The Perfect Calm: Three Reasons to Feel Good About the New Year

January 5, 2018 Patrick Ercolano

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Economic reports make frequent use of the word “but,” as in, “some developments look positive, but there are storm clouds on the horizon,” or, “times are difficult now, but there is light at the end of the tunnel.”

Heading into the early months of 2018, however, we may be able to dispense with the caveats and give that word a rest. That’s because three trends have come together to create not the perfect storm, but the perfect calm. How long this calm will last is hard to say, although the first quarter of the year is setting up rather nicely. Here’s what’s happening.

  1. Synchronized global economic growth

    The general global economic growth we have been hoping and waiting for over the past five years arrived in 2017, and continues into this year. Starting with the U.S., it spread to the stubborn European economy and the long-suffering Japanese economy. China is in good shape, they have successfully reduced their dependency purely on exports and heavy industries to a more service and local economy focus.

    We have seen good data coming out of Canada, especially in the second half of the year, with unemployment hitting 5.9%, numbers not seen for almost 10 years. As Canada lead G-7 countries in GDP growth in 2017, rebounding after a technical recession in 2015, this was quite a positive surprise.


  2. Strong and healthy corporate profits

    We are also seeing that global economic growth pumping up the profits of successful corporations around the world. This trend is happening not only across geographic regions, but across sectors as well. Employment levels are very good right now, and interest rates are still low; ideal conditions for consumer spending. That economic engine is expanding the top line of corporations in consumer discretionary, consumer staples, information technology, and even materials that supply the basics for the housing industry.

    Corporate profits have been solid in 2017, after 2 years of being flat. They have been on a strong uptrend throw-out the year, so this would be classified as a continuing and improving trend that bodes well for 2018.


  3. Continuing low inflation and interest rates

    Continuing low inflation is perhaps the most pleasant surprise, because it allows interest rates to stay low as well. Any short term spikes in inflation we saw in 2017 was mostly related to gasoline prices, not from a cycle of wage and price increases that compel central banks to tighten monetary policy. And deflation in the economy, something that has been worrying central banks for almost a decade, seems to be a risk of the past.

    While it is true that the Fed raised rates three times last year, and the Bank of Canada twice, those increases only leave the U.S. short term rate at 1.5% and the Canadian rate at 1.0%. Seeking to get ahead of the curve, the U.S. has pledged rates at 3.0% by 2020 – still not a very high interest rate.




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What does this mean for investors?

So, the markets look positive and stable – at least for the early months of 2018. What does this mean for investors?

Firstly, we believe equities should still outperform fixed-income. Simply because stock valuations have been rising for a while, returns from equities will likely not be as generous as in previous years. We also believe returns from fixed-income will be lower than previous years, as current economic conditions do not favour this asset class.

Secondly, it’s still not a bad time to be a borrower if you have a mortgage or some other household debt. Rates are still low and we expect to see slow and gradual increases, not creating conditions that would be detrimental to the housing market in Canada. The Organization for Economic Co-operation and Development (OECD) has issued warnings about the high levels of household debt in Canada, so 2018 may be a good time to discuss this with your advisor if this is your case.

As always, we recommend that you stick to your long-term plan for investing. Expert advice is valuable rain or shine; and fortunately, conditions are sunny right now. MD is always watching conditions in the economy, and we are sensitive to changes and the measures we can take to protect your invested savings.

In the meantime, however, enjoy the perfect calm of early 2018. We’ve gone through a lot to get here!

 

About the Author

Patrick Ercolano

Patrick Ercolano, CFA, MBA, is a Lead Portfolio Manager with the Investment Management and Strategy team at MD Financial Management. He oversees strategic and tactical asset allocation mandates, alternative investment mutual funds and is a member of MD’s Tactical and Risk Allocation Committee.

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