The global economy has delivered above-trend growth and a modest rise in inflation this year. This trend is expected to end, as increasing dependence on U.S. demand should not be capable of carrying the rest of the world. We expect that the combination of the escalating trade dispute with China and monetary tightening by the Federal Reserve will start to weigh on U.S. growth in 2019. In November, we evolved our twelve-month forward-looking outlook to reflect our view that we are moving closer to a U.S. inflationary environment that will likely precede a recession in the U.S. in late 2019 or 2020. The current outlook now factors in three months of growth followed by nine months of inflation over the twelve-month forecast period.

Third quarter GDP reports point to Developed Market divergences, as U.S. GDP grew at a 3.5% annualized rate with a greater than 9% gain in import volumes.Meanwhile, Germany and Japan’s GDP rates both contracted.2 Due to the size of these latter two economies – the third and fourth largest in the world respectively – they play an important role in driving global growth. In addition, the political and economic weakness of Italy, the Eurozone’s third-largest economy, is a concern. Data announced towards the end of the month showed that Italy’s GDP growth rate had fallen to zero in the third quarter, adding further pressure to the political impasse over the budget.2 The 2.4% budget deficit proposed by the new Italian government creates the risk that Italian government debt may be downgraded to sub-investment grade.

The trade war is showing early signs of affecting the U.S. economy, which has so far had a strong 2018. In October, a net number of 250,000 jobs were created and wage growth continued to accelerate to 3.1%, the fastest annual gain since 2009.3 In contrast, the trade tariffs that the U.S. imposed on Chinese imports and Chinese retaliation to the U.S. have impacted the U.S. manufacturing and agricultural sectors, and rising interest rates are beginning to cause private consumption to slow. In Canada, the NAFTA (renamed the USMCA) resolution paves the way to potential additional Bank of Canada rate hikes.

In U.S. equity markets, low stock correlations typically favour stock pickers, but do not address the opportunities to take advantage of the magnitude of dispersion. It is notable that in October, the odds of picking a large underperformer were greater than those of selecting a large outperformer. Volatility, correlation, and dispersion all rose in the S&P Global 1200 Index in October. U.S. equities ended the month with a loss of 6.8% for the S&P 500, loss of 9.6% for the S&P MidCap 400, and a loss of 10.5% for the S&P SmallCap 600. The S&P/TSX Composite lost 6.3%, bringing it into the red for 2018 year-to-date. Latin America was the sole region to post a positive return, with the S&P Latin America BMI up 4.9%, driven exclusively by Brazil, as the S&P Brazil BMI gained 18.4%, while Mexico’s fell by 11.2%. The S&P Europe 350 posted its worst month since January 2016, falling 5.3% in October. The S&P United Kingdom fell similarly in local terms. Trade tensions and concerns regarding the outlook for global growth in China rattle nerves through the Asian markets, with the S&P Pan Asia BMI down 9.8%. Japanese equities erased their gains in September, with the S&P/TOPIX 150 down 9%. Though there were few safe havens left, the S&P GSCI Gold Index gained 2% in October.

In November, we decided to maintain our current asset allocation across all models. Allocation to Equities will remain at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 60% in Tactical Growth, and 70% in Tactical Aggressive Growth, providing exposure to U.S. equities, with the balance in all models allocated to U.S. municipal bonds and mid-term U.S. treasuries. This asset allocation is reflective of the current relative attractiveness of interest rates in the U.S. versus the rest of the world.

We will continue to monitor the data for growth, inflation, and recession signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Bureau of Economic Analysis. National Economic Accounts. Gross Domestic Product, Third Quarter 2018 (Second Estimate).

2 Trading Economics. Third Quarter 2018 Germany, Japan, Italy GDP Estimates.

3 Bureau of Labour Statistics. Current Employment Statistics Highlights. November 2, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. October 31, 2018 and November 21, 2018. Index performance is based on total returns and expressed in the local currency of the index. Returns for European regional indices are expressed in Euros.

In October, we evolved our twelve-month forward-looking outlook to reflect a six-month period of Growth, followed by a six-month period of Inflation. The global economy remains on track for another year of solid growth, likely to be just under 4%, as we enter the fourth quarter of 2018. However, domestic factors are causing the overall picture to become more uneven across countries and regions. Our view continues to reflect the impact of the escalating U.S. trade war and the risk to the U.S. economy as monetary policy tightens.

