Alfred Lee: Slowly Inching Towards Normalization (BMO ETF Strategy Report)

by Alfred Lee, CFA, CMT, DMS, Vice President, BMO ETFs
Portfolio Manager & Investment Strategist
BMO Asset Management Inc.


In this report, we highlight our strategic and tactical portfolio positioning strategies for the first quarter using various BMO Exchange Traded Funds. Our key strategy changes are outlined throughout the report and in our quarterly outlook on page six.

• After reneging on its hints of tapering back at the September Federal Open Markets Committee (FOMC) meeting, the U.S. Federal Reserve (Fed) finally came through by announcing its intention to scale back its monthly bond buying program. Unlike the asset wide sell-off we experienced in the summer months, however, equity markets continued to rally into the end of the year.

• Much of the equity market strength in the last several weeks was due to the tapering and hence a more hawkish monetary policy was already priced-in from the summer sell-off. The removal of stimulus was actually a sign of economic improvement, boosting investor confidence this time around.

• The movement in the Canadian yield curve since the Fed announcing “No Taper” in September has been notably different than its U.S. counterpart over the three months. Shorter term rates in Canada have actually fallen, whereas longer rates have been more steady (Chart A). Stateside, has been the opposite, the short-end has been extremely steady, given the Fed’s pledge to keep rates low until 2015, but longer rates have been more volatile. (See the Changes to Portfolio Strategy section to see our fixed income positioning)

• The term structure in VIX1 futures contracts, which we often mention, has been flattening out (Chart B). This implies investors expect less equity market volatility in the future. This is somewhat concerning for two reasons: firstly, this essentially means equity markets are priced for perfection, making unexpected headline risk more reactive when they occur and secondly, lower volatility will bait more and more investors to allocate to equities, which could lead bond yields to rise too quickly.

• In 2014, we expect interest rates to continue dictating the moves in assets. Macro-economic policy and therefore a top-down view will still be prominent. However, as the global economy continues to stabilize, more emphasis will be put on getting exposure to certain assets, sectors and factors, rather than just chasing broad beta. Since we expect intra-market correlation to ease, complementing passive/ systematic strategies with bottom up investing will also likely serve investors well as markets move to normalization.

• That’s not to say that markets won’t see headwinds in the new year. While the macro-economic backdrop has improved for the most part, the technical picture is looking overbought. Furthermore, the fundamentals in certain areas, while not overbought, are beginning to look a slightly more rich. In addition to markets being priced for perfection, we continue to believe there is an excess amount of leverage in the system, leaving markets extremely vulnerable should rates move up too quickly.


Read/Download the full report in the slidedeck below:

Alfred Lee - BMO ETF Portfolio Strategy Report January 2014 -

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