Three interest rate cuts in, the Bank of Canada is now firmly entrenched in an easing cycle that has major implications for where Canadians’ money can earn them the best returns.
The shift from interest rate hikes to cuts warrants a “refresh” of Canadian portfolios, investment experts tell Motorcycle accident toronto today.
“I think any time you see a shift or a potential shift in the cycle, it’s definitely worth taking a look,” says Derek Dedman, vice-president and portfolio manager at WDS Investment Management.
Some yields will take a hit
The Bank of Canada’s benchmark interest rate now stands at 4.25 per cent, 75 basis points lower than the peak of recent years. That has a direct impact on any loans Canadians might have with variable rates of interest, but also on certain savings vehicles.
Some of the most immediate impacts of rising and lower interest rates are felt in bond pricing, explains Josh Sheluk, chief investment officer and portfolio manager at Verecan Capital Management.
Bond prices head higher as interest rates drop and vice versa, he explains. Yields on these bonds will also follow the Bank of Canada’s direction on policy rates.
“As you think interest rates peak or interest rates might be coming down, that’s the time when you want to increase the interest rate sensitivity on the bond side of the portfolio,” he explains.
Other conservative income streams are also tied loosely or directly to the Bank of Canada’s policy rate.
Guaranteed investment certificates (GICs) typically allow customers to lock in their cash for a set return over a period of six months, a year, two years or more, sacrificing liquidity for certainty. GICs tend to closely mirror yields in the bond market, with a five-year GIC largely basing its yield on a five-year government bond, for example.
High-interest savings accounts on offer from big banks also rise and fall in correlation with the central bank’s policy rate. Sheluk says there’s been an easing in these rates on offer in the Canadian marketplace over the past few months.
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But Sheluk also notes that, historically, the time to make shifts away from GICs or HISAs is when they’re at their possible peaks — before rates actually start falling.
“A little bit counterintuitively and with a forward-looking approach, that’s actually a great time to start looking at other investments aside from those things, because it does signal that for interest rates, probably the next move is going to come down, bolstering the performance of some other types of investments,” he says.
Looking back to the rate-cut cycle of the 1990s, Sheluk says it probably would have benefited the typical investor to keep a balanced portfolio as borrowing costs fell rather than load up on high-yield fixed-income products when they were at their peak.
Waiting too late to anticipate a change in the policy rate or other major shifts can put investors behind the curve, he warns.
“I would say that the refresh or relook at the portfolio should happen on a fairly consistent basis regardless of the environment,” Sheluk says.
How do stocks react to rate cuts?
The stock market has less of a direct correlation with the Bank of Canada’s interest rate cycle. But Dedman says an easing cycle can be better “in general” for stocks because it signals an effort to stimulate growth in the economy and that better conditions should be on the way for businesses.
Dedman says it can be tempting for investors who are seeing yields drop in the bond market to want to replace that income source with a dividend-paying stock. But he warns that the risk profiles of a bond and a stock, even for an established, “blue-chip” company, are vastly different things.
He cautions that investors ought not to chase a yield at the expense of losing liquidity when it’s needed, putting their short-term investment goals at risk if the stock’s value hits a downturn.
But if you’re looking for sectors today to increase exposure in your portfolio, both Sheluk and Dedman point to industries like utilities and real estate as areas where companies could benefit in a lower interest rate environment.
Both are capital-intensive and therefore require financing to get projects off the ground, a task made easier as borrowing costs fall.
Before piling into utilities and real estate investment trusts (REITs), both portfolio managers urge caution: falling interest rates are not the only factor that feeds into a company’s performance, and by extension, its stock price.
“It’s worthwhile to remind ourselves why interest rates are coming down,” Sheluk says.
Risks remain as rates fall
Canada’s economy is still facing stark headwinds even as interest rates fall; the unemployment rate rose to a seven-year high outside the pandemic last month and economic growth has been turbulent.
The Bank of Canada is dropping its policy rate in an effort to reduce pressure on the economy, but Sheluk notes that it takes a while for rate cuts to filter down to businesses and households in the same way rate hikes stifle growth with a lag.
In other words, while interest rates might signal better days ahead, those days are not here yet.
“Growth is coming down as well with inflation, with interest rates, and that is not necessarily the best time to start loading up on riskier assets,” Sheluk says.
“Being a little bit on the conservative side with portfolio positioning now, I think is warranted.”
Shifts in a portfolio also depend on the kind of investor you are, Dedman notes. A more active, “tactical” investor may be able to find opportunities in a low-growth environment that could pay off down the road, he says.
But if you’ve got a long-term horizon and are more passive in your investments, there likely aren’t big changes to make. He compares the portfolio refresh to going into the barbershop for a trim, not getting a buzzcut.
“I don’t really recommend taking big swings one way or the other,” he says.