In both the Eurozone and Japan, domestic demand growth has remained above potential and in line with the 2017 rate. However, contribution from trade has weakened. Growth in the United Kingdom has continued to soften since 2016 and the Brexit vote. In China, trade slowdown continues to result in uneven growth. Tariffs imposed by both the U.S. and China haven’t been large enough to materially impact global trade.

In the U.S., a late cycle fiscal stimulus from tax cuts has boosted household and business spending, pushing already robust growth even higher. However, we expect the multiplier from the tax cuts to add only 20-30 basis points to growth in 2018 and even less in 2019. Most of that is likely to come from business investment, reflecting the immediate expensing of capital expenditures. The widening in the trade deficit to $53.2 billion in August suggests that even before the latest round of tariffs, there were signs that previous retaliatory tariffs on U.S. exports were starting to take effect with goods exports to China slowing sharply in August¹. After providing a big boost in the second quarter, the new USMCA agreement that is replacing NAFTA has relieved some trade tensions, but over 10% of total imports are now taxed following the levy placed on an extra $200 billion of Chinese goods¹. The opposing forces of U.S. fiscal stimulus and trade tensions should dominate the macro picture for the rest of 2018.

While Canada’s growth has been partially driven by gains in consumer and business spending, the revival in exports, owing to robust demand from the U.S. and a weaker Canadian dollar, has been a larger recent contributor. These tailwinds have helped to offset some effects from newly imposed tariffs and have sent the trade surplus with the U.S. to its highest level since 2008. The Bank of Canada raised its trend-setting interest rate for the third time this year, by another 0.25% up to 1.75%, on October 24th².

September was mixed for U.S. equities. The S&P 500 gained 0.6%, while the S&P MidCap 400 lost 1.1% and the S&P SmallCap 600 lost 3.2%. For the quarter, the S&P 500 gained 7.7%, driven by a strong economy, outperforming both Mid and Small Caps. The S&P/TSX Composite continued its August decline to end the quarter down 0.6%. In Europe, the S&P Europe 350 finished September up 0.6%, and 1.4% for the third quarter. The S&P United Kingdom Index gained 1.4% in September, benefitting from a decline in sterling. France and Sweden also made significant positive contributions for the month. Despite growing trade tensions in the area, Japan had a strong month with the S&P/TOPIX 150 returning 5.9% and 7.2% for the quarter. Commodities did well with the S&P GSCI gaining 3.9% in September, driven by gains in crude oil.

We maintained the asset allocation in Tactical Growth and Tactical Aggressive Growth. In Tactical Conservative and Tactical Moderate Growth, equity exposures were reduced by 10%. Five percent came out of each U.S. Mid Caps and U.S. Small Caps, with the total being redeployed into 3-7 year U.S. Treasuries. This move is consistent with our recognition that tax cuts from earlier in the year are having a short-term positive impact on the U.S. economy that is more than offsetting the uncertainty created by the trade wars initiated by the U.S. on China as well as many other trading partners including Canada and Mexico.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 Capital Economics. United States Chart Book. October 18, 2018.

2 Bankofcanada.ca. Policy Interest Rate.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. September 28, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.  

 

In September, we maintained our outlook to reflect the impact of escalating global trade wars. We are currently factoring in a six-month period of Stagnation followed by six months of Inflation.

During 2018, global growth appears to have peaked at 3.8% after picking up steam through the second half of last year1. We expect further moderation due to weakening emerging markets momentum driven by investor capital outflows and currency depreciations.

Following a stellar 2017, activity in the Euro Area has slowed due to decreasing foreign demand. The ECB is expected to end its asset purchase program this December, while the Bank of England will likely remain on hold with their program at least until after Brexit is official next March. The UK and EU are expected to come to terms on a withdrawal agreement before the end of the year, which should prevent a chaotic exit scenario. Japan’s economic momentum should move in the opposite direction, expecting to strengthen in 2019 due to a temporary boost in infrastructure spending for the summer 2020 Olympic Games. The more material and pressing issues among the list of global risks are China-U.S. trade tensions and escalation in the global trade war.

The U.S. is leading the global charge, thanks to widespread momentum across the consumer and manufacturing sectors. A double dose of fiscal stimulus provided a boost to an already buoyant economy, as Q2 GDP was reported at 4.2%2. The case for more Fed tightening hinges on inflation returning, which the Fed assumes will happen and is talking about hiking rates well ahead of the economic data release and market expectations. As central banks raise interest rates gradually, the US dollar should weaken. The second quarter’s drop in the trade deficit is reversing. The July trade deficit jumped to $50.1B from a downwardly-revised $45.7B in June, in line with expectations and the advance data. The core story behind all the noise is that strong domestic demand is drawing in imports, offsetting the gains in exports. However, the underlying picture is not as bad as the headlines would lead to believe. Soybean exports fell by $0.7B, the beginning of the unwinding of the export surge triggered by China’s advance notice that it would impose tariffs on U.S. soybeans, effective July 63. Meanwhile, the Canadian economy is moderating towards a more sustainable, albeit above-trend pace, though the fate of NAFTA is clouding the outlook.

