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.