October 2017

In October, we changed our outlook to Growth for the next three months, reverting back to Stagnation for the following nine months. The economic expansion in advanced economies seems set to continue for the next year, led by rising household consumption and business investment. Although most economies are approaching full employment, inflation has remained below targets.

The ECB is likely to taper its asset purchases during 2018 and raise rates to around 1% by the end of 2019. Inflation is likely to remain below the ECB’s target. Prospects for emerging economies have improved, as Brazil and Russia have come out of recession. China’s economy is likely to slow gradually. In Australia and New Zealand, GDP growth is steady however, inflation remains very weak. We expect the Reserve Banks of both countries to hold rates until 2019.

Having raised interest rates twice this year, we don’t expect the Bank of Canada to move again this year. The economy is benefiting from a rise in business investment and exports, however, there is a risk of downturn in consumer spending next year as household debt weighs and house prices may start to fall.

The U.S. Fed is expected to continue to unwind QE slowly while raising rates. After a slow start to this year, the economy benefitted from looser financial conditions, as bond yields and the dollar have fallen. Since the relationship between spare capacity and inflation has weakened since the financial crisis, average earnings growth should remain very subdued. The recent economic growth was driven by consumer spending and business investment, while exports contributed meaningfully on the back of a softer dollar and firming global demand. The Fed is likely to look through any storm-related economic weakness and seems commitment to one more rate hike this year.

Yields rose during September, with the 10-year Treasury increasing to 2.33%¹. The move up in yields resulted in weak bond returns with the S&P U.S. Treasury Bond Index down 0.77% and the S&P U.S. Investment Grade Corporate Bond Index down 0.24%. The search for yield led the increase in the S&P U.S. High Yield Corporate Bond Index, up 0.87%.

During September, U.S. Equities were strong performers, led by the S&P SmallCap 600 Index gaining 7.7%. The S&P Midcap 400 returned 3.9% and the S&P 500 returned 2.1%. The S&P/TSX Composite was up 3.1% with the Energy sector as the top performer gaining 7.7%.

The Eurozone also posted strong gains in Euro terms, with the MSCI EMU Index returning 4.4%, however, recent Euro weakness weighed on gains. The MSCI EAFE Index of developed market companies returned 2.5%. Emerging Markets, measured by the MSCI EM Index, came under slight pressure from a strong U.S. Dollar, as the index dropped 0.3%.

Unlike the strength seen in September, US dollar weakness was a key highlight in 2017. In the third quarter, strong gains were posted by the euro, up 3.4%, British pound, up 2.9%, Brazilian real, up 4.6%, and Canadian dollar, up 4.0%.  The Mexican peso, down 0.7%, and Japanese yen, down 0.2%, slightly depreciated. From the start of the year to September, the US dollar is down 8%. Commodities broadly rallied in Q3 with oil finally joining metals in positive territory. WTI, up 12%, copper, up 9.5%, and gold, up 3.1%, all posted gains in Q3.

In October, we revised our asset allocation, adding currency-hedged exposure to Canadian equities across all models. Asia ex Japan and currency-hedged Australian equity exposure were added to Growth and Aggressive Growth at 5% and 10% each. We reduced 3-7 Year Treasuries in all models and reduced European equities in Growth and Aggressive Growth.

 

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

 

¹Treasury.gov. Resource Centre. Daily Treasury Yield Curve Rates.

Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Fixed Income. September 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.