2019 Portfolio Updates – Page 2 – Frame Global Asset Management

Geopolitical risks are expected to dominate global asset class performance over the coming months. Consideration of ongoing trade tensions and the aftermath of the U.S. government shutdown have led us to revise our forward outlook to reflect our view that the U.S. economy will experience stagnation over the next twelve months.

While still undergoing revisions, global growth in 2018 is estimated to have been 3.7%, with signs of a slowdown in the second half of 2018 leading to downward revisions for several economies. Growth in the Euro area is set to moderate from 1.8% in 2018 to 1.6% in 2019 and 1.7% in 2020. Growth rates have been marked down for many economies: Germany, due to soft private consumption, weak industrial production following the introduction of revised auto emission standards, and subdued foreign demand, Italy, due to weak domestic demand and higher borrowing costs as sovereign yields remain elevated, and France, due to the negative impact of street protests and industrial action. China’s economy slowed in 2018 mainly due to financial regulatory tightening to rein in shadow banking activity, and the widening trade dispute with the United States. Growth in emerging and developing Asia is expected to decline from 6.5% in 2018 to 6.3% in 2019.¹

The FOMC made a major dovish shift at the January meeting as the balance of risks had shifted dramatically over prior weeks due to disappointing global growth and tightening financial conditions. In January, solid job creation and wage gains were reported, but the December retail sales report indicated that total retail sales plunged 1.2%, the most in any month since 2009.² Headline CPI was flat in January, held down by a large 3.1% drop in energy prices, particularly gasoline. The ex-food and energy core CPI increased 0.24%.³ The timing and composition of the increases hint that tariffs may be playing a role in this surge in core goods prices. Increases have been firmer in some areas where Chinese goods have a sizable presence, such as household furnishings, video and audio products, and apparel, but less so in categories such as vehicles, where China is not significant in US markets.³ Growth for the United States is expected to decline slightly to 2.5% in 2019 with the unwinding of fiscal stimulus.⁴

Unlike the final month of 2018, U.S. equities started 2019 strong. The S&P 500 gained 8.0%, while smaller caps did even better, with the S&P MidCap 400 up 10.5% and the S&P SmallCap 600 up 10.6%. U.S. bonds gained across the board, with corporates outpacing Treasuries in line with the shift in confidence and muted inflation pressures. Chinese equities had a strong month as the S&P China 500 gained 7.3% given the continued trade negotiations with the U.S., and despite continued fears about slowdowns in both global and domestic growth. European equities rallied in January with the S&P Europe 350 finishing the month with a gain of 6.2%, the best monthly total return for the benchmark since October 2015. Canadian equities started the year on a positive note, with the S&P/TSX Composite gaining 8.7%, and the Canadian dollar firmed due to the rebound in crude prices and the U.S. dollar weakness. Oil prices were higher as OPEC and allies followed through on pledges to cut production at the beginning of the year, while the political crisis in Venezuela also threatened to disrupt supply. Gold posted its fourth straight monthly gain after the Fed signaled a more dovish stance, and the US dollar weakened. Central banks reacted to rising macroeconomic and geopolitical pressures by bolstering their gold reserves. Russia, which is “de-dollarising” its reserves, bought 274.3 tons of gold in 2018, funded by the almost total sale of its U.S. Treasuries portfolio.⁵

In February, we held our asset allocation constant at the January allocations. Allocation to Equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth and 60% in Tactical Aggressive Growth, continuing the exposure to U.S. equities, with the balance in all models allocated to U.S. municipal bonds and mid-term U.S. treasuries. This asset allocation continues to reflect our concerns that the U.S. economy is slowing but is more stable than other global equity markets and the 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

¹International Monetary Fund, World Economic Outlook. January 2019.

²Trading Economics, U.S. Retail Sales. January 2019.

³JP Morgan, Global Data Watch. February 15, 2019.

⁴International Monetary Fund, World Economic Update. January 2019.

