Recent reasons to hope for a more stable global economy in 2019 are contending with reasons to worry. Hope has come from the temporary U.S./China tariff truce and an oil supply shock that will positively impact global consumer spending next quarter. Concern remains as global geopolitical risks escalate, and the fading benefit of fiscal stimulus combined with tighter monetary policy in the U.S. is causing a slowdown in rate-sensitive sectors that will spread to the broader economy and beyond the U.S. borders if not addressed. Global business surveys indicate declines in activity in China and softness in most European countries. In December we revised our twelve-month forward outlook to reflect the delayed impact of inflation on the U.S. economy. We continue to believe that U.S. economic growth is moving toward an inflationary environment that will likely precede a recession in late 2019 or in 2020. The current outlook now factors in six months of growth followed by six months of inflation over the twelve-month forecast period.

The outlook for the euro-zone has deteriorated in recent months as business and consumer sentiment has softened and GDP growth has slowed. Negotiations over the UK’s withdrawal from the EU are likely to go down to the wire. Italy’s economy is expected to go into recession next year, raising fresh doubts about the sustainability of its public debt. The French government is facing significant pushback to implementing additional structural reforms. In Japan, the impact on potential growth of allowing entry to foreign workers under a new law can be equated to a rise in the labor participation rate of 5 percent, doubling the current pace. ¹

The tension between the U.S. and China is more about rules governing direct investment, intellectual property, and technology theft than it is about the current U.S. trade deficit with China. The U.S. has hit $250 billion of Chinese goods with tariffs since July, and China has retaliated by imposing duties on $110 billion of U.S. products. China is tracking a 6.1% real GDP gain this quarter, but there are signs that domestic demand continues to struggle. ² A 2.9% drop in exports held back factory output, even as shipments to the U.S. rose. If the pre-tariff price of Chinese exports to the U.S. declined by as much as 10% under a scenario in which a 25% tariff is levied on all US imports from China, it would still result in a serious inflationary hit to the remaining $267 billion of annual Chinese exports to the U.S. ³

The modest 155,000 job rise in U.S. non-farm payrolls in November reflected a broad-based slowdown across sectors. ⁴ The November Consumer Price Index (CPI) was flat (0.02%), while the ex.-food and energy core CPI increased 0.21%. A 2.2% decline in energy prices held down the headline. ⁵

After October’s sharp declines, U.S. equities returned to positive territory in November. The S&P 500 was up 2.0%, while the S&P Midcap 400 gained 3.1% and S&P Smallcap 600 gained 1.5%. Canadian equities returned to positive territory in November, with the S&P/TSX Composite up 1.4%. Global trade uncertainty and declines in commodity prices factored into the S&P Europe 350 declining 0.8% in November. The S&P United Kingdom dropped 1.4% as markets waited on the outcome of Brexit negotiations. Emerging markets rebounded from October’s losses, with the S&P Emerging BMI up 4.7%. The S&P Pan Asia BMI gained 3.3%, with the negative exception being Australia. S&P China 500 gained 3.7%.

In December, we continued to maintain our current asset allocation across all models. Allocation to Equities will remain at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 60% in Tactical Growth, and 70% in Tactical Aggressive Growth, providing exposure to U.S. equities, with the balance in all models allocated to U.S. municipal bonds and medium-term U.S. treasuries. This asset allocation is reflective of the current relative attractiveness of interest rates in the U.S. versus the rest of the world.

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 Capital Economics, Global Economics Update. December 14th, 2018.

² JP Morgan, Cross Asset Strategy. December 14, 2018.

³ CNN Business, “The trade war is pushing business out of China, but not into America.” November 16th, 2018.

⁴ Trading Economics. U.S. November Non-Farm Payrolls.

⁵ Trading Economics. U.S. CPI, November 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. November 30th, 2018. Index performance is based on total returns and expressed in the local currency of the index.

In October, we evolved our twelve-month forward-looking outlook to reflect a six-month period of Growth, followed by a six-month period of Inflation. The global economy remains on track for another year of solid growth, likely to be just under 4%, as we enter the fourth quarter of 2018. However, domestic factors are causing the overall picture to become more uneven across countries and regions. Our view continues to reflect the impact of the escalating U.S. trade war and the risk to the U.S. economy as monetary policy tightens.

In both the Eurozone and Japan, domestic demand growth has remained above potential and in line with the 2017 rate. However, contribution from trade has weakened. Growth in the United Kingdom has continued to soften since 2016 and the Brexit vote. In China, trade slowdown continues to result in uneven growth. Tariffs imposed by both the U.S. and China haven’t been large enough to materially impact global trade.

