GLOBAL GROWTH DECELERATES TO STILL-DECENT RATES

The world’s major stock markets suffered double-digit declines in the second half of 2018 due to trade tariffs, rising rates and a global slowdown. The market has essentially bounced back with easing trade tension, communication from the Federal Reserve that they are going to hold interest rates, and stimulus in the US economy. Looking forward, economic momentum is slowing and the deceleration was largely incorporated into RBC forecasts from last quarter, but the hit to confidence from financial-market volatility, and the extended U.S. government shutdown, which was not part of our base-case a quarter ago, had negative economic impacts.

Globally, RBC’s forecast is for 3.50 percent growth in 2019 and 3.25 percent growth in 2020, down from nearly 4.00 percent from the past two years. Further deceleration in 2020 seems likely as economic slack has diminished and the U.S. will encounter fiscal headwinds next year. To be clear, we are expecting growth to moderate, but with low interest rates around the world, a trade deal in the works and China providing additional stimulus, we are cautiously optimistic on the global stock market.

 

THREE MAIN RISKS

The three main risks to our outlook are 1) protectionism (tariffs), 2) Chinese growth and the 3) U.S. economy. Tariffs enacted thus far are starting to inflict economic damage through slowing global trade, although we don’t see further protectionist policies being actively implemented. The U.S. is leading the charge on tariffs and it’s possible that current tariffs remain in place for longer than anticipated. Moreover, moderating activity in China is a particular concern as the country is now the world’s second-largest economy and biggest contributor to global growth. The Chinese government has announced a variety of measures to counteract slowing growth, but in doing so it has renewed concerns over potential debt problems. In the U.S., we also see a few areas of risk: the U.S. economy is now extremely tight, the rate at which consumers miss payments on auto loans is at an elevated level and still-rising, and the yield curve is extremely flat (i.e. interest rates for long-term bonds are very similar to those of short term bonds, which is usually a signal that the economy may experience future difficulties). However, the fact we are in late cycle doesn’t mean investors should necessarily avoid risk-taking. Instead, we take it to mean that the risk-reward case is just not as strong as compared to earlier points in the cycle, and volatility will likely be greater in this environment. To further protect portfolios, we have been focused on generating dividend income.

 

FOUR CANADIAN CHALLENGES

 

            Despite strong U.S. growth in 2017 and 2018, the Canadian economy has lately begun to slow. Looking to the future, we identify four key macroeconomic challenges for the Canadian economy. These are slowing U.S. growth (which, as mentioned previously, is expected to decrease), a weakening domestic housing market, poor competitiveness versus the U.S. and a challenging domestic environment for the production and transport of crude oil.

            We are paying particular attention to the housing market. Although we do not expect a nation-wide market bust, we are seeing price and resale activity declines in Vancouver (until recently Canada’s hottest real estate market).  As a result of higher borrowing costs and tougher housing rules, consumers’ ability to borrow has been reduced considerably. Existing home sales are down sharply in major markets and home prices are rising only modestly at the national level. What was once a boost to growth in the economy may be morphing into a modest drag. Canada’s economic challenges are likely to prevent the Canadian dollar from going higher in the near future.

 

 

            On a global basis, we still see growth in the coming years –we just see slower growth. However, we are somewhat concerned about the Canadian economy, especially now that the housing market could begin to help contract, not expand, the economy. Therefore, considering the different risk-reward profiles across the globe, we maintain our preference for investment in US and international equities over Canadian stocks.

 

            As usual, we are happy to address any questions or comments you may have.

For those who have asked, please see enclosed pictures of our daughters and the latest addition to the family: “Frosty the Snowman”.