As 2018 dawns, there’s good news: broad-based global growth.
“The global economy is in a synchronized global growth phase,” says Aubrey Basdeo, managing director and head of Canadian fixed income at BlackRock in Toronto. “We’re not dependent on one country to carry global growth. It’s spread out, so it’s more sustainable. […] That’s what’s contributing to this low volatility you’re seeing in markets.”
“Previous laggards” like Europe and Japan are growing now at “above-trend rates,” says Candice Bangsund, vice-president and portfolio manager with Fiera’s global asset allocation team in Montreal. Developing countries are also showing more stability.
David Stonehouse, portfolio manager and vice-president at AGF in Toronto, says he’s constructive on continued economic growth in the near term. For example, infrastructure spending in Canada and tax reform in the U.S. should be in play in 2018.
On the other hand, “It comes down to whether or not the consumer can hang on, and part and parcel of that will be the housing market,” he says.
Looking abroad, “China’s been remarkably resilient,” he says, and Europe is surprisingly solid, with a third-straight year of more than 2% GDP growth.
“There are very few economies struggling, so it’s been a real sweet spot for economic growth,” Stonehouse says.
Lack of inflationary pressure is more good news for the global economy.
“We expect 2018 to be a story of synchronized monetary normalization,” Bangsund says. The “subdued inflationary backdrop is allowing central banks to take their time in removing accommodation, and essentially leaving the global liquidity backdrop fairly supportive. The global economy can continue on uninterrupted for 2018.”
Such an environment underpins her preference for equities over fixed income.
But the rosy macro picture isn’t enough for everyone.
“An hour spent studying the economy is worth far less than an hour spent studying a company,” says Phil Taller, senior vice-president and portfolio manager with Mackenzie’s growth team in Toronto. As a secular investor, he says he spends most of his time trying to understand whether or not companies will grow—regardless of how the broader economy is performing.
That means examining a company’s products and services, why consumers like them and why the company is winning competitively, he says.
However it’s perceived, the economic sweet spot won’t last forever.
“The next 12 months [aren’t] going to look like the last 12 months in terms of job creation and growth for Canada,” says Alexander Schwiersch, vice-president and portfolio manager with Invesco (fixed income) in Toronto.
He’s cautious on Canada due to the indebted consumer and the housing market. He shortened duration leading up to the Bank of Canada’s second rate hike in 2017, but has since reversed course.
There are also NAFTA negotiations, where a collapse would be “a shock to the Canadian economy,” slowing growth, says Basdeo. And he notes that potential U.S. corporate tax cuts would favour equities over fixed income.
Basdeo warns that fixed income markets might not be priced for inflation, which is “temporarily suppressed by transitory factors” but should trend upward in 2018.
Though Stonehouse is optimistic for the next nine months or so, “we do start to get concerned after that,” he says.
Globally, “Populism is still an issue that hasn’t played out fully yet,” he says, referring to the 2018 Italian elections.
Bangsund points to weak support for the euro in Italy, creating an opportunity for a populist agenda to take hold. Also on her radar: Brexit, potential U.S. policy reforms and NAFTA.
Eyes on the prize: equities
So long as synchronized global growth and stronger commodity demand continue, Bangsund favours “cyclically biased and commodity-levered plays, such as Canada and emerging markets.” Further, “steeper yield curves should bode well for the financial sector, and banking specifically,” she says.
Bangsund is bullish on crude, which aligns with her overweight call on the TSX. More favourable supply-demand is also forecasted.
Overall, Stonehouse is “constructive tactically” in the near term on equities. That said, “Our eyes are wide open to the possibility of a more challenging equity environment potentially in the latter stages of 2018,” because of potentially less growth and also tighter monetary policy.
Generally, industrials are set to benefit from capital and infrastructure spending, and potential U.S tax reform. Stonehouse holds CP Rail, which has favourable capacity constraints relative to competitors and should benefit from contract renewals. He also holds trucking company TFI International.
He’s constructive on healthcare, which he prefers to technology in 2018 because pricing pressures should start abating. Names include Thermo Fisher Scientific (life sciences) and Becton Dickinson (med tech equipment). Technology still looks good, but is in the latter stages after such a good run, Stonehouse says. He still likes Microsoft, for example.
In 2018, Taller will “stick with our mostly secular and defensive growth.” He’s more heavily weighted on healthcare and technology, and will remain so, depending on prices.
“When things get overheated, we tend to walk away,” he says, adding that many med tech names are overpriced as investors seek the safety of growth. “There’s safety, but there’s also what you’re paying for,” he says. “It’s always a trade-off.”
He doesn’t own drug or biotech stocks because of “drug risk: whether a drug works or not.” Instead, he’s exposed to the therapeutic drug supply chain, from discovery to manufacturing and sales. Holdings include Bio-Techne and INC Research.
Finding your fix in fixed income
With growth and tighter monetary policy, Stonehouse says he expects higher bond yields—“but not enormously so.”
“Canada has a more challenged outlook and should perform at least as well as the U.S., if not better,” he says.
He expects a “modest rise in yields first. The outlook becomes more challenging in the latter stages of 2018 when yields might retreat.”
He’s bearish on the German 10-year bond, which has “room to rise to the 1% range” as the ECB tapers. “That should have a spillover effect on bond markets elsewhere in the world. So we don’t have exposure to the European market right now.”
Australia and New Zealand provide “attractive yields and great rule-of-law fundamentals,” he says, with no substantial rate hikes forecasted. Norway has a “strong fiscal situation.”
