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December 2017

In December, we continued our Growth outlook for the next three months, reverting to Stagnation for the following nine months as we see the initial impact of U.S. tax reform on consumer and business behavior contributing to short-term U.S. growth. Global growth is expected to return to its trend rate of 3.7% in 2018 as GDP improvements spread around the world¹. The IMF expects only 6 of the 192 economies it covers to fail to grow in 2018¹. The end of the energy and commodities recession is a favorable trend. Capex is bottoming out and commodity exporters are doing better on stronger terms of trade.

This year should build on improvements we saw last year in developing and advanced economies. Brazil and Russia emerged from deep recessions, fiscal stimulus supported Japan and domestic demand buoyed the Eurozone. French President Emmanuel Macron announced structural reforms to the EU last year, aimed at addressing the tension between a single monetary policy and varying fiscal conditions among EU member states. Without reform, strong members like Germany would continue to boom, while weaker members like Italy would struggle. Negotiation outcomes regarding NAFTA will impact the U.S., Canada and Mexico and global trade. Both NAFTA and the WTO established new rules and standards for global trade upon which trade and financial globalization are now based. The demise of the deal and a view to bilateral agreements between the U.S. and it’s trading partners suggests that greater trade conflicts will become the norm, not only within NAFTA but also with China and others.

In China, domestic macro signals and international dynamics suggest moderate deceleration of GDP growth of 6.4% in 2018 from 6.8% in 2017¹. The threat of U.S. trade protectionism is a real concern, but the immediacy of the North Korea crisis may drive a more collaborative and less confrontational U.S.-China bilateral relationship in coming months.

As we enter 2018, U.S. GDP growth is experiencing a strong upswing, borrowing costs remain low, the dollar has been trending lower and despite the low unemployment rate, inflation and wage growth have not picked up. Tax reform will add to this but only in the short-term. The stimulus, worth $1.5trn over the next decade, equivalent to about 0.8% of GDP per year, is expected to contribute a moderate boost to GDP growth, which is projected at 2.5% for 2018². Meanwhile the stimulus would add to the budget deficit that was already projected to widen over the next decade, due to a rebound in interest costs and the impact of the aging population on mandatory spending. With the weaker dollar pushing imported goods prices higher and domestic economic conditions strengthening, an increase in core inflation in 2018 and a Fed hike in interest rates by a cumulative 100 basis points in 2018 is expected.

In November, U.S. equities were up again with the S&P 500 gaining 3.1%, its 13th consecutive month of gains. The S&P MidCap 400 and the S&P SmallCap 600 both registered gains of 3.6%. Canadian equities were positive, with the S&P/TSX Composite up 0.5%. The S&P U.S. Aggregate Bond Index outperformed investment-grade corporates but was in negative territory, down 0.03%. The S&P Taxable Municipal Bond Select Index was the top-performing component, returning 0.5% in November. Longer duration bonds continued to outperform short and intermediate duration.

In December, we shifted exposure within the fixed income allocation, removing all model exposure to 20+ Year Treasury Bonds. We believe that the flattening of the yield curve that benefitted the long end has played out.  This exposure was added to the 3-7 Year Treasury in the Tactical Conservative Model and to the Municipal Bond for all other models.

 

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

 

¹ State Street Global Advisors. 2018 Global Market Outlook.

² Capital Economics. US Economic Outlook Q4 2017.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income. November 30, 2017.  Index performance is based on total returns and expressed in the local currency of the index.  European regional index returns are expressed in Euros.

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November 2017

In November, we continued our Growth outlook for the next three months, reverting back to Stagnation for the following nine months. Synchronous global growth is expected to remain in place for 2017. Contributions to this growth include inflation standing below most central banks’ 2% objective, G3 capital goods orders climbing at the fastest pace since 2014, and 68% of OECD nations have unemployment rates under the organization’s assessment of “global NAIRU” (Non-Accelerating Inflation Rate of Unemployment) ¹. Either aggressive central bank actions, a worldwide trade war, escalating tensions in Northeast Asia or a combination of all three are risks to this synchronized global growth.

