In October, we evolved our twelve-month forward-looking outlook to reflect a six-month period of Growth, followed by a six-month period of Inflation. The global economy remains on track for another year of solid growth, likely to be just under 4%, as we enter the fourth quarter of 2018. However, domestic factors are causing the overall picture to become more uneven across countries and regions. Our view continues to reflect the impact of the escalating U.S. trade war and the risk to the U.S. economy as monetary policy tightens.
In both the Eurozone and Japan, domestic demand growth has remained above potential and in line with the 2017 rate. However, contribution from trade has weakened. Growth in the United Kingdom has continued to soften since 2016 and the Brexit vote. In China, trade slowdown continues to result in uneven growth. Tariffs imposed by both the U.S. and China haven’t been large enough to materially impact global trade.
In the U.S., a late cycle fiscal stimulus from tax cuts has boosted household and business spending, pushing already robust growth even higher. However, we expect the multiplier from the tax cuts to add only 20-30 basis points to growth in 2018 and even less in 2019. Most of that is likely to come from business investment, reflecting the immediate expensing of capital expenditures. The widening in the trade deficit to $53.2 billion in August suggests that even before the latest round of tariffs, there were signs that previous retaliatory tariffs on U.S. exports were starting to take effect with goods exports to China slowing sharply in August¹. After providing a big boost in the second quarter, the new USMCA agreement that is replacing NAFTA has relieved some trade tensions, but over 10% of total imports are now taxed following the levy placed on an extra $200 billion of Chinese goods¹. The opposing forces of U.S. fiscal stimulus and trade tensions should dominate the macro picture for the rest of 2018.
While Canada’s growth has been partially driven by gains in consumer and business spending, the revival in exports, owing to robust demand from the U.S. and a weaker Canadian dollar, has been a larger recent contributor. These tailwinds have helped to offset some effects from newly imposed tariffs and have sent the trade surplus with the U.S. to its highest level since 2008. The Bank of Canada raised its trend-setting interest rate for the third time this year, by another 0.25% up to 1.75%, on October 24th².
September was mixed for U.S. equities. The S&P 500 gained 0.6%, while the S&P MidCap 400 lost 1.1% and the S&P SmallCap 600 lost 3.2%. For the quarter, the S&P 500 gained 7.7%, driven by a strong economy, outperforming both Mid and Small Caps. The S&P/TSX Composite continued its August decline to end the quarter down 0.6%. In Europe, the S&P Europe 350 finished September up 0.6%, and 1.4% for the third quarter. The S&P United Kingdom Index gained 1.4% in September, benefitting from a decline in sterling. France and Sweden also made significant positive contributions for the month. Despite growing trade tensions in the area, Japan had a strong month with the S&P/TOPIX 150 returning 5.9% and 7.2% for the quarter. Commodities did well with the S&P GSCI gaining 3.9% in September, driven by gains in crude oil.
We maintained the asset allocation in Tactical Growth and Tactical Aggressive Growth. In Tactical Conservative and Tactical Moderate Growth, equity exposures were reduced by 10%. Five percent came out of each U.S. Mid Caps and U.S. Small Caps, with the total being redeployed into 3-7 year U.S. Treasuries. This move is consistent with our recognition that tax cuts from earlier in the year are having a short-term positive impact on the U.S. economy that is more than offsetting the uncertainty created by the trade wars initiated by the U.S. on China as well as many other trading partners including Canada and Mexico.
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 Capital Economics. United States Chart Book. October 18, 2018.
2 Bankofcanada.ca. Policy Interest Rate.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. September 28, 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.