In January, we continued our Growth outlook for the next three months. Global growth has become more trend line in 2018, led by global demand and a revival in commodity prices, allowing most policymakers the flexibility to pursue much-needed reforms without stifling growth. A few developed market central banks are facing conflicting signals as economic growth has moved decisively above trend, driving unemployment rates to lows not seen since the early 1980s, while core inflation has remained stuck at levels still well below target. As we advance through the year we will likely see a sustained move up in wage and price inflation that would prompt faster and more broadly-based policy normalization. Rate hikes in the U.S., the U.K., Canada and Australia are expected while the European Central Bank is expected to leave rates unchanged but begin to taper asset purchases as the Eurozone’s big three economies continue to diverge: Germany’s unemployment at 5.7% continues to fall to levels not seen since before unification, while unemployment in France has risen to 9.2% and Italy is struggling with the highest of the three at 11.2%¹. Japan still struggles with demographics that constrain GDP growth even though Japanese equities were one of the best performing asset classes in 2017. New governance incentives have motivated companies to focus on returns, dividends and repurchasing shares. China’s performance, which has been better than expected, indicates an orderly deceleration of growth and a slowing of credit expansion, suggesting a deceleration to 6.4% growth for 2018 from 6.8% last year¹. The Bank of Canada seems cautious, emphasizing uncertainty surrounding the ongoing NAFTA negotiations, so the risks are likely tilted toward fewer hikes.
The U.S. economy continues to show strength, despite a soft patch in early 2017, as tax cuts of about $1.0 trillion (or about 0.5% of GDP) over the next decade could help lower the unemployment rate further to 4.0%¹. In 2018, growth of 2.7% is expected¹. Consumer spending and business fixed investment continue to be major drivers of growth and would benefit from lower personal and corporate tax rates. Corporate earnings growth continues to drive equity market multiples. Cold weather in North America played a role in boosting oil prices recently, with the 40% jump in Brent crude since June 2017 owing to more fundamental demand and supply dynamics.
2017 was an outstanding year for U.S. equities. Large caps stood out, with the S&P 500 Index up 22%, marking 14 consecutive months of gains. The S&P MidCap 400 and the S&P SmallCap 600 gained 16% and 13%, respectively. The S&P/TSX Composite was up 9%. The S&P Europe 350 ended the year at 11% while the S&P United Kingdom gained 12%. The index benefitted when market participants deemed a so-called “hard Brexit” less likely, however this was offset by the positive impact on Pound Sterling. The S&P China 500 had the highest total return in 2017, gaining 35%. The government’s attempts to control rising debt may restrict short-term growth. The S&P 500 Bond Index gained 0.9% in December and 6% for 2017. Continued curve flattening drove long-duration bonds. The 10+ year sub index returned 12% for the year. The S&P U.S. Aggregate Index lagged investment-grade corporate bonds, returning 0.4% for the month and 3.3% for 2017.
In January, we shifted exposure from the U.S. mid term treasury bond to European and Pacific equities across all models. This is in line with our extended Growth outlook, recognizing strength in Europe and Asia while avoiding growth challenges in other economies and markets. Tactical Growth and Tactical Aggressive Growth models saw exposure to the midterm treasury bond eliminated, reducing fixed income exposure from 38% and 33% to 23% and 20% respectively.
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. Step Forward, Look Both Ways.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income, Europe. December 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.