In the U.S., a late cycle fiscal stimulus from tax cuts has boosted household and business spending, pushing already robust growth even higher. However, we expect the multiplier from the tax cuts to add only 20-30 basis points to growth in 2018 and even less in 2019. Most of that is likely to come from business investment, reflecting the immediate expensing of capital expenditures. The widening in the trade deficit to $53.2 billion in August suggests that even before the latest round of tariffs, there were signs that previous retaliatory tariffs on U.S. exports were starting to take effect with goods exports to China slowing sharply in August¹. After providing a big boost in the second quarter, the new USMCA agreement that is replacing NAFTA has relieved some trade tensions, but over 10% of total imports are now taxed following the levy placed on an extra $200 billion of Chinese goods¹. The opposing forces of U.S. fiscal stimulus and trade tensions should dominate the macro picture for the rest of 2018.

While Canada’s growth has been partially driven by gains in consumer and business spending, the revival in exports, owing to robust demand from the U.S. and a weaker Canadian dollar, has been a larger recent contributor. These tailwinds have helped to offset some effects from newly imposed tariffs and have sent the trade surplus with the U.S. to its highest level since 2008. The Bank of Canada raised its trend-setting interest rate for the third time this year, by another 0.25% up to 1.75%, on October 24th².

September was mixed for U.S. equities. The S&P 500 gained 0.6%, while the S&P MidCap 400 lost 1.1% and the S&P SmallCap 600 lost 3.2%. For the quarter, the S&P 500 gained 7.7%, driven by a strong economy, outperforming both Mid and Small Caps. The S&P/TSX Composite continued its August decline to end the quarter down 0.6%. In Europe, the S&P Europe 350 finished September up 0.6%, and 1.4% for the third quarter. The S&P United Kingdom Index gained 1.4% in September, benefitting from a decline in sterling. France and Sweden also made significant positive contributions for the month. Despite growing trade tensions in the area, Japan had a strong month with the S&P/TOPIX 150 returning 5.9% and 7.2% for the quarter. Commodities did well with the S&P GSCI gaining 3.9% in September, driven by gains in crude oil.

We maintained the asset allocation in Tactical Growth and Tactical Aggressive Growth. In Tactical Conservative and Tactical Moderate Growth, equity exposures were reduced by 10%. Five percent came out of each U.S. Mid Caps and U.S. Small Caps, with the total being redeployed into 3-7 year U.S. Treasuries. This move is consistent with our recognition that tax cuts from earlier in the year are having a short-term positive impact on the U.S. economy that is more than offsetting the uncertainty created by the trade wars initiated by the U.S. on China as well as many other trading partners including Canada and Mexico.

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 Capital Economics. United States Chart Book. October 18, 2018.

² Bankofcanada.ca. Policy Interest Rate.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. September 28, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.  

 

In August, we maintained our outlook to reflect the impact of the escalating global trade wars.  We are currently factoring in a six-month period of Stagnation followed by six months of Inflation. While the baseline forecast for the global economy continues for 2018 and 2019, the potential for disappointment remains. Tariffs generate what economists call a “deadweight loss,” with the impact on prices and consumption that results usually larger than the tariff revenue that is generated.

In June, the U.S. government announced its intention to apply tariffs on an additional $200 billion of imports from China and threatened tariffs on imports of autos and parts in the future. This news follows earlier imposed tariffs on a variety of imports including solar panels, washing machines, steel and aluminum. Retaliation was swift, as the European Union, Canada, Mexico, and China imposed tariffs on imports from the United States. China is struggling to balance several challenges to its economic health with high levels of indebtedness. Euro area GDP growth fell short of expectations with a 0.3% increase in Q2, down slightly from the Q1 0.4% gain¹. That leaves Euro area growth over the first half of the year at roughly half of 2017’s pace. A slowdown in France, the currency bloc’s second largest economy, was partly to blame. Euro area inflation rose above 2% for the first time since 2012, though core inflation remains well below the European Central Bank’s target. From the Central Bank’s policy path for the coming months, we expect net asset purchases trimmed to zero by the end of 2018 and rate hikes off the table at least through next summer.

In the U.S., Q2’s advance GDP report came in at 4.1% annualized, one of the highest quarterly growth rates in the last decade¹. The economy was performing very well, with domestic demand up almost 4%, led by a rebound in consumer spending and another solid increase in business investment. However, tariffs imposed by the U.S. on imports is expected to raise prices and lower real disposable incomes for consumers, jeopardizing the livelihoods of American workers. U.S. tariffs threaten consumer spending going forward since nearly 11 million jobs are supported by exports and millions of additional jobs directly depend on imports.

