Multi-Asset

Quarterly Outlook 2018: Room to Grow

Not long ago, even ardent fans conceded that Tiger Woods was likely to finish his career with 14 major championships. After four back surgeries and a personal life that took too many detours through the tabloids, Tiger’s body, mind and his game were surely played out. What about now? After steady improvement this year and competitive appearances in the last two 2018 majors, Woods claimed victory on September 23 for the first time in five years.
November 2018
Not long ago, even ardent fans conceded that Tiger Woods was likely to finish his career with 14 major championships. After four back surgeries and a personal life that took too many detours through the tabloids, Tiger’s body, mind and his game were surely played out. What about now? After steady improvement this year and competitive appearances in the last two 2018 majors, Woods claimed victory on September 23 for the first time in five years.

Maybe that impressive portfolio of 14 major titles isn’t done growing after all. Despite a few worrisome signs, we think the same of the U.S. economic cycle. While the current economic cycle approaches record length, we see scope for optimism with further bright days ahead.

In September, BMO’s global multi-asset team convened in London for our annual secular forum, where we evaluate the world from a longer term perspective to formulate our market expectations over the next five years. The team discussed several topics currently occupying the minds of investors, such as the escalation of the so-called trade wars and the potential for a U.S. recession in the next one to two years. We offer our views on these topics below along with our perspective on market-moving events in other key regions.

 

Trade wars:

Everyone loses but some lose more

Trade tensions intensified in the third quarter as President Trump announced additional tariffs on $200 billion of Chinese goods at a 10% rate (potentially rising to 25% in January 2019), while China responded with 25% tariffs on $60 billion of U.S. goods. However, we continue to have a more benign view than consensus on trade, reflected in the modest risk-on stance in our portfolios. While concerning, the direct impact of the tariffs implemented and proposed thus far remains small and we believe the U.S. and China will reach a deal. In addition, we have yet to see “secondorder” effects from tariffs, such as lower consumer/business confidence and reduced spending, which would cause greater concern.

 

Emerging markets:

How dangerous is the selloff?

Emerging markets (EM) continued their selloff during the quarter. Fears of contagion increased as economic weakness in Turkey intensified and a few EM central banks raised rates significantly to support their currencies. China was not immune from the EM weakness, in part due to the trade dispute with the U.S. Chinese equities have sold off nearly 20% since the end of January. Our base case is that the pockets of weakness are country-specific, but we don’t think they will trigger a crisis in EM as they appear relatively healthy with better fundamentals as compared to previous periods of stress.

 

Japan:

Resisting the tightening tide

The Bank of Japan maintained a highly accommodative policy as inflation is stuck well below its 2% target, we expect policy will remain largely stimulative in the coming quarters. Prime Minister Shinzo Abe was overwhelmingly re-elected and we believe stability and continuity in the political arena is positive for Japan.

 

Europe:

Lower growth and persistent political risk

The outlook for Europe remains underwhelming as PMIs weakened and the European Central Bank (ECB) revised down its forecast for GDP. However, ECB President Mario Draghi noted that he expects a “relatively vigorous” pickup in inflation as tighter labour market supports wage growth. The ECB will halve its bond-buying program in October and end its balance sheet expansion in December, but interest rate should stay on hold until mid-to-late 2019. We continue to believe that the Italian coalition may be short-lived as it will have difficulty delivering on election promises. Finally, it was a challenging quarter for U.K. Prime Minister Theresa May. While we still expect a deal, time is running out and the probabilities of “no deal” and “hard Brexit” likely increased during the quarter.

 

U.S. equity earnings:

Going beyond the stimulus boost

When the fiscal stimulus package in the U.S. was announced in 2017, most equity analysts forecasted a onetime boost to U.S. equity earnings. However, earnings have remained exceptionally strong, with second-quarter results even managing to slightly outpace those of the first quarter. Earnings growth is expected to slow from its current pace, but growth should remain near 20% until year end. Even with trade tensions, S&P 500 companies with more global exposure actually reported higher earnings and sales growth in the second quarter as compared to their domestic-focused counterparts. While our “behavioural” assessment of U.S. equities has been very strong, we feel the bar for corporate earnings has been set relatively high. In light of very strong recent performance, we are considering modestly reducing our bias toward U.S. equities.

 

Canadian Equities:

Positive, but Lagging U.S.

After solid economic performance in 2017 where real GDP growth topped 3.0%, growth is set to moderate to 2.1% this year and about 2% in 2019. However, a combination of higher borrowing costs, macro-prudential measures, elevated household-debt (chart 1), and concerns over competitiveness suggest the risks to this above-trend medium-term outlook are generally skewed to the downside despite evidence that capital spending in the commodity sector should remain a tailwind, notably after the confirmation of a $40bn investment in a liquefied natural gas terminal in Kitimat, B.C.

Chart 1: Household debt-to-GDP (%)

Quarterly Outlook 2018: Chart 1: Household debt-to-GDP (%)

Source: Statcan, bls. As of December 31, 2017

Moreover, a relatively benign fiscal deficit and population growth above 1% should provide a solid buffer against a recession scenario. Even though our base-case has always been that North-American trade flows would remain largely intact, the agreement on NAFTA 2.0, renamed USMCA, removes a big cloud of uncertainty over Canada.

Oil prices have more than doubled since their 2016 lows and we remain constructive on energy prices due to ongoing geopolitical tensions and a tighter demand and supply balance. However the supply glut for Alberta crude remains a headwind for the Canadian energy sector as the benchmark price for Alberta oil trades at a hefty discount to WTI (chart 2) since late 2017. Without additional shipping capacity for crude, this headwind will persist.

Chart 2: WCS-WTI differential (price per barrel)

Quarterly Outlook 2018: Chart 2: WCS-WTI differential (price per barrel)

Source: Bloomberg, as of September 30, 2018

We continue to think Canadian equities will lag U.S. equities, both on slower economic growth and corporate earnings, and we therefore maintain an overweight on U.S. stocks. While Canadian equities have been trading cheaply on market price-to-earnings (P/E) (chart 3), we don’t see the catalysts on the horizon that would cause the valuation gap to narrow in the near-term.

Chart 3: P/E ratios

Quarterly Outlook 2018: Chart 3: P/E ratios

Source: Bloomberg, as of September 30, 2018

Positioning

We continue to favour a modest overweight to global equities, funded by underweights to rates and credit. Within equities, we retain a preference for U.S. equities relative to Canada and other developed markets. However we are considering reducing our U.S. overweight modestly in response to very strong relative performance. While we remain tilted toward developed-market equities relative to EM equities, we believe that we may be nearing the trough for EM and that the longer-term outlook is positive. Within fixed income, we retain an underweight position to both sovereign bonds and credit. On currency, our core view is that the U.S. dollar will experience broad but modest strength, particularly against the Canadian dollar, where lots of good news has recently been priced in, and weaken modestly versus the yen.

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.

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.

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