The recent upswing in euro area growth indicates that factors are well positioned to continue to drive growth although labor market slack will need to be absorbed. The Japanese economy is growing at the fastest pace in several years, while Prime Minister Abe’s election victory guarantees the continuation of expansive monetary and fiscal policy for the future. China’s economy continues to defy expectations for a sharp slowdown and has been in stabilization mode, and is on its way to meet the government’s growth target this year of 6.5% or above.

The U.S. economy proved resilient to hurricane distortions in August and September and rose at a 3.0% annualized rate during the third quarter². Improving economic activity outside the United States is a tailwind for U.S. economic growth and profits of American firms with significant foreign business while overseas demand and a softer greenback have helped the U.S. manufacturing sector. The consumer continues to thrive in the environment of strong job creation while higher stock values and business investment are also contributing positively.

The Federal Reserve is expected to pursue its plan to raise interest rates once again in December although the flattening of the yield curve over the past couple of months has sent a message that the market does not agree with the Fed regarding the strength of the current economic cycle. The flattening yield curve has historically been a signal that a recession is on the way but the decline in the 10-year Treasury yield since the start of this year is due to a drop back in the term premium component, with the implied risk-free short rate expectations component continuing to trend higher. This reflects foreign interest that results from less attractive options abroad due to the continuing expansion of other major central banks’ balance sheets, low and stable inflation and a rebound in global savings.

After a strong first half to 2017, the Canadian economy moderated towards more sustainable levels in Q3. The Bank of Canada has reduced expectations for further rate hikes in the near-term as the economy adapts to previous rate hikes and new mortgage rules, while downside risks pertaining to NAFTA negotiations and elevated consumer debt levels also warrant some caution.

Global equity markets were broadly higher in October. U.S. equities rose again with the S&P 500 up 2.3%, the S&P MidCap 400 up 2.2% and the S&P SmallCap 600 saw smaller gains of 1.0%. Canadian equities have been performing well, with the S&P/TSX Composite Index rising 2.7% for the month. Equity gains extended to overseas markets, with the S&P Europe 350 rising 2.0%, MSCI Japan Index up 5.6% and MSCI Australia Index up 3.8%.

North American fixed income markets diverged in October as the S&P 500 Bond Index gained 0.37% for the month and stood at 5.23% for the year ending October. In currency markets, the U.S. Dollar strengthened for the month as speculation mounted regarding the Federal Reserve chairmanship and specifics on plans for tax reform. However, since the start of 2017 to the end of October, the U.S. Dollar Index (DXY) is down 7.5%.

In November, we added exposure to the broader Pacific Region including Australia, Hong Kong, New Zealand and Singapore, by replacing direct exposure to Australia. We also added exposure to Asia ex Japan. Under fixed income, we reduced exposure to Long Treasury and Muni bonds in the Conservative and Moderate Growth models and reduced Muni Bonds in the Growth 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

 

¹ BCA Research. U.S. Investment Strategy. November 13, 2017.

² Capital Economics. U.S. Economics. U.S. Rapid Response. October 27, 2017.

 Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income. October 31, 2017.  Index performance is based on total returns and expressed in the local currency of the index.  European regional index returns are expressed in Euros. 

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October 2017

In October, we changed our outlook to Growth for the next three months, reverting back to Stagnation for the following nine months. The economic expansion in advanced economies seems set to continue for the next year, led by rising household consumption and business investment. Although most economies are approaching full employment, inflation has remained below targets.

The ECB is likely to taper its asset purchases during 2018 and raise rates to around 1% by the end of 2019. Inflation is likely to remain below the ECB’s target. Prospects for emerging economies have improved, as Brazil and Russia have come out of recession. China’s economy is likely to slow gradually. In Australia and New Zealand, GDP growth is steady however, inflation remains very weak. We expect the Reserve Banks of both countries to hold rates until 2019.

