Global growth continues to be weak, with the global economy impacted by the U.S.-China trade war on the one hand, and global monetary easing on the other. The trade standoff has taken a toll on business confidence, industrial production, and trade flows. It has weighed heavily on global manufacturing and hit export-oriented economies, including China, Taiwan and Korea. The trade war has had less impact on the more domestic-oriented economies like the U.S. though, and as a result, there is a pronounced growth divergence among sectors and regions within the global economy. 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 2021.
China’s growth slowed to 6.2% year-over-year in the second quarter from 6.4% in the first quarter, as the escalating U.S.-China trade tensions weakened business confidence and export growth.1 Emerging market economies that are less levered to the global export cycle, such as India and Brazil, have also succumbed to a slowdown in growth amidst weaker consumer spending and slow progress on reforms.
Beyond U.S.-China trade tensions, other global risks exist. Eurozone growth is slow, with Germany and Italy teetering on the edge of recession. The European Union granted the U.K. a three-month extension on Brexit, moving the deadline to January 31. The U.K. will also face a general election on December 12, adding a degree of uncertainty to future negotiations. The U.K. economy contracted in the second quarter of 2019, adding to the overall negative mood.2 Violent protests continue in Hong Kong despite a significant concession from the territory’s government in officially pulling the controversial extradition law. Growing tension in the Middle East, made worse by attacks on the Saudi oil fields, create another headwind.
Given the weak growth backdrop and elevated geopolitical risks, many global central banks have undertaken easing, aiming to stimulate growth and counter the negative effects of the trade war. At the same time, globalization appears to have increased the co-movement of government bond yields. The correlation of 10-year government bond yields in the major G7 economies increased steadily from the 1980s until 2007 and has remained high since then.3 This means that the diversification benefit from investing in foreign bond markets has fallen. With interest rates already at near or below zero in many countries, the power of monetary policy is diminished.
U.S. Real GDP grew 1.9% in the third quarter, a slowdown from 2.0% growth in the second quarter.4 A divide in the U.S. economy exists between business investment, flagging the trade war and weaker confidence and consumer spending/housing benefiting from a strong job market and the decline in longer-term interest rates. Nonfarm payrolls topped expectations with a 128,000 increase in October. Prior-month upward revisions lifted September to 180,000 and August to 219,000.5 The Bank of Canada left interest rates unchanged at 1.75% when they met on October 30. There have now been three consecutive Federal Reserve rate cuts with no matching move from the Bank of Canada, bringing U.S. overnight rates below those in Canada.6
U.S. equities posted gains in October with the S&P 500, S&P MidCap 400 and S&P SmallCap 600 gaining 2.2%, 1.1% and 2.0%. Canadian equities lost in October, with the S&P/TSX Composite down 0.9%. European equities ended the month in positive territory as the S&P Europe 350 gained 1.1% while the S&P United Kingdom declined 2.0%.
In November, we maintained the October allocation between Equities and Fixed Income across all models. Allocation to equities remains at 17% in Tactical Conservative, 22% in Tactical Moderate Growth, 36% in Tactical Growth, and 44% in Tactical Aggressive Growth. Within the Fixed Income allocation, we shifted the remaining balance of our 20+ year maturity treasury exposure in each of our portfolio models to the 7-10 year maturity in order to protect the portfolio from a rebound in long rates as treasury yields have been declining and the yield curve is close to inverted. Gold continues to be present in all models as it performs well in high risk, low yield environments as a risk-free asset class.
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 Trading Economics, China GDP. October 18, 2019.
2 Trading Economics. United Kingdom GDP. September 30, 2019.
3 Capital Economics. Asset Allocation. October 24, 2019.
4 Trading Economics. U.S. GDP. October 30, 2019.
5 Trading Economics. U.S. Nonfarm Payrolls. November 1, 2019.
6 Trading Economics. U.S. Overnight Repo Rate. November 2019.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. October 31, 2019. Index performance is based on total returns and expressed in the local currency of the index.