The pace of global growth continues to slow this year as policy uncertainty takes its toll on the world’s economy. The 1% decline in global growth over the past year in conjunction with the trade war and a number of geopolitical conflicts raises the risk of recession as the rules-based approach to governing international trade is breaking down.1 We are monitoring these developments and have concluded that our Stagnation outlook for the U.S. economy over our forecast time horizon of twelve months still stands, with a recession likely in the last quarter of 2020.

In a year in which politics is generating a large negative sentiment shock, macroeconomic policy has thus far cushioned the blow. The Fed’s early-year pivot away from normalization signals a more growth-supportive policy. China’s moves on multiple fronts are validating its commitment to do “whatever it takes” to prevent growth from slipping below 6%.2 Reinforcing the two largest economies’ efforts, 17 of the 30 central banks have lowered policy rates in the last three months.3

Developing market unemployment rates stand at a 40-year low although the major growth disappointments this year have come from Western Europe. Germany’s GDP shrank 0.3% quarter over quarter in the second quarter. Excluding Germany’s contraction, Euro area GDP rose 1.2% quarter over quarter. At the country level, growth in Italy was also weak at 0.1% quarter over quarter, and other countries were sluggish including France at 1%. These were offset by some firmer performances including Portugal at 2%, Spain at 1.9%, and the Netherlands at 2.1%.4 Boris Johnson began his term as U.K. Prime Minister with demands for a renegotiation of the E.U. withdrawal agreement, issuing a threat to leave without one otherwise. The pound sterling declined to near its lowest in two years.

While the outlook for global economic growth may be more qualified, recent U.S. data has exceeded expectations. Consumers continue to power the U.S. economy. Tariffs have done little to reduce the U.S. trade deficit with China and the country’s overall deficit continues to widen, particularly with Mexico, the EU, and some of China’s neighbours. Exports have slowed over the last year while imports have continued to increase. U.S. industry is participating in the global slowdown as factory output fell again in July after declining in the first half of 2019.5 Despite the slowing, job gains are still solid. U.S. business investment declined in Q2 for the first time since 2016.6

The FOMC statement on July 31st explained that Fed motivation to cut was driven by negative global factors. The cut of 0.25 percentage points was America’s first in over a decade. Despite President Trump’s complaints that the strong dollar is holding back the economy, the dollar isn’t that far above its long-run average. The 3% appreciation over the past 12 months is minor in comparison to the 16% surge in late 2014 and early 2015.7 The strengthening against the Chinese renminbi has actually been a positive by limiting the upward pressure on prices from tariffs on Chinese goods.

The odds of the Bank of Canada following the U.S. Fed and other global peers with lower interest rates have increased as the U.S.-led trade war with China has intensified – with risks if anything tilted to an earlier move than the 25 basis point cut that was expected in early 2020.

After a record June, accompanied by continued earnings beats and a month-end interest rate cut from the Federal Reserve, U.S. equities continued to post gains in July. The S&P 500 was up 1.4% while the S&P MidCap 400 was up 1.2% and the S&P SmallCap 600 was up 1.1%.  Canadian equities gained during July, with the S&P/TSX Composite up 0.3%. The S&P Europe 350 gained 0.3% on the month. Asian equities were mixed in July on the back of increased regional and global trade concerns. In fixed income, Treasuries declined.

The risk that rates could move into negative territory would have dramatic consequences for the bond, equity, and currency markets in the United States. In response to this threat, we added gold across all models in August. Allocation to equities is now at 17% in Tactical Conservative, 22% in Tactical Moderate Growth, 36% in Tactical Growth, and 44% in Tactical Aggressive Growth. Equity exposure was maintained in the S&P 500 in all models. The S&P MidCap 400 was eliminated in the Conservative and Moderate Growth models and reduced in the Growth and Aggressive Growth models. Exposure to U.S. Municipal Bonds was reduced in the Conservative and Moderate Growth models.

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 J.P.Morgan. Global Data Watch. August 16, 2019.