Having raised interest rates twice this year, we don’t expect the Bank of Canada to move again this year. The economy is benefiting from a rise in business investment and exports, however, there is a risk of downturn in consumer spending next year as household debt weighs and house prices may start to fall.

The U.S. Fed is expected to continue to unwind QE slowly while raising rates. After a slow start to this year, the economy benefitted from looser financial conditions, as bond yields and the dollar have fallen. Since the relationship between spare capacity and inflation has weakened since the financial crisis, average earnings growth should remain very subdued. The recent economic growth was driven by consumer spending and business investment, while exports contributed meaningfully on the back of a softer dollar and firming global demand. The Fed is likely to look through any storm-related economic weakness and seems commitment to one more rate hike this year.

Yields rose during September, with the 10-year Treasury increasing to 2.33%¹. The move up in yields resulted in weak bond returns with the S&P U.S. Treasury Bond Index down 0.77% and the S&P U.S. Investment Grade Corporate Bond Index down 0.24%. The search for yield led the increase in the S&P U.S. High Yield Corporate Bond Index, up 0.87%.

During September, U.S. Equities were strong performers, led by the S&P SmallCap 600 Index gaining 7.7%. The S&P Midcap 400 returned 3.9% and the S&P 500 returned 2.1%. The S&P/TSX Composite was up 3.1% with the Energy sector as the top performer gaining 7.7%.

The Eurozone also posted strong gains in Euro terms, with the MSCI EMU Index returning 4.4%, however, recent Euro weakness weighed on gains. The MSCI EAFE Index of developed market companies returned 2.5%. Emerging Markets, measured by the MSCI EM Index, came under slight pressure from a strong U.S. Dollar, as the index dropped 0.3%.

Unlike the strength seen in September, US dollar weakness was a key highlight in 2017. In the third quarter, strong gains were posted by the euro, up 3.4%, British pound, up 2.9%, Brazilian real, up 4.6%, and Canadian dollar, up 4.0%.  The Mexican peso, down 0.7%, and Japanese yen, down 0.2%, slightly depreciated. From the start of the year to September, the US dollar is down 8%. Commodities broadly rallied in Q3 with oil finally joining metals in positive territory. WTI, up 12%, copper, up 9.5%, and gold, up 3.1%, all posted gains in Q3.

In October, we revised our asset allocation, adding currency-hedged exposure to Canadian equities across all models. Asia ex Japan and currency-hedged Australian equity exposure were added to Growth and Aggressive Growth at 5% and 10% each. We reduced 3-7 Year Treasuries in all models and reduced European equities in Growth and Aggressive Growth.

 

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

 

¹Treasury.gov. Resource Centre. Daily Treasury Yield Curve Rates.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income. September 29, 2017.  Index performance is based on total returns and expressed in the local currency of the index.  European regional index returns are expressed in Euros. 

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September 2017

In September, we continued with our Stagnation Outlook for the twelve-month forward period. The global economy continues to chug along with the July IMF forecast for global economic growth of 3.5% for 2017 and 3.6% for 2018 looking attainable¹. All 46 countries monitored by the OECD are on a growth track this year for the first time since 2007².

Rising geopolitical risks including North Korean nuclear tests and American hurricanes have contributed to short-term offsets to this optimism. At his Jackson Hole address in late August, European Central Bank President Mario Draghi told the audience that U.S. protectionist policies also pose a serious risk for growth in the global economy.

Global central bank asset purchases, which have totaled almost $2 trillion this year alone, are the best explanation for money flowing into both bonds and stocks. Shifts in growth and central bank policies are likely to sustain flows away from the U.S. dollar and toward the euro and emerging market currencies. The dollar had acquired a premium in late 2014 and 2015 as it became clear that the Fed would be first to engage in tightening policy. At the same time, political turmoil in the Eurozone helped drive investors into U.S. assets in search of higher yields and better growth. The anticipated lower economic growth in the U.S. will not be enough to keep those flows while growth in Europe and emerging markets are much better.