⁵World Gold Council. Gold Demand Trends Full year and Q4 2018. January 31, 2019.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. January 31, 2019. Index performance is based on total returns and expressed in the local currency of the index.

As we enter 2019, there is a heightened focus on downside risks both domestically and globally in the markets and in the broader economy. A negative feedback loop has emerged that is centered in the U.S., linking bad policy choices to falling asset prices, tighter financial conditions, and weaker corporate earnings. In the short-term, the current U.S. government shutdown is having more than an impact of inconvenience on the U.S. economy. In January, we revised our twelve-month forward outlook to reflect the delayed impact of inflation on the U.S. economy. We believe that U.S. economic growth is moving toward stagnation and will be followed by an inflationary environment that will likely precede a recession in 2020. The current outlook now factors in six months of stagnation followed by six months of inflation over the twelve-month forecast period.

The IMF said in an update to its World Economic Outlook in October that it is now predicting 3.7% global growth in both 2018 and 2019, down from its July forecast of 3.9% growth for both years.^¹ Across emerging market and developing economies, prospects are mixed. The downgrade reflects the introduction of import tariffs between the United States and China, weaker performances by Eurozone countries, and rising interest rates that are pressuring some emerging markets with capital outflows into the stronger U.S. dollar, notably Argentina, Brazil, Turkey, South Africa, Indonesia, and Mexico.

In conjunction with the global growth downgrade, the IMF downgraded the 2019 U.S. growth forecast to 2.5% from 2.7% and cut China’s 2019 growth forecast to 6.2% from 6.4%.¹ Our focus over the next six months is on the impact of tighter Fed policy that is likely to hit business investment and, in combination with the stronger dollar, weigh on industrial output too, causing GDP growth to slow sharply.

The Canadian economy is set to weather the current slump in global oil prices better than it did in 2015, but it will not escape unscathed. The 9,300 job increase in employment in December was better than expected and the unemployment rate held at a 40-year low of 5.6%.² The housing market is showing signs of weakness and higher interest rates are starting to weigh on consumer spending. With this considered, we expect the Bank of Canada to cut rates in 2019.

U.S. equities experienced a very disappointing year in 2018. The S&P 500 was down 4.4%, its first negative year since 2008, still better than the S&P MidCap 400 and S&P SmallCap 600 down 11.1% and 8.5%, respectively. In the month of December, the S&P 500 declined 9.0%, while Mid-Caps were down 11.3% and Small-Caps lost 12.1%. Canadian equities were negative, with the S&P/TSX Composite down 5.4% for the month and 8.9% for the year. The S&P Europe 350 fell 5.5% in December and 9.9% for the year, mostly due to Brexit tensions, global trade uncertainty, and sharp declines in commodity prices. Internationally, most markets underperformed the U.S., with the S&P Developed Ex-U.S. BMI and S&P Emerging BMI both down about 14% for the year. The S&P China 500 completed 2018 with a loss of 19%.

In January, we shifted our fixed income exposure out of 3-7 year Treasuries and into 7-10 year Treasuries in all models. In addition, in the Tactical Growth and Tactical Aggressive Growth models, an additional 10% was taken out of the S&P 500 and added to 7-10 year Treasuries. Allocation to Equities remains at 30% in the Tactical Conservative model and 40% in the Tactical Moderate Growth model, and decreased to 50% in the Tactical Growth model, and 60% in the Tactical Aggressive Growth model. We continued exposure to U.S. equities, with the balance in all models allocated to U.S. municipal bonds and mid-term U.S. treasuries. This asset allocation is reflective of the current concern that the U.S. economy is slowing while the relative attractiveness of interest rates in the U.S. versus the rest of the world prevails.

While the poor market depth and soft liquidity that marked December 2018 are beginning to fade, weak sentiment is likely to remain a prominent feature in the coming months. 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 International Monetary Fund, World Economic Outlook. October 2018.

² Trading Economics, Canadian Employment. December 2018.

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