2 Trading Economics, China GDP Annual Growth Rate. July 15, 2019.

3 J.P.Morgan. Global Data Watch. August 16, 2019.

4 Trading Economics, Euro Area GDP. August 14, 2019.

5Trading Economics, U.S. Factory Orders. August 2, 2019.

6 Trading Economics, U.S. Economic Indicators. July 19th, 2019.

7Trading Economics, U.S. Currency Exchange Rates. August 21st, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. July 31, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

 

The pace of global growth is slowing this year as policy uncertainty takes its toll on the world’s economy. Data points to the global economy expanding by 3.3% this year, slower than 2018’s 3.6% pace, with trade volumes declining and business sentiment deteriorating. Central bank actions and intentions have boosted both equity and bond markets so far this year, a sign that investors think monetary policy support will be sufficient to offset trade headwinds. This action by central banks supports our Stagnation outlook for the U.S. economy as growth is capped over our forecast time horizon of twelve months.

The prospect of a prolonged U.S.-China trade war, the lack of clarity around Brexit, and political and economic upheaval in countries like Venezuela have contributed to the downside risks of our outlook. European economies have notable international financial and economic linkages, and a sharp economic downturn in Europe would affect banks, markets, and the global economy.

The U.S. economy continued to grow at a solid clip in the first quarter of 2019 on the back of net exports and inventory building. U.S. inflation is closer to the Fed’s objective but has been below 2% for much of the last decade. With inflation pressures remaining “muted,” a rate cut would be less about the state of recent economic data and more about providing insurance against trade tensions and slowing global growth. Prospects for some American companies have dimmed. Analysts expect earnings of the biggest companies, which have just begun reporting second quarter results, to have declined. This would mark two consecutive quarters of falling profits. 2

The Bank of Canada looks set to diverge from the Fed, holding rates steady. Firmer current core inflation (close to 2% for the last year) and an already more accommodative stance give the BoC some room to move later. 3

After a setback in May, a dovish Federal Reserve and optimism surrounding a potential trade deal during the G20 talks contributed to a rebound in U.S. equities in June. The S&P 500 was up 7.0% while the S&P MidCap 400 was up 7.6% and the S&P SmallCap 600 was up 7.5%. For the second quarter, large-caps outperformed smaller-caps with the S&P 500 up 4.3%, the S&P MidCap 400 up 3.0% and the S&P SmallCap 600 up 1.9%. The S&P/TSX Composite was up 2.5% in June and up 2.6% in the second quarter. The S&P Euro (350 Eurozone), S&P Europe 350, and S&P United Kingdom indexes were up 4.5%, 3.3%, and 3.2% for the quarter, respectively. The S&P China 500 was up 6.6% in June but remained in negative territory for the quarter, down 0.62%. U.S. fixed income performance was positive across the board, with corporates outperforming Treasuries, while commodities declined during the quarter, driven by weakness in energy, industrial metals, and livestock.

In July, we maintained the existing allocation between equities and bonds across all models. This asset allocation continues to reflect our expectation that the U.S. economy is under pressure but is more stable than other global equity markets.  Allocation to equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth, and 60% in Tactical Aggressive Growth. Within equities, exposure is distributed between the S&P 500 and S&P MidCap 400. We are of the view that smaller companies will feel the impact of the uncertainty that exists in the current climate while longer treasuries will continue to benefit from the downward pressure on interest rates and the relative attractiveness of interest rates in the U.S. versus the rest of the world.

Economic and market risks are elevated as a result of the U.S. administration’s use of tariffs at a time when global growth is slowing. From our perspective, financial market volatility in Europe could spill over to global markets, including the United States, leading to a pullback of investors and financial institutions from riskier assets, which could amplify declines in equity prices and increases in credit spreads. In addition, spillover effects from banks in Europe could be transmitted to the U.S. financial system directly through credit exposures as well as indirectly through the common participation of globally active banks in a broad range of activities and markets. The consequent U.S. dollar appreciation and weaker global demand in such a scenario would depress the U.S. economy through trade channels, which could reduce earnings of some U.S. businesses, particularly exporters. Such effects could harm the creditworthiness of affected U.S. businesses, particularly those that already have high levels of debt. 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 International Monetary Fund, World Economic Outlook. April 2019.

