Investment Solutions Group

October 2022 Capital Markets View

GLOBAL EQUITY SUMMARY

After a strong bear market rally in August, global equity markets resumed their decline through
September, making for one of the worst starts to a year for equity markets on record. While price/
earnings compression was the primary driver of market performance, earnings expectations have
remained relatively stable. However, slowing global growth, tighter financial conditions and geopolitical
friction are weighing on earnings expectations for coming quarters. Inflation remains a persistent problem
and threatens to erode corporate profit margins due to higher input costs, wage growth and the reaction
function of central banks as they combat price increases. Global growth is expected to weaken into 2023
as central banks drive up policy rates and engage in quantitative tightening programs, raising borrowing
costs for consumers, businesses and countries. Energy prices are a key concern as the winter months
approach, particularly as Europe is grappling with potential energy shortages due to the Russia/Ukraine
conflict and its heavy reliance on green energy. Energy has been the sole sector in positive territory, with
communication services and information technology the worst performing sectors. US dollar strength
remains a risk to equity markets making USD denominated commodities like oil more expensive to foreign
countries and making US exports more expensive.
For the full story
Forward Price to Earnings
see page 3
■ One quarter ago ■ Current ■ 10 Year Average

20x
18x
Forward P/E Ratio

16x
14x
12x
10x
8x
6x
4x
2x
0x
United States Canada EAFE Europe ex UK Japan United Australia Asia Emerging Global
Kingdom ex Japan Markets

Source: Source: FactSet as of 30 September 2022. United States = S&P 500, Canada = MSCI Canada, United Kingdom = MSCI
United Kingdom, Japan = MSCI Japan, Australia = MSCI Australia, Global = MSCI AC World, Europe ex UK = MSCI Europe ex-UK,
EAFE = MSCI EAFE, Asia ex Japan = MSCI Asia ex Japan, Emerging Markets = MSCI Emerging Markets.

SALES GROWTH (YOY%) NET PROFIT MARGIN (%) DIVIDEND YIELD (%)
Current 10-Year Average Current 10-Year Average Current 10-Year Average
United States 12.2 3.9 13.1 10.9 1.7 1.9
Canada 10.4 5.0 15.3 10.7 3.4 3.0
EAFE 12.7 1.9 9.9 7.3 3.6 3.2
Europe ex UK 12.7 2.1 10.1 7.5 3.6 3.2
Japan 10.6 2.2 6.9 5.3 2.6 2.1
United Kingdom 18.4 1.1 11.6 8.2 4.4 4.1
Australia 8.9 1.8 17.7 14.4 5.2 4.5
Asia ex Japan 12.6 6.7 10.1 9.5 2.8 2.5
Emerging Markets 14.5 7.0 11.2 9.6 3.4 2.7
Global 12.7 3.6 11.7 9.2 2.4 2.4

Source: FactSet as of 30 September 2022. Data shown are trailing (last twelve months). United States = S&P 500, Canada = MSCI Canada,
United Kingdom = MSCI United Kingdom, Japan = MSCI Japan, Australia = MSCI Australia, Global = MSCI AC World, Europe ex UK = MSCI
Europe ex-UK, EAFE = MSCI EAFE, Asia ex Japan = MSCI Asia ex Japan, Emerging Markets = MSCI Emerging Markets.

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Capital Markets View
October 2022

GLOBAL FIXED INCOME SUMMARY

Global fixed income markets have had their worst start to a year on record as credit concerns join
the chorus along with inflation and hawkish central banks. Inflation rates remain persistently high in
the United States and Europe forcing the central bankers to keep the pressure on through rate hikes and
eventual quantitative tightening. The US Federal Reserve remains among the most hawkish central banks
amid expectations they will hike rates north of 4.6% in early 2023, up from the current upper bound of
3.25%. While the speed of rate hikes is notable, so too is the magnitude, with three consecutive hikes of
0.75% following hikes of 0.50% and 0.25% so far in 2022. Credit spreads, which had been relatively
stable through mid-year, started to show modest signs of stress through the end of September. Global
aggregate, global investment grade, global high yield and emerging markets debt benchmarks all
remain in the red for the year. However, the combination of higher sovereign yields and wider credit
spreads has reintroduced meaningful carry into fixed income markets, in particular on the shorter end of
the curve where policy rates have a more direct influence. The US Treasury curve has further inverted with
2s to 10s showing a more than -50 basis point spread, a traditional warning sign for a potential recession
in the near future. Both the European Central Bank and Bank of England have been scrambling to tighten
monetary policy, but economic conditions continue to deteriorate in the region as high energy prices
risk stifling economic activity. A soft landing for the US, and indeed many developed economies, looks
For the full story
see page 10 increasingly unlikely.
Central Bank Policy Rates

