July 2019

The pace of global growth is slowing this year as policy uncertainty takes its toll on the world’s economy. Data points to the global economy expanding by 3.3% this year, slower than 2018’s 3.6% pace, with trade volumes declining and business sentiment deteriorating. ¹  Central bank actions and intentions have boosted both equity and bond markets so far this year, a sign that investors think monetary policy support will be sufficient to offset trade headwinds. This action by central banks supports our Stagnation outlook for the U.S. economy as growth is capped over our forecast time horizon of twelve months.

The prospect of a prolonged U.S.-China trade war, the lack of clarity around Brexit, and political and economic upheaval in countries like Venezuela have contributed to the downside risks of our outlook. European economies have notable international financial and economic linkages, and a sharp economic downturn in Europe would affect banks, markets, and the global economy.

The U.S. economy continued to grow at a solid clip in the first quarter of 2019 on the back of net exports and inventory building. U.S. inflation is closer to the Fed’s objective but has been below 2% for much of the last decade. With inflation pressures remaining “muted,” a rate cut would be less about the state of recent economic data and more about providing insurance against trade tensions and slowing global growth. Prospects for some American companies have dimmed. Analysts expect earnings of the biggest companies, which have just begun reporting second quarter results, to have declined. This would mark two consecutive quarters of falling profits. ²

The Bank of Canada looks set to diverge from the Fed, holding rates steady. Firmer current core inflation (close to 2% for the last year) and an already more accommodative stance give the BoC some room to move later. ³

After a setback in May, a dovish Federal Reserve and optimism surrounding a potential trade deal during the G20 talks contributed to a rebound in U.S. equities in June. The S&P 500 was up 7.0% while the S&P MidCap 400 was up 7.6% and the S&P SmallCap 600 was up 7.5%. For the second quarter, large-caps outperformed smaller-caps with the S&P 500 up 4.3%, the S&P MidCap 400 up 3.0% and the S&P SmallCap 600 up 1.9%. The S&P/TSX Composite was up 2.5% in June and up 2.6% in the second quarter. The S&P Euro (350 Eurozone), S&P Europe 350, and S&P United Kingdom indexes were up 4.5%, 3.3%, and 3.2% for the quarter, respectively. The S&P China 500 was up 6.6% in June but remained in negative territory for the quarter, down 0.62%. U.S. fixed income performance was positive across the board, with corporates outperforming Treasuries, while commodities declined during the quarter, driven by weakness in energy, industrial metals, and livestock.

In July, we maintained the existing allocation between equities and bonds across all models. This asset allocation continues to reflect our expectation that the U.S. economy is under pressure but is more stable than other global equity markets.  Allocation to equities remains at 30% in Tactical Conservative, 40% in Tactical Moderate Growth, 50% in Tactical Growth, and 60% in Tactical Aggressive Growth. Within equities, exposure is distributed between the S&P 500 and S&P MidCap 400. We are of the view that smaller companies will feel the impact of the uncertainty that exists in the current climate while longer treasuries will continue to benefit from the downward pressure on interest rates and the relative attractiveness of interest rates in the U.S. versus the rest of the world.

Economic and market risks are elevated as a result of the U.S. administration’s use of tariffs at a time when global growth is slowing. From our perspective, financial market volatility in Europe could spill over to global markets, including the United States, leading to a pullback of investors and financial institutions from riskier assets, which could amplify declines in equity prices and increases in credit spreads. In addition, spillover effects from banks in Europe could be transmitted to the U.S. financial system directly through credit exposures as well as indirectly through the common participation of globally active banks in a broad range of activities and markets. The consequent U.S. dollar appreciation and weaker global demand in such a scenario would depress the U.S. economy through trade channels, which could reduce earnings of some U.S. businesses, particularly exporters. Such effects could harm the creditworthiness of affected U.S. businesses, particularly those that already have high levels of debt. We will continue to monitor the data for growth, inflation, and recession 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 International Monetary Fund, World Economic Outlook. April 2019.

² The Economist. Profits are down in America Inc. July 20, 2019.

³ RBC Economics. Current Trends Update – Canada. July 19, 2019.

 

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. June 28, 2019. Index performance is based on total returns and expressed in the local currency of the index.