Fourth Quarter 2023

BMO ETF Portfolio Strategy Report (Q4 2023)

All prices, returns and portfolio weights are as of market close on September 30, 2023, unless otherwise indicated.

Inflation Remains in the Driver’s Seat

As we head into the year’s final quarter, investors are still trying to determine the state of the economy and the market over the next 12-24 months. While many have been vocal about where we find ourselves in the near future, nobody knows for certain, as many unknown variables can dictate the outcome.

A year ago, we outlined that a reopening of the economy would initially cause inflation to rise until supply chains normalized, and then it would recede. Regardless of the data point, inflation has improved dramatically over the last 12 months. The disinflationary pressures have enabled central bankers to become less hawkish, allowing risk assets to recover in 2023

Consumer price index (CPI) in the U.S. vs. Canada
Consumer price index (CPI) in the U.S. vs. Canada
Source: Bloomberg, Global Asset Management, October 1, 2017-July 12023

Will we see a soft,” hard,” or no landing” scenario?

Despite inflation looking remarkably better in 2023, we believe that outside of a geo-political or unforeseen black-swan event, inflation remains the primary risk factor that determines whether we find ourselves in a soft,” hard,” or no landing” scenario. This is true as inflation will dictate the response of central bankers, and monetary policy still sets the tone for the markets despite a slight increase in the focus on microeconomics (particularly balance sheet durability) in the recent year. Unrest in the Middle East also has the potential to disrupt the oil supply, which can re-accelerate inflation.

Below, we outline how these three specific scenarios can transpire:

Soft landing” (slight recession)

A soft landing” remains our base case scenario. Although the recent CPI prints in Canada and the U.S. have been concerning, disinflation never occurs in a straight line and the base effect is partly the cause. Interest rate changes typically need 18-24 months to take full effect, so central bankers hope the slack of monetary tightening is working its way through the economy. If the worst of inflation is behind us, this allows central bankers to rely more heavily on forward guidance to rein in inflation. However, for forward guidance to be effective, occasional rate hikes may be used to give the Federal Reserve (Fed) and the Bank of Canada (BoC) credibility.

Central banks will then wait for the delayed effects of higher interest rates, which reinforces the higher for longer narrative. This would lead to a continuation of bond yields repricing higher, which means a further bear steepening in the yield curve. Interest rate cuts priced into the market would be pushed out further, favouring companies with durable balance sheets and those that are not overly leveraged.

Focus on defensive-oriented equities (Quality and Low Volatility) and higher quality investment grade fixed income. 

Implied Inflation Trends Downward in Late 2024
Implied Inflation Trends Downward in Late 2024
Source: Bloomberg, Global Asset Management.

Hard landing” (deep recession)

While inflation has trended in the right direction over the last year, the more recent CPI prints have been concerning, as there were signs of a reacceleration in prices. In Canada, the shelter component has risen, which is not surprising given mortgage payments are a function of interest rates and mortgage payments help determine the cost of rent. However, energy prices have been the primary concern, as oil prices have steadily risen since June. We view energy as one of the main wildcards in a scenario where inflation could re-accelerate. Increasing geo-political tensions could add to further supply chain disruption and exacerbate inflation. Price increases in this scenario would lead central bankers to tighten monetary policy aggressively, similar to 2022, which would lead to a hard landing. Recent coordinated attacks on Israel by Hamas could create instability in the region and, if further escalated, could disrupt oil supplies. Though there are no talks of an oil embargo, new information continues to surface daily, which needs to be digested.

Interest rates moving up too quickly would create a shock in the system, as we found a year ago with the implosion of U.K. pension plans and the U.S. regional bank failures earlier this year. This scenario would leave the Fed with the difficult choice of fighting inflation by hiking rates aggressively or giving up on the inflation fight and avoiding real economic hardship. This is the decision Fed Chairman Paul Volcker faced when inflation re-emerged in the early 1980s.

Focus on cash and cash-like” investments, real assets and alternative strategies, such as long-short equities. 

Oil prices have risen higher
Source: Bloomberg, Global Asset Management, as of October 102023.

No landing” (avoid a recession)

This scenario would be very similar to a soft landing.” However, signs of normalizing inflation would come earlier and be more reaffirming. This would pave the way for central bankers to confidently ease interest rates as needed. The continued strength of the labour market makes this an outside possibility.

The yield curve would then normalize through a bull steepener,” where short- and mid-term rates would fall more than longer-term rates. However, even in this scenario, we would not envision a rapid cutting of the overnight rate, as central banks would leave monetary easing in the holster for the next economic slowdown.

Focus on cyclical-oriented equities (Consumer Discretionary, Value) and lower quality fixed income (high yield). 