■ One year ago ■ Current

3.5
3.0 3.25 3.25
2.5
Policy Rate (%)

2.0 2.25 2.35

1.5
1.0
0.25 0.25
0.5 0.25 0.75 0.25
0.10 0.10
0.0
-0.50 -0.10 -0.10
-0.5
US Federal Reserve European Bank of Japan Bank of England Bank of Canada Reserve Bank
Central Bank of Australia

Source: FactSet as of 30 September 2022.

YIELD TO MATURITY (%) DURATION (YEARS)

Current 10-Year Average Current 10-Year Average
US Treasuries 4.1 1.6 6.1 6.2
Global ex US Sovereigns 3.0 1.2 7.1 7.5
Emerging Markets Debt 8.6 5.7 6.8 7.3
Global Investment Grade 5.4 2.6 6.2 6.6
Global High Yield 10.4 6.5 4.2 4.2
US Municipal Bonds* 4.0 2.1 7.2 6.2

Source: FactSet as of 30 September 2022. US Treasuries = Bloomberg Barclays US Aggregate Government Treasury Index, Global
Sovereigns ex US = Bloomberg Barclays Global Aggregate ex US, Emerging Market Debt = JP Morgan EMBI Global, Global Investment
Grade = Bloomberg Barclays Global Aggregate Corporate, Global High Yield = Bloomberg Barclays Global High Yield, Municipal Bond
= Bloomberg Barclays US Municipal.
*yield to maturity unavailable for the municipal bond, so yield to worst is shown instead.

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

UNITED STATES
■ The US Federal Reserve has cemented plans to raise interest rates through the neutral
rate in order to combat inflationary pressures. Markets are pricing rate hikes through
the middle of 2023, peaking at more than 4.6%. At the same time, the Fed is allowing
up to $95 billion in bonds a month to roll off its balance sheet, targeting $60 billion in
Treasuries and $35 billion in mortgage-backed securities.
■ Equity markets are back in a bear market following a bounce in equity prices from
mid-June through mid-August and have suffered a 15% decline from that mid-August
peak. As of the end of Q3, the S&P 500 was only 9% above pre-pandemic levels and
some indices, such as the Russell 1000® Value and the Russell 2000®, are near pre-
pandemic levels.
■ Energy remains the sole sector in positive territory through the end of Q3, with
utilities flat and consumer staples off more than 8%. Communication services has
been the worst performing sector, down 38%, followed by technology and consumer
UNFAVORABLE FAVORABLE discretionary, both down 29%. UNFAVORABLE FAVORABLE
■ While valuations are much closer to historical averages at 18x, if the US enters a
recession, earnings, which on average drop around 30%, are at risk. Should this occur,
there could be further downside pressure on equity markets.
■ Profit margins have come off of their peak but, at 12%, remain elevated relative to their
long-term average of around 7%. Rising input costs and wages could further compress
profit margins if companies are unable to pass those costs along to consumers. Wage
growth is running around 5% in the US as a worker shortage keeps the labor market
tight. Prior to the pandemic, wages were growing at about 3% annually.
■ US dollar strength has been a headwind for US-based multinationals as they translate
foreign earnings back into dollars. In Q3, the strong dollar is projected to shave S&P
500 earnings by about 10%.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