Federal Reserve officials are reviewing their most basic inflation models. Minutes from the July FOMC meeting showed a revealing debate over why the economy isn’t producing more inflation in a time of easy financial conditions, tight labor markets and solid economic growth. The central bank has missed its 2% price goal for most of the past five years.

Sustained loosening of financial conditions is unique to this tightening campaign, driven in large part by persistently strong equity market returns and a weakening dollar. This behavior has confounded markets and Fed officials. Further tightening is coming as the Fed will soon start shrinking its balance sheet. Since 2008, the Fed has been buying assets resulting in about $2.5 trillion of Treasury bonds and $1.8 trillion in mortgage-backed securities on the balance sheet³. The Fed does not plan to sell these assets; however, as the securities mature, it will stop reinvesting the proceeds, with the permitted monthly run-off gradually rising. U.S. 30-year bonds are most impacted by tightening but the lack of inflation coupled with credit contraction creates a scenario of further flattening of the U.S. Treasury yield curve.

During August, investors nervous about North Korea and other geopolitical risks favored the relative safety of bonds, pushing bond yields lower and prices higher. Long duration government and agency bonds outperformed in that environment, while short duration securities underperformed. August results for U.S. Treasuries posted positive returns, as yields tightened across the entire curve. The S&P 500 gained 0.3% in August, outperforming S&P MidCap 400 (down 1.5%) and S&P SmallCap 600 (down 2.5%). Outside the United States, Canadian equities were positive with the S&P/TSX Composite up 0.7%, while the S&P Developed Ex-U.S. BMI was flat and S&P Emerging BMI gained 3%.

In September, we revised our asset allocation in the Conservative and Moderate Growth models while maintaining the Growth and Aggressive Growth models.  The changes reflect our view that we will continue to see a flattening of the U.S. yield curve and an opportunity in the long end of the yield curve.  In both Conservative and Moderate Growth, we eliminated U.S. Mid-Caps and added to long U.S. Treasuries. In Moderate Growth, we also added a portion to the S&P 500.

 

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

 

¹IMF. World Economic Outlook. July 23, 2017.

²BCA Research. Global Investment Strategy. Fourth Quarter 2017: Goldilocks And The Recession Bear. October 4, 2017.

³Federalreserve.gov. Quarterly Report on Federal Reserve Balance Sheet Developments. July 26, 2017.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income. August 31, 2017.  Index performance is based on total returns and expressed in the local currency of the index.  European regional index returns are expressed in Euros.

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August 2017

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.

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July 2017

In July, we continued with our global Stagnation Outlook for the twelve-month forward period. According to the International Monetary Fund (IMF), the World Economic Outlook continues as expected with global output projected to grow by 3.5% in 2017 and 3.6% in 2018.1 At the country level, growth projections are lower for the United States, assuming fiscal policy will be less expansionary than anticipated. Japan, China and the euro area have seen some solid momentum, revising growth upward. Expectations for fiscal support in China have also supported an upward growth revision. Inflation remains generally below targets in advanced economies and has been declining in many emerging economies including Brazil, India and Russia.

Several advanced economies face excess capacity and slowing potential growth from aging populations, weak investment, and slow productivity growth. Projected global growth rates for 2017–18 are below pre-crisis averages, particularly for most advanced economies and commodity-exporting emerging and developing economies. Policy setting should remain consistent with weak core inflation expectations and muted wage pressures.

Long-term bond yields in advanced economies rebounded in late June and early July after declining since March. The U.S. Federal Reserve raised short-term interest rates in June, but markets still expect monetary policy to normalize gradually. Between March and the end of June, the U.S. dollar depreciated around 3.5% in real terms while the euro strengthened by a similar amount on increased confidence.

Canadian GDP has been outpacing other G7 countries in 2017, with full-time employment rebounding sharply and macro momentum remaining positive. The Bank of Canada raised interest rates in July and WTI stabilized around US$45/bbl. The Canadian Dollar has risen to US$0.80, a 10% rebound from its low in May of US$0.73.2 It appears that Canadian sentiment has improved in response to a shift toward hawkish policy.

