2018 Portfolio Updates – Page 2 – Frame Global Asset Management

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.

In January, we continued our Growth outlook for the next three months. Global growth has become more trend line in 2018, led by global demand and a revival in commodity prices, allowing most policymakers the flexibility to pursue much-needed reforms without stifling growth. A few developed market central banks are facing conflicting signals as economic growth has moved decisively above trend, driving unemployment rates to lows not seen since the early 1980s, while core inflation has remained stuck at levels still well below target. As we advance through the year we will likely see a sustained move up in wage and price inflation that would prompt faster and more broadly-based policy normalization. Rate hikes in the U.S., the U.K., Canada and Australia are expected while the European Central Bank is expected to leave rates unchanged but begin to taper asset purchases as the Eurozone’s big three economies continue to diverge: Germany’s unemployment at 5.7% continues to fall to levels not seen since before unification, while unemployment in France has risen to 9.2% and Italy is struggling with the highest of the three at 11.2%¹. Japan still struggles with demographics that constrain GDP growth even though Japanese equities were one of the best performing asset classes in 2017. New governance incentives have motivated companies to focus on returns, dividends and repurchasing shares. China’s performance, which has been better than expected, indicates an orderly deceleration of growth and a slowing of credit expansion, suggesting a deceleration to 6.4% growth for 2018 from 6.8% last year¹. The Bank of Canada seems cautious, emphasizing uncertainty surrounding the ongoing NAFTA negotiations, so the risks are likely tilted toward fewer hikes.

The U.S. economy continues to show strength, despite a soft patch in early 2017, as tax cuts of about $1.0 trillion (or about 0.5% of GDP) over the next decade could help lower the unemployment rate further to 4.0%¹. In 2018, growth of 2.7% is expected¹. Consumer spending and business fixed investment continue to be major drivers of growth and would benefit from lower personal and corporate tax rates. Corporate earnings growth continues to drive equity market multiples. Cold weather in North America played a role in boosting oil prices recently, with the 40% jump in Brent crude since June 2017 owing to more fundamental demand and supply dynamics.

2017 was an outstanding year for U.S. equities. Large caps stood out, with the S&P 500 Index up 22%, marking 14 consecutive months of gains. The S&P MidCap 400 and the S&P SmallCap 600 gained 16% and 13%, respectively. The S&P/TSX Composite was up 9%. The S&P Europe 350 ended the year at 11% while the S&P United Kingdom gained 12%. The index benefitted when market participants deemed a so-called “hard Brexit” less likely, however this was offset by the positive impact on Pound Sterling. The S&P China 500 had the highest total return in 2017, gaining 35%. The government’s attempts to control rising debt may restrict short-term growth. The S&P 500 Bond Index gained 0.9% in December and 6% for 2017. Continued curve flattening drove long-duration bonds. The 10+ year sub index returned 12% for the year. The S&P U.S. Aggregate Index lagged investment-grade corporate bonds, returning 0.4% for the month and 3.3% for 2017.

In January, we shifted exposure from the U.S. mid term treasury bond to European and Pacific equities across all models. This is in line with our extended Growth outlook, recognizing strength in Europe and Asia while avoiding growth challenges in other economies and markets. Tactical Growth and Tactical Aggressive Growth models saw exposure to the midterm treasury bond eliminated, reducing fixed income exposure from 38% and 33% to 23% and 20% respectively.

Deborah Frame, President and CIO

¹ State Street Global Advisors. 2018 Global Market Outlook. Step Forward, Look Both Ways.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income, Europe. December 29, 2017. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.

February 2018

January 2018