Every January since the market crash, people have thought the year ahead would mean strong growth in the U.S. economy. This year, however, don’t be overconfident.
“The Donald Trump presidency [has] been a catalyst to set that mind frame,” says Patrick O’Toole, vice-president of global fixed income at CIBC Asset Management. He co-manages the Renaissance Canadian Bond Fund, an underlying fund in the Renaissance Optimal Income Portfolios.
“[He] is supposed to bring growth back at a stronger level, supposed to have inflation come back higher finally, and the manufacturing and export sectors are going to soar,” he adds. “Well, we’re thinking the strong growth belief out there is probably a little too optimistic again.”
For the past six or seven years, O’Toole has had “below-consensus growth expectations,” and he’s making that call again. “We see higher interest rates […] in the second half of 2016 acting as a headwind on the economy, and the strong U.S. dollar is going to act as a headwind against helping some of Trump’s targets.”
In particular, a strong dollar will impede manufacturing and exports. And as for promised infrastructure spending, it won’t boost 2017 growth much. “Maybe it’ll be more meaningful in 2018, but for 2017 it’s not much beyond a rounding error,” says O’Toole.
Stemming from this, he anticipates U.S. corporations will hold back on capital expenditures. “We think [they] could suffer a little bit with a strong dollar that’s going to dampen corporate profits. We expect to see the business sector’s mindset a little more cautious than what people may be expecting.”
And, even though consensus says inflation is likely to increase in 2017, O’Toole is skeptical. “If you’re having lower growth than people expect, inflation probably peaks early in 2017, moves a little lower, and then if we do get some tariffs, you could have a temporary move higher. But we think it’s going to be very tough for inflation to be sustained longer-term.”
Interest rate expectations
If economic growth is lower than predicted, O’Toole says the Federal Reserve may hike interest rates once or twice in 2017. “I think there’s even a risk they’ll be moved to the sidelines if growth does expect to slow in the second quarter [to] early third quarter like we believe.”
The Bank of Canada, on the other hand, is likely to “sit tight and do nothing. […] We already have the Canadian dollar below its purchasing power parity level by roughly 10%. So we should see some traction from the export sector; that should give a boost to growth.”
As well, Canadian infrastructure spending is likely to increase in 2017 as federal government spending is unleashed. “U.S. growth, which we think is going to be below consensus but still better than Canadian growth, [will] help our economy along as well. So I think the Bank of Canada doesn’t have to do much,” says O’Toole.
Much like O’Toole’s overall 2017 outlook, he anticipates bond yields will be lower than consensus. To find growth this year, he encourages investors to stay diversified. “On the fixed income side, continue to focus on areas that benefit from modest growth and that potentially could do even better if growth is even better than we think and we do get a little bit of inflation.”
Currently, O’Toole is overweight every sector. “We’re about double weight corporate bonds in our portfolio versus the benchmark in Canada, [which] is a little below 30%; we’re around 60%. We’re just more cautious about what names we buy as opposed to worrying about sector over- and underweights.”
As for equities, “The stock market is going to face a little bit of challenge,” says O’Toole. “It doesn’t mean it’s going to have a bad year, but if higher labour costs continue, they may have to absorb some of that. Given that price-earning ratios already aren’t cheap, it’s a tougher starting point for the equity markets than we’ve seen the past couple of years.”