MAST Asset Allocation Outlook: Lower Uncertainty But Still Plenty of Fear

Heightened uncertainty from trade policy has been a core investment theme this year, but the synchronized central-bank response, especially from the Fed, has been unambiguously supportive of risk assets.
December 2019
  • The re-acceleration thesis is slowly emerging while trade optimism remains high, which is helping drive stocks to record highs. We expect the macro environment to remain supportive of risk assets heading into 2020.
  • Global growth is stabilizing and with a trade détente and accommodative monetary policy, the mini-cycle should reboot by next summer. If need be, we expect central banks to continue easing in 2020 and further support the cycle.
  • The Canadian economic outlook remains soft, but households should stay a key driver of growth, most notably via a strong housing market. We also expect U.S. consumers to keep the expansion going.
  • While some degree of trade tensions is likely to persist in 2020, a de-escalation will comfort central banks and business confidence, and the scope for rate cuts should be less intense in coming months. We expect the future BoC policy path to be more closely aligned with the Fed next year.
Uncertainty always creates doubt, and doubt creates fear.

– Oscar Munoz

Lower Uncertainty But Still Plenty of Fear

For a change, November went by with little trade drama while macro indicators increasingly suggest a bottoming in growth for the U.S., European and Chinese economies. The U.S. once again surprised to the upside with third quarter GDP growth clocking 2.1% and Q4 growth tracking higher near 1.5%, whereas the Canadian growth slowed to 1.3%. Not all too exciting, but enough to push out gloomy recessionary calls. In Europe, the German economy narrowly avoided a technical recession, but growth remains underwhelming across Europe and calls for fiscal stimulus are mounting yet remain ignored so far (Source: Euractiv). Equities have rallied hard this year but investors remain fearful, which continues to drive demand for safe-haven government bonds.

More New Highs for Stocks in November

Trade optimism helped send global stocks to new highs in November (MSCI ACWI, +2.5%), led by U.S. stocks with a 3.6% gain for the S&P 500. Meanwhile, the Nasdaq 100 climbed 4.1% on better-than-expected earnings, bringing year-to-date performance to 34.1%. European (MSCI Europe, +2.5%) and Japanese (Nikkei, +1.6%) stocks lagged as earnings underperformed and growth expectations still fail to significantly improve versus a resilient U.S. outlook. A persistent area of weakness in stocks remains emerging markets, which fell slightly (MSCI EM, -0.2%) as growth anxiety persists in China and elsewhere, leaving the year-to-date performance at a meager 7.7%. Finally, Canadian stocks had a solid month (S&P TSX, +3.6%) as the energy sector rebounded 7% after a 10% rout the previous month.

Following a tumultuous October, the more benign risk-sentiment in November helped to slightly lift yields on government bonds in Canada and the U.S., up by 5 and 8 basis points, respectively. The U.S. dollar climbed nearly a percent on better-than-expected macro indicators, notably the strong payrolls report (Source: CNBC). Meanwhile, the loonie fell 0.9% as investors temporarily lost confidence that the Bank of Canada (BoC) could remain on the sidelines much longer.

Equity Factors: Late-cycle reflation hope not good for defense

Playing defense in equity factors was challenging as global Low-Vol stocks underperformed (+0.6%) for the second month in a row, whereas High-Div (+1.5%) and Value (+1.7%) also lagged the broad market (MSCI ACWI, +2.5%). For Value, it was the 11th month of underperformance versus Growth (+3.1%) in the past year. Year-to-date, Value (+16.5%) has significantly lagged the broad market (+22.9%) whereas Growth (+28.2%) has outperformed on reflation optimism through lower interest rates (Figure 1). Interestingly, cautious investors have been best rewarded so far this year with Quality (+29.8%) as late-cycle anxiety calls for cautious optimism.

Figure 1: Year-to-date Performance, Value Continues to Struggle

In Canada, the BMO Canadian Low-Volatility Equity ETF (ticker: ZLB, +4.1%) rebounded and outperformed the broad market BMO S&P/TSX Capped Composite Index ETF (ticker: ZCN, +3.7%) after a tough October for Canadian Low-Vol stocks.