While our assessment over the last year on disinflationary pressures has been accurate, recent geo-political tensions have increased uncertainty with oil, which is a wildcard in reigniting inflation. Our base case remains a soft-landing scenario; however, there are many variables and outside events that are rapidly unfolding, which could lead to a change and repricing of assets.

Things to keep an eye on

Energy is the real wildcard that can re-accelerate inflation, as it is an input cost on many goods, including transportation. The emptying of the U.S. Strategic Petroleum Reserve (SPR) over the last several years means it will need to be replenished eventually, placing an additional demand on the grid. There are many ways in which the Israel-Hamas conflict can unfold in the coming weeks and months, which could have a major impact on oil.

Recommendation: Energy has been one of our key growth themes, and unfortunately, the recent conflict could further exacerbate supply constraints on oil. A cold winter in Europe could lead Russia to weaponize natural gas supplies. All of this could put an increasing reliance on North American energy. North American energy companies have been steadily raising their dividends as they have been hesitant in expanding infrastructure, given the government’s push towards renewable energy reliance. The BMO Equal Weight Oil & Gas Index ETF (Ticker: ZEO) or the BMO Covered Call Energy ETF (Ticker: ZWEN) allow investors to target energy companies. 

Underlying Constituents of BMO Equal Weight Oil & Gas Index ETF (Ticker: ZEO)



% change in cash flow from operations

Cash flow from operating activities (now)

Cash flow from operating activities (1-year ago)

Arc Resources Ltd





Imperial Oil Ltd





Tourmaline Oil Corp





Keyera Corp





Cenovus Energy Inc





Enbridge Inc





Pembina Pipeline Corp





Canadian Natural Resources





Suncor Energy Inc





TC Energy Corp





Source: Bloomberg (Cash Flow from Operations quoted in Millions).

*Cash from Operating Activities calculated as Net Income + Depreciation & Amortization + Other Noncash Adjustments + Changes in Non-cash Working Capital.

Coming into the year, we were optimistic that we would see a rebound in asset prices. Besides supply-side healing, there was already an extreme amount of negativity priced into the market. We anticipated that monetary policy would become less hawkish, particularly in North America, benefiting equities and bonds. Repricing in the broader markets has already occurred, which means the low-hanging fruit of simply buying broad beta” for short-term returns is likely behind us for the time being. The Citi Economic Surprise Index supports this, showing recent positive data has been priced into the markets. 

Recommendation: We believe tactical opportunities are still available in sector and thematic-based ETFs. Our three major themes include not only Energy but also large-cap U.S. Technology. We believe these two themes will provide growth to a portfolio. The other theme is Canadian banks, a trade based on attractive fundamental valuations. The BMO Covered Call Technology ETF (Ticker: ZWT) provides exposure to large-cap U.S. Technology companies with the addition of a covered call overlay. For Canadian bank exposure, investors can consider the BMO Equal Weight Banks Index ETF (Ticker: ZEB).

Comparing the Global and U.S. Citi Economic Surprise Index
Comparing the Global and U.S. Citi Economic Surprise Index
Source: Bloomberg, BMO Global Asset Management, September 19, 2022-September 192023.

Over the last several months, the yield curve has been experiencing some normalization vis-à-vis a bear steepener. The U.S. five- and 10-year yields stand at 4.61% and 4.65%,1 respectively — the highest levels since 2007. This bond repricing results from the market finally acknowledging that interest rates will remain higher for longer. In the absence of a black swan event, we don’t expect the Fed or BoC to cut rates until later in 2024, which means the front end of the curve will remain relatively locked at 5.5% and 5.0%, respectively. For the yield curve in the U.S. and Canada to normalize, it probably means five- and 10-year yields would have to move higher. 

Recommendation: Our recommendation for fixed income favours a barbell with an overweight to the short end of the curve. No matter how the yield curve eventually normalizes, the short end of the curve will likely be better positioned. We favour U.S. investment grade on the short end of the curve, given its greater diversification to Canadian corporates. Investors get some additional yield pick-up. The BMO Short-Term US IG Corporate Bond Hedged to CAD Index ETF (Ticker: ZSU) allows investors to target this area with a yield to maturity (YTM) of 6.0% and a duration of 2.55 years.1

U.S. Treasuries yield curve today vs. 2022
U.S. Treasuries yield curve today vs. 2022
Source: Bloomberg, BMO Global Asset Management.