CANADA
■ Like most other developed market central banks, the Bank of Canada has hiked
policy rates aggressively, by 3% so far this year, while at the same time shrinking its
balance sheet.
■ Inflation has declined from 8.1% in June, but remains stubbornly high, bolstering the
Bank of Canada’s plans to hike into 2023.
■ Consumer confidence in Canada has hit the lowest level since 2008 with more than
half of Canadians expecting the economy to weaken in the next 12 months.
■ The Canadian housing market has been under pressure as higher rates crimp
affordability. More than half of the mortgages issued since July 2021 are variable
UNFAVORABLE FAVORABLE rate mortgages. UNFAVORABLE FAVORABLE
■ Canadian manufacturing activity contracted for the second consecutive month in
August as the global economy also showed signs of slowing.
■ Higher interest rates and fears of recession have slowed mergers and acquisitions
from 2021’s record pace.
■ Valuations have dropped precipitously from their 2021 levels and trade at 11x, well
below the historical average of 15x next year’s earnings. However, sales growth and
net profit margins remain elevated.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

EUROPE EX UK
■ The MSCI Europe-ex UK index declined 23.2% year to date through the end of
September. European shares have been buffeted by a variety of headwinds, most
prominently the price and scarcity of sources of energy due to Russia’s invasion of
Ukraine.
■ While the global economic backdrop is challenging, Europe faces a particularly
difficult near-term economic landscape. With inflation at its highest in decades and the
continent’s energy supply severely disrupted as a result of Moscow’s attack on Ukraine,
Europe faces a difficult winter ahead as it scrambles to replace the oil, natural gas and
coal that it would normally import from Russia. Progress has been made on finding new
energy sources, but harsher-than-normal winter weather could force energy rationing,
which would likely further undermine consumer and business confidence.
■ The European economy must also contend with sharply rising interest rates as the
European Central Bank attempts to rein in 9% inflation. At its last two meetings, the
ECB aggressively raised rates by 125 basis points and markets expect another 250 bp
of hikes by late 2023, including another 75 bp hike in October. With inflation far above
target, quantitative tightening is likely to be the next tool used by the ECB to reduce
liquidity. Equity market valuations tend to suffer during times of rising rates.
■ Slowing economic growth should put pressure on corporate profits in the quarters
ahead. Profits in the region have been relatively resilient, but much of the strength
has been limited to commodity producers, which tend to have a larger weighting in
UNFAVORABLE FAVORABLE European equity indices than in the US. A very weak euro exchange rate has been UNFAVORABLE FAVORABLE

a tailwind for European multinationals of late. Finally, a quite-robust level of equity

buybacks is a factor that could cushion equities in the current uncertain environment.
■ Surging inflation and a post-pandemic rebalancing of demand is curtailing the global
appetite for European manufactured goods while China’s economic slowdown has
crimped demand for European capital goods.
■ Anti-EU sentiment did not play a major role in the recent Italian election campaign
and with billions in EU recovery aid in the pipeline, it is not likely to be a major source of
tension in the near term.
■ Given the higher-rate, higher-inflation economic backdrop over the near term,
European shares may benefit from lower exposure to the technology sector and
greater exposure to financials than those in the US.
■ Historically, rising real yields have been supportive of cyclicals, which make up a
significant portion of the European index.
■ While European equity valuations continue to moderate, they do not yet reflect the
substantial risk of recession in coming months. At 11.3x next year’s earnings estimate,
they are below the 10-year average of 14.7x, but above the 8.5x lows of 2008 after the
Global Financial Crisis and the 9x lows of the European sovereign debt crisis.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

