In August, we continued with our Stagnation Outlook for the twelve-month forward period. This outlook is centered on the United States. The pickup in global growth remains on track, a departure from years past when estimates slid lower as the year progressed. The International Monetary Fund (IMF) projects global output to grow by 3.5% in 2017 and 3.6% in 20181. Aggressive central bank actions and escalating tensions in Northeast Asia are risks to this growth.
Following earlier dollar strength that exerted a significant drag to exports in 2015 and 2016, the recent strength of U.S. exports comes from a 7% depreciation of the dollar to August 212. Over the same period the euro has strengthened on increased confidence in the euro area recovery and a decline in political risk.
The IMF has revised down the growth forecast for the United States for 2017 from 2.3% to 2.1% and for 2018 from 2.5% to 2.1%3. The main reason for the revision, especially for 2018, is that fiscal policy may be less expansionary than previously thought. Meanwhile, market expectations for fiscal stimulus have contracted.
Improving economic activity outside the U.S. is a tailwind for both U.S. economic growth and profits of U.S. firms with significant business abroad. The U.S. unemployment rate dropped to a 16-year low of 4.3% in July, though the number part-time workers that would prefer a full-time job remains slightly above its pre-recession level4. Tighter conditions have not led to a big pick-up in wage growth yet. Oil prices have receded, reflecting strong inventory levels in the United States and a pickup in supply.
The IMF revised down its 2017 growth forecast for the United Kingdom on weaker-than-expected activity in Q1. Meanwhile, it has revised up projections for many euro area countries, including France, Germany, Italy, and Spain, where Q1 growth was generally above expectations.
Global equity prices remained strong in July, signaling continued market optimism regarding corporate earnings. The S&P 500 gained 2.0%, outperforming mid-caps and small-caps, both up 1.0%. The S&P/TSX Composite came in flat as a weaker U.S. dollar continues to boost the price of Canadian exports. The S&P Developed Ex-U.S. BMI gained 3.0% while S&P Emerging BMI was up 6.2%. In a mixed month for European equity investors, the S&P Europe 350 gained 3.2% as Eurozone economic confidence reaching its highest level for a decade.
In developed markets, long-term bond yields rebounded in late June and early July after declining since March. The U.S. Fed raised short-term rates in June, but markets still expect a very gradual path of U.S. monetary policy normalization. As electoral uncertainty reduced in Europe, bond spreads over Germany have compressed sharply in France, Italy, and Spain, firming signs of recovery.
All model asset allocations were revised in August. The weaker U.S. dollar creates opportunity for greater U.S. exports while S&P 500 companies with foreign operations would be negatively impacted by the weaker dollar. Weighing both, we reduced U.S. midcaps by 5% in all models and added that weight to U.S. large-caps. We removed Canadian equities altogether as NAFTA negotiations through the end of September has cast uncertainty over trade between the two countries. We replaced Canada with an addition to 3 to 7-year U.S. Treasuries. The balance includes Europe and some Australia in the Tactical Growth and Aggressive Growth Models. We maintain 10% in 20+ U.S. Treasuries in all models because of uncertainty around a delay in the next rate hike and the looming threat of a government shutdown around the debt ceiling deadline.
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
[1] IMF. World Economic Outlook Update. July 2017.
[2] Capital Economics. United States Chartbook. August 22, 2017.
[3] IMF. World Economic Outlook Update. July 2017.
[4] Capital Economics. United States Chartbook. August 22, 2017.