August provided strong returns for U.S. equities. The S&P 500 gained 3.3%, as economic strength and strong corporate earnings boosted returns. Small caps outperformed large, with the S&P SmallCap 600 up 4.8%. Conversely, most non-U.S. markets declined in August. European equities were down amid a worsening environment for international trade, with the S&P Europe 350 off 2.3%, nearly wiping out its year-to-date returns. Italian equities and bonds had a poor month, influenced by concerns over the exposure of Italian financial institutions to the pressured Turkish economy. The S&P United Kingdom dropped 3.4% after the pound sterling rose sharply against the euro over the last few sessions.  E.U. chief Brexit negotiator Michel Barnier’s comments on a potentially unique trade deal triggered the sterling response. Canadian equities declined, with the S&P/TSX Composite down 0.8%.

In September, we increased our exposure to U.S. equities across all models to 40%, 50%, 60%, and 70% in the Tactical Conservative, Moderate Growth, Growth and Aggressive Growth models, respectively. This is consistent with our recognition that the tax cuts from earlier in the year are having a short-term positive impact on the U.S. economy that is more than offsetting the uncertainty created by the trade wars initiated by the U.S. on China, and on other trading partners including Canada and Mexico. We added this net new exposure to U.S large caps, with additional exposure coming out of U.S. small cap.

The combination of synchronized global growth and improved commodity prices are expected to contribute to worldwide inflation, though not to levels over the next six months that would threaten the status of the economic recovery. This reflationary backdrop bodes well for equities and commodities (excluding gold) at the expense of fixed income and the US dollar.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 TD Economics. Quarterly Economic Forecast. September 18, 2018.

2 U.S. Department of Commerce. Quarterly GDP Estimate Release. August 29, 2018.

3 Pantheon Macroeconomics. The Weekly U.S. Economic Monitor. September 4, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. August 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.

In August, we maintained our outlook to reflect the impact of the escalating global trade wars.  We are currently factoring in a six-month period of Stagnation followed by six months of Inflation. While the baseline forecast for the global economy continues for 2018 and 2019, the potential for disappointment remains. Tariffs generate what economists call a “deadweight loss,” with the impact on prices and consumption that results usually larger than the tariff revenue that is generated.

In June, the U.S. government announced its intention to apply tariffs on an additional $200 billion of imports from China and threatened tariffs on imports of autos and parts in the future. This news follows earlier imposed tariffs on a variety of imports including solar panels, washing machines, steel and aluminum. Retaliation was swift, as the European Union, Canada, Mexico, and China imposed tariffs on imports from the United States. China is struggling to balance several challenges to its economic health with high levels of indebtedness. Euro area GDP growth fell short of expectations with a 0.3% increase in Q2, down slightly from the Q1 0.4% gain1. That leaves Euro area growth over the first half of the year at roughly half of 2017’s pace. A slowdown in France, the currency bloc’s second largest economy, was partly to blame. Euro area inflation rose above 2% for the first time since 2012, though core inflation remains well below the European Central Bank’s target. From the Central Bank’s policy path for the coming months, we expect net asset purchases trimmed to zero by the end of 2018 and rate hikes off the table at least through next summer.

In the U.S., Q2’s advance GDP report came in at 4.1% annualized, one of the highest quarterly growth rates in the last decade1. The economy was performing very well, with domestic demand up almost 4%, led by a rebound in consumer spending and another solid increase in business investment. However, tariffs imposed by the U.S. on imports is expected to raise prices and lower real disposable incomes for consumers, jeopardizing the livelihoods of American workers. U.S. tariffs threaten consumer spending going forward since nearly 11 million jobs are supported by exports and millions of additional jobs directly depend on imports.

Protectionism could also hurt corporate profits. The “rest-of-the-world” component has been driving U.S. profit growth the past few years, increasing its share of overall U.S. corporate profits to 20.3% in Q1 this year, a four-year high2. Continuing protectionism from Washington can potentially harm corporate America’s profitability, offsetting some of the benefits from tax cuts. The U.S. President initiated an investigation into imports of motor vehicles and parts from Canada on national security grounds – the same justification used for steel and aluminum tariffs. If the ultimate outcome of the investigation is the imposition of tariffs of a similar magnitude, the impact to Canada would be significant, potentially reducing growth in 2019 growth by 0.5%.3 Business investment would be the most significantly impacted, reducing Canada’s long-run economic capacity.