UNITED KINGDOM
■ The UK market’s heavy exposure to the energy sector, as well as a currency tailwind
from the weakest British pound in nearly 40 years, has helped the index dramatically
outperform its global peers, trading less than 5% lower compared with a nearly 23%
drawdown in the Europe ex-UK index.
■ Like in the euro area, an energy-driven cost of living crisis is battering the UK economy.
New Prime Minister Liz Truss has unveiled an energy price cap scheme estimated
to cost upwards of £200 billion, much of which could end up on the government’s
balance sheet, straining public finances. While the price cap is expected to restrain
inflation, energy supplies are expected to remain constrained, having a negative
impact on growth, though potentially allowing the Bank of England to hike rates less
than it otherwise would have, all else being equal. However, inflation is also expected
to moderate more slowly under the mechanism than under a more typical, recession-
driven scenario.
■ Compounding the difficultly of the BOE’s inflation battle is Truss’s intention to cut
taxes by the largest percentage in 50 years, adding additional strain to the UK’s fiscal
position. Historically, the combination of tight monetary and loose fiscal policy has
been a difficult one for asset prices. However, market and political outcry have caused
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
Truss to scale back her plans.
■ A sharp deterioration in the value of the pound after the announcement of the
government’s economic package, which tested record lows, has pushed up
expectations of additional BOE rate hikes. Before the package, markets expected rates
to end the year around 3.5%. Today, they expect rates to jump to 4.40% by year’s end.
A dramatic deterioration in the UK’s terms of trade is underway as import price rises
have far outstripped export price hikes.
■ While a weak currency exacerbates the inflation backdrop, the export-oriented UK
market tends to benefit from favorable currency translation effects as earnings are
repatriated. That helps partially explain the UK’s dramatic outperformance compared
with its developed counterparts. Heavy exposure to energy also helps.
■ Valuations remain attractive at 8.6x next year’s earnings, which compares with a
10-year average of 13.3x. Over the last 15 years, P/E ratios have only been lower
during the European sovereign debt crisis in 2011 (8.4x) and during the global
financial crisis (7.8x).

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

JAPAN
■ Japanese shares continue to dramatically outperform most developed market peers,
falling 9.4% on the year through 30 September. Shares of exporters have gotten a
significant tailwind from the weakest yen exchange rate in nearly a quarter-century,
which improved export competitiveness. Japan has thus far not encountered the same
headwinds from tighter domestic monetary policy that have weighed heavily on other
developed markets.
■ Amid a 26% decline in the yen versus the dollar from the start of 2022, the Bank of
Japan intervened in the foreign exchange market to buy yen for the first time since
1998. While the weak yen boosts earnings of Japanese exporters, it also contributes
to import price inflation, especially for USD-denominated raw materials. Despite yen
weakness and rising inflation, the BOJ pledged to maintain ultra-low rates and continue
its yield-curve control policy until wages begin to rise.
■ With a continued stark divergence in monetary policy compared with other developed
market central banks and with interest rate differentials expected to remain wide,
UNFAVORABLE FAVORABLE Japanese equities looks better positioned than most to ride out what looks like a UNFAVORABLE FAVORABLE
difficult period for markets ahead.
■ Q2 economic growth came in stronger than expected at an annualized rate of 3.5%,
primarily from a jump in consumer and business spending following the lifting of
COVID-related restrictions. However, in the second half of the year, the economy faces
uncertainty as China’s economy continues to slow and rising prices of raw materials
pose a threat to Japan’s key manufacturing sector.
■ Japanese companies have been returning capital to shareholders via buybacks at an
increasing rate, which has been supportive of equity prices. Additionally, Japanese
companies have begun to display pricing power, which has translated into better
margins and profits.
■ From a valuation perspective, Japanese shares remain reasonably attractive at 11.8x
next year’s earnings estimate, which is below the 10-year average of 14.2x.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

ASIA EX JAPAN
■ Through the year’s first nine months, the MSCI AC Asia-ex Japan index has fallen
23.4%, slightly worse than the MSCI World index’s 22.9% decline. Asian shares fell
9.4% in September, outpacing the 8.1% decline in developed markets.
■ India (-1.9% through Q3) has been a standout performer amid tumultuous global
market swings, while China (-31% ytd), Taiwan (-29%) and Korea (-28%) have
been drags.
■ China’s economy continues to struggle amid weakening global demand, rolling COVID
lockdowns and ongoing stress in the country’s property market.
■ Taiwan and Korea have seen export orders weaken as the pandemic-inspired pull-
UNFAVORABLE FAVORABLE forward of demand in developed markets creates a lull in demand for manufactured UNFAVORABLE FAVORABLE
goods relative to services. This is particularly true of semiconductor-intensive tech
equipment such as personal computers, monitors, etc.
■ With information technology making up the largest share of the index, the sector’s
more than 40% year-to-date drawdown has been a major drag on the index. Energy,
a small percentage of market cap, was the only positive sector.
■ From a valuation perspective, equities in the region are trading below the 12.7x 10-year
average at 11.3x.