2 The Economist. Profits are down in America Inc. July 20, 2019.

3 RBC Economics. Current Trends Update – Canada. July 19, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. June 28, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

Our outlook is focused on tension between politics, policy and the positioning of the corporate sector. The world economy remains vulnerable to the U.S – China power play. If tariffs persist or are ramped up further, already weak world trade volumes will struggle to gain traction. In addition, rising political conflict (Brexit and Italy) and uncertainty have weighed on business sentiment over the past year and global capex is stalling. The dovish stance by central banks supports our Stagnation outlook for the U.S. economy as growth is capped over our forecast time horizon of twelve months.

China is committed to maintaining 6% growth and will respond to any slowing with further easing.1 The U.S. and China have each raised tariffs and appear to be broadening the conflict to their respective tech sectors.  The results of the European Parliament elections showed a significant step up in support for populist parties, who now control 28% of total seats in Parliament, up from 22% before. Turnout in the elections was low at 37%, some 30%-35% lower than may be expected in a general election or second referendum.2 The Brexit Party’s win (mostly at the expense of the Conservatives) sent the message that many voters are willing to support a no-deal.

In the U.S., the FOMC is ready to respond to slowing GDP and job growth.  Consensus expects two rate cuts later this year. Job growth has slowed through May, with the latest jobs report showing only 150,000 jobs added on average over the three months through May, down from a three-month moving average for job growth of 245,000 as recently as January.3 Trade policy could dampen growth further as most of the data reports that have been released to date cover a period before the recent escalations regarding tariffs toward China. The U.S. administration is using trade barriers as a tool of broader foreign policy and is signaling it will no longer defend the rules based global trading order it helped create over the past quarter century. The US dollar, still one of the world’s strongest currencies, has been trading at close to the highest levels in two years.

In Canada, there are signs that the recent economic slowing is giving way to a recovery as oil production curtailments are less frequent and housing markets have come off their bottom. The current 1.75% Bank of Canada policy rate is consistent with an economy operating at or near capacity. Economic growth is expected to settle around its trend pace of 1.7%. Population aging, private indebtedness, and modest productivity gains mean a slower pace relative to history.

In May, the trade war levied its toll, sending equity markets into reverse.  In contrast to the strong performance during the first four months of 2019, U.S. equities suffered. The S&P 500 lost 6.4%, while the S&P MidCap 400 lost 8.0% and the S&P SmallCap 600 lost 8.7%. Canadian equities posted losses in May, with the S&P/TSX Composite down 3.1%. The S&P Europe 350 dropped 4.7%, giving up all of April’s gains and moving into the negative territory for the second quarter. The S&P United Kingdom was down 2.9%. Asian equities dropped sharply in May. The S&P Pan Asia BMI declined 5.4%, with all 11 sectors finishing in the red. Fixed income performance was mostly positive, with Treasuries outperforming corporates. The 10-year U.S. Treasury Bond yield closed the month at 2.1%, down from the previous month’s yield of 2.5% (2.69% for year-end 2018, 2.40% for 2017, and 2.45% for 2016).

In June, we maintained the existing allocation between equities and bonds across all models. Allocation to equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth, and 60% in Tactical Aggressive Growth. Within equities, we eliminated exposure to the S&P SmallCap asset class and distributed the exposure equally between the S&P 500 and the S&P MidCap. We are of the view that smaller companies will feel the impact of the uncertainty that exists in the current climate while longer treasuries will continue to benefit from the downward pressure on interest rates and the relative attractiveness of interest rates in the U.S. versus the rest of the world.

Our outlook for 2019-20 has focused on tension between politics, policy, and the positioning of the corporate sector. Rising political conflict and uncertainty have weighed on business sentiment for a year and global capex is stalling. 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 South China Morning Post. China lowers 2019 GDP growth target to 6-6.5 per cent range. March 5, 2019.