Bangsund sees opportunity in emerging markets, which have improving fundamentals and benefit from rising commodity prices and her base-case scenario of synchronized global growth. “You’re getting an attractive yield compared to traditional North American government bonds,” she says.
In emerging markets, Stonehouse is constructive on Argentina as it introduces market-friendly reforms. In contrast, he’s reduced exposure to Mexico amid NAFTA uncertainty and 2018 elections.
While Bangsund’s more lightly weighted on fixed income, because of potential rising rates and because she sees little value in government bonds, opportunities nevertheless remain.
Investors should “look further up the risk spectrum, particularly seeing as the economic backdrop is still supportive and the tone in the credit markets is quite positive,” she says. “Low risk of recession and low risk of default essentially bode well for corporate bonds and high yield.”
Basdeo says fixed income positioning should reflect more spread risk and less interest rate risk. That means holding “more corporate bonds relative to what you had, say, a year ago; however, you have to look at valuations as well.”
He’s more lightly weighted on corporate bonds, “simply because across the globe everything looks very rich,” he says. And in the low volatility environment, spreads are narrow. “Given how tight they are, there’s very little room for error,” he says.
Schwiersch says that, while some tightness in spreads is justified, “we’re taking some risk down.” He’s reduced his high-yield exposure, though he continues to hold names such as Iron Mountain, which stores and manages documents. “It’s a pretty efficient business,” he says, explaining that some businesses store hard copies of documents but rarely ask to retrieve them.
To capitalize on divergent monetary policy, fixed income investors require global exposure, including the U.S., Europe and emerging markets, says Basdeo.
Schwiersch further points out that a significant portion of Canadian fixed income is financials. To diversify, he invests in maple bonds—foreign companies that issue in Canadian dollars, like UPS, Pepsi and Wells Fargo. “You get the other side of the NAFTA negotiation,” he says. “You get away from the indebted Canadian consumer.”
Another example is AT&T, which provides almost 50% more spread than similarly leveraged Canadian telecoms, he says.
There are two more reasons for global exposure: an increasing portion of the world’s GDP will come from emerging markets, and they tend to have better debt-to-GDP ratios than developed markets, says Basdeo.
Another tip: invest in sectors “immune to the Amazon effect,” he says.
Industrials might fit the bill. Stonehouse holds Finning, the world’s largest Caterpillar dealer, which will benefit from infrastructure spending. He also holds machinery manufacturers Meritor and Navistar, both of which benefit from increased demand for Class-8 trucks as the trucking business cycle recovers.
In energy, Schwiersch favours lower-cost oil producers like Canadian Natural Resources: “Good management, low leverage […] and assets that could keep making money even when prices [are] low—that’s how we expose ourselves to oil.” He’s also exposed to pipelines, such as Interpipe.
Go for gold?
Stonehouse remains constructive on gold, saying it’s an inflation hedge and especially an insurance policy for geopolitical developments, though not imminently necessary. “Gold will not start to look better until things start to look worse again geopolitically and economically,” he says.
Bangsund and Taller take a pass on the shiny stuff.
Says Bangsund: “Improving growth and a revival in inflation mean that the path of least resistance for interest rates is going to be higher. That reduces the appeal of non-yielding assets such as gold.”
Taller has a different take: “Our preference is to find companies that make their customers’ lives better, cheaper, faster,” he says. “That’s our best bet.”
Canada runs hot in 2017
Top marks for 2017 performance go to the Canadian economy, with annual growth projected at 3.1% by the Bank of Canada in its October report. Unfortunately, that performance didn’t translate to the TSX, a result “largely at odds with our overweight call for Canadian equities,” says Candice Bangsund, vice-president at Fiera Capital in Montreal, adding that the TSX’s weighting in cyclical sectors was a contributing factor.
Despite that, “we maintained our overweight TSX exposure because that divergence create[d] somewhat of a valuation gap and a compelling opportunity for the TSX to catch up to its global peers,” she says. The TSX perked up late in the year.
Phil Taller, senior vice-president at Mackenzie, who invests in secular stocks, wasn’t enticed by the hot economy. “After many years of recovery and with tightening having begun, we felt caution was prudent,” he says. Over the last year and a half, he sold some of his cyclical exposure. “We cut our banks a fair bit, some of our industrial cyclical exposure and some of our semiconductor exposure.”
With that move, he missed the party; however, his tech and healthcare holdings did well in 2017’s first half. And he later added back his financials at a discount. “If we are going to be invested in some businesses that are more cyclical, we’d prefer companies where the shares don’t reflect the enthusiasm,” he says.
Another surprise in 2017 was the Bank of Canada’s hawkishness.
“At the start of the year, the market was pricing in about a 20% chance of a rate hike at some point,” says David Stonehouse, vice-president at AGF in Toronto.
He thought that probability was low and took a short-duration stance—a wise move. Post-hikes, “we’ve seen a pretty substantial bond market sell-off in Canada, and substantial strengthening in the Canadian dollar,” he says.
He effectively cut U.S. dollar exposure in his core funds, despite expecting a range-bound Canadian dollar at year’s start. “We managed to avoid the majority of the U.S. dollar weakening and Canadian strengthening,” as markets underestimated the BoC and Canadian economy relative to their stateside counterparts.
Another surprise for Stonehouse was the lack of action from the Trump administration. “The only [policy] that’s probably worked this year has been deregulation—and it’s been by omission rather than commission.”
Global economic growth projections
|Market||Projected growth (%)|
|Oil-importing emerging markets||4.0||4.0|
Source: Bank of Canada monetary policy report, October 2017