Protectionism could also hurt corporate profits. The “rest-of-the-world” component has been driving U.S. profit growth the past few years, increasing its share of overall U.S. corporate profits to 20.3% in Q1 this year, a four-year high². Continuing protectionism from Washington can potentially harm corporate America’s profitability, offsetting some of the benefits from tax cuts. The U.S. President initiated an investigation into imports of motor vehicles and parts from Canada on national security grounds – the same justification used for steel and aluminum tariffs. If the ultimate outcome of the investigation is the imposition of tariffs of a similar magnitude, the impact to Canada would be significant, potentially reducing growth in 2019 growth by 0.5%.³ Business investment would be the most significantly impacted, reducing Canada’s long-run economic capacity.

Global financial markets reacted negatively to apparently souring trade relationships. The MSCI All-Country World index was down significantly after U.S. tariff announcements. In July, U.S. equities gained across all cap sizes. The S&P 500 gained 3.7%, while the S&P MidCap 400 gained 1.8% and the S&P SmallCap 600 gained 3.2%. Canada and Europe were also positive, with the S&P/TSX Composite up 1.1% and the S&P Europe 350 up 3.2%, with nearly all countries contributing positive returns. June’s focus on trade tensions and political risk largely gave way to positive earnings figures, economic data, and central bank guidance in Europe.

Asian equities also enjoyed a positive month, though China and Korea contributed negatively to the region as lingering trade tensions continued to have an impact on markets. U.S. fixed income performance was mixed with high yield corporate bonds the strongest sector.

In August, we shifted a portion of our fixed income exposure to U.S. equities in both the Growth and Aggressive Growth models, resulting in equity exposure shifting from 50% to 60% and from 53% to 65%, respectively. The shift was out of the existing U.S. municipal bond position and into U.S. mid-caps.

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 RBC Economics. Financial Markets Monthly. August 10, 2018.

²National Bank of Canada. Monthly Economic Monitor. Economics and Strategy. July/August 2018.

³ TD Economics. Potential U.S. Auto Tariffs: Canadian Scenario Analysis. June 18, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. July 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.  

In June we carried the outlook forward from May with Growth in the first half of the twelve-month time horizon heading toward Inflation in the back half.

World trade weakened slightly in Q1 2018 to 4.4% compared to 4.7% in 2017¹. The global economy was handed a curve ball in May as the U.S. unilaterally and simultaneously confirmed tariffs on China, Europe, Canada and Mexico including $50 billion on Chinese imports and new duties on foreign steel and aluminum across all countries who import to the United States. IMF Director Christine Lagarde announced that a trade war would lead to “losers on both sides”. This comes as the IMF also announced their forecast of U.S. growth declining in 2022 as the initial boost of tax cuts is offset by the drag of the greater debt burden associated with lower tax revenues².

U.S. tariffs have prompted Europe, Mexico, Canada and China to introduce or announce plans retaliatory for counter-measures. Due to China’s pivotal role in the global supply chain, a fall in Chinese exports related to the U.S. trade conflict could inflict collateral damage on other economies and thus enhance macroeconomic risk.

The eurozone had been identified as the stand-out performer going into 2018 as eurozone data was consistently above expectations at the start of the year but it has surprised to the downside in recent months. The European Central Bank and Bank of Japan are both still engaged in quantitative easing (QE), although Europe is expected to wind down its QE program by the end of the year.

U.S. GDP growth is expected to rebound in Q2 2018 following growth of 2.3% in Q1. The fiscal stimulus (tax cuts and increased spending) extends the duration of the U.S. cycle. The Federal Reserve is still on course to raise interest rates four times this year. With the budget deficit expected to rise in coming years, passing $1 trillion in 2020, according to Congressional Budget Office estimates, the government has been issuing debt heavily³. The total for 2018 has been $443.7 billion, a nearly nine-fold increase from the same period a year ago, according to the Securities Industry and Financial Markets Association.

We are watching the recent trend of foreign governments that have pulled back their purchases of longer-term U.S. debt as trade tensions have escalated. Foreigners held $6.17 trillion of the total $14.84 trillion of Treasury debt outstanding through April. China, the largest owner of U.S. debt, reduced its level in April by $5.8 billion to $1.18 trillion, while Japan, the second largest, cut its holdings by $12.3 billion to $1.03 trillion. Ireland, the U.K. and Switzerland also pulled back. When counting all securities (including T-bills), the April decline came to $47.6 billion, a 0.8% reduction from March⁴.

The month of May provided strong returns for US equities, with the S&P 500 gaining 2.4%, and S&P MidCap 400 and S&P SmallCap 600 gaining 4.1% and 6.5%, respectively. Canadian equities did well, with the S&P/TSX Composite up 3.1%.

