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.