Global financial markets reacted negatively to apparently souring trade relationships. The MSCI All-Country World index was down significantly after U.S. tariff announcements. In July, U.S. equities gained across all cap sizes. The S&P 500 gained 3.7%, while the S&P MidCap 400 gained 1.8% and the S&P SmallCap 600 gained 3.2%. Canada and Europe were also positive, with the S&P/TSX Composite up 1.1% and the S&P Europe 350 up 3.2%, with nearly all countries contributing positive returns. June’s focus on trade tensions and political risk largely gave way to positive earnings figures, economic data, and central bank guidance in Europe.

Asian equities also enjoyed a positive month, though China and Korea contributed negatively to the region as lingering trade tensions continued to have an impact on markets. U.S. fixed income performance was mixed with high yield corporate bonds the strongest sector.

In August, we shifted a portion of our fixed income exposure to U.S. equities in both the Growth and Aggressive Growth models, resulting in equity exposure shifting from 50% to 60% and from 53% to 65%, respectively. The shift was out of the existing U.S. municipal bond position and into U.S. mid-caps.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

1 RBC Economics. Financial Markets Monthly. August 10, 2018.

2National Bank of Canada. Monthly Economic Monitor. Economics and Strategy. July/August 2018.

3 TD Economics. Potential U.S. Auto Tariffs: Canadian Scenario Analysis. June 18, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. July 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.  

In July, we updated our outlook to reflect the impact of the escalating global trade wars. We are now factoring in a six-month period of Stagnation followed by six months of Inflation. While the baseline forecast for the global economy continues for 2018 and 2019, the potential for disappointments has increased.

The WTO issued a monitoring report in July on G20 trade measures covering the period from mid-October 2017 to mid-May 2018. The report shows that a total of 39 new trade-restrictive measures were applied by G20 economies during that period¹. These measures include tariff increases, stricter customs procedures, imposition of taxes and export duties.

The IMF’s World Economic Outlook forecast from April 2018 for global growth is in line with projections to reach 3.9% in 2018 and 2019². Risks to the outlook are increasing amid rising oil prices, higher yields in the United States, escalating trade tensions, and market pressures on the currencies of some economies with weaker fundamentals. Growth projections have been revised down for the euro area, Japan, and the United Kingdom, reflecting negative surprises to activity in early 2018 and among emerging markets, projections have been revised down for Argentina, Brazil, and India. In the Euro economy, growth is projected to slow gradually from 2.4% in 2017 to 2.2% in 2018 and 1.9% in 2019. Forecasts for Germany, France and Italy have been revised down for 2018. Japan’s growth forecast was reduced to 1.0% for 2018 following a tightening in the first quarter due to weak private consumption and investment. The slowing of China’s economy amid an escalating trade war was evident as the country continued to restrict credit growth, putting the brakes on the world’s second-largest economy. China generates about a third of global growth.

With firmer readings on inflation and strong job creation, the US Federal Reserve continued the course of gradual policy normalization, raising the target range for the Federal Funds rate by 25 basis points in June, while signaling two additional rate hikes in 2018 and three in 2019. The percentage of small businesses reporting price increases remains near a 10-year high in June, at 14%. While U.S. government debt was downgraded by the S&P to AA+ in 2013, the other two main rating agencies are expected to follow suit as the federal deficit is expected to grow in the aftermath of federal tax cuts.

June was an unstable month with U.S. equities ending the second quarter with gains across all cap sizes. Over the quarter, the S&P 500 gained 3.4% and the S&P MidCap 400 was up 4.3%. Small caps widely outperformed, cushioned from trade tensions, as the S&P SmallCap 600 gained 8.8%. In June, the S&P 500 gained 0.6%, the S&P MidCap 400 gained 0.4% and the S&P SmallCap 600 gained 1.1%. Canadian equities also gained in Q2 with the S&P/TSX Composite up 6.8% and 1.7% in June. The Canadian economy has benefited from the rise in oil prices that began in February. The Bank of Canada hiked its overnight rate target 25 basis points to 1.50% in July. The S&P Europe 350 fell by 0.6% in June as trade tensions and European political risk soured sentiment although gains earlier in the quarter meant the S&P Europe 350 finished the quarter with a gain of 4.4%.

