We’re now in the later stages of the business cycle – past the growing pains of economic recovery, through the mid-cycle slowdown but not yet closing in on the finish line.
We see accelerating economic growth, buoyant business and consumer confidence, job creation and rising (albeit modest) wage growth.
All of it is culminating to create a virtuous cycle that fuels earnings growth while supporting the health and expansion of corporations through either organic growth or merger and acquisition activity. Inflation has bounced off its lows. Global real GDP growth is trending higher and enjoying broad regional contribution.
The combination of these factors is resulting in much stronger nominal economic growth that can propel both earnings and yields higher.
Looking back to the malaise of 2014-2016 where we saw an economic slowdown, commodity correction and severe currency adjustments, here is where we hoped to end up.
Key takeaways from mid-year 2017
We expect synchronized but modest global economic growth ahead. We are not yet near the end of the business cycle expansion and see no indication of a recession within the next 18-month horizon.
At this point in the cycle we continue to favour equities over bonds as well as investment grade corporate and high yield over sovereign bonds.
Equities have begun to make headway after a prolonged period of sideways movement. We see most equity markets capable of making gains, with the divergence in relative results mainly due to current valuation levels.
We are constructive on Canadian equities and expect a total return of 8% over the next 12 months. That consists of 5% from price appreciation, plus a 3% dividend.
Canadian companies are enjoying solid earnings growth and investors benefit from cheaper valuations.
We expect stable results from the financial sector, and an opportunity for energy and materials to go from a drag on the S&P/TSX Composite returns to a small lift.
However, we see headwinds for the Canadian market coming from high valuations in the industrial, consumer staples and telecom sectors.
Our base case outlook for U.S. equities is for a flat price return with a total return of 2%. That is based on the contribution from the dividend yield.
Considering current earnings per share (EPS) estimates and using reasonable valuation assumptions, we see the U.S. market as fully valued and our analysis highlights little reason to expect further share price growth to continue into year-end.
We are not concerned about a serious bout of equity market downside. Rather, we see current elevated valuations as an impediment to strong returns.
While we are most cautious in our forecast for U.S. equities, we recognize that the risks to our U.S. market outlook are not one-sided. We acknowledge the positive catalysts that could drive a return of between 3% and 8% higher than our current forecast, hence we are only recommending a slight underweight in U.S. equity positioning.
We see equity markets outside of the United States offering some of the best return potential. The economies in these regions are showing improvement and the pace has surprised most forecasts.
Europe is our most favoured market, followed by emerging markets with overweight recommendations to both.
European equities sport larger EPS growth forecasts and a superior dividend yield.
Emerging markets can benefit from both equity price appreciation and a potential currency tailwind.
Fixed Income investors face a sideways market. We expect slowly rising, normalizing yields.
A combination of “risk-off” events - no inflation scare and softer North American GDP growth - have led to better-than-expected results for fixed income investors so far in 2017. Unfortunately, we feel this is a temporary reprieve and expect the adjustment back to normalized rates will be a multi-year process. As such, we continue to see headwinds for fixed income investors.
Investors that adopt a well-diversified approach that incorporates investment-grade corporate and high-yield bonds could manage total returns in the 1 to 2% range for the next 12 months.
Fixed income’s role in portfolio construction as a risk mitigation tool is not hampered by this forecast. Neither yields nor equities will travel a straight line, and high-quality fixed income securities can offset bouts of equity market weakness regardless of the underlying trend or the absolute level of yields.
We forecast WTI oil prices to range between US$45 and US$55, averaging US$52 through the next 12 months.
Barring a major shift on trade policy, we do not forecast excessive strength for the U.S. dollar in the coming year.
We see little reason for the Canadian dollar to move outside of a US 72¢ to US 77¢ range, expecting an average exchange rate of US 75¢ over the next 12 months.
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This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.