AUSTRALIA
■ Softer commodity and energy prices have seen Australian shares fall 3.5% this month,
as measured by the ASX200 index, and down 2.3% for the quarter, however still
outperforming developed market peers.
■ The Reserve Bank of Australia surprised the market in early October by raising its case
rate by just 0.25%, instead of 0.5%, to 2.60%, the sixth hike in as many months for a
total rise of 250 bps. The market expects policy rates to peak around 3.9% in mid-2023.
■ The RBA is balancing fighting the highest inflation in at least two decades with a
slowing economy and a rapid correction in the housing market (which depresses
spending). The jobless rate rebounded to 3.5% in August from a 48-year low of 3.4% in
July, driven by a revival in inbound-migration and an improving participation rate.
■ Australia enjoys stronger growth prospects than many countries, but those prospects
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
are projected to wane over the coming quarters amid softer external demand. To
illustrate, the July trade surplus narrowed sharply and was well below forecasts.
■ Valuations remain attractive at just below 12.6x next year’s earnings. Earnings remain
vulnerable in an economic slowdown with the market dominated by materials (22%),
energy (6%) and financials (29%) which are particularly levered to the housing market.
■ Australian consumers are heavily exposed to rising rates as variable-rate home
loans account for 65% of outstanding mortgage credit. But the looming risk is how
borrowers who took out ultra-low, fixed-rate loans will fare as two-thirds are scheduled
for refinancing before the end of 2023.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK EQUITY INSIGHTS LONG-TERM VIEW

EMERGING MARKETS
■ Emerging markets equities performed in line with developed markets through the end
of September, falling 22.7% compared with a 22.9% decline in the MSCI World Index.
■ Relatively strong performance from India (-1.9% through September) and Saudi Arabia
(unchanged) stood in contrast to large declines in China (-31% ytd), Taiwan (-29%) and
Korea (-28%). China’s economy continues to struggle amid weakening global demand,
rolling COVID lockdowns and ongoing stress in the country’s property market.
■ Taiwan and Korea have seen export orders weaken as the pandemic-inspired pull-
forward of demand in developed markets creates a lull in demand for manufactured
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
goods relative to services. This is particularly true of semiconductor-intensive tech
equipment such as personal computers, monitors, etc.
■ Latin America was the best-performing subregion, falling just 4.7% as strong
performance from Chile (+24%) helped partially offset losses elsewhere in the region.
■ From a valuation perspective, P/E ratios in the region are below their 11-year average,
trading at 10.4x NTM earnings, just below the 10-year average of 12x.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

US TREASURIES
■ We expect further inversion of the US Treasury yield curve in the months ahead as the Fed
pushes forward with its plan to aggressively tighten monetary policy in an effort to curb
inflation, notwithstanding the attendant risks to economic growth. As of the September
meeting, the consensus view of the FOMC was for a terminal federal funds rate of 4.6%,
implying the Fed will continue to hike into 2023, hold steady through the end of the
year and not cut until 2024. Market views around the Fed’s course have been subject to
significant swings, as evidenced by elevated rate volatility — which we expect will continue.
■ The US economy, while showing some signs of decelerating, has surprised the markets with
its resilience, which has been supported by a consumer buoyed by a strong labor market,
a healthy balance sheet, ready access to credit and accumulated savings. These dynamics
have made it more difficult for the Fed to slow the economy and, as a result, inflation may
be more persistent and could subside at a slower pace than expected. This could require
the Fed to raise expectations for its terminal rate and push the front end of the Treasury
curve higher. So, while we think much of the rate adjustment is past us, upside risks to rates
remain. The counter to this argument for still higher rates is that threats to financial stability,
a severe selloff in risk markets or a sharp retrenchment in economic activity could force
the Fed to end its hiking cycle early. Either way, the odds of a “soft landing” appear to be
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
receding, with a recession the more likely outcome.
■ The opportunity to profit from shifting portfolios to overweight duration versus benchmark
indices appears to have been deferred, at least for a time, though we anticipate continued
bear flattening in the near term. However, as recession approaches, rates should rally; the
key to success will be properly anticipating the peak in rates.
■ Technicals for Treasuries look mixed. With quantitative tightening (QT) underway,
there will be increasingly less support from a large and price-insensitive buyer. Though
the yield adjustment process is now well advanced, we think it is still too soon to discount
the possibility of investor flight into less rate sensitive assets, such as cash. On the other
hand, the looming prospect of recession suggests the possibility of a safe haven bid for
the asset class.
■ Valuation has improved markedly due to the rate sell-off in response to Fed tightening.
In our view, the sharp increase in rates is setting up the Treasury market for better total
returns, recognizing that long-term performance tends to correlate highly with starting
yields, which are now significantly higher than they have been for most of the last decade.