2 J.P.Morgan Economic Research. Global Data Watch. May 31, 2019.

3 Trading Economics, U.S. Non-Farm Payrolls. June 7th, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. May 31, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The global economy entered 2019 facing headwinds that included the ongoing uncertainty around the U.S. war on trade, a series of idiosyncratic events in the Euro area and the U.S. government shutdown. In April, the IMF lowered its growth forecast for 2019 to 3.3% from the previous level of 3.5% in its latest World Economic Outlook. This is the third time in six months that the fund has revised its outlook downward and is now projecting a decline in growth this year for 70% of the global economy.1 We continue to position our portfolio models to reflect the view that the U.S. will experience GDP growth over the next twelve months that is below 2.5%, resulting in Stagnation.

The U.S.-China trade tensions re-escalated in May with trade negotiations breaking down and tariffs raised by both sides.  The new baseline of the U.S.’s 25% tariff on US$200 billion in imports from China and China’s 5%-25% tariff on US$60 billion of U.S. goods reverses 45 years of pro-trade U.S. leadership.2 Recent experience also indicates that the tariffs will have a broader impact on other trading partners. While first quarter Chinese GDP growth came in better-than-expected at 6.4%, supported by a jump in industrial production and retail sales, it is likely to come under pressure in the remainder of 2019.3

The European economy has entered its fifth year of recovery, which is now reaching all EU member states. European parliamentary elections in May look set to increase the representation of populist parties, but Eurozone reform is unlikely before the next major downturn. In Germany, the economy grew, expanding by 0.4% in the first quarter.4 The trade war between the U.S. and China, two of Germany’s three largest export markets, is creating greater uncertainty. Brexit continues to dominate the political and policy environment in the United Kingdom.

In the United States, real GDP grew by 3.2% annualized in Q1 2019 after downshifting to 2.2% in Q4 2018.5 Business spending on equipment came to a halt after surging the prior quarter, partly due to trade policy uncertainty and a fading lift from tax cuts. Exports rose, which, coupled with a large drop in imports (largely payback from earlier moves to get ahead of tariffs), provided a full 1% trade related lift to GDP. On May 1st, the Fed held the rate target and guidance steady at 2.25-2.50%.6 The policy statement noted household spending and business investment slowing in Q1, an easing in global financial conditions, and improving data in China and Europe. Canada saw a robust April Labor Force Survey and good news on consumption and manufacturing have followed with auto sales having rebounded in the first three months of the year.

In April, large cap stocks in the U.S., Europe, Japan, and across Emerging Market indices displayed moderately high dispersion and near-record low volatility and correlations. U.S. equities were positive in April. The S&P 500, S&P MidCap 400, and S&P SmallCap 600 gained 4.1%, 4.0%, and 3.9%, respectively. Canadian equities posted gains, with the S&P/TSX Composite up 3.2%. The S&P Europe 350 gained 3.8% on the month with first-quarter earnings coming in better-than-feared for Europe’s blue-chips, and with further promises of stimulus from the European Central Bank. Another Brexit delay was welcomed by the U.K.’s equity markets as the S&P United Kingdom gained 2.1% in April. Chinese equities continued their recent winning streak as the S&P China 500 gained 1.9% in April to make it a 23.3% gain for the year to the end of April. Oil was stronger, aided by U.S. plans to tighten sanctions on Iran and political turmoil in Venezuela.

In May, we maintained the existing allocation between equities and bonds across all models. Allocation to equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth, and 60% in Tactical Aggressive Growth.  Within fixed income, we added exposure to long-term treasury bonds while we reduced positions in municipal bonds and 7-10-year treasury bonds. This asset allocation continues to reflect our expectation that the U.S. economy is under pressure but is more stable than other global equity markets. Longer treasuries will continue to benefit from the downward pressure on interest rates and the 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

 

1International Monetary Fund. World Economic Outlook. April 2019.

