In May, we continued our Growth Outlook for the next six months followed by Inflation for the following six months. The global economy is running at its fastest pace since the very early days of the current economic recovery. The IMF upgraded its outlook for 2018 and 2019, calling for the world economy to achieve closer to 4% growth during those periods, nearly matching the pace set in the prior decade¹. The details of the IMF report reveal that every major economy is expected to remain in expansion mode, a synchronicity not seen since the 1990s. This broad strength is a key factor driving global yields and commodity prices higher.
In the euro area, 2018 got off to a disappointing start as real GDP growth slowed to 0.4% in the first quarter, the weakest performance since the third quarter of 2016. Both headline and core inflation were soft in April, slipping back to 1.2% and 0.7%, respectively².
In Japan, the expansion became shakier, while growth in China took a stronger start this year, after solid data reported on industrial value-added, fixed asset investment, and steel and electricity output. World output has powered through trade uncertainty, initial Fed tightening, rising fuel costs, and a return of some market volatility.
U.S. economic data released in April reflect a slowdown in the rate of growth during the first quarter. Unemployment has reached a multi-decade low and is likely to push still lower in the coming months. Combined with U.S. fiscal stimulus, support for household consumption is anticipated. The IMF estimates that the structural budget deficit among advanced economies will widen 0.3 percentage points as a share of GDP this year, and another 0.6 ppts in 2019 – a rough measure of the net fiscal stimulus to growth, with almost all coming from the U.S. tax and spending steps¹. Headlines around U.S. trade policy and general political dysfunction are a persistent feature but have so far not been significantly disruptive to the economy.
The Canadian economy continues to perform well despite some volatility early this year. Rising commodity prices and the solid outlook for Canada’s major trading partners provide support. The March 2018 job numbers came in at a loss of 1,100, well below consensus expecting a 20,000 gain³. With inflation close to the Bank of Canada’s target, the case for rate hikes is high and the BOC is expected to keep pace with the Fed. Aside from the housing market, the primary economic risk remains the turbulence related to ongoing NAFTA negotiations.
For the month of April, U.S. large-cap equities returned to positive territory, with the S&P 500 up 0.4%. S&P Small Cap 600 gained 1.0%. Energy was the top performing sector, up 9%, aided by rising oil prices. Canadian equities gained, with the S&P/TSX Composite up 1.8%. Europe had a strong start to the earnings season, while easing geopolitical tensions competed with concerns of a trade war. Despite tensions, S&P Europe 350 gained 4.8%, pushing the European equity benchmark into a positive YTD for 2018. The S&P Emerging BMI posted a loss of 0.8%, due to headwinds including rising rates and the dollar’s strong performance. Bond yields have been creeping up so far in 2018, leading to a significant shift in the relative attractiveness of equities versus bonds. With bonds yielding less than equities for most of the post-2008 cycle, equities have enjoyed a yield advantage for nearly a decade. Now, rising yields are levelling the playing field. The S&P 500 Bond Index was down 0.8% in April, as both investment-grade and high-yield issues were negative for the month.
We carried the outlook from April through to May with Stagnation in the first half of the 12-month time horizon heading toward Inflation in the back half. We maintained the fixed income exposure in all models while shifting some equity exposure from the Pacific Region and Europe back to the United States. We added U.S. Small Caps in the same weights that Asia was reduced across all models. We added U.S. Midcaps in the same weights that Europe was reduced across all 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 IMF. World Economic Outlook. Cyclical Upswing, Structural Change. April 2018.
² Alliance Bernstein. Global Macro Outlook. May 2018.
³ Scotiabank. Strategic Edge Weekly. May 14, 2018.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Fixed Income. April 30, 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.