Trade Wars: Waiting for Trump

Time is of the essence for President Trump to prime the pump of his election campaign on “wins” and solidify reflation expectations. In early December, President Trump surprised with his “patient” stance, declaring “I can wait” for a deal with China (Source: CNBC), while threatening of tariffs on European goods and reimposing steel tariffs on Brazil and Argentina. Such actions however are more likely tactical and do not portend another breakdown in negotiations with China.

Because all negotiating parties are feeling the negative impact of trade uncertainty via deteriorating business confidence, we continue to expect a milder context for trade tensions into 2020. Progress surrounding the ratification of USMCA is gaining traction (Source: CNBC), which is good news for Canada.

Canadian Equities: Cyclicals have room to grow

Stock sector rotation is largely driven by macro developments which influence growth expectations and interest rates. A good example of such a relationship is the pro-cyclical Financials versus the defensive Utilities sectors (Figure 2). With growth expectations and market pricing for central-bank easing bottoming out, our positive base case for the outlook means Canadian financials should outperform in coming months. Strong mortgage credit demand, underpinned by low interest rates, strong labour markets and housing demand, will support Financials and make Utilities less attractive.

Figure 2: Interest Rates Drive Sector Rotation

Fed: On hold as far as the eye can see… Unless trade wars re-escalate and growth sinks

Fed cuts have helped lift consumer confidence and growth expectations, notably through stronger housing activity, but the path of policy remains closely tied to how trade uncertainty may derail business confidence and investment decisions. Fourth-quarter U.S. GDP growth is likely to show the bottom of the cycle (Figure 3). With early signs of growth bottoming out in Germany and China, and some green shoots in the U.S. where consumers have remained resilient, the Fed has probably bought itself some time until the market dictates another rate cut. What matters most for investors and asset allocation, is that the Fed’s willingness to ease further in the event of unexpected economic weakness remains intact, which helps limit the downside risks to equities, in our view.

Figure 3: Recession Fears Fall as Growth Expectations Recover

Source:  Bloomberg, BMO Global Asset Management

Bank of Canada: In lock-step with the Fed

The BoC’s December decision (Source: Bank of Canada) delivered a more confident tone regarding the resiliency of the Canadian economic outlook. After lagging the Fed for the past couple years, we expect future BoC policy to more closely align with the Fed in 2020. Because the primary transmission channel of Canadian monetary policy operates through consumer credit and mortgages to finance houses, Canada has already imported significant Fed easing, resulting in nearly a 100bp drop in the financing costs of 5-year mortgages without a single BoC rate cut. Unsurprisingly, Canadian real-estate is heating up again (Source: Globe and Mail).

Outlook and Positioning: Glass half-full optimism prevails

Heightened uncertainty from trade policy has been a core investment theme this year, but the synchronized central-bank response, especially from the Fed, has been unambiguously supportive of risk assets and led to a P/E expansion for stocks. Our conviction that central banks will continue to act against downside risks and that growth is bottoming out across Europe, North America and China, has led us to slightly increase our modest overweight to equities versus bonds. We also shifted to a small overweight of duration given our belief that risks over the path of interest rates will remain skewed to the downside as central banks seek to extend the cycle and meet their inflation and growth mandates.

Regionally, we removed our overweight to Canadian stocks versus EAFE as we are more bullish on the global economy, while remaining overweight to U.S. stocks versus EAFE as we expect the U.S. leadership to persist. Finally, we think the loonie will struggle to breakout of its $0.74-0.77 range in the next couple months as the Canadian and the U.S. economic outlook converge to slightly below-trend growth.

Happy holidays from the MAST team.

The performance for (ZLB) for the period ended November 29th, 2019 is (as follows: 19.73% (1 Year); 10.77% (3 year); 9.85% (5 year); and 13.78% since inception (on October 21st, 2011).

The performance for (ZCN) for the period ended November 29th, 2019 is (as follows: 15.66% (1 Year); 7.29% (3 year); 6.05% (5 year); 6.51% (10 year); and 7.08% since inception (on May 29th, 2009).

This article is for information purposes. The information contained herein is not, and should not be construed as, investment, tax or legal advice to any party. Investments should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

This commentary has been prepared by BMO Asset Management Inc. the portfolio manager. This update represents their assessment of the markets at the time of publication. Those views are subject to change without notice as markets change over time.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

BMO Global Asset Management is a brand name that comprises BMO Asset Management Inc., BMO Investments Inc., BMO Asset Management Corp., BMO Asset Management Limited and BMO’s specialized investment management firms.

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