Weekly Market Update (January 9 – January 13, 2017)

By Craig Fehr January 13, 2017

Canadian stocks were little changed and U.S. stocks were marginally lower on the week as the beginning of the fourth quarter's earnings season and political headlines captured investors' attention. While aggregate index earnings are expected to rise in the U.S., not all companies will meet analysts' projections. That's why we recommend investors monitor their portfolios' exposure to any single investment. By owning several stocks within each market sector, you may be able to reduce your portfolio's volatility – especially through the earnings season.

Our Quarterly Market Outlook

2016 in Review
The TSX was among the best performing markets for the year, delivering its highest return since 2009. Gains were largely driven by the rebound in commodity prices, which helped power the energy sector to a 32% increase and a 42% rise in the materials sector, which combined make up one third of the domestic index.

The U.S. presidential election was undoubtedly one of the key market stories of the year. Pre-election volatility pivoted to post-election enthusiasm, as markets rallied on the prospects of faster growth spurred by policy proposals from president-elect Trump. Notable proposals that could impact economic growth include tax reform for individuals and businesses, an infrastructure spending program and regulatory changes. Earlier in the year, the unexpected outcome of the Brexit vote also prompted volatility, as global markets reacted sharply to the uncertainty, with the S&P 500 falling 6% over the following two days. This would prove to be the extent of the pullback, with stocks recovering the losses within the next week. The economic and political impacts of Brexit will continue to be a market influence in 2017.

Economic Outlook
GDP growth averaged 0.9% since the beginning of 2015 — the slowest annual pace so far in this expansion. We believe GDP growth in 2017 will be in the 1.5%-2% range. While this is similar to the recent rate of expansion, we expect the underlying contributors to growth to undergo a bit of a shift, with less of a boost from consumer spending and weaker housing market activity (owed to increased regulations and less construction), but a slightly better contribution from export activity.

We expect exports to provide a boost to growth this year, helped by increased demand from a faster-growing U.S. economy, along with the lower Canadian dollar. Manufacturing activity has improved for four straight months, reflecting the benefits of both of these factors. We think the loonie is likely to remain below $0.80 for a while longer, driven by stabilization in oil prices and the wider gap in interest rates between Canada and the U.S.

The combination of potential production cuts from OPEC and firmer demand stemming from slightly faster global economic growth should provide some support for oil prices. On the other hand, the return to above $50 offers a more attractive price environment for production in North America, which is showing up in the U.S., where the oil rig count has risen nearly 50% since May.

Equity Outlook
Canadian stocks delivered a 21% gain last year, a feat we don't expect to be repeated. We think the combination of slow economic growth, low interest rates and sector imbalances (the TSX index has only small exposures to sectors such as consumer, technology, and health care) will produce more moderate returns this year. Domestic equities should see some support from stabilizing oil prices, but we don't expect the TSX to outpace global markets like it did in 2016.

With valuations at full levels, we think gains from here will be driven by the pace of earnings growth. Slightly better GDP growth, coupled with reduced headwinds from the U.S. dollar and oil prices (which have pressured earnings per share growth over the past several quarters), should support a rebound in S&P 500 profits, while TSX earnings will be highly sensitive to natural resources and performance from the banks. We think the bull market in stocks can continue, but expect more volatility and periodic pullbacks versus the steady ascent we've seen recently.

While last year saw underperforming asset classes like Canadian large-caps, small- and mid-caps, and emerging markets stage a rebound; industry performance also diverged in the rally, creating an opportunity for sector rebalancing. Cyclicals have led the way during the recent run (financials, industrials, energy and materials delivered an average return of 31% in 2016), while defensive sectors (consumer staples, health care, telecom) posted more modest gains.


Fixed Income Outlook
After having hiked rates one time in each of the past two years, we think the U.S. Fed is likely to hike a few times in 2017, ushering in a period of slow, measured monetary policy tightening. Upcoming rate hikes will be data dependent, and since economic readings are likely to be broadly positive but periodically uneven, the path of rate hikes is far from being pre-set. In any event, we think a slow approach to rate hikes in 2017 will set the stage for a slowly rising interest rate environment in the U.S. In contrast, fairly subdued growth and inflation pressures will keep the Bank of Canada on hold in 2017 as it tries to combat the economic pressures of lower oil prices, weak business investment and high consumer debt levels.

