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Travel with Caution, Not Fear 2.0

The title to this year’s economic forecast is…the same as last year. Admittedly, I will fail to earn any creative title credit, but the fact of the matter, there are similarities between 2019 and 2020 with a few exceptions.

The 2019 forecast painted a picture of uncertainty due to trade anxiety and the rising possibility of recession. However, there was reasonable expectation when the market plumbed new lows in the 4th quarter of 2018 it would lead to recovery in 2019 despite recession fears. And so, it was. 2019 turned out to be a decent market growth year for both equities and fixed income albeit unevenly spread across the year. Growth was driven more by share buybacks and strong consumerism while corporate earnings declined. The US manufacturing sector did, in fact, have a recession, mainly due to trade uncertainty, but a recession at large was not in the cards and would appear to be even less probable than originally expected for 2020. Central bank interest rate easing contributed to further expansion. It has been stated, by whom I do not recall, “markets don’t die of old age, the Fed kills them with rate increases”.  2019 started with increased rates but ended lower.

While Canadian economists predicted a reasonably optimistic view for 2020 Canadian economic growth and market performance, it is determined, largely, by what happens elsewhere. Canada is an exporting nation and can’t rely as heavily on consumers as can the US.  At the time of writing this article the headline, “Bank of Canada holds interest rate, but cuts growth forecasts as economy’s engine loses momentum” from the Financial Post crossed my desk. The “new outlook is one of underperformance, with room for stimulus.” Reading between the lines, stimulus equals interest rate cut. As in most life situations events don’t occur in isolation; one event leads to another, akin to traffic flow when you slow to a crawl only to find when you get to “accident ground zero”  it no longer exists or more infuriatingly, it’s on the other side of the median! Even though the jobless rate is low (plus rising wages) and the housing market remains strong, business investment softened in last year’s third quarter, no doubt due to trade concerns and that in turn, led to softening numbers on consumer confidence and spending. Perhaps we achieve stall speed as we would on the 401 but inevitably traffic picks up and this metaphorically illustrates the ebb and flow of economic growth. The accident has already happened, we’re just waiting for the traffic to start moving.

Without a “made in Canada” recession and energy sector support through improved clarity from the federal government and industry for pipeline plans, there is more optimism in the air. Funny how contagious that can be. There is expectation that the Canadian market, having lagged competing US markets in recent years, may outperform the S&P500 in 2020.

The challenge for the US market(s) is to absorb its rich valuation over the last year that maybe wasn’t entirely earned. Consider the fact that Tesla is worth the same as Ford and GM combined or that Apple is worth the same as all the companies on the German DAX market combined. Not everything is expensive, but this suggests buying some well-known names may be hazardous. 

In every US election year since 1930 US markets have displayed volatility and headwinds. The year following a US presidential election, has rewarded those who were patient, regardless of the elected party heading to the Whitehouse. The US is too big to ignore. There will always be opportunities south of the border.

US managers, on the other hand, are quick to point out to American investors that if you think the best stocks are in the US, think again. They observe that international indices don’t show the complete picture. Capital Group, headquartered in Los Angeles state, “International indices generally have a greater concentration of value-oriented stocks in “old economy” sectors such as materials, financials and energy. Contrast that with the US, where technology and health care dominate. International markets may not be heavily weighted with high-flying tech stocks, but they have no shortage of market leading companies. A significant part of the health care sector is US-based, but large pharmaceutical companies Novartis, AstraZeneca and Novo Nordisk all call Europe home. Compared to US stocks, international equities have also had higher average dividends yields and lower valuations, making them more attractive for defensive minded investors in a late cycle environment.”

The final market comment goes to emerging markets; historically considered high risk due to sector or region. Today nearly 66% of stock returns from EM companies are directly attributed to company fundamentals in the same manner of assessing companies globally. Thirty years ago, 66% of the return was specific to region and sector. Today, emerging markets are benefitting from the trade agreement, Comprehensive and Progressive Agreement (TPP without the US) and according to Invesco’s Talley Leger, Senior Investment Strategist, a flat to weaker US dollar should boost Emerging Markets relative to US stocks.

In conclusion, there are global bright spots to consider such as reduced recession fears and improving market opportunities domestically, the US, Europe and emerging markets. Globally most central banks reduced their interest rates in 2019.  Canada held out from either raising or dropping rates in 2019 but as stated earlier may ease once this year. Correspondingly this will stimulate economic growth and the markets. 

I would be remiss in not mentioning continued risks associated US/China trade, expansion of tariffs by US on China or Europe, Middle East tensions, Brexit, Trump impeachment trial within US election year or trade wars becoming currency wars. When written in Chinese the word “crisis” is composed of two characters one representing danger and the other represents opportunity. 

Speak with us about how the outlook impacts your objectives and whether portfolio adjustments are in order.

Cam