Weekly Market Update (October 7 – October 11, 2019)

Stocks rose globally on optimism that Chinese and U.S. officials made progress in negotiations that laid the groundwork for a truce on additional tariffs. Positive comments on the Brexit front added to the optimism, leading international developed-market stocks to record their biggest weekly rise in four months. We think reduced uncertainty can be a catalyst for improved returns in international equities, but we would also caution that trade negotiations are ongoing, and more twists and turns could prompt volatility, as they have in the past.

Our Quarterly Market Outlook
Stocks appear on track to finish the year strong, with the S&P 500 near a record high, despite a volatile past quarter during which slower global growth and trade tensions caused recession fears to spike. Twists and turns on the U.S./China trade front continue to drive market swings, with stocks rising last week on optimism that both sides are looking at a phased approach to a trade deal, which was announced after market close on Friday. This incremental progress is encouraging, but additional phases of agreement or a larger deal that includes key issues like intellectual property, technology transfers and enforcement will likely take more time. Thus, trade issues will remain a source of volatility. More broadly, we expect stocks to continue to rise but at a slower pace than they have over the past few years, supported by ongoing economic growth, earnings growth and lower interest rates. Here is an overview of our latest quarterly market outlook: 

Economic Outlook: Slower Growth but No Recession
We don’t see a recession materializing in the coming year, extending this already longest-ever expansion through 2020. A healthy labour market and fresh stimulus from the Federal Reserve are key pillars of support, but trade, election and geopolitical uncertainties are increasing headwinds. We think the Canadian and U.S. economies will grow at below-trend pace in the 1% - 2% range next year, with domestic growth slightly below that in the U.S.

• The backbone of the expansion remains reasonably sturdy. Unemployment in both countries is at multi-decade lows, and monthly job growth is extending the longest streak on record, which should support better than 3% wage gains ahead. In addition, the Fed has shown a willingness to cut rates to extend the business cycle.
• Domestically, household debt levels remain elevated and housing investment continues to slow, which we think will dictate a slower pace of growth in Canada versus the U.S. We expect the rate of growth to slow on both sides of the border. We suspect the combination of impaired business confidence stemming from the U.S. / China trade spat, along with the lagged effects of the Fed’s rate hikes will be on display as we enter 2020. However, lower corporate and household borrowing costs and further progress on trade negotiations make a case for sustained growth.

Equity Outlook: Uncertainty Drives Volatility
We expect equities to outperform bonds this year based on a slowing but still-supportive macroeconomic backdrop and steady corporate fundamentals. Risks tied to geopolitical concerns, trade uncertainties and slowing global growth will continue to make it a bumpy ride in our view.

• As the effect of U.S. tax cuts and the oil rally has faded, earnings growth stalled this year. Estimates are for Canadian and U.S. earnings to accelerate in coming months, with year-over-year growth in trailing 12-month profits improving from the three-year low of 3.2% in the third quarter to 6% in the fourth quarter¹. We expect further gains in 2020.
• Tariffs tensions, geopolitical challenges such as Brexit, and tepid global growth pose challenges for equity returns. An impeachment inquiry in the U.S. adds to the headline risk that may, at times, unsettle investor sentiment. However, history shows that economic and corporate conditions, not politics, are what matter most for long-term stock performance.

Fixed Income Outlook: Interest Rates Lower for Longer
The U.S. inversion of the yield curve this year has raised worries of an approaching recession. However, despite trade uncertainty and slowing global growth, we don’t think a U.S. or Canadian recession is imminent. We expect equities to outperform fixed-income investments, but bonds will, in our view, continue to help stabilize investor portfolios during normal bouts of volatility.

• Though low by historical standards, Canadian and U.S. interest rates are still higher than most developed countries. For that reason, foreign demand for U.S. Treasury's reached a record high this year, up 7% from a year ago, and has kept long-term rates low. Since investment-grade and high-yield corporate bonds are tethered to corporate earnings, we expect default risk to remain low due to still-solid economic and corporate conditions.
• We recommend owning bonds of varying maturities, including high-yield bonds, to reduce risk associated with the return of normal volatility in the late stages of the economic cycle.

International Outlook: Challenges Remain but Expansionary Policies Improve Prospects
Overseas equities underperformed last quarter as trade tensions escalated and manufacturing activity contracted. Trade and other geopolitical uncertainties, including Brexit, are likely to keep volatility elevated, but we expect growth to stabilize and returns to improve.

• Global growth peaked early last year and has been decelerating since April 2018 as growth in Europe and China fizzled amid political and trade uncertainty. In response to weaker growth, major central banks around the world have either started or continued to ease monetary policy to stimulate economic growth. While such stimulus efforts typically lag in affecting the economy, we believe they can improve the growth outlook and provide support.
• Global manufacturing activity continues to struggle in the face of weaker global trade and shaken business confidence, with export-reliant economies such as Germany the most affected. Positively, most major economies are experiencing better trends in their services sectors and tight labour markets, which reassures us the global economy is not likely headed into a recession. Headwinds remain, but we believe any de-escalation in trade tensions could be a catalyst for a rebound in overseas equities.

^{Sources: S&P Indices Data}

Angelo Kourkafas, CFA
Craig Fehr, CFA
Nela Richardson, PhD

^{Bloomberg, 10/11/19.  Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results.}

In a holiday-shortened week in Canada, important economic data being released include inflation on Wednesday and manufacturing shipments Friday. In the U.S. the third-quarter earnings season kicks off on Monday, with 6% of S&P 500 companies reporting earnings throughout the week.