U.S. equities posted positive returns in June with the S&P 500 up 0.6%, S&P MidCap 400 up 1.6% and S&P SmallCap 600 3.0%. Canadian equities continued to decline in June as macroeconomic fears, an overly dovish Bank of Canada, and sliding oil prices prompted investors to exit. Global equity markets were mixed in June with the MSCI EAFE Free returning -0.8% and MSCI Emerging Markets gaining 1.6%.

The S&P Europe 350 posted a loss of 2.5%, its biggest monthly decline since the U.K. voted to leave the European Union. The S&P United Kingdom Index dropped 2.5% for the month, contributing significantly to the losses in the broader index as the U.K. represents about a quarter of the S&P Europe 350. Mixed messages coming from both Mark Carney and Mario Draghi resulted in a bond sell off. Commodities ended June in negative territory, with the S&P GSCI down 2%.

In July, we reviewed our current asset allocation across all models and concluded that the current asset allocations remained the most optimal. U.S. Equity exposure for all models remains in mid and large caps with exposure to Canada and Europe making up the balance along with exposure to Australia in the Tactical Growth and Aggressive Growth Models. We continue to hold a 10% exposure across all models in the 20+ U.S. Treasury Bond as we anticipate the Fed move to start reducing the balance sheet. This reduction represents policy tightening and is expected to flatten the yield curve and bring down 10+ year yields, driving up the long end of the curve.

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.  Canada Economics Weekly.  July 28, 2017.

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June 2017

In June, we continued with our global Stagnation Outlook for the twelve-month forward period. Although growth was lower than expected in Q1 in several G7 economies, a slow expansion is now well established across the board. That said, some of these economies have made a much better recovery from the crisis than others.

The European Central Bank’s dovish policies have depressed the value of the euro and boosted German manufacturing. Germany has diffused its inflationary pressures by outsourcing jobs and production to central Europe. As a result, wages in central Europe are rising and inflation is accelerating.1

Meanwhile, global core inflation, which has remained stable at a 2% pace in recent years, also slipped this quarter to an estimated 1.7%, raising concerns that it will be more difficult to lift inflation back toward central bank targets.  The recent downshift in China has been a source of concern particularly as it has been mirrored across Asian industry. Global credit conditions remain supportive despite a slowdown in the United States. The latest data on bank lending point to downward pressure on GDP growth in advanced economies, although the slowdown in credit growth has been concentrated almost exclusively in the United States.

After a disappointing 1.2% annualised gain in Q1, U.S. GDP is on track to rise in the second quarter. Industrial production has rebounded in recent months, helped by the continued turnaround in activity in the mining sector. After hitting a 5-year high of 2.7% earlier in 2017, headline CPI inflation has fallen back to 1.9%, due mostly to the recent decline in energy prices.  Core inflation has also slowed in recent months with the annual rate falling to 1.7% in May and the 3-month annualised rate plunging to a 7-year low of zero. There is widespread weakness in core inflation. Despite the Fed raising interest rates again in June and reiterating its plans to continue gradually tightening policy, it appears that markets are pricing in only one 25bp rate hike by the end of 2018. The 10-year Treasury yield has declined even though there were three rate hikes since December last year. The dollar has also continued to decline, with the Fed’s trade-weighted dollar index having now completely reversed its prior surge following last November’s presidential election. Furthermore, the stock market has continued to weather the Fed tightening.

