The four-decade period of stable inflation and interest rates has ended, and a new regime of greater macro and market volatility is playing out. As the global economy continues to recover from the energy crisis, we continue to expect moderate global growth in 2023-24, with a drag from the cumulative impact of monetary policy tightening on economic activity and employment, and significant divergence between advanced and emerging market countries. While growth projections for certain major economies have improved, Europe is likely to face tighter-for-longer financing conditions. We continue to anticipate a mild contraction in the U.S. in late 2023 and slow growth in other developed markets. Long-term trends will keep production capacity constrained in the new regime of higher macro and market volatility. In July, we maintained our twelve-month forward outlook for the U.S. economy of six months of Stagnation, followed by three months of Recession and then three months of Stagnation.
China’s trade surplus fell from a year earlier, as exports dropped more than imports amid persistent weak demand from home and abroad. Meanwhile, the trade surplus with the U.S. widened slightly in June.1 China’s annual inflation rate edged up to 0.2% in May2 while China’s surveyed urban unemployment rate stood at 5.2% in May.3 The Eurozone economy shrank 0.1% in the first three months of 2023, falling into a mild technical recession.4 Annual core inflation in the Euro Area increased to 5.4% in June.5 The seasonally adjusted unemployment rate in the Euro Area was at a record low of 6.5% in May 2023.6 Eurozone imports tumbled 11.9%, the lowest level since February 2022, down mostly from Russia, Norway, U.K., Switzerland, China, and Turkey. Exports declined 3.6%.7
The U.S. economy grew by an annualized 2% in Q1 2023. Exports were up 7.8% and imports rose at a slower 2%, pushing the contribution from net trade higher to 0.58 percentage points.8 The annual core consumer price inflation rate in the United States fell to 4.8% in June9 while the unemployment rate in the U.S. decreased slightly to 3.6%, indicating a consistently tight labor market and allowing the Federal Reserve the flexibility to continue raising interest rates as a means to combat inflation.10 The Canadian economy expanded an annualized 3.1% in the first three months of 2023.11 The annual inflation rate in Canada fell to 3.4% in May12 while the unemployment rate in Canada rose to 5.4% in June.13 Canada posted a trade deficit of CAD 3.44 billion in May of 2023, shifting from a downwardly revised surplus of CAD 0.89 billion in the prior month.14
Concerns around the Fed’s future rate trajectory did not deter U.S. equities from posting gains across the board, with the S&P 500 up 16.9% in the first half of 2023. Mid Caps and Small Caps turned in 8.8% and 6.03%, respectively. The S&P 500 posted a gain of 6.6% in June, trailing smaller caps, with the S&P Mid Cap 400 up 9.2% and the S&P Small Cap 600 up 8.2% for the month. Canadian equities finished the month on the upside. The S&P/TSX Composite climbed 3.4%. The S&P Europe 350 extended its year-to-date gains in June, with the pan-European bellwether ending 2.5% higher for the month. All but Denmark among the 16 countries contributed positively to pan-European equity returns in the month. The French market was the brightest spot, contributing +0.8%, followed by Germany and Italy, with 0.4% each. The S&P Pan Asia BMI advanced 3.4% in June, extending its YTD gain to 6.3%. Eleven of 14 S&P Pan Asia BMI regions ended June in the black, with Japan the largest contributor to the regional benchmark with 1.4%.
In July, exposure to Canadian equities was reduced to reflect concerns about the prolonged interest rate tightening cycle in Canada and the impact that it is having on the economy. Cash across all models was reduced, from 20% to 10%, reflecting our view that the anticipated U.S. recession will be short and mild and is priced into valuations outside of Technology and Healthcare. U.S. equity exposure was increased while 5% was added to the 3-to-7-year treasury bond, across all models. We continue to maintain our gold exposure across all models as we expect gold to remain supported on the back of rangebound bond yields and a weaker dollar.
We are positioned for a mild recession in the U.S. in the third quarter. An economic deterioration could be driven by a significant increase in defaults following tighter credit conditions or other unintended consequences of the rate environment. Historically, such periods have resulted in higher volatility, significant stock market pullbacks, and an overall appetite for high quality, liquid assets such as gold. Our approach to portfolio management is nimble, opportunistic, and deliberate in identifying asset classes that are best placed to generate returns in a new world order. 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 Trade. July 15, 2023.
2 Trading Economics. China Inflation. June 9, 2023.
3 Trading Economics. China Unemployment. June 16, 2023.
4 Trading Economics. EU GDP. June 8, 2023.
5 Trading Economics. EU Inflation. June 30, 2023.
6 Trading Economics. EU Unemployment. June 30, 2023.
7 Trading Economics. EU Trade. June 15, 2023.
8 Trading Economics. U.S. GDP. June 29, 2023.
9 Trading Economics. U.S. Inflation. July 12, 2023.
10 Trading Economics. U.S. Unemployment. July 7, 2023.
11 Trading Economics. Canada GDP. May 31, 2023.
12 Trading Economics. Canada Inflation. June 27, 2023.
13 Trading Economics. Canada Unemployment. July 7, 2023.
14 Trading Economics. Canada Trade. July 6, 2023.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. June 30, 2023. Index performance is based on total returns and expressed in the local currency of the index.