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

AGENCY MORTGAGE-BACKED SECURITIES

■ US housing is highly rate sensitive and one of the first sectors of the economy to slow in
response to higher interest rates. The cost of financing a 30-year fixed-rate mortgage has
more than doubled year to date, making housing less affordable for new homebuyers
and the cost of financing less attractive for existing homeowners who may be looking to
move. This has many ramifications beyond lower home sales; mobility may become more
limited, for example, and new household formation may slow. Nevertheless, we expect any
resulting downward pressure on home prices to be countered by constrained inventory,
which appears likely to be a multi-year story after years of underbuilding.
■ Agency MBS remains one of the most liquid asset classes, but the sector has been trading
at wider bid/ask spreads than has commonly been the case partly due to market technicals.
Very broadly, agency MBS face challenging technicals. With QT underway, a large, price-
insensitive buyer, the Fed, is in the process of stepping back from the market. Moreover,
there remains a technical risk that this unwind could become more active over time
(outright sales versus allowing holdings to roll off). In addition, banks — the second-largest
source of demand — are also less inclined to buy as deposit growth slows/reverses, loan
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
growth continues and cash buffers are bolstered. This leaves asset managers — a price-
sensitive buyer base — as the primary buyer of the asset class. While demand dynamics are
weakening, one potentially mitigating technical factor is slowing home sales, which means
less mortgage origination and therefore lower MBS supply.
■ Agency MBS have been trading near their March 2020 wides (based on nominal spreads)
and appear attractively valued versus their long-term history. Within the sector, we see
better opportunity in coupons not heavily owned by the Fed or by banks, as well as in
specified pools versus to-be-announced.
■ With interest rate volatility likely to remain elevated, we see limited scope for spread
tightening in the near-term. However, we expect them to outperform other spread markets
in the event of a recession.
■ The mix of fundamentals, technicals and valuation leaves us disposed to continue adding
exposure to agency MBS pass-throughs.

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

GLOBAL EX US SOVEREIGNS
■ Non-US bond performance was mixed in Q3, with general outperformance relative to US
Treasuries outside of the UK which underperformed sharply as the government announced
an unexpected unfunded fiscal expansion.
■ We remain defensive in non-US rates, with a preference for the dollar-bloc markets. Non-
US rates positions are, however, becoming less directional and more focused on a number
of country-specific and relative value country views.
■ We like markets that are at a mature stage of their tightening cycles and where the
underlying local economy is sensitive to tightening monetary conditions as a result of
higher household leverage or inflated real estate markets. We feel such markets could see
their central banks pause earlier than the Fed, leading to an outperformance of their local
bond markets. Examples include Canada and New Zealand. Canadian inflation appears to
be showing signs of peaking and employment has declined for 3 months in a row, causing
Canadian bonds to outperform sharply in Q3.
■ We are overweight South Korea bonds — another example of a central bank at a mature
stage of its tightening cycle. In addition, its open, export-orientated economy is vulnerable
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
to global trade and geopolitical risks.
■ We dislike the UK market, especially longer maturity bonds. The increased issuance
resulting from unfunded tax cuts and energy rebates will come at a time of weakening
domestic demand for gilts from UK pension schemes and quantitative tightening by the
Bank of England.
■ We continue to be defensive towards Japanese bonds despite recent outperformance
caused by ongoing bond market support from the Bank of Japan. Existing policies are
becoming increasingly unsustainable with the yen dropping a further 6.6% in Q3, causing
the central bank to intervene in the FX market and to harden its rhetoric
■ Chinese bonds massively outperformed in Q3 on a flight to safety amid continuing
concerns over the stability of the real estate market and the impact of COVID lockdowns
on economic growth. Bond valuations look expensive, especially on a hedged basis, with
10-year Chinese bond yields 109 bps lower than US Treasuries at the end of Q3.