2J.P. Morgan. Global Data Watch. May 17, 2019.

3Trading Economics. China GDP Annual Growth Rate. April 17, 2019.

4Trading Economics. Germany GDP Annual Growth Rate. May 15, 2019.

5Trading Economics. United States GDP Growth Rate. April 26, 2019.

6Trading Economics. Fed Funds Rate Growth Rate. May 1, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. April 30, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

The current global economic expansion is already one of the longest in the post-war period, beginning in the second quarter of 2009 and now almost a decade long.  After three years of upgrades to global growth projections, the last three or four months have seen modest downgrades from organizations such as the IMF and the OECD ¹. Although we have a more favorable view of the U.S. economy than other areas of the world, we would note that the U.S. is not immune to the global growth slowdown. We continue to position our portfolio models to reflect our view that the U.S. will continue to experience Stagnation over the next twelve months.

Central banks have softened their stance on actual or expected policy tightening, with most citing downside risks either to their own or global economy as their reasoning. European economic growth continues to disappoint. Brexit has hung over Britain for the last three years. It has contributed to weaker growth in the U.K. and to the gloomier sentiment among both businesses and households. In Germany, concerns in the auto industry (transition to a new emission testing regime) and a low level of Rhine water were temporary drags on activity. Italy suffered from a blow to confidence and tighter financial conditions amid the quarrels over the 2019 budget proposal. In France, yellow vest protests and a low approval with President Macron continue.

China’s economy may re-accelerate as a result of lower interest rates, a resolution to the trade conflict, and more economic stimulus. Q1 Chinese GDP growth came in at an estimated 6.4%, exceeding expectations ². Growth was supported by a jump in industrial production and in retail sales. China has cut taxes, lowered short-term interest rates, and revved up infrastructure spending.

In March, the U.S. Fed’s Beige Book reported a slight increase in growth, as the negative impact of the government shutdown was seen in autos, restaurants, and manufacturing, where consumer spending was slow ³. U.S. job growth in March returned after a weak February as 196,000 jobs were created, easing recession fears. The unemployment rate held steady at 3.8% ⁴. The Fed met and left interest rates unchanged, signaled that there would be no additional interest rate increases for 2019 and that it would end its balance sheet reduction in September. Canada’s three points of potential friction are commodities, the U.S., and China. Canada’s trade deficit narrowed to $4.2 billion in January from a record $4.8 billion shortfall in December ⁵. Lower crude oil prices were behind Canada’s wider trade deficit toward the end of last year.

The S&P 500 completed its best quarter since 2009, gaining 13.6%, while the S&P MidCap 400 and S&P SmallCap 600 gained 14.5% and 11.6%, respectively. Canadian equities gained this quarter with the S&P/TSX Composite up 13.3%. International markets also rallied in the first quarter, with the S&P Europe 350 up 13.2%, S&P United Kingdom up 9.9% and S&P China 500 up 21.0%. The U.S. dollar appreciated slightly in the first quarter, with the U.S. Dollar Index (DXY) rising 1.2%. The euro declined 2.2%, and the yen declined 1.1%, while the Canadian dollar was up 2.2% and the Mexican peso was up 1.1% against the dollar. Oil also gained in Q1, driving the S&P GSCI up 15.0% and the DJCI up 7.5%. Tailwinds included supply cuts from OPEC and U.S. sanctions against Iran and Venezuela.

In March, the S&P 500 gained 1.9% while the S&P MidCap 400 and S&P SmallCap 600 declined by 0.6% and 3.3%, respectively. Canadian equities gained with the S&P/TSX Composite up 1.0%. European equities were also positive as the S&P Europe 350 gained 2.3% and the S&P United Kingdom gained 3.3% on the month. The U.S. Treasury 10-year yield fell below money market rates, a signal some perceive as an indicator of recession.

