Your Market Review

It’s becoming clearer why world GDP growth accelerated sharply last year. Latest data from the CPB showed trade volumes not only reaching a new record but also growing in 2017 at 4.5%, the fastest pace since 2011.

 

Stock market

Canadian

The S&P/TSX continues to struggle. What ails Canadian equities? The answer is P/E compression due to NAFTA uncertainty and household debt. In our view, the current pessimism about the S&P/TSX is overdone.

 

US

For S&P 500 constituents in Q4, 76% had sales and 78% had earnings that beat analyst expectations. But what about the outlook? For profits to continue surprising on the upside, financial conditions in general (not just monetary policy) must remain supportive.

 

International

Early in February global equities went through a correction worse than any since August 2015, when China surprised markets with a devaluation of the renminbi. This time around, the surge in volatility and the drop in equity markets was triggered not by China but by 10-year U.S. Treasuries.

 

Economy

Canadian

Barring the implementation of protectionist policies stateside, Canadian exporters should enjoy positive spillovers from the recently announced ramp up in U.S. fiscal stimulus. Domestic demand will also find support as business investment continues to recover, consumers enjoy higher incomes courtesy of housing wealth effects and a strong labour market, and provincial governments ramp up spending ahead of elections in Ontario and Quebec. Rising inflation pressures should prompt the Bank of Canada to raise interest rates further, although the extent of monetary tightening will depend on the outcome of NAFTA negotiations.

 

People close to the process say the U.S. side, expressed the need to finish before Mexican presidential elections in July, is now showing more flexibility and had dropped its insistence that all autos made in NAFTA nations should have 50% U.S. content. The Canadian dollar strengthened against its U.S. counterpart on the news. The Bank of Canada has been worrying that uncertainty over the future of the North American Free Trade Agreement may weigh on the economy. Comments last week from Governor Stephen Poloz have reinforced expectations the central bank will take its time raising rates after hiking them three times since last July.

 

The central bank signaling growing confidence that U.S. tax cuts and government spending will boost the economy and inflation and lead to more aggressive future tightening.

 

Early in February global equities went through a correction worse than any since August 2015, when China surprised markets with a devaluation of the renminbi. This time around, the surge in volatility and the drop in equity markets was triggered not by China but by 10-year U.S. Treasuries.

 

US

Fed sees as expected at least two more rate hikes this year. U.S. stocks were little changed after the announcement as the U.S. Federal Reserve raising interest rates as expected and a recovery in Facebook shares.

 

To be sure, economic activity is already buoyant. While GDP growth is slated to soften in Q1 ─ with consumers taking a breather after drawing on savings the prior quarter ─ we anticipate an acceleration in subsequent quarters amidst strong fundamentals. Higher wage growth associated with a tight labour market, federal tax cuts on personal income, sky-high confidence, low interest rates, and easy access to credit, all bode well for consumption spending this year. Increased consumer confidence explain in part why household debt rose to a record US$13.1 trillion at the end of last year. And the good news is that the increased leverage is not coming at the expense of higher risks to financial stability because the quality of loans is better than say 10 years ago, as evidenced by declining subprime shares of mortgages and auto loans. Business investment, which bounced back sharply last year, also seems destined for another good year propped up by strong corporate profits and a good global economic outlook. As such, domestic demand should accelerate this year.

 

As if tax cuts were not enough, the U.S. Congress opted for another dose of fiscal stimulus, this time by increasing spending caps. That prompted an upgrade to our U.S. GDP growth forecasts by a little less than half a percentage point for both this year and next. But this growth spurt is temporary because it comes at the expense of future growth. The budget deficit, which is now projected to soar next year past US$1 trillion (more than 5% of GDP), will have to be addressed down the road via spending cuts and tax hikes. Should Congress not wake up to this reality, markets will make them. The recent uptick in Treasury yields was just a warning shot.

 

As if tax cuts were not enough, the U.S. Congress opted for another dose of fiscal stimulus, this time by increasing spending caps. That prompted an upgrade to our U.S. GDP growth forecasts by a little less than half a percentage point for both this year and next. But this growth spurt is temporary because it comes at the expense of future growth. The budget deficit, which is now projected to soar next year past US$1 trillion (more than 5% of GDP), will have to be addressed down the road via spending cuts and tax hikes. Should Congress not wake up to this reality, markets will make them. The recent uptick in Treasury yields was just a warning shot.

