Mackenzie Asset Allocation Team
- From North Korea to the chaotic Trump White House, geopolitical risks made headlines again last quarter. However, despite the headline noise, the MSCI World Index returned 3.9% for the quarter in local currency terms, a reminder that headline based investing is rarely rewarding. The index has gained for 11 consecutive months dating back to November 2016, which is tied for the 2nd longest string of positive monthly returns since 1970. This quarter, we saw very strong performance from emerging markets with the MSCI Emerging Markets index returning 7.7% in local currency and 3.9% in Canadian dollars. China, Russia, and Brazil all posted double digit returns. Canadian equities also performed well, returning 3.7%. Oil prices rose during the period, contributing to healthy Canadian energy sector returns (+6.6%). US equities rose 4.5% in USD but, a strong Canadian dollar (+3.9% vs. USD) wiped out most gains.
- In bonds, yields were generally flat globally but, were higher in Canada. As a result, Canadian bonds, as represented by the FTSE TMX Canada Universe Bond Index fell 1.7%. In contrast, global bond markets moved slightly higher with the Bank of America Merrill Lynch Global Broad Market Index Hedged to CAD returning 0.6%. High yield bonds was the best performing bond asset class with the Bank of America Merrill Lynch US High Yield Index Hedged to CAD advancing 1.8%.
Outlook & Strategy
Asset Mix: Global economy in high gear, supporting global stocks
We expect that the global economy will continue growing above-trend with low inflation this quarter, supporting stocks relative to lower risk government bonds for the following reasons:
- Today, most major economies enjoy strong growth compared to the last 5 years.
- Tax reform in the US should support US economic activity.
- China’s leadership will aim to ensure above-target growth, particularly ahead of the National Party Congress this year
- Resiliency in the euro zone to political shocks. Also, a loose monetary stance, reduced fiscal austerity and recovery in domestic demand will support steady job gains.
- Japan is also expected to grow above trend, benefitting from a weak yen, strong consumer spending and public investment, and ultra-loose monetary policy.
- Major emerging markets, including Brazil, Russia and South Africa are benefiting from improved commodity prices and easy access to foreign capital.
- Steady economic growth with low inflation has historically favoured stock markets.
Currency: Loonie expected to strengthen further
Strong investor enthusiasm for the Canadian dollar is expected to persist this quarter as investors anticipate higher interest rates given above-trend economic growth. Factors we expect will continue supporting the dollar include:
- Market expectations for further monetary tightening by the Bank of Canada due to above-trend economic growth will support the Canadian dollar.
- The US dollar may be under pressure due to potential uncertainty in Fed policy in 2018 as the Fed’s senior leadership could change significantly with multiple vacancies on the Fed’s board and President Trump may also replace Janet Yellen as Fed Chair. In addition, persistent weakness in inflation may provide ammunition for a slower pace of US rate hikes.
- The yen is expected to remain weak as the Bank of Japan continues to maintain its ultra-loose monetary policy, showing little sign of pulling back like other major central banks.
Relative Equity: Expecting a challenging environment for Canadian equities
Even though we view economic and inflationary trends as supportive of stocks in general, not all equity markets are expected to gain equally. Despite headline news of impressive GDP growth and a strong loonie, these factors are actually expected to be headwinds for Canadian equities in the near term:
- Recent GDP growth has pushed growth expectations significantly above our estimates of potential or long-run growth makes sustainability difficult. Should realized GDP growth slow, downward pressure could build in Canadian stocks.
- Since 30% of Canada’s economy is export-based, a stronger loonie could dampen the profit outlook of companies with export revenues.