In April, we held our asset allocation constant at the March allocations. Allocation to Equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth, and 60% in Tactical Aggressive Growth. We continue 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 continues to reflect our concerns that the U.S. economy is slowing but is more stable than other global equity markets and the relative attractiveness of U.S. interest rates 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

 

¹Aviva Investors. House View, Q2 2019.

²Trading Economics, China GDP Annual Growth Rate. April 17, 2019.

³The Beige Book. Summary of Commentary on Current Economic Conditions By Federal Reserve District. March 6, 2019.

⁴Bureau of Labor Statistics. Labor Force Statistics from the Current Population Survey. Unemployment Rate.

⁵Trading Economics, Canada Balance of Trade. April 17, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. March 29, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

Progress on U.S./China trade negotiations and the Federal Reserve’s more dovish rhetoric regarding further interest rate hikes have not convinced us to change our forward outlook that expects the U.S. economy to experience stagnation over the next twelve months. Geopolitical risks remain elevated with Brexit’s outcome uncertain, upcoming elections in the European Union, and the leadup to the U.S. 2020 presidential election campaign likely to impact economic growth and markets. In addition, the combined effects of sanctions on Iran’s and Venezuela’s oil sectors, Saudi Arabia’s need to push oil prices up in order to get its finances in order, and the recent agreement by OPEC and other countries to cut production, means that geopolitics could have an outsized impact on oil prices over the next several months.

The Eurozone quarterly economic growth was confirmed at 0.2% in the fourth quarter of 2018, slightly above the previous period’s revised figure of 0.1%.1 Both Germany and Italy have been hit hard, partly due to slowing demand for their exports. While Germany has plenty of fiscal room, Italy, with public debt of more than 130% of GDP, has less ability to address its problems.2 The growth slowdown in China last year was a concern to businesses and market participants and was amplified by the escalation in trade tensions with the United States. Progress on U.S./China trade talks occurred as the March 1st deadline for hiking the tariff on $200 billion of China’s goods was deferred, pending further progress on structural reforms and enforcement measures. Outside of China, U.S. trade issues include USMCA ratification, metals tariffs, and a threatened U.S. duty on European autos.

The trade spat with China has resulted in a record increase in the U.S. goods trade deficit. China, which accounts for over half of the deficit, has significantly reduced purchases of U.S. oil after importing a record amount last summer.3 The trade gap is challenging U.S. growth, one of the reasons that U.S. real GDP slowed to 2.6% (annualized) in Q4 from 3.4% in Q3.Also challenging was the shockingly small February 20,000 headline job gain.  Monetary policy is expected to remain accommodative through 2019.

Canada’s GDP expanded at an annualized pace of just 0.4% in the fourth quarter of 2018, well below the 1% expected by consensus.4 Domestic demand was a major drag on Q4 growth as consumption stalled (the worst performance since 2012), while government spending, business investment, and residential investment all subtracted from growth.

Following the significant drawdowns and large price swings in risk assets in late 2018, realized market volatility has dropped sharply across equity markets in 2019. U.S. equities managed to continue their winning streak in February. The S&P 500 gained 3.2% for the month, and smaller caps did even better, with the S&P MidCap 400 and S&P SmallCap 600 up 4.2% and 4.4%, respectively.  Apart from U.S. Treasuries, bonds gained.  Canadian equities were up in February, with the S&P/TSX Composite up 3.2%. Benefitting from global risk-on sentiment, European equities jumped in February, as the S&P Europe 350 gained 4.1% on the month. With less than four weeks to go until Brexit, U.K. equities rallied, sending the S&P United Kingdom up 2.4% on the month. In a major concession, U.K. Prime Minister Theresa May promised Parliament an opportunity to vote to extend Article 50 by up to three months and to prevent a no-deal Brexit, if it rejected her updated withdrawal agreement. German equities gained in February, despite the country narrowly avoiding a recession. Italian equities were also up on the month, even after Italy officially entered into recession. February was a positive month for Asian equities, with the exception of Korea and India. Commodities continued to post gains in February, driven by the boost in oil prices as a result of supply cuts from OPEC.