 

International

The world economy continues to grow at a decent clip, propped up by trade flows which are boosting both the OECD and emerging markets. That trend should continue in 2018 as exporters to the U.S. get an added lift from the latter’s enhanced fiscal stimulus.

 

Europe :The eurozone managed to grow 2.5% in 2017, the best in a decade and better than even the U.S. While the global trade uptick boosted the zone’s exports, domestic demand was also solid. Loose central bank policies helped stimulate credit and spending. Consumption, for instance, continued to improve as evidence by retail volumes which are now within a hair of the 2007 peak.

 

Japan : Improving trade allowed export powerhouses in both advanced and emerging markets to flourish. Industrial production in the OECD grew at the fastest pace in years courtesy of the U.S., the Eurozone and Japan. Japan’s exports even soared to an all-time high, propping up economic growth as a result. So much so that Japan’s 1.6% growth print in 2017 was not only double the Bank of Japan’s estimate for potential growth but was also the best in four years.

 

China : The uptick in world trade was a boon to China last year. The world’s second largest economy grew a better-than expected 6.9% in 2017 as exports bounced back. Not surprisingly, industrial production (including electricity output) picked up significantly. While growth is expected to soften slightly this year, China will still remain the envy of the world. A projected 6.5% growth print, in line with Beijing’s stated objective, is feasible more so with the implementation of China’s ambitious 5-year plan now in full swing.

 

But a widening U.S. trade deficit raises odds of growth busting protectionist policies being implemented. Another major risk that threatens to derail global growth is the sizable amount of leverage in the world’s financial system at a time of rising interest rates.

 

Summary

Canadian

Canada’s GDP expanded at an annualized pace of 1.7% in the fourth quarter last year, allowing for a 3% growth print for 2017 as a whole, the best annual performance in six years. While trade was an expected drag on growth in Q4 due to surging imports, domestic demand provided more than an offset thanks to gains for consumption, government spending, business investment and residential construction. Consumption found support from solid gains in real disposable incomes which offset the impact of a rising savings rate. Nominal GDP grew for an eighth consecutive quarter, which will pad government coffers further. A decent handoff from December ─ GDP grew 0.1% (unannualized) in that month ─ points to a decent performance in the first quarter as well.

 

US

 

With financial conditions as pro-growth as they are now, the economy can be expected to continue expanding at a fairly brisk pace. This development, coupled with the Trump administration’s recent success in implementing its probusiness agenda of tax cuts and deregulation, has been reflected in earnings revisions.

 

With so much good news now priced in, the S&P 500 is more vulnerable to disappointment. A key risk factor for the profit outlook is the apparent U.S. tilt to protectionism. After all, the foreign share of S&P 500 sales is more than 40 per cent.

 

International

 

All in all, we continue to expect the global economy to replicate if not top last year’s growth print. Slightly tighter monetary policy in some economies are unlikely to derail the ongoing improvement in domestic demand, while exporters should continue to benefit from buoyant world trade.

 

Our asset allocation

We are confortable with our asset allocation at the moment. While raising interest rates in the coming month could have a significant impact, we are currently comfortable with our current weighting. We will monitor the situation closely and take action if we see any opportunities.

Fixed income

The bond market seems to have incorporated the additional rate hike at its current level. In the coming weeks, we will search for any opportunities, regarding the duration of the fixed income portion as well as in the geographic area of our investments. We would like to be positionned to mitigate future interest rate increases. As soon as we see interesting opportunities, we will adjust the portfolio accordingly.

 

Stocks

We still believe we are nearing the end of the stock cycle. The market volatility earlier this year lead us to believe that we might continue to go though market bumps. Our strategy for the beginning of the year was to secure the profits and it allowed us to better cope with the fluctuations since February. We will look closely at the impact of events in Canadian, US and international markets and adjust the portfolio if we feel we should adjust the risks.

 

Disclaimer: The opinions expressed herein do not necessarily reflect those of National Bank Financial. . The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. National Bank Financial is an indirect wholly-owned subsidiary of National Bank of Canada. The National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). National Bank Financial is a Canadian Investor Protection Fund member (CIPF).