The month of May saw mixed results across U.S. equities. The S&P 500 gained 1.4% while S&P SmallCap 600 lost 2.1%. International equity markets performed well as the S&P Europe 350 gained 4.9%, S&P Asia 50 gained 4.8% and S&P Emerging BMI gained 1.7%. Meanwhile in Canada, the S&P/TSX Composite lost 1.3%. U.S. fixed income markets were positive in May. Municipal bonds were the top performer with the S&P National AMT-Free Municipal Bond Index returning 1.4%. Commodities ended May poorly with the S&P GSCI losing 1.5%. The combination of the lukewarm investor response to OPEC extending its restriction on production and the news that a rise in Libyan output had increased production among OPEC countries for the first time this year sent the S&P GSCI Crude Oil index down 2.8%.2

We rebalanced in June to reflect our continued Stagnation outlook. Across all models, we replaced U.S. Small Caps with U.S. Large Caps in response to the postponement of corporate tax reform that is now better reflected in Large Cap valuation. We maintained Canadian and European Equity exposure as well as the long-term U.S. Treasury Bond. Financial conditions appear more accommodative since late last year due to lack of evidence of inflation in the U.S. despite Fed rate hikes. Our shift to long bonds reflects our view that this may not reverse in the near-term. For more insight into our views on the changing impact of inflation, see our most recent White Paper: A Regime Change Underway, available on our website.

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] BCA. Emerging Markets Strategy – Central Europe: Beware of An Inflation Outbreak (Special Report), June 21, 2017.

[2] Index Returns: S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income. May 2017.

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May 2017

In May, we continued with our global Stagnation outlook for the twelve-month forward period. The outlook for the world economy is improving and world trade has picked up. Manufacturing conditions in advanced economies are improving and point to a rebound in economic growth in Q2.

The recovery in the euro-zone has gained momentum after being captivated by the closely-fought first round of the French elections in April and the second round on May 7 that brought considerable relief. The flash composite PMI for the euro-zone stayed at its highest level in six years and the composite PMIs for Germany and France reached six-year highs1.  As the remaining European Union nations present an increasingly unified front ahead of the upcoming “Brexit” negotiations, the medium-term economic outlook for the U.K. weakened while the prospect of a big win for Theresa May’s Conservative party in a general election slated for June 8th helped the British pound strengthen.

The U.S. looks set to hold back from extreme protectionist policies, and any changes to NAFTA seem slow to materialize. Although the Trump administration claims that external trade is a drag on economic growth, for the past five years the monthly trade deficit has been broadly unchanged in dollar terms. That said, the goods trade deficit widened slightly in April, as exports declined by 0.9% m/m and imports increased by 0.7% m/m2. The decline in exports was driven by a 7.5% m/m slump in automotive exports and a 4.5% m/m fall in consumer goods exports3.

The slowdown in Q1 GDP growth to just 0.7% annualized resulted from lower government spending and inventories4. Investment spending added 1.7% to growth, its largest contribution in five years5. The recent weakness in inflation and the political dysfunction that threatens to delay tax reform have resulted in only a modest decline in interest rate expectations. Monetary policy looks set to diverge from other major economies as the U.S. Fed continues to prepare investors for future rate hikes. Headline CPI inflation remains elevated, yet core inflation was unexpectedly weak in both March and April, bringing the three-month annualized core inflation rate to a six-year low of only 0.6% in April6.  The headline unemployment rate declined to a 10-year low of 4.4% in April, a level that would typically cause the Fed to behave hawkish7. However, wage growth remains at a low of 2.5% year over year8.

U.S. Equity markets were positive this month with the S&P 500 gaining 1.0% and S&P 600 Small Cap gaining 0.9%. International equity markets performed well in April with S&P Developed Ex-U.S. BMI and the S&P Emerging BMI both up 2%.

April results for U.S. fixed income returned to positive territory, with the S&P Preferred Stock index as the top performer, up 1.2% for the month. All the aggregate’s components had positive returns; S&P Taxable Municipal Bond Index up 0.9%, and S&P Investment Grade Corporate Bonds up 1.2%. The S&P U.S. High Yield Corporate Bond Index returned 1.1% for April.

Commodities performed poorly, driven by continued weakness in Energy, while the current increased level of geopolitical risk resulted in gold prices benefiting from the asset’s status as a safe haven.

