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Fall 2018 Market Outlook: Expect Continued Growth, but Volatility Is Back

Key take-aways:

• We expect to see continued growth in the global economy.

• Geopolitical risks are topped by a China–U.S. trade clash.

• Interest rates are gradually resetting to historical norms.

The one-way, upward run of the markets in 2017 will be remembered as an unusual time, when economies around the globe grew in sync and equity markets went steadily upward.

Over the last quarter, we’ve seen a return to more typical market volatility as investors react to news of diverging business cycles, interest rate hikes and fears of an escalating China–U.S. trade war.

Looking ahead, our own proprietary indicators on economic growth, inflation, corporate outlooks and capital markets tell us that current market gyrations are normal, and not a slide into bear market turf.

As we review the last quarter, we highlight three of the key trends shaping markets and how we’ve positioned MD Financial Management portfolios.

1. Global economy still in growth mode, with stocks favoured

Overall, the global economy is stable and continues to grow. We have seen broad-based earnings growth across countries and sectors. Additionally, there are no material signs of stress apparent in credit and banking markets.

Fundamental data support our view that global equity markets should continue to outperform fixed-income investments over the next 12 months. We continue to maintain a tactical, higher-than-benchmark allocation to equities in MD portfolios, with selective positioning in regional economies.

America first among equity markets

The U.S. economy is holding strong, buoyed by tax reform and budget deals, and our indicators point to ongoing expansion. Earnings and earnings sentiment remain high, with unemployment rates low and inflation in check.

We believe U.S. equities will continue to outperform global markets, and have increased our portfolio’s overweight allocation. Information technology, consumer discretionary and health care stocks all continue to deliver strong gains, while small capitalization stocks—less vulnerable to looming global trade tensions—can provide diversification.

Canada breathing again, post-NAFTA

For Canada, completion of a revised NAFTA deal with the United States and Mexico is generally positive for all countries involved, despite a few give-and-takes on agriculture. The Canadian dollar saw an immediate lift after the announcement of the new United States–Mexico–Canada Agreement, although it’s not quite a done deal until ratified.

Our economy has strengthened primarily due to domestic factors and Canada could now stand to benefit from a stronger U.S. economy, with the success of a new trade pact in place.

Changing cycles in the Eurozone

We have seen business cycles diverge in the Eurozone. A key indicator of business conditions, gathered from the purchasing managers’ index, appears to have peaked. We’ve trimmed our portfolio overweight positions in Germany and France as those economies grow more slowly—although they are still trending upward.

Less attractive is the United Kingdom, where growth expectations have been hampered by the drawn-out uncertainties of the Brexit negotiations—even fundamentals may not matter there in the near term.

Emerging markets facing difficulties

There has been weakness across emerging market economies since March. A number of countries (Turkey, Argentina, Venezuela and Russia) face challenges from domestic issues, along with a higher U.S. dollar and interest rates, which have a negative impact on performance.

Emerging market economies most closely tied to China’s global supply chain could also feel the effects of changes in Chinese economic and monetary policy or additional U.S. trade tariffs on imports.

2. Geopolitical risks heightened by a China–U.S. trade war

We’ve followed the trade dynamics between China and the United States closely since President Donald Trump’s election and, so far, the global economy has absorbed the effects of new tariffs without major disruption.

But this trade rift between the world’s first-largest and second-largest economy is not just a Republican Party issue. The drive to stop China from unfairly acquiring American intellectual property is non-partisan, and it can be expected to keep pressure on trade, whatever the result is of the upcoming U.S. mid-term elections.

At the same time, China has been engineering a slowdown in its growth, recently reported at 6.5%, year-over-year, in the third quarter of 2018. We are monitoring the risk in Chinese monetary and fiscal policy indicators to gauge potential impact on our regional allocations.

3. Rising interest rates expected to remain contained

Around the world, central banks have been gradually tightening monetary policy, post-crisis. Rates have risen in North America but remain contained elsewhere.

We expect the Bank of Canada to continue to raise interest rates alongside the U.S. Federal Reserve, in a gradual and measured approach. Rates are still structurally low, there’s little inflationary pressure and monetary policies remain accommodative.

Any headwind from the increase in rates may fade as bond yields have stabilized over the last six months and are unlikely to move materially higher without a meaningful jump in inflation.

Staying invested to benefit from all market cycles

At this time, fundamental and economic data remain positive for equities over the next 12 months despite a return to more normal levels of volatility—and those expected ups and downs.

As economic expansion shifts to later-stage growth in much of the world, we’ll be carefully assessing all the factors that drive risk—not just what’s being talked about in the headlines—and will make suitable adjustments to our strategy when appropriate.

MD’s portfolios are designed to ride out market gyrations, protect capital and take advantage of global opportunities through the entire economic cycle. For more information about our approach, current market news or your portfolio, please reach out to your MD Advisor, anytime.