In April, we continued with our global Stagnation outlook for the twelve-month forward period. After a lackluster showing in 2016, economic activity in emerging and developing economies is projected by the International Monetary Fund to pick up the pace in 2017 and 2018. There is a wide dispersion of possible outcomes, however. Persistent structural problems such as low productivity growth, binding structural impediments and existing policies are increasing in advanced economies. These threaten global economic integration and the cooperative global economic order that has served the world economy in both emerging market and developing economies.
A long-awaited cyclical recovery in global manufacturing and trade is underway. The IMF predicts that world growth will rise from 3.1% in 2016 to 3.5% in 2017 and 3.6% in 2018. Eurozone economic data has been encouraging so far, and the uptrend in capital goods orders bodes well for investment spending. Private-sector credit growth has accelerated to the fastest pace since the 2008-09 financial crisis. The unemployment rate has fallen and there is less spare capacity in European labor markets today than when the U.S. Fed first hinted at tapering its asset purchases in 2013. Other encouraging data shows the outlook for France is improving despite uncertainty about the outcome of the presidential election there.
In the United States, manufacturing activity has been strengthening in recent months, largely because the drag from the past appreciation of the dollar has faded. Prospects for stimulative tax cuts and infrastructure spending, along with the fears of blowing out the budget deficit, all seem to have been pushed further back in the time horizon for the U.S. economy. The decline in core consumer prices in March, the first monthly fall in seven years, may be a signal of underlying weakness in the real economy. The key message from the March Fed meeting may be at odds with this trend, as they now believe that inflation has finally reached its 2% target.
U.S. equities were flat in March as the S&P 500 gained 0.1% and S&P SmallCap 600 declined by 0.1%. The S&P 500 dispersion recorded its second-lowest monthly reading for a decade1. The present low dispersion coincides with lower correlation and much lower benchmark volatility than in July 2011, the last time dispersion was this low. Similar trends are seen globally, with low benchmark volatility, moderate-to-low correlations, and low dispersion. U.S. Small Caps and Latin America are exceptions to this trend, while Japan’s equity market continues to show higher correlation than its peers.
The Fed’s announcement of another interest rate hike negatively affected most fixed income sectors. March results for U.S. fixed income were flat or negative, with the broad S&P U.S. Aggregate Index down 0.04% for the month. Mortgage backed securities and Preferred bonds posted positive returns for the month. Outside the U.S., International equity markets performed strongly in March. Canadian equities were positive, with the S&P/TSX Composite TR Index up 1.3%. In Europe, the S&P Europe 350 TR gained 3.4%. The MSCI United Kingdom increased 1.7%. The European Central Bank’s hawkish tone at its March meeting indicated that tighter monetary policy was coming, causing most European bond indices to fall in March.
We rebalanced the portfolio models in April to reflect our continued Stagnation Outlook, while factoring in the relative opportunities in International Equities. We reduced U.S. Mid Caps and Small Caps in all models. Exposure to Australia was eliminated in the Conservative and Moderate Growth models and reduced in the Growth and Aggressive Growth Models, as the early March positive revision from the IMF benefited the Australian equity market disproportionately relative to Europe. Exposure to Europe was initiated in the Conservative, Moderate Growth and Growth models and increased in the Aggressive Growth portfolio. Exposure to fixed income was increased across all models including reinitiating exposure to Municipal Bonds in the Aggressive Growth portfolio model.
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
Data Source: Bloomberg
 S&P Dow Jones Indices. Index Dashboard: Dispersion, Volatility & Correlation. March 31, 2017.