targets and again, linking it to where we are today. I mean, we're at a high level. Real rates are high on a historical basis.
So being able to sort of clip those coupons and meet those payment requirements is super important. And I think the opportunities are there right now. If I think about some of the pension plan, they sit down at the beginning of the year, they think about where things are and what their plans are, and a lot of these plans have a lot more retirees than ever before.
So, they are relying on the fixed income for that income and insurance at the same time. So, they want to protect the funding levels that they've achieved. So, I think that resonates whether we're retail investors or institutional investors. But I think that's great. I think that brings everything home and ties it together. Thanks, Hafiz. It's been great conversation! Everyone,
I look forward to the next Portfolio Manager Views, an ongoing dialog between portfolio managers. Thanks again for your time.
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