We rebalanced the portfolio models in May to reflect our continued Stagnation outlook. Across all models, we lowered exposure to U.S. Small Cap and Canadian Equity, added to European Equity and a new position in Long-term U.S. Treasury Bonds. Financial conditions have become more accommodative since late last year, even though the Fed has hiked its policy rate twice during that time and our shift in the direction of long bonds reflects our view that this will not be unwinding in the near-term.

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] Capital Economics, Global Economics Data Response. May 23, 2017.

[2] Capital Economics, US Rapid Response. May 25, 2017.

[3] Capital Economics, US Rapid Response. May 25, 2017

[4] Capital Economics, United States Chart Book. May 17, 2017.

[5] Capital Economics, United States Chart Book. May 17, 2017.

[6] Capital Economics, United States Chart Book. May 17, 2017.

[7] BLS.gov

[8] BLS.gov

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April 2017

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

 

[1] S&P Dow Jones Indices.  Index Dashboard: Dispersion, Volatility & Correlation.  March 31, 2017.

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March 2017

In March, we continued with our global Stagnation outlook for the twelve-month forward period. Expectations for the world economy in 2017 are relatively unchanged from last month. The U.S. economy is expected to stagnate as Trump fiscal stimulus is not expected until 2018. Political clouds on the horizon include the first round of the French election and the official start to the U.K.’s “Brexit” negotiations. Meanwhile, Trump’s “America first” approach to international relations and trade policy is an evolving challenge for the rest of the world and will be assessed on an ongoing basis for impact on the global recovery.

The Federal Reserve raised its benchmark rate to 1% (+25 basis points) on March 15th, a move that was widely expected. The Fed’s decision to hike interest rates in light of the apparent weakening in economic data since the start of the year, with the Atlanta Fed’s Q1 GDP tracker having fallen below 1% annualised, was expected. Treasuries rallied and the dollar weakened because a hawkish Fed did not turn incrementally more hawkish, and Yellen’s press conference largely stuck with the tone of her previous speech on the outlook. The committee’s confidence in the economy remains intact while recent inflationary pressure has been downplayed and the March intervention does not represent an acceleration in the normalization process. The FOMC upgraded its assessment of business investment that “appears to have firmed somewhat”.

One of the main stories from February’s employment report was the turnaround in employment growth in the three main goods-producing sectors of mining, manufacturing, and construction. When looking at the overall employment picture, inconsistencies remain (hours worked, wages, soft non-energy exports and investment intentions) and lack of clarity on U.S. tax and trade issues contributes to uncertainty. Residential investment grew to a historic peak of 7.6% of GDP, more than half of which representing renovations & transfer costs which could ease even as new construction remains elevated.

Stock market optimism has helped loosen financial conditions in the U.S. since December, even as short-term borrowing costs have advanced following the Fed rate hike. Credit spreads have fallen while the U.S. dollar has struggled to maintain its post-election ascent so far this year.  This constitutes stimulus to the global economy that offsets the tightening cycle.

U.S. equities performed strongly in February, with the S&P 500 gaining 4%, S&P Midcap 400 gaining 3% and S&P SmallCap 600 up 2%. Canadian equities posted slight gains in February, with the S&P/TSX Composite TR up 0.2%. The S&P Europe 350 TR added 2.9% and moved into positive territory for the year. After a somewhat lackluster start to the year, the S&P/ASX 200 returned 2.3% in February. Results for U.S. fixed income were positive for the month, with investment grade corporates and high yield continuing to perform better than Treasuries. Commodities performance was mixed, with Gold Spot up 3.1% and Nymex WTI Crude 0.9%.

Following the Fed’s move, we made some small changes to the portfolio models in March. In the Conservative and Moderate Growth models, we increased the allocation to U.S. Small Caps over Mid Caps. In Aggressive Growth, we shifted a portion out of U.S. Mid Caps into European Equities. In fixed income, we shifted a portion from 3-7 year Treasury and added to the U.S. Muni bond exposure in the Conservative, Moderate Growth, and Growth models. This furthers the shift to Muni Bonds that began in February.

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

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