Changes to portfolio strategy







BMO Ultra Short-Term Bond ETF



BMO Money Market Fund ETF Series



BMO Canadian Bank Income Index ETF



Asset allocation:
  • Despite growing uncertainty and markets being closer to fair value,” we are still overweight equities. Risk-free rates at levels we haven’t seen in nearly 20 years mean, in theory, equity risk premiums would be lower, making the opportunity cost of not being in equities more minimal. However, the 5-6% yields from cash and fixed income are insufficient to provide growth, particularly for long-term investors. Investors with long-time horizons should trust the process that equities over the long term have historically increased in value, regardless of the changing headline risk. However, while we are overweight equities, we are positioned defensively, favouring factor exposure, such as Low Volatility and Quality. 
  • Given the market is finally acknowledging that interest rates will remain higher for longer, investors should focus on mature businesses with more certain cash flows and/​or companies with durable balance sheets and lower financial leverage. Our core equity exposures remain centred around the Low Volatility and Quality factors, such as the BMO Low Volatility Canadian Equity ETF (Ticker: ZLB), the BMO Low Volatility US Equity ETF (Ticker: ZLU) and the BMO MSCI USA High Quality Index ETF (ZUQ). Higher interest rates tend to create a slower growth environment, and the recent increase in geo-political tensions is a greater reason to be defensive. Historically, the Low Volatility and Quality factors have demonstrated a better ability to manage downside risk and often complement one another given their differing sector exposures.
  • Our three key themes for tactical or satellite” exposures remain large-cap U.S. Technology and North American Energy for growth, while Canadian banks remain our longer-term valuation play. Sector-based ETFs, such as ZWT and the ZEO, provide targeted exposure to areas we believe will provide more near-term growth. Canadian banks may remain undervalued for a year or more, but with actual loan losses coming in less than stated provisions and a normalizing yield curve could prove to be the catalyst needed. The BMO Equal Weight Bank Index ETF (Ticker: ZEB) provides efficient access to the Big Six” Canadian banks and yields 5.4%.1
Fixed Income:
  • The yield curve has continued to normalize over the last several months, with yields on the mid and long end continuing to rise. As we don’t expect rate cuts for at least another year, near-term rates will likely remain locked at current levels. If the yield curve becomes upward-sloping soon, mid-term rates will have to move well beyond the 5% level. Investors should, therefore, be better served by overweighting the front end of the curve and minimizing duration risk. On the front end, we look to U.S. investment grade credit, as higher sustained interest rates should favour higher quality issuers over non-investment grade. The BMO Short-Term US IG Corporate Bond Hedged to CAD Index ETF (Ticker: ZSU) allows investors to target low duration U.S. corporate issuers, which provides diversification benefits to Canadian investors. 
  • We typically aren’t proponents of holding cash or cash-like” investments, as staying invested generally is the best course of action. However, we believe the potential for upcoming volatility will create mispricing in the market. Having some dry powder on hand allows investors to move swiftly and redeploy into areas that will trade below fair value. We will be switching out of our position in the BMO Ultra Short-Term Bond ETF (Ticker: ZST) in favour of the BMO Money Market Fund ETF Series (Ticker: ZMMK) for pure cash exposure. 
  • We believe a modern-day balanced portfolio should have non-traditional exposures, as 2022 was a good reminder that traditional assets, such as bonds and equities, can become correlated in certain environments. It can be argued that cash in this environment can be utilized as a non-traditional exposure, as it provides diversification to stocks and bonds and, in theory, can improve a portfolio’s efficient frontier. We are trimming our position in the BMO Canadian Bank Income Index ETF (Ticker: ZBI) by 1.0% to allocate to ZMMK. 

Stats and portfolio holdings

Investment objective and strategy:

The strategy involves tactically allocating to multiple asset-classes and geographies to achieve long-term capital appreciation and total return by investing primarily in ETFs.