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

EMERGING MARKETS
■ Persistent inflationary pressures and an aggressive policy response from global central
banks continued through the third quarter, while the ongoing Russia-Ukraine conflict,
an uncertain Chinese recovery after a significant economic slowdown and a strong US
dollar remained overhangs on emerging markets. Macroeconomic uncertainty along with
increased recession risks led the asset class to produce a negative total return for the fifth
consecutive quarter.
■ We maintain a cautious stance across EM portfolios as the risks to the growth outlook are
skewed to the downside and the probability of recession is rising. Given the Fed’s focus
on inflation, upside risks to rates remain and serve as a headwind to EM given the longer
duration profile of the asset class. While growth is recovering in China off its Shanghai-
lockdown lows, the likely growth trajectory in the second half of 2022 (and into 2023) is still
very subdued, undermining any recovery in global growth. Europe faces a possible energy
crisis, high inflation and slower growth driven in large part by the ongoing conflict between
Russia and Ukraine. These downside risks to global growth will inevitably lead to pressures
on risk appetite and portfolio flows. With elevated levels of inflation and likely upward
pressure on energy prices — particularly gas prices toward the end of the year — the global
macro backdrop remains a challenge for EM debt.
■ From a top-down perspective, there are some factors that mitigate the macro challenges.
EM central banks are well advanced in their tightening cycles relative to G-10 central banks,
which should limit deterioration in external imbalances. The pandemic and resulting
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
economic challenges have been felt primarily in higher fiscal deficits and in public debt
levels in many EM countries — as it has in DM countries. As a result, some high-debt
countries will need to undertake more committed adjustment efforts to avoid further
deterioration. That said, while EM public debt to GDP has increased, it remains, on average,
well below developed countries such as the US, France and the UK.
■ In addition, valuations in emerging markets debt remain attractive relative to the
benchmark’s 5-year history. EM sovereign debt offers attractive valuation relative to US
high yield corporates, while the yield offered by the asset class is the highest it has been
since 2009. Historically, EM spreads tend to anticipate recessionary peaks in yields,
pointing to a potentially strong buy case over the next 6 to 12 months.
■ Technicals have been challenged, driven by consistent outflows from both the hard and
local currency asset classes. EM bond fund outflows have reached the $70 billion mark
year to date ($36.3 billion hard currency and $33.7 billion local currency), and represent
the largest outflows since 2005. We believe market conditions will remain challenging for
EM sovereigns given expectations of further tightening in financial conditions and new
issuance will remain below historical averages for the remainder of the year. New issuance
year to date stands at $71.8 billion compared with $162.5 billion in 2021 and $215.9 billion
in 2020.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

GLOBAL INVESTMENT-GRADE CORPORATES

■ Spreads widened 5 bps to 180bps in Q3, ending the quarter at recent wides. Spreads
attempted to rally earlier in the quarter on the hope of a potential Fed pivot, only to give
back all these gains as the Fed reaffirmed its commitment to raising rates, emboldened by
tight labor markets and elevated inflation prints.
■ European investment grade underperformed the US marginally in Q3, with the spread
between the European and US markets widening to 66bps, a premium last seen at the
depth of the Greek sovereign debt crisis in 2011.
■ We feel such a premium makes European IG attractive and fairly prices the strong
probability of recession in Europe. We also feel the chance of recession in the US has
increased during Q3, making the US market appear relatively expensive.
■ While a recession would inevitably lead to higher leverage and declining margins, we are
inclined to see this as more of a challenge for equity holders since net interest coverage is
extremely strong for IG companies. Leverage also declined post-COVID and investment
grade companies also benefited from a strong wave of debt issuance in 2020–2021 at
UNFAVORABLE FAVORABLE UNFAVORABLE FAVORABLE
attractive funding levels.
■ Investment grade companies have also benefited from a reopening of primary markets in
Q3, unlike in high yield where issuance is very challenged.
■ We favor financials versus industrials, as financials, in our view, are better insulated from
the economic slowdown, having built up significant capital buffers. We can also find names
with idiosyncratic positive catalysts in countries such as the UK, US and Spain. However,
real estate exposure is a risk and something we are monitoring closely, especially in
countries such as Sweden.
■ Many investment grade bonds are trading at steep discounts to par (some below 60 price
for longer maturity bonds) making such bonds increasingly attractive relative to new issues.
■ The distress in the UK bond markets in Q3 has led to some attractive valuations relative to
the US in sectors such as telecoms.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

