Canada's fund managers are set to plow more money into shares of cyclical, industrial and technology companies as the Bank of Canada hikes interest rates, and to allocate a greater share of their bond portfolio to short-term corporate debt.
The Bank of Canada raised interest rates last Wednesday for the first time in seven years. Investors say that higher rates will weigh on bonds, but they expect a combination of only gradual rate increases and solid economic growth to support stocks.
"Stronger growth and slowly rising interest rates create positive value for equities … it's at the root of our preference for equities over fixed income," said Candice Bangsund, vice-president of global asset allocation at Fiera Capital Corp.
She is buying energy, materials and financials, which together make up nearly two-thirds of the S&P/TSX composite index.
Canada's benchmark index has doubled from its financial crisis trough in 2009, despite its underperformance relative to other major markets this year as the price of oil, one of the country's major exports, fell.
Still, investors say that the rally in stocks can continue and look to those sectors that will benefit most from a rosy growth outlook.
"We have quite a few information technology names … the valuations can look scary, but the growth really has been impressive," said Manulife Asset Management equity analyst Ian Scott.
Mr. Scott likes Kinaxis Inc. and Shopify Inc., whose fast growth and international expansion reduce their sensitivity to higher rates in Canada.
The Bank of Canada has projected that the country's economy will expand by 2.8 per cent this year and that global economic growth will pick up to 3.4 per cent.
The improved growth outlook can help support Canadian industrials, said Shailesh Kshatriya, director of Canadian strategies at Russell Investments Canada, who is most bullish on overseas stocks because of attractive valuations.
But companies with high debt loads and a lot of refinancing to do in the coming years should be avoided, said David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates Inc.
He is also wary of sectors of the economy that could be hurt by a stronger dollar, such as exporters of auto parts and transportation.
The loonie has surged more than 6 per cent since the Bank of Canada turned hawkish in June.
A rising-rate environment tends to increase banks' net interest margins, but some investors say that a slowdown in Canada's housing market will weigh on bank shares.
"We do think that real estate is at the point now of inflection," said Sadiq Adatia, chief investment officer at Sun Life Global Investments. "We think that the rate hike will be a damaging [for the economy] at some point down the road."
Mr. Adatia favours increased allocation to international stocks and is buying bonds to add some defensiveness to his portfolio.
He favours debt with a shorter maturity, which tends to be less sensitive to movement in interest rates, but also likes to take the extra risk of owning corporate rather than government debt as global economic growth is solid, enhancing returns.