Low rates in Canada continue to offer lower financing costs for domestic consumers and businesses, a condition that is likely to remain in place until steadier economic growth emerges. As for the Fed, upcoming rate hikes are more akin to taking a foot off the accelerator as opposed to hitting the brakes. The U.S. economy is near full employment (a key reason the Fed should be raising rates), but labour market improvement has not reached its end. Even three quarter-point hikes next year would leave the Fed Funds rate under 1.5%, well below a level of interest rates that would choke-off loan demand or economic expansion.

The U.S. dollar index has risen to a 14-year high, an ascent driven by the Fed hiking rates at a time when the vast majority of central banks around the world are maintaining or increasing monetary stimulus. This, coupled with the prospects of improving growth and firming inflation expectations in the U.S., is likely to provide ongoing support for the value of the dollar in 2017. That said, we think this view is, at least in large part, priced into currency values at this point. The wider gap between Canadian and U.S. rates will, in our view, keep some downward pressure on the loonie for a while longer, helping exports and international investment returns.

International Outlook
U.S. GDP growth is poised to improve modestly thanks to a healthy labour market, an accommodating monetary policy (still in the early stages of Fed rate hikes), an improving business investment climate and the potential for fiscal stimulus. Wage increases have risen to the highest level since 2009, while debt-servicing costs (credit expenses as an amount of disposable income) have fallen to the lowest levels in decades. We think these factors will support ongoing consumer spending — which makes up more than two-thirds of U.S. GDP.

Expectations for growth in the U.S. have risen since the U.S. election, responding to policy proposals around tax reform, infrastructure spending and adjustments to trade and regulations. We note that policy actions under the Trump administration are still in the planning phase, so there is no guarantee that these proposals will become law or retain their current form. Nevertheless, we do think the combination of more expansionary fiscal policies and reduced regulatory burden that incent business investment can have a positive impact on U.S. GDP, though we do not expect this to show up in growth until later in 2017 or 2018.

Globally, we expect slightly better growth, though the overall pace is likely to remain subdued. Developed markets like Europe and Japan face long-run challenges to growth, but we believe policy stimulus will provide a foundation for modest improvement in the near run. Meanwhile, after several years of deceleration, we believe growth in China will begin to stabilize, helped by better demand from developed markets (export destinations). Global GDP growth is expected to move higher this year, for the first time since 2014.

The Stock & Bond Market

Index Close Week YTD
TSX 15,497
0.0% 1.4%
S&P 500 Index 2,275
-0.1% 1.6%
10-yr GoC Yield 1.72% -0.02% -0.01%
Oil ($/bbl) $52.50 -2.8% -2.3%
Canadian US $0.76 0.8% 2.4%

Source: Bloomberg. Past performance does not guarantee future results.

The Week Ahead

Next week, the Bank of Canada is largely expected to keep short-term interest rates steady on Wednesday, and inflation data will be reported on Friday.

Important Information

The Weekly Market Update is published every Friday.

Edward Jones does not provide access to past weekly summaries.

The S&P/TSX Composite Index and S&P 500 Index are unmanaged indices and cannot be invested into directly.
Diversification does not guarantee a profit or protect against loss
Dividends may be increased, decreased or eliminated at any time without notice.

Investors should understand the risks involved of owning investments, including interest rate risk, credit risk and market risk.

Special risks are inherent to international investing, including those related to currency fluctuations and foreign political and economic events.

The value of investments fluctuates and investors can lose some or all of their principal.

The content of this report is for informational purposes only and should not be interpreted as specific investment advice. Investors should make investment decisions based on their unique investment objectives and financial situation. While the information is believed to be accurate, it is not guaranteed and is subject to change without notice.

"Member - Canadian Investor Protection Fund"

Diversification does not guarantee a profit or protect against loss.

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