Ticker ETF Name Sector Positioning Price Management Fee* Weight (%) 90-Day Vol Volatility Contribution Yield(%) Yield/Vol**
Fixed Income
ZDB BMO Discount Bond Index ETF Fixed Income Core $13.87 0.09% 9.0% 7.6 7.1% 2.6% 0.34
ZSU BMO Short-Term US IG Corporate Bond Hedged to CAD Index ETF Fixed Income Tactical $12.85 0.25% 7.0% 4.1 3.0% 3.3% 0.81
ZTIP.F BMO Short-Term US TIPS Index ETF (Hedged Units) Fixed Income Tactical $28.10 0.15% 5.0% 2.5 1.3% 4.0% 1.60
ZTL BMO Long-Term US Treasury Bond Index ETF Fixed Income Tactical $35.33 0.20% 5.0% 6.8 3.5% 3.9% 0.57
ZMMK BMO Money Market Fund ETF Series Fixed Income Tactical $49.96 0.12% 3.0% 1.3 0.4% 4.9% 3.64
Total Fixed Income 29.0% 15.3%
ZLB BMO Low Volatility Canadian Equity ETF Equity Core $39.39 0.35% 17.0% 10.8 19.1% 2.9% 0.27
ZRE BMO Equal Weight REITs Index ETF Equity Tactical $19.45 0.05% 4.0% 16.5 6.9% 5.5% 0.33
ZLU BMO Low Volatility US Equity ETF Equity Core $44.64 0.30% 8.0% 9.4 7.8% 2.4% 0.26
ZLD BMO Low Volatility International Equity Hedged to CAD ETF Equity Core $24.48 0.40% 7.0% 9.5 6.9% 2.8% 0.29
ZEO BMO Equal Weight Oil & Gas Index ETF Equity Tactical $64.51 0.55% 4.0% 17.5 7.3% 4.6% 0.26
ZUH BMO Equal Weight US Health Care Hedged to CAD Index ETF Equity Tactical $65.17 0.35% 4.0% 10.6 4.4% 0.5% 0.05
ZEB BMO Equal Weight Banks Index ETF Equity Tactical $31.33 0.55% 8.0% 13.9 11.5% 5.3% 0.38
ZUQ BMO MSCI USA High Quality Index ETF Equity Core $62.89 0.30% 10.0% 11.9 12.4% 1.0% 0.08
ZWT BMO Covered Call Technology ETF Equity Tactical $33.66 0.65% 3.0% 17.1 5.3% 4.4% 0.26
Total Equity 65.0% 81.6%
Non-Traditional Hybrids
ZPR BMO Laddered Preferred Share Index ETF Hybrid Tactical $8.84 0.45% 3.0% 7.1 2.2% 6.3% 0.89
ZBI BMO Canadian Bank Income Index ETF Hybrid Tactical $26.93 0.25% 3.0% 2.6 0.8% 3.4% 1.31
Total Alternatives 6.0% 3.0%
Total Cash 0.0% 0.0 0.0% 0.0%
Portfolio 0.31% 100.0% 9.6% 100.0% 3.3% 0.34
Source: Bloomberg, BMO Asset Management Inc., as of September 30, 2023. *Management Fee as of July 17, 2023. ** Yield calculations for bonds are based on yield to maturity, including coupon payments and any capital gain or loss that the investor will realize by holding the bonds to maturity and. For equities, it is based on the most recent annualized income received divided by the market value of the investments. Please note yields of equities will change from month to month based on market conditions. The portfolio holdings are subject to change without notice and only represent a small percentage of portfolio holdings. They are not recommendations to buy or sell any particular security.
Portfolio holdings
portfolio holding
Source: Bloomberg, BMO Asset Management Inc., as of October 102023.

Portfolio characteristics
Regional breakdown (overall portfolio)
Regional Breakdown
Source: Bloomberg, BMO Asset Management Inc., as of October 102023.
Equity sector breakdown
Equity sector breakdown
Source: Bloomberg, BMO Asset Management Inc., as of October 102023.
Fixed income sector breakdown



Weighted Average Term




Weighted Average Duration


Investment Grade Corporate


Weighted Average Coupon


Non-Investment Grade Corporate


Weighted Average Current Yield


Weighted Average Yield to Maturity


Weighted Average Term: The average interest received by a bond investor, expressed on a nominal annual basis.

Weighted Average Current Yield: The market value-weighted average coupon divided by the weighted average market price of bonds. 

Weighted Average Yield to Maturity: The market value-weighted average yield to maturity includes coupon payments and any capital gain or loss that the investor will realize by holding the bonds to maturity. 

Weighted Average Duration: The market value-weighted average duration of underlying bonds divided by the weighted average market price of the underlying bonds. Duration is a measure of the sensitivity of the price of a fixed income investment to a change in interest rates. 

Weighted Average Coupon: The average time it takes for bonds to mature in a fixed income portfolio.

The portfolio holdings are subject to change without notice and only represent a small percentage of portfolio holdings. They are not recommendations to buy or sell any particular security.

Source: Bloomberg, BMO Global Asset Management, as of October 102023.

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1 Bloomberg, as of October 102023.

Volatility: Measures how much the price of a security, derivative, or index fluctuates. The most commonly used measure of volatility when it comes to investment funds is standard deviation.

Yield curve: A line that plots the interest rates of bonds having equal credit quality but differing maturity dates. A normal or steep yield curve indicates that long-term interest rates are higher than short-term interest rates. A flat yield curve indicates that short-term rates are in line with long-term rates, whereas an inverted yield curve indicates that short-term rates are higher than long-term rates.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

The viewpoints expressed by the individuals represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.

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