In fixed income, the S&P 500 Bond Index lost 0.4% in June. The S&P U.S. Aggregate Bond Index was flat in June with MBS, covered bonds, taxable municipals and investment-grade corporates reporting losses for the month.

As we continue to watch the impact that the U.S. led trade war is having on the U.S. economy and the ripple effect to trading partners, we maintained the asset allocation and the same exposures that we introduced in June. This asset mix has worked well in our shifted outlook to Stagnation followed by inflation over the next twelve months.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹ WTO OMC. Report on G20 Trade Measures (Mid-October 2017 to Mid-May 2018). July 4, 2018.

² IMF. World Economic Outlook Update, July 2018: Less Even Expansion, Rising Trade Tensions.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. June 29, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.

In June we carried the outlook forward from May with Growth in the first half of the twelve-month time horizon heading toward Inflation in the back half.

World trade weakened slightly in Q1 2018 to 4.4% compared to 4.7% in 2017¹. The global economy was handed a curve ball in May as the U.S. unilaterally and simultaneously confirmed tariffs on China, Europe, Canada and Mexico including $50 billion on Chinese imports and new duties on foreign steel and aluminum across all countries who import to the United States. IMF Director Christine Lagarde announced that a trade war would lead to “losers on both sides”. This comes as the IMF also announced their forecast of U.S. growth declining in 2022 as the initial boost of tax cuts is offset by the drag of the greater debt burden associated with lower tax revenues².

U.S. tariffs have prompted Europe, Mexico, Canada and China to introduce or announce plans retaliatory for counter-measures. Due to China’s pivotal role in the global supply chain, a fall in Chinese exports related to the U.S. trade conflict could inflict collateral damage on other economies and thus enhance macroeconomic risk.

The eurozone had been identified as the stand-out performer going into 2018 as eurozone data was consistently above expectations at the start of the year but it has surprised to the downside in recent months. The European Central Bank and Bank of Japan are both still engaged in quantitative easing (QE), although Europe is expected to wind down its QE program by the end of the year.

U.S. GDP growth is expected to rebound in Q2 2018 following growth of 2.3% in Q1. The fiscal stimulus (tax cuts and increased spending) extends the duration of the U.S. cycle. The Federal Reserve is still on course to raise interest rates four times this year. With the budget deficit expected to rise in coming years, passing $1 trillion in 2020, according to Congressional Budget Office estimates, the government has been issuing debt heavily³. The total for 2018 has been $443.7 billion, a nearly nine-fold increase from the same period a year ago, according to the Securities Industry and Financial Markets Association.

We are watching the recent trend of foreign governments that have pulled back their purchases of longer-term U.S. debt as trade tensions have escalated. Foreigners held $6.17 trillion of the total $14.84 trillion of Treasury debt outstanding through April. China, the largest owner of U.S. debt, reduced its level in April by $5.8 billion to $1.18 trillion, while Japan, the second largest, cut its holdings by $12.3 billion to $1.03 trillion. Ireland, the U.K. and Switzerland also pulled back. When counting all securities (including T-bills), the April decline came to $47.6 billion, a 0.8% reduction from March⁴.

The month of May provided strong returns for US equities, with the S&P 500 gaining 2.4%, and S&P MidCap 400 and S&P SmallCap 600 gaining 4.1% and 6.5%, respectively. Canadian equities did well, with the S&P/TSX Composite up 3.1%.

The S&P Europe 350 ended the month down 1.2% after a strong start due to a more co-operative tone between the U.S. and China, and indications that Italy would finally have a government. A re-emergence of trade tensions and an increase in Italian and Spanish political risk later in the month weighed on the European equity benchmark. Emerging and frontier markets posted losses, with the S&P Emerging BMI and S&P Frontier BMI down 3.5% and 7.5%, respectively. Performance influences include the dollar’s strong performance. Performance in U.S. fixed income was mostly positive with S&P Municipal Bond High Yield Index leading the pack with a gain of 1.7%.

As we are cautious of the direction that a trade war is taking the U.S. economy and the ripple effect to trading partners, we made a major shift in asset allocation away from Canada, Europe and the Pacific Region and into short-term U.S. bonds across all models. We allocated equal amounts to Municipal Bonds, the 3-7 year U.S. Treasuries and U.S. Small Caps in the Tactical Conservative and Tactical Moderate Growth Models. We allocated proportionally more of the 3-7 year U.S. Treasuries in Tactical Growth and Tactical Aggressive Growth Models.

We continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹ World Trade Organization. 2018 Press Release: Strong trade growth in 2018 rests on policy choices. April 12, 2018.

² IMF. World Economic Outlook Update, January 2018: Brighter Prospects, Optimistic Markets, Challenges Ahead.

³ Congressional Budget Office. The Budget and Economic Outlook: 2018 to 2028. April 2018.

⁴ CNBC. Russia cuts Treasury holdings in half as foreigners start losing appetite for US debt. June 18, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. May 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.

In May, we continued our Growth Outlook for the next six months followed by Inflation for the following six months. The global economy is running at its fastest pace since the very early days of the current economic recovery. The IMF upgraded its outlook for 2018 and 2019, calling for the world economy to achieve closer to 4% growth during those periods, nearly matching the pace set in the prior decade¹. The details of the IMF report reveal that every major economy is expected to remain in expansion mode, a synchronicity not seen since the 1990s. This broad strength is a key factor driving global yields and commodity prices higher.

In the euro area, 2018 got off to a disappointing start as real GDP growth slowed to 0.4% in the first quarter, the weakest performance since the third quarter of 2016. Both headline and core inflation were soft in April, slipping back to 1.2% and 0.7%, respectively².

In Japan, the expansion became shakier, while growth in China took a stronger start this year, after solid data reported on industrial value-added, fixed asset investment, and steel and electricity output. World output has powered through trade uncertainty, initial Fed tightening, rising fuel costs, and a return of some market volatility.

U.S. economic data released in April reflect a slowdown in the rate of growth during the first quarter. Unemployment has reached a multi-decade low and is likely to push still lower in the coming months. Combined with U.S. fiscal stimulus, support for household consumption is anticipated. The IMF estimates that the structural budget deficit among advanced economies will widen 0.3 percentage points as a share of GDP this year, and another 0.6 ppts in 2019 – a rough measure of the net fiscal stimulus to growth, with almost all coming from the U.S. tax and spending steps¹. Headlines around U.S. trade policy and general political dysfunction are a persistent feature but have so far not been significantly disruptive to the economy.

The Canadian economy continues to perform well despite some volatility early this year. Rising commodity prices and the solid outlook for Canada’s major trading partners provide support. The March 2018 job numbers came in at a loss of 1,100, well below consensus expecting a 20,000 gain³. With inflation close to the Bank of Canada’s target, the case for rate hikes is high and the BOC is expected to keep pace with the Fed. Aside from the housing market, the primary economic risk remains the turbulence related to ongoing NAFTA negotiations.

For the month of April, U.S. large-cap equities returned to positive territory, with the S&P 500 up 0.4%. S&P Small Cap 600 gained 1.0%. Energy was the top performing sector, up 9%, aided by rising oil prices. Canadian equities gained, with the S&P/TSX Composite up 1.8%. Europe had a strong start to the earnings season, while easing geopolitical tensions competed with concerns of a trade war. Despite tensions, S&P Europe 350 gained 4.8%, pushing the European equity benchmark into a positive YTD for 2018. The S&P Emerging BMI posted a loss of 0.8%, due to headwinds including rising rates and the dollar’s strong performance. Bond yields have been creeping up so far in 2018, leading to a significant shift in the relative attractiveness of equities versus bonds. With bonds yielding less than equities for most of the post-2008 cycle, equities have enjoyed a yield advantage for nearly a decade. Now, rising yields are levelling the playing field. The S&P 500 Bond Index was down 0.8% in April, as both investment-grade and high-yield issues were negative for the month.

We carried the outlook from April through to May with Stagnation in the first half of the 12-month time horizon heading toward Inflation in the back half. We maintained the fixed income exposure in all models while shifting some equity exposure from the Pacific Region and Europe back to the United States. We added U.S. Small Caps in the same weights that Asia was reduced across all models. We added U.S. Midcaps in the same weights that Europe was reduced across all models.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹ IMF. World Economic Outlook. Cyclical Upswing, Structural Change. April 2018.

² Alliance Bernstein. Global Macro Outlook. May 2018.

³ Scotiabank. Strategic Edge Weekly. May 14, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. April 30, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.  

In April we continued our Growth Outlook for the next six months followed by Inflation for the following six months.

Global momentum remains strong as the IMF forecasts 3.9% growth this year and next, the fastest since 2011 thanks to increasing investment and trade. The strength of global demand is leading to a significant increase in most commodity prices relative to last year. This is benefitting commodity exporting nations, such as those in the Pacific Alliance, where growth is expected to be much stronger than in 2017. While monitoring this we are also watching the intensifying standoff between the United States and China that threatens to flare up into the biggest trade confrontation since WWII. In addition, record levels of global debt could become a destabilizer and at the very least will lead to higher levels of interest rates around the globe.