The S&P Europe 350 ended the month down 1.2% after a strong start due to a more co-operative tone between the U.S. and China, and indications that Italy would finally have a government. A re-emergence of trade tensions and an increase in Italian and Spanish political risk later in the month weighed on the European equity benchmark. Emerging and frontier markets posted losses, with the S&P Emerging BMI and S&P Frontier BMI down 3.5% and 7.5%, respectively. Performance influences include the dollar’s strong performance. Performance in U.S. fixed income was mostly positive with S&P Municipal Bond High Yield Index leading the pack with a gain of 1.7%.

As we are cautious of the direction that a trade war is taking the U.S. economy and the ripple effect to trading partners, we made a major shift in asset allocation away from Canada, Europe and the Pacific Region and into short-term U.S. bonds across all models. We allocated equal amounts to Municipal Bonds, the 3-7 year U.S. Treasuries and U.S. Small Caps in the Tactical Conservative and Tactical Moderate Growth Models. We allocated proportionally more of the 3-7 year U.S. Treasuries in Tactical Growth and Tactical Aggressive Growth Models.

We 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 World Trade Organization. 2018 Press Release: Strong trade growth in 2018 rests on policy choices. April 12, 2018.

² IMF. World Economic Outlook Update, January 2018: Brighter Prospects, Optimistic Markets, Challenges Ahead.

³ Congressional Budget Office. The Budget and Economic Outlook: 2018 to 2028. April 2018.

⁴ CNBC. Russia cuts Treasury holdings in half as foreigners start losing appetite for US debt. June 18, 2018.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. May 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.

In April we continued our Growth Outlook for the next six months followed by Inflation for the following six months.

Global momentum remains strong as the IMF forecasts 3.9% growth this year and next, the fastest since 2011 thanks to increasing investment and trade. The strength of global demand is leading to a significant increase in most commodity prices relative to last year. This is benefitting commodity exporting nations, such as those in the Pacific Alliance, where growth is expected to be much stronger than in 2017. While monitoring this we are also watching the intensifying standoff between the United States and China that threatens to flare up into the biggest trade confrontation since WWII. In addition, record levels of global debt could become a destabilizer and at the very least will lead to higher levels of interest rates around the globe.

China’s economic outlook is favourable. While we expect growth to decelerate gradually in 2018–19, China is aiming for 6.5% expansion this year. The Euro area has been running a primary fiscal surplus since 2014, which moved close to 1% of GDP in 2017. Over the past five quarters, nominal GDP growth averaged 4% annualized, compared with an average of 2.7% in the prior three years. Germany continues to lead with growth of almost 3% y/y by the end of 2017. A question on the monetary policy front is whether the ECB will make further asset purchases once the current round of QE comes to an end in September, or whether the program will be phased out more gradually.

The U.S. was already on a path toward rising fiscal deficits before the introduction of limited tax reforms. Unfunded social security obligations and health care expenditures were the main driver. Adding an extra U.S.$1.5 trillion to cumulative deficits over the next decade further erodes the deficit outlook. The current earnings season is expected to show significant support for equities as companies deliver on shareholder return from the tax windfall. Based on the recent FOMC minutes a rate hike at the June policy meeting is expected.

The Bank of Canada faces similar conditions to the Fed. Economic growth is solid, unemployment is low, and core inflation averaged 2% on an annual basis for a second straight month in March.

For Q1 2018, the S&P 500 ended down 1.2%, the first negative quarter in 9 quarters. The S&P TSX Composite fell 5% over the quarter and rates rose across the board. Gold held steady, rising 1.7%.

The month of March was challenging for U.S. large-cap equities, with the S&P 500 down 3%. Smaller caps performed better, as the S&P MidCap 400 and the S&P SmallCap 600 registered gains of 1% and 2%, respectively. International markets declined, as the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI posted March losses of 2% and 3%, respectively.  Canadian equities were slightly negative in March, with the S&P/TSX Composite down 0.16%. The S&P 500 Bond Index gained 0.15% in March, as high-quality and long-duration bonds outperformed for the month. The S&P U.S. High Yield Corporate Bond Index was down 0.45% for March as investor sentiment favored safer, higher-quality bonds.

Our outlook did not change from March and as a result we maintained our asset allocations across all models. U.S. Equity exposure ranges from 12% in Conservative, to 25% in Moderate Growth, Growth and Aggressive Growth while International equity allocations are 41%, 38%, 50% and 53% respectively. This highlights our view that Europe and the Asia Pacific regions are expected to perform well because of issues highlighted in the update.

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

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. March 31, 2018. Index performance is based on total returns and expressed in the local currency of the index. European regional index returns are expressed in Euros.