September 2019
While geopolitical developments have always played a role in economies and markets, their scale and impact has been steadily rising since the 2008 financial crisis. Against a hostile trade backdrop, the global economy is losing momentum. Forecasts for world GDP growth this year have fallen to 3.2% from the 3.9% economists expected a year ago.1 Uncertainty about Brexit and U.S.-China trade relations have combined with stresses in some emerging economies to weigh on the outlook. In August, the U.S. escalated its trade war with China by threatening to impose 15% tariffs on roughly US$300 billion of goods exported by China to the U.S., which until now had been exempted from trade barriers. September saw an unprecedented liquidity squeeze in USD money markets, the ECB resumption of unconventional easing, a second consecutive Fed cut and other central bank decisions, and an attack on Saudi oil infrastructure. The drone attack on the Abqaiq oil process facility in Saudi Arabia resulted in a loss of approximately 5.7 million barrels (5% of global oil supply).2
Inverted yield curves and slumping manufacturing activity that are traditional recession predictors are contributing to a cautious business mood. Few governments have committed to providing fiscal support, leaving extraordinary stimulative monetary policy as the tool of choice to combat the recession threat. Our concern is that central banks in several countries are operating at the limits of what monetary policy can do. This has negative feedback implications for fiscal policy and financial markets.
In the Euro area, GDP growth is expected to remain subdued in Q3. The persistence of healthy labour market conditions as well as efforts by several central banks to shore up an expansion will provide support to the global economy. Germany remains in an industrial sector slowdown that saw GDP decline in two of the last four quarters (year-over-year growth of 0.4% is the weakest since the euro crisis).3 Other more domestically oriented economies like France and Spain have expanded more steadily. UK GDP surprised to the upside in July, rising 0.3% month-over-month.4 It looks like the UK will avoid a technical recession (two consecutive quarters of negative growth) in Q3 but uncertainty around another Brexit deadline will make it hard to predict the economy’s underlying direction.
In the U.S., the stronger-than-expected 0.6% month-over-month rebound in industrial production in August suggests that the drag on U.S. producers from weaker global demand may be starting to fade.5 The U.S. consumer is holding up very well, as shown by August retail sales were up 0.4% month-over-month and 4.1% year-over-year.6 The Fed voted to cut its key policy interest rate by an additional 25 basis points to 2.00% on September 18th. The measure of core inflation remains low at 1.6% year-over-year. The Fed cut the interest rate on excess reserves (IOER) rate by 30 basis points to 1.8%. The offer rate on the reverse repo facility was cut by 30 basis points to 1.7%, in order to make it less attractive so it doesn’t soak up as much liquidity.7
After a slow start to the year, Canada’s economy bounced back as real GDP growth accelerated to 3.7% annualized in the second quarter. Trade contributed to growth as exports surged at the fastest pace in five years. Nominal GDP grew 8.3% annualized, on top of the prior quarter’s 5.7% increase.8 The USMCA has yet to be ratified. Canada’s direct exposure to China is relatively limited, as China accounts for about 5% of Canadian exports.9
U.S. equities declined in August, reflecting implications of an inverted yield curve and a possible trade war with China. Large caps declined, with the S&P 500 down 1.6%, while the S&P Midcap 400 and S&P SmallCap 600 were down 4.2% and 4.5%, respectively. Interest rates in the U.S. declined across the board, leading to strong fixed income performance. Canadian equities gained in August, with the S&P/TSX Composite up 0.4%. The S&P Europe 350 declined 1.4%. U.K.’s fears of a “no deal” outcome helped send the S&P United Kingdom down to a 4.2% loss in August while sovereign bond prices rose across the continent. Asian equities slipped lower in August, as protests in Hong Kong combined with U.S.-China trade war worries weigh on regional markets. The S&P China 500 lost 0.6% in August. Asian fixed income indices ticked up across the board.
We maintained the August asset allocation across all models in September. Allocation to equities remains at 17% in Tactical Conservative, 22% in Tactical Moderate Growth, 36% in Tactical Growth, and 44% in Tactical Aggressive Growth. With Treasury yields declining, Gold is present in all models as it performs well in high risk, low yield environments as a risk-free asset class. Geopolitics now a primary driver of markets. 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. July 2019.
2 S&P Dow Jones Daily Dashboard. September 16, 2019.
3 Trading Economics. Germany GDP Growth. August 27, 2019.
4 Office for National Statistics. UK GDP Growth for July 2019. September 9, 2019.
5 Trading Economics, U.S. Industrial Production MoM. September 17, 2019.
6 Trading Economics, U.S. Retail Sales in August. September 13, 2019.
7 Federal Reserve, IOER. September 19, 2019.
8 Trading Economics, Canada GDP. August 30, 2019.
9 Trading Economics, Canada Exports. August 30, 2019.
Index return data from Bloomberg and S&P Dow Jones Indices Index Dashboard: U.S., Canada, Europe, Asia, Fixed Income. August 30, 2019. Index performance is based on total returns and expressed in the local currency of the index.