China’s economic outlook is favourable. While we expect growth to decelerate gradually in 2018–19, China is aiming for 6.5% expansion this year. The Euro area has been running a primary fiscal surplus since 2014, which moved close to 1% of GDP in 2017. Over the past five quarters, nominal GDP growth averaged 4% annualized, compared with an average of 2.7% in the prior three years. Germany continues to lead with growth of almost 3% y/y by the end of 2017. A question on the monetary policy front is whether the ECB will make further asset purchases once the current round of QE comes to an end in September, or whether the program will be phased out more gradually.

The U.S. was already on a path toward rising fiscal deficits before the introduction of limited tax reforms. Unfunded social security obligations and health care expenditures were the main driver. Adding an extra U.S.$1.5 trillion to cumulative deficits over the next decade further erodes the deficit outlook. The current earnings season is expected to show significant support for equities as companies deliver on shareholder return from the tax windfall. Based on the recent FOMC minutes a rate hike at the June policy meeting is expected.

The Bank of Canada faces similar conditions to the Fed. Economic growth is solid, unemployment is low, and core inflation averaged 2% on an annual basis for a second straight month in March.

For Q1 2018, the S&P 500 ended down 1.2%, the first negative quarter in 9 quarters. The S&P TSX Composite fell 5% over the quarter and rates rose across the board. Gold held steady, rising 1.7%.

The month of March was challenging for U.S. large-cap equities, with the S&P 500 down 3%. Smaller caps performed better, as the S&P MidCap 400 and the S&P SmallCap 600 registered gains of 1% and 2%, respectively. International markets declined, as the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI posted March losses of 2% and 3%, respectively.  Canadian equities were slightly negative in March, with the S&P/TSX Composite down 0.16%. The S&P 500 Bond Index gained 0.15% in March, as high-quality and long-duration bonds outperformed for the month. The S&P U.S. High Yield Corporate Bond Index was down 0.45% for March as investor sentiment favored safer, higher-quality bonds.

Our outlook did not change from March and as a result we maintained our asset allocations across all models. U.S. Equity exposure ranges from 12% in Conservative, to 25% in Moderate Growth, Growth and Aggressive Growth while International equity allocations are 41%, 38%, 50% and 53% respectively. This highlights our view that Europe and the Asia Pacific regions are expected to perform well because of issues highlighted in the update.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. March 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.

In March, we continued our Growth Outlook for the next six months followed by Inflation for the following six months. Fundamentals (job growth, corporate profits, corporate and consumer confidence) remain very strong globally for now even as manufacturing downshifts. The commitment by President Trump to impose tariffs on China would be the main driver of U.S. inflation by way of higher prices on all goods subjected to these tariffs coming into the U.S. from China. Any retaliation by China would negatively impact exports from the U.S to China and collateral damage to other economies would most likely have a negative impact on growth globally.  Independent from the tariffs, we expect China will continue to lose momentum through 2018.  The news that North Korea, South Korea and the U.S. may meet to discuss reducing tensions on the peninsula has contributed to lower volatility in March. In Europe, retail sales and Industrial production data have disappointed in January and the subdued pace of core inflation and wage growth has kept the ECB moving very slowly toward the end of easing. Global growth is still expected to come in at 3% for 2018.

The U.S. economy is now in the late stages of the business cycle. Employment growth has been decelerating for several years and productivity growth is sluggish. Any boost from Trump’s fiscal stimulus would be short lived and the cumulative effects of monetary policy tightening would take a toll. The U.S. Federal Reserve raised the prime lending rate by 0.25% on March 20. The new Fed Chair, Powell’s, first conference largely echoed the messages of his predecessor, Janet Yellen.

During March, a seventh round of NAFTA talks concluded in Mexico City. Negotiations are advancing slowly with only 6 out of 30 chapters completed. Tensions continue to flare regarding Trump’s plan for steel tariffs. Progress was not made on more controversial issues such as dispute resolutions, national content, and the sunset clause. The decision to exclude NAFTA countries from steel and aluminum tariffs was encouraging, even if its conditionality on NAFTA being completed was ill-received by Mexico and Canada. If limited progress continues, it is unlikely NAFTA negotiations will be completed until 2019, especially with elections approaching in both Mexico and the United States.

