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.

In February, we continued our Growth outlook for the next three months. The data coming in from 2017 confirms that the synchronized world economic recovery also contributed to global EPS growth across most markets in 2017.

China continues to grow but a slowdown is underway, resulting from policy tightening as the authorities became more concerned about financial stability risks. Local governments have imposed restrictions on property sales and on lending to property developers, which led to a sharp slowdown in property construction in recent years.

Euro area GDP rose 0.6% in Q4/27, the fifth consecutive quarter of above-potential growth. Early indicators point to continuing momentum at the start of 2018¹. January’s composite purchasing managers’ index rose for a third straight month, hitting its highest in more than a decade thanks to further improvement in the services sector.

The U.S. economy is now in the late stages of the business cycle, employment growth has been decelerating for several years with sluggish productivity growth. Any boost from fiscal stimulus is not expected to be sustained as dividends and share buybacks don’t lead to long-term capital investments that are required to support sustainable long-term growth. In the recent months, there have been close to $200 billion of buyback announcements, over double from a year ago².  Also, the cumulative effects of monetary policy tightening will likely take a toll with the Fed raising its policy rate three times over the past year and begun the process of balance sheet reduction while more Emerging Market central banks have loosened policy rather than tightened over this period. Following consecutive gains of over 3% in Q2 and Q3, headline U.S. GDP growth slowed slightly to 2.6% in Q4 of 2017. With the U.S. economy already facing capacity limits and tax cuts set to push demand even higher, inflation risks are tilted to the upside.  Market-based inflation expectations rose to three-year highs and energy prices have picked up, putting upward pressure on nominal yields. The rollover of government debt maturing in 2018 and promise of increased Treasury supply to finance tax cuts have contributed to the rise in bond yields.

In Canada, solid economic data and a positive tone expressed by Governor Poloz raised market expectations that the Bank of Canada may hike rates at the start of 2018. On January 17, the Bank of Canada raised the overnight rate by 25 basis points to a post-crisis high of 1.25%. The bank kept a balanced tone and their forecasts unchanged despite including a modest downturn of business investment and exports related to NAFTA uncertainty.

U.S. equities had a strong start in 2018. In January, the S&P 500 gained 6%, marking the best opening month since Jan 1997. The S&P MidCap 400 and the S&P SmallCap 600 each gained 3%. Equity volatility rose with the VIX passing the 14 level on January 30th for the first time since August 2017. Internationally in January, the S&P Developed Ex-U.S. BMI and the S&P Emerging BMI gained 5% and 9%, respectively. U.S. fixed income was negative across the board in January, driven by the rise in Treasury yields. Commodities also started the year positive with the S&P GSCI and the DJCI both up 3%.

At mid-month in February we chose to maintain portfolio weights across all models. This was based on our view that the outlook in January continues to reflect the recent fiscal and monetary policy developments in the United States. This would result in economic growth for the U.S. in the next twelve months while there is growing awareness that these policies will front-end load growth, leading to inflation in 2019. We expect to address inflation in our outlook in the coming months.

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

¹RBC Economics. Financial Markets Monthly. February 9, 2018.

²Gluskin Sheff. Breakfast with Dave. Economic Commentary. David A. Rosenberg. March 2, 2018.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Fixed Income. January 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 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.

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.