February 2018

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.