In March, we held our asset allocation constant at the February allocations. Allocation to Equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth, and 60% in Tactical Aggressive Growth, continuing the 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 continues to reflect our concerns that the U.S. economy is slowing but is more stable than other global equity markets, and the 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

 

1Trading Economics, Europe GDP. March 2019.

2Trading Economics, Italy Government Debt to GDP. December 2018.

3BMO Capital Markets. North American Outlook. March 4, 2019.

4Trading Economics, Canada GDP. January 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. February 28, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

Geopolitical risks are expected to dominate global asset class performance over the coming months. Consideration of ongoing trade tensions and the aftermath of the U.S. government shutdown have led us to revise our forward outlook to reflect our view that the U.S. economy will experience stagnation over the next twelve months.

While still undergoing revisions, global growth in 2018 is estimated to have been 3.7%, with signs of a slowdown in the second half of 2018 leading to downward revisions for several economies.  Growth in the Euro area is set to moderate from 1.8% in 2018 to 1.6% in 2019 and 1.7% in 2020. Growth rates have been marked down for many economies: Germany, due to soft private consumption, weak industrial production following the introduction of revised auto emission standards, and subdued foreign demand, Italy, due to weak domestic demand and higher borrowing costs as sovereign yields remain elevated, and France, due to the negative impact of street protests and industrial action.  China’s economy slowed in 2018 mainly due to financial regulatory tightening to rein in shadow banking activity, and the widening trade dispute with the United States. Growth in emerging and developing Asia is expected to decline from 6.5% in 2018 to 6.3% in 2019.1

The FOMC made a major dovish shift at the January meeting as the balance of risks had shifted dramatically over prior weeks due to disappointing global growth and tightening financial conditions. In January, solid job creation and wage gains were reported, but the December retail sales report indicated that total retail sales plunged 1.2%, the most in any month since 2009.2 Headline CPI was flat in January, held down by a large 3.1% drop in energy prices, particularly gasoline. The ex-food and energy core CPI increased 0.24%.3 The timing and composition of the increases hint that tariffs may be playing a role in this surge in core goods prices. Increases have been firmer in some areas where Chinese goods have a sizable presence, such as household furnishings, video and audio products, and apparel, but less so in categories such as vehicles, where China is not significant in US markets.3 Growth for the United States is expected to decline slightly to 2.5% in 2019 with the unwinding of fiscal stimulus.4

Unlike the final month of 2018, U.S. equities started 2019 strong. The S&P 500 gained 8.0%, while smaller caps did even better, with the S&P MidCap 400 up 10.5% and the S&P SmallCap 600 up 10.6%. U.S. bonds gained across the board, with corporates outpacing Treasuries in line with the shift in confidence and muted inflation pressures. Chinese equities had a strong month as the S&P China 500 gained 7.3% given the continued trade negotiations with the U.S., and despite continued fears about slowdowns in both global and domestic growth. European equities rallied in January with the S&P Europe 350 finishing the month with a gain of 6.2%, the best monthly total return for the benchmark since October 2015. Canadian equities started the year on a positive note, with the S&P/TSX Composite gaining 8.7%, and the Canadian dollar firmed due to the rebound in crude prices and the U.S. dollar weakness. Oil prices were higher as OPEC and allies followed through on pledges to cut production at the beginning of the year, while the political crisis in Venezuela also threatened to disrupt supply. Gold posted its fourth straight monthly gain after the Fed signaled a more dovish stance, and the US dollar weakened. Central banks reacted to rising macroeconomic and geopolitical pressures by bolstering their gold reserves. Russia, which is “de-dollarising” its reserves, bought 274.3 tons of gold in 2018, funded by the almost total sale of its U.S. Treasuries portfolio.5

In February, we held our asset allocation constant at the January allocations. Allocation to Equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth and 60% in Tactical Aggressive Growth, continuing the 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 continues to reflect our concerns that the U.S. economy is slowing but is more stable than other global equity markets and the 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

 

1International Monetary Fund, World Economic Outlook. January 2019.

