For financial markets, “this is probably as good as it gets.”
So says Avery Shenfeld, chief economist and managing director at CIBC Capital Markets, referring to the year ahead. He was one of five economists who shared predictions at Economic Outlook 2018, an event presented by the Economic Club of Canada and CPA Ontario.
“Central bankers are raising interest rates,” he said. “The purpose of those rate hikes—even if they’re mild—is to start to stall economic growth, and we’re going to see some of that in 2019.” Markets would subsequently see a slowdown.
But for 2018, Shenfeld forecasts continued positive performance for U.S. equities, with total returns of 7% to 8%.
For the TSX, don’t expect a barnburner, he said, though returns will be positive and better than those of the bond market. His TSX forecast is based in part on easing oil prices (to $55 per barrel) and NAFTA uncertainty, which probably isn’t fully priced in, he said.
BoC versus the Fed
All the economists agreed that growth in Canada will be solid this year, with forecasts ranging from 1.9% to 2.4%. As if on cue, today’s impressive jobs numbers for December support the positive viewpoint—and put speculation about central bank action front and centre.
Douglas Porter, chief economist and managing director at BMO, leans toward the higher end of GDP, with forecasted Canadian growth of about 2.25% in 2018. “That will be enough to get the Bank of Canada still raising rates further,” probably three times, he said. That would lift the overnight rate to 1.75%—the highest in a decade, he said, adding that his forecast is largely priced in the markets.
Shenfeld expects the BoC to raise twice; the Fed, three times. That’s because, in contrast to the U.S., Canada will be challenged by a lack of competitiveness (thanks to U.S. tax reform) and by policy such as the new mortgage rules.
U.S. markets aren’t fully priced for the Fed hikes, said Shenfeld—nor for inflation, which he expects to creep upward by year-end.
Also at year-end, he said bond markets will be affected by the end of quantitative easing (QE) in Europe, and perhaps diminished QE in Japan. That means global yields will increase, with the U.S. 10-year close to 3%, he said.
With no similar QE unwinding in Canada nor funding of larger deficits, Canada probably won’t see much of a bond market sell-off, he said.
When asked about cannabis regulation, none of the economists commented. But bitcoin fans received a clear message: Shenfeld said he expects the cryptocurrency to eventually come to “an unhappy end.”
To stay competitive relative to the U.S., the loonie must depreciate about 5%, said Shenfeld. He expects that will be accomplished in 2018, due in part to NAFTA negotiation breakdowns and easing oil prices.
Porter predicted the loonie would depreciate by 3% to 5% if NAFTA is dropped, which is one of his top three economic risks. The loss of NAFTA would result in a 1% loss in Canada’s economic output, he said, as well as higher consumer prices of about a percentage point. NAFTA risk is particularly concerning for business investment, he said.
Porter described two additional risks:
- The housing market: He expects the Toronto housing market to soften in 2018—especially for detached homes, which have experienced declines of more than 12% since Ontario introduced its fair housing plan. Those prices “will weaken a little bit further through the first half of 2018,” he said.
- Canada’s less competitive tax environment, relative to the U.S.: Increased business taxation in Canada will frustrate the business investment outlook, he said, as will increases to the minimum wage, which challenge small business. “Ontario small business confidence is […] at its lowest level in nine years,” said Porter, “even at a time when consumer confidence is at its highest level in a decade—and, of course, the equity market is at an all-time high.”
Despite their positive growth outlook, risk was top-of-mind for all the economists.
Jean-François Perrault, chief economist and senior vice-president at Scotiabank, said his “big” risks included U.S. protectionism and geopolitics in North Korea, which could affect global recovery.
Beata Caranci, chief economist and senior vice-president at TD, highlighted the risk from U.S. fiscal stimulus. There’s no previous example in the U.S. or elsewhere where a similar amount of fiscal stimulus was introduced into an economy near cycle-end—and where business was flush with cash. As a result, if inflation takes off, economists’ forecasts will be off the mark, she said.
The high level of asset prices is another risk, said Craig Wright, chief economist and senior vice-president at RBC.
Market correction coming?
Is the climbing stock market an indication that investors aren’t taking risk seriously? asked an audience member.
Not only is the equity market climbing, “the market is putting a very low price on hedging against big volatility in the equity market,” said Shenfeld. “It’s as if people are saying that not only are things good, but they’re unlikely to get bad.”
He noted the economy likewise exhibits little volatility, with the U.S., for example, having little variation in year-to-year growth.
“The equity market is taking its cue from the economy,” he said. The concern is, if the economy experiences a shock, the market could overreact as investors are taken by surprise.
“We haven’t had a financial market correction in two years, and that […] is anomalous,” said Caranci. “In a typical year, you do get about a 10[%] to 12% reset on asset prices.”
She says there are currently no red flags—except that volatility is “incredibly” low and risk appetite is “incredibly” high in an environment where central banks are hiking rates.
Wright also noted that market volatility indicators are at record lows, and that former Bank of Canada governor Carney said risk is often highest when measures of risk are lowest. “That’s […] the environment we’re in,” he said.