Growth with Volatility

Global economic conditions over the next 12 months will continue to favour equities over fixed income as accelerating growth in the US positively impacts worldwide corporate profits.  The $1.5 trillion US Tax Reform Bill passed in late December combined with a likely Infrastructure Package in the first half of 2018 should boost US domestic employment, wages, consumption and investment.  The Trump/Republican agenda has effectively shifted the policy emphasis from monetary to fiscal stimulus leaving the US Federal Reserve free to normalize interest rates as conditions permit.  It is the intersection of strong domestic activity and rising interest rates that will result in a much more volatile climate for capital markets, foreign exchange rates and investor confidence. Our key assumptions are as follows:

 

  • S&P 500 earnings will rise to record levels driven by sales growth rather than improving margins. Breadth in the US market will increase noticeably as the technology sector lags the overall index. Cyclical sectors (industrials, materials and consumer discretionary) along with small and mid-cap indexes will provide market leadership.
  •  US interest rates will rise as the Federal Reserve continues to remove excess liquidity leaving market forces to dictate the course of bond yields. With a current yield to maturity of approximately 2.5%, bond benchmarks (Aggregate in the US and Universe in Canada) may have difficulty producing positive returns in 2018.  Active management of credit, currency and duration will remain essential to fixed income allocations and returns.
  • Trump is expected to take a hard line on trade which could negatively impact Canada and Mexico but to what extent, it is difficult to quantify. Needless to say, it will not be helpful to either the Canadian or Mexican domestic economies.
  • A tougher trade environment may prompt European leaders to adopt more stimulative domestic fiscal policies on top of already highly stimulative monetary policy. This would be a continued positive for the MSCI EAFE index.  It would also lead to a reversal of the decline in the US dollar seen in 2017 making currency hedging a major decision for US investors abroad.
  • Despite an expected strengthening in the US dollar, we look for commodity prices to rise, especially industrial metals (copper, nickel, zinc, steel etc.) due to high physical demand combined with stable to declining inventory levels.