2Trading Economics, U.S. Retail Sales. January 2019.

3JP Morgan, Global Data Watch. February 15, 2019.

4International Monetary Fund, World Economic Update. January 2019.

5World Gold Council. Gold Demand Trends Full year and Q4 2018. January 31, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. January 31, 2019. Index performance is based on total returns and expressed in the local currency of the index.

 

 

As we enter 2019, there is a heightened focus on downside risks both domestically and globally in the markets and in the broader economy. A negative feedback loop has emerged that is centered in the U.S., linking bad policy choices to falling asset prices, tighter financial conditions, and weaker corporate earnings. In the short-term, the current U.S. government shutdown is having more than an impact of inconvenience on the U.S. economy. In January, we revised our twelve-month forward outlook to reflect the delayed impact of inflation on the U.S. economy. We believe that U.S. economic growth is moving toward stagnation and will be followed by an inflationary environment that will likely precede a recession in 2020. The current outlook now factors in six months of stagnation followed by six months of inflation over the twelve-month forecast period.

The IMF said in an update to its World Economic Outlook in October that it is now predicting 3.7% global growth in both 2018 and 2019, down from its July forecast of 3.9% growth for both years.¹ Across emerging market and developing economies, prospects are mixed. The downgrade reflects the introduction of import tariffs between the United States and China, weaker performances by Eurozone countries, and rising interest rates that are pressuring some emerging markets with capital outflows into the stronger U.S. dollar, notably Argentina, Brazil, Turkey, South Africa, Indonesia, and Mexico.

In conjunction with the global growth downgrade, the IMF downgraded the 2019 U.S. growth forecast to 2.5% from 2.7% and cut China’s 2019 growth forecast to 6.2% from 6.4%.¹ Our focus over the next six months is on the impact of tighter Fed policy that is likely to hit business investment and, in combination with the stronger dollar, weigh on industrial output too, causing GDP growth to slow sharply.

The Canadian economy is set to weather the current slump in global oil prices better than it did in 2015, but it will not escape unscathed. The 9,300 job increase in employment in December was better than expected and the unemployment rate held at a 40-year low of 5.6%.² The housing market is showing signs of weakness and higher interest rates are starting to weigh on consumer spending. With this considered, we expect the Bank of Canada to cut rates in 2019.

U.S. equities experienced a very disappointing year in 2018. The S&P 500 was down 4.4%, its first negative year since 2008, still better than the S&P MidCap 400 and S&P SmallCap 600 down 11.1% and 8.5%, respectively. In the month of December, the S&P 500 declined 9.0%, while Mid-Caps were down 11.3% and Small-Caps lost 12.1%. Canadian equities were negative, with the S&P/TSX Composite down 5.4% for the month and 8.9% for the year. The S&P Europe 350 fell 5.5% in December and 9.9% for the year, mostly due to Brexit tensions, global trade uncertainty, and sharp declines in commodity prices. Internationally, most markets underperformed the U.S., with the S&P Developed Ex-U.S. BMI and S&P Emerging BMI both down about 14% for the year. The S&P China 500 completed 2018 with a loss of 19%.

In January, we shifted our fixed income exposure out of 3-7 year Treasuries and into 7-10 year Treasuries in all models. In addition, in the Tactical Growth and Tactical Aggressive Growth models, an additional 10% was taken out of the S&P 500 and added to 7-10 year Treasuries. Allocation to Equities remains at 30% in the Tactical Conservative model and 40% in the Tactical Moderate Growth model, and decreased to 50% in the Tactical Growth model, and 60% in the Tactical Aggressive Growth model. We continued 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 concern that the U.S. economy is slowing while the relative attractiveness of interest rates in the U.S. versus the rest of the world prevails.

While the poor market depth and soft liquidity that marked December 2018 are beginning to fade, weak sentiment is likely to remain a prominent feature in the coming months. 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 International Monetary Fund, World Economic Outlook. October 2018.

² Trading Economics, Canadian Employment. December 2018.

 

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