GLOBAL HIGH-YIELD CORPORATES

■ In Q3, the ICE BofA Global High Yield index average OAS narrowed 27 bps to 610 bps while
the US modestly outperformed EUR High Yield. In emerging markets, spread levels remain
optically wide, driven by distress within the Chinese property sector. Notably, high yield
outperformed most other fixed income asset classes on a spread basis despite a weakening
macro backdrop and a hawkish Fed.
■ Developed market default rates remain at post-pandemic lows. High yield companies
issued new debt in 2020–2021 to extend maturities and put cash on balance sheets.
Meanwhile, improving profitability for most industries has brought leverage to multi-
year lows.
■ Despite US HY spread levels being near multi-year highs, they remain below the year-
to-date wides seen in early July, and well below recessionary levels. Notably, the US CCC- UNFAVORABLE FAVORABLE
UNFAVORABLE FAVORABLE
BB differential has widened to the 78th percentile, which reflects a more challenging
economic backdrop. However, the potential range of outcomes for CCC forward-looking
returns is wide.
■ European high yield spreads are wider than those in the US despite higher average credit
quality. The spread premium reflects a more challenging macro backdrop as well a liquidity
premium given the smaller, less liquid nature of the Euro market.
■ We believe the challenging macro backdrop and tightening financial conditions continued
to warrant caution within high yield at current valuations levels.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

OUTLOOK FIXED INCOME INSIGHTS LONG-TERM VIEW

US MUNICIPAL BONDS
■ The tax-exempt municipal outflow cycle resumed late in Q3 following a respite in July and
early August as the Fed reaffirmed its inflation focus, sending rates higher. The current
outflow cycle is the largest on record and may persist until rate increases subside. However,
historically, performance has turned positive prior to inflows resuming.
■ Returns for taxable munis have been sharply negative this year given the longer duration
of the asset class, yet a base of institutional investors provides more stable flows. With
the move higher in rates, the return outlook for taxable munis has improved considerably
this year. Historically, munis exhibit higher quality and lower default rates relative to
corporate bonds which should provide a degree of downside mitigation if the economy
enters a recession.
■ Municipal issuers, in general, are in strong fundamental positions. Healthy tax collections
and high property valuations should buffer state and local governments against economic
UNFAVORABLE FAVORABLE softening. Rising wages and supply costs remain manageable overall but have pressured UNFAVORABLE FAVORABLE

margins in certain sectors (notably health care).

■ Valuations are mixed, though investment grade tax-exempt and taxable municipal nominal
yields are at their highest levels since 2011, a distinct positive. Tax-exempt muni/treasury
ratios ended the quarter at roughly fair value and corporate ratios were relatively attractive
across the curve. While spreads have widened, they remain tighter than their five-year
average. Taxable munis continue to offer a yield premium over same-quality corporates.
■ Using history as a guide, starting yields have been highly correlated with subsequent
five-year returns. For investors willing to tolerate near-term elevated levels of volatility, the
outlook for long-term returns is the most attractive in years.

KEY: July ‘22 October ‘22

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Capital Markets View
October 2022

MFS Capital Markets View is published each quarter to provide a broad perspective on current risks and
opportunities across asset classes and regions.
The Current Outlook and Long-Term View illustrations include return and risk expectations for equity,
fixed income and alternative asset classes across country, regional and global markets. The focus of these
illustrations is to provide a strategic, long-term, current and forward-looking view of various global markets.
We use a proprietary top-down approach by employing quantitative, country-based models as the foundation
for our expectations and then integrating bottom-up fundamental views from our global equity and fixed
income investment teams to inform our final expectations.
Our expectations are developed across 26 countries comprising 18 developed countries and 8 emerging
market countries.
Capital Markets View is for informational purposes only and any general commentary on market activity,
industry or sector trends, or other broad-based economic or political conditions, does not constitute a
recommendation or investment advice.

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