Global equities had a rough ride in February. The S&P 500 ended the month down 3.7% while the S&P MidCap 400 and the S&P SmallCap 600 lost 4.4% and 3.9%. Canadian equities were negative with the S&P/TSX Composite down 3.0%. International markets performed poorly as the S&P Europe 350 lost 3.9%, and the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI posted losses of 4.6% and 4.1%, respectively.

Interest rates rose across the board, negatively impacting February performance in U.S. fixed income. The S&P 500 Bond Index lost 1.5% in February, as the pull back in corporate bonds extended throughout the credit spectrum.  For the first time in four years, the yield on the 10-year U.S. Treasury hit 2.90%. Commodities were also down in February, with the S&P GSCI and the DJCI down 3.3% and 1.9%, respectively.

Due to the updated outlook that adds Inflation in the back half of our twelve-month forward time horizon, we shifted within the U.S. equity market cap exposures in all models. We reduced exposure to the S&P 500 across all models and shifted that exposure to different equity segments. In Tactical Conservative, we shifted to the S&P MidCap. In Tactical Moderate Growth, we shifted to the S&P MidCap and the S&P SmallCap. In Tactical Growth and Tactical Aggressive Growth, we shifted to S&P SmallCap. Over the twelve-month time horizon used in our model creation, we expect global growth around 3% and inflation in the G7 economies close to 2%.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. February 28, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros. 

In February, we continued our Growth outlook for the next three months. The data coming in from 2017 confirms that the synchronized world economic recovery also contributed to global EPS growth across most markets in 2017.

China continues to grow but a slowdown is underway, resulting from policy tightening as the authorities became more concerned about financial stability risks. Local governments have imposed restrictions on property sales and on lending to property developers, which led to a sharp slowdown in property construction in recent years.

Euro area GDP rose 0.6% in Q4/27, the fifth consecutive quarter of above-potential growth. Early indicators point to continuing momentum at the start of 2018¹. January’s composite purchasing managers’ index rose for a third straight month, hitting its highest in more than a decade thanks to further improvement in the services sector.

The U.S. economy is now in the late stages of the business cycle, employment growth has been decelerating for several years with sluggish productivity growth. Any boost from fiscal stimulus is not expected to be sustained as dividends and share buybacks don’t lead to long-term capital investments that are required to support sustainable long-term growth. In the recent months, there have been close to $200 billion of buyback announcements, over double from a year ago².  Also, the cumulative effects of monetary policy tightening will likely take a toll with the Fed raising its policy rate three times over the past year and begun the process of balance sheet reduction while more Emerging Market central banks have loosened policy rather than tightened over this period. Following consecutive gains of over 3% in Q2 and Q3, headline U.S. GDP growth slowed slightly to 2.6% in Q4 of 2017. With the U.S. economy already facing capacity limits and tax cuts set to push demand even higher, inflation risks are tilted to the upside.  Market-based inflation expectations rose to three-year highs and energy prices have picked up, putting upward pressure on nominal yields. The rollover of government debt maturing in 2018 and promise of increased Treasury supply to finance tax cuts have contributed to the rise in bond yields.

In Canada, solid economic data and a positive tone expressed by Governor Poloz raised market expectations that the Bank of Canada may hike rates at the start of 2018. On January 17, the Bank of Canada raised the overnight rate by 25 basis points to a post-crisis high of 1.25%. The bank kept a balanced tone and their forecasts unchanged despite including a modest downturn of business investment and exports related to NAFTA uncertainty.

U.S. equities had a strong start in 2018. In January, the S&P 500 gained 6%, marking the best opening month since Jan 1997. The S&P MidCap 400 and the S&P SmallCap 600 each gained 3%. Equity volatility rose with the VIX passing the 14 level on January 30th for the first time since August 2017. Internationally in January, the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI gained 5% and 9%, respectively. U.S. fixed income was negative across the board in January, driven by the rise in Treasury yields. Commodities also started the year positive with the S&P GSCI and the DJCI both up 3%.

At mid-month in February we chose to maintain portfolio weights across all models. This was based on our view that the outlook in January continues to reflect the recent fiscal and monetary policy developments in the United States. This would result in economic growth for the U.S. in the next twelve months while there is growing awareness that these policies will front-end load growth, leading to inflation in 2019. We expect to address inflation in our outlook in the coming months.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.

 

Deborah Frame, President and CIO

 

¹RBC Economics. Financial Markets Monthly. February 9, 2018.

²Gluskin Sheff. Breakfast with Dave. Economic Commentary. David A. Rosenberg. March 2, 2018.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Fixed Income. January 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.