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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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February 2017

In February, we adjusted our twelve-month forward outlook to remove Inflation for the U.S. and reverted to Stagnation across all global economies. Last year, markets had to digest Britain’s vote to leave the European Union (EU) and the unexpected victory of Donald Trump in the U.S. presidential election. This year, markets will focus on three political events: first, the general election in Netherlands; second, the presidential election in France, and third, the federal election in Germany.

Investors are now coping with geopolitical and macroeconomic risks, from disintegration of the EU, a hard landing in China, to trade wars and military conflicts. The U.S. economy added 227,000 jobs in January and saw the strongest monthly employment gains since August 2016. The average number of jobless claims applications filed in January reached the lowest level since 1973, while the unemployment rate inched up to 4.8% in January (from 4.7%), as the participation rate recovered along with improving economic confidence.

Both headline and core CPI were stronger in January and producer prices have been trending up. This should not be viewed as the beginning of a new, more dangerous inflation problem, as core goods prices have been decoupling from finished goods producer prices (i.e. the last stage of production) since 2000. This speaks to the massive deflationary pressure at the end of the supply chain: a combination of deflation from imported goods, major technological advances in supply chain management, and logistics. Changing consumer behavior in an e-commerce age also means that consumers are not price takers. These factors imply that any budding inflation pressures are expected to stay trapped at the earlier stages of the supply chain and PPI will not be driving CPI prices higher.

U.S. equities kicked off the year on a positive note. In January, the S&P 500 TR gained 1.9%, the S&P Midcap 400 TR gained 1.7%, and S&P Smallcap 600 TR was down 0.4%. S&P 500 Energy TR was the worst performing sector, down by 3.6%, a reversal after last year’s rebound. It was a tough month for energy prices, with S&P GSCI Energy down 4.7% and Natural Gas Futures off 16%. While the initial OPEC agreement was announced 7 weeks ago, and Russia has been adhering to the production limits, prices are not materially increasing. Metals performed better, with copper spot and gold spot prices rising 8% and 5.5%, respectively. Safe-haven assets have been undergoing a recovery since mid-December as gold, the Japanese yen, and the Swiss franc have all appreciated.  January results for U.S. fixed income were generally positive, with investment grade corporates and high yield bonds continuing to perform better than Treasuries. The U.S. dollar index retreated by 2.7% on the back of a firmer euro (almost 60% of the DXY basket) and a stronger Canadian dollar (+3%).

Shifting back to a Stagnation outlook for the United States, we made some changes in the portfolios in February. While we maintained our exposures to U.S. mid and small caps across all models, we increased equity exposure to both Canada and Australia, and removed our neutral currency hedge to both. We lowered exposure to the 3-7 Year Treasury to fund this shift.  We also closed our position in Mortgage Backed Securities and moved that exposure into Municipal Bonds across all models.  Municipal bonds behave well in Stagnation and concern of changes to their tax advantaged status has greatly diminished.

Since November, markets have been adjusting to the surprise of a Trump Presidency and a Republican Congress.  We believe the President’s disruptive style will continue to persist in the future.

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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January 2017

In January, we maintained our twelve-month forward outlook to reflect the inflationary environment that is expected to result from the new regime in the U.S. while the rest of the world continues to struggle with stagnation. While the International Monetary Fund projects that global GDP in 2017 will improve to 3.4% from 3.1%, there is currently a wide dispersion of projections given the uncertainty surrounding the policy stance of the incoming U.S. administration and its global ramifications. With price pressures building in the U.S., but not elsewhere, monetary policy divergence leading to upward pressure on the dollar will create some headwinds. The Federal Reserve is targeting three interest rate hikes next year while other global central banks remain accommodative. Powerful structural forces including an ongoing overhang of debt, adverse demographics in most major economies, ineffective monetary policy, and low financial asset returns will challenge all global economies including the United States.

U.S. fiscal stimulus will be implemented at a time when the economy is already close to full employment. At 4.7% in December, the unemployment rate is now below Fed officials’ median estimate of its natural level. The impact that technology has had in creating uneven incomes and a decline in employment opportunities will continue to be a challenge. America’s current job creation recognizes that there has been technological displacement in select industries that previously had not benefited from technological innovation. The Great Recession revealed the weakening of the link between value creation and job creation. Please see our 2016 Fourth Quarter Summary Outlook to see our additional thoughts on the impact that this global phenomenon has and will continue to have on the ability of all economies to grow.

The anticipated tightening in U.S. monetary policy commenced as December saw the Fed announce an increase in its key interest rate for just the second time in the last seven years. The S&P 500 Total Return Index surged to the finish in 2016, up 12% for the year, as investors indicated optimism with Trump’s pro-growth policies. It is notable that only about 50% of the index outperformed, with gains led by cyclical areas such as Financials, Energy, Industrials, and Materials, as these areas are expected to be direct beneficiaries of the new regime. Gains in smaller-cap equities were even stronger, as the S&P Mid-Cap 400 Total Return Index and the S&P Small-Cap 600 Total Return Index were up 20.7% and 26.6%, respectively, for the year. Global equity markets generally ended the year positively, while underperforming the U.S, in part due to the currency headwinds caused by the rising dollar. An exception was Canadian equities, with the S&P/TSX Composite Total Return Index up 21.1% for the year. The MSCI Emerging Markets Net Total Return Index ended the year up 11.2%, although the MSCI China Net Return USD Index posted a more modest 2016 return of only 0.9%. The European Central Bank continued with quantitative easing policy throughout the year and yields declined.

Following major asset allocation shifts in December, we maintained these allocations in all models in January. The models continue to reflect exposure to asset classes that provide superior expected returns in this new environment, while attempting to avoid the asset classes expected to detract from positive returns. This continues to include a high exposure to U.S. mid- and small-cap equities, and smaller exposures to Australia and Canada. Fixed Income exposure is short duration across all models.

We continue to believe reflation in the U.S. will be the key investment theme in 2017, a significant departure from the post-2008 period when dovish monetary policy kept interest rates on a downward spiral. We do not expect the new regime to carry out all the extreme protectionist threats that were at the center of the election campaign. In addition, with commodity prices likely to recover, aggregate growth in emerging economies will continue to accelerate, although China’s economy will likely continue to slow.

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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