At the beginning of the year, we pointed out the uncertainties surrounding a rising interest rate environment and whether economic growth can offset central banks’ efforts to normalize interest rates. We are now at the halfway point of 2018 and the Global economy continues to speed ahead in a synchronized growth trajectory on track for a forecasted 3.3% global GDP growth this year. However, all is not rosy. The rising trade tensions have now replaced recession fears and are serving as the new headwind to strong performance in the Equities market.
In the first half of 2018, headlines from the Trump administration on trade tariffs resulted in a market that has been more volatile on a short term basis, but the net effect has been much more neutral.
Mid-Year Major Indexes Performances (as of June 29th, 2018)
S&P 500 1.6%
S&P/TSX Composite -0.2%
Euro Stoxx 50 -4.5%
Here are three key questions to ask for the rest of 2018
Will the Canadian loonie continue to weaken?
The protectionist measures announced so far this year had the immediate effect of boosting the U.S. Dollar value. Year-to-date, U.S. Dollar has risen against Canadian loonie by 6.2%. The rally in the Energy market had muted effect on the loonie as the discount widened between WTI and Canadian Crude Oil Prices. Continued U.S. Dollar strength is conceivable given the rising trade tensions in the near term, however, prolonged protectionist policy would have unpredictable impact over the long run and weaken the U.S. Dollar’s status as the world’s reserve currency.
Given the stronger than expected Canadian GDP growth in April, the market now has priced in a ~75% July interest rate hike from Bank of Canada, giving a boost to the loonie at June month end.
Can U.S Equity Market continue to deliver strong?
In our base case scenario for the U.S. Equities, the market will deliver strong performance in 2018.
Earnings Growth 2018E: S&P500 12% (ex tax) Positive
Valuation: S&P500 Forward P/E 17.2x 2018 & 15.6x 2019 Positive
TSX P/E 15.7x 2018 & 14.0x 2019
Sentiment: Global synchronized growth vs. trade tensions Neutral
Bull markets in the U.S. last from 18 to 33 years and we are now 9 years into the current bull market. The base scenario is for the P/E multiple to stabilize at the current level and corporate earnings to deliver double digit growth. In other words, as the price at which investors pay for Equities remain unchanged, returns will be driven by corporate earnings growth.
How would trade escalations impact investors?
While trade protectionism is not all bad and can be beneficial to certain domestic industries, the overall net effect will result in lower economic growth and in turn, lower rate of return for investors.
Even though the global economies have delivered strong growth into the first half of 2018, the direct impact on higher input costs and the indirect impact on global business sentiment cannot be underestimated.
The currently enacted import tariff by the U.S. has been a small percentage of total import and GDP. However, the U.S. has threatened to impose a much wider range of tariffs that will disrupt current global integrated supply chains. In economic terms, the supply side shock can predictably lead to higher inflation, tightening financial conditions and lowering GDP growth.
We will likely have more clarity in Q42018 on the newly announced tariffs.
Rita Li works with high net worth individuals and families to provide a high touch service in holistic wealth management planning. Her team encompasses professionals with in-depth taxation and legal backgrounds, together, they strive to deliver a high standard of service to clients. Rita is a Chartered Financial Analyst CFA® and Certified Financial Planner CFP® with expertise in asset management. Rita obtained her MBA from Richard Ivey School of Business. Contact Rita for a complimentary consultation to determine whether the services she provides can be the right fit for you and your family.
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