Weekly Market Update (January 13 – January 17, 2020)

The combination of better-than-expected economic data, encouraging corporate earnings from U.S. banks, and the signing of the "phase-one" trade agreement pushed Canadian and U.S. stocks to fresh record highs last week. Strong U.S. retail sales and a surge in U.S. housing starts point to a resilient consumer supported by the health of the labor market. The long-awaited "phase-one" trade agreement between the U.S. and China was formally signed last week, largely meeting expectations. Specific terms included commitments from China to increase purchases by $200 billion over the next two years ($78 billion of manufactured goods, $52 billion in energy, $32 billion of agricultural products, and $38 billion in services). We believe that the agreement removes some uncertainty, but trade issues will likely remain a source of volatility in the year ahead.

Stocks closed at record highs last week as the U.S. and China signed the long-awaited "phase-one" trade agreement. The terms of the deal were largely in line with expectations and included commitments from China to increase its purchases of U.S. goods and services by $200 billion over the next two years.

In our view, the recent trade agreement is a major step towards de-escalation of the trade tensions between the two countries. It removes the near-term threat of new tariffs and raises the hopes for a more comprehensive deal to be achieved. However, tariffs on two-thirds of U.S. imports from China remain in place, and attention now shifts to implementation and enforcement. Potential failure to meet the terms of the deal can create temporary setbacks and result in additional retaliatory tariffs. We believe further tariff relief, or a more comprehensive truce including structural issues, like industrial subsidies, is unlikely to materialize before the U.S. election. Last week's agreement removes some uncertainty, but trade issues will likely remain a source of volatility in the year ahead. More broadly, we expect Canadian and U.S. stocks to continue to rise but at a slower pace than they have over the past decade, supported by ongoing economic growth, modest earnings growth, and accommodative central banks. Here is an overview of our latest quarterly market outlook: 

Economic Outlook: Consumers Lead the Way
We expect Canadian growth to be between 1.5%-1.8% in 2020. We expect consumers to fuel the economic expansion. In addition, accommodative monetary policy should provide a modest support to the economy in the first half of 2020.

• A healthy labour market and low interest rates will help drive spending again this year at a similar pace to last year. Monthly job gains are leveling off, but we still expect the unemployment rate to stay near a four-decade low and wages should continue to grow faster than inflation.
• Manufacturing should show a slow but steady expansion. Importantly, the lull in manufacturing growth has not spilled over to the much larger service sector. The signing of the "phase-one" trade deal removes some uncertainty, but questions remain.
• We expect the Bank of Canada (BoC) to maintain the current target in interest rates and stimulus measures in the U.S. should help Canada avoid a recession this year.

Equity Outlook: More Moderate Gains Ahead
2019's gains were among the strongest of the 2000s and well outpaced our expectations. We don’t think this exhausts the bull market’s tank, but it does temper our expected return for this year.

• We think an uptick in volatility, and a short-term pullback, is a reasonable expectation. However, we don’t think pullbacks will give way to a bear market, as the conditions that are historically associated with a bear market are not in place. Unemployment in Canada enters 2020 below 6%. In years after an unemployment rate below 6%, the TSX posted an average return of 6.9%¹.
• In our view, 2019's sizable returns won't be replicated this year. However, since 1950, when the S&P 500 rose by more than 20%, the average return in the next year was 11.3%, indicating that great years don’t have to be followed by bad ones¹.
• With valuations slightly above long-term averages, there is limited potential, in our view, for material expansion in the price-to-earnings ratio from here, meaning that the pace of market gains will be set by the pace of earnings growth.

Fixed Income Outlook: Long-term Rates Likely to Rise Modestly
We expect equities to outperform bonds this year as moderate economic growth continues, with no recession imminent. However, political and other uncertainties could drive volatility higher, highlighting the stabilizing role fixed-income investments typically play during market pullbacks.

• Last years sizable decline in long-term interest rates reflected recession fears, a global slowdown, and expectations of a policy shift from central banks. With global growth showing signs of stabilization, trade tensions easing, and market expectations more aligned with current monetary policy, we don’t think the 10-year government bond yield is likely to fall materially below 1.5% in Canada and 2% in the U.S.
• The Bank of Canada will be less inclined to proceed in “insurance” rate cuts as the potential benefit from easing could be offset by the side effect of further stoking the already frothy housing market.
• While the BoC didn’t follow other major central banks in cutting interest rates last year, Canadian consumers and businesses benefited from low global rates that suppressed domestic ones. We expect the markets and economy to continue to benefit from last year’s easing as monetary policy changes impact the real economy with a lag (typically six to nine months).

International Outlook: Global Growth on Track to Rebound
International stocks performed well in 2019 but still trailed Canadian and U.S. stocks amid trade and other geopolitical uncertainties. Challenges remain, but there are signs global manufacturing may be stabilizing. We expect a modest re-acceleration in global growth. Which, together with depressed valuations and a likely rangebound Canadian dollar, could position international investments to outperform in 2020.

• Forward-looking business surveys have shown signs of economic activity bottoming in emerging and developed markets and are consistent with an improving demand environment. At the same time, activity in the services sector of most major economies remains robust, and central-bank policies are likely to stay accommodative until growth or inflation picks up.
• International stocks are priced at a 20% discount to U.S. stocks, with emerging-market stocks at a 30% discount². While valuations alone don't necessarily translate to better short-term results, they have historically been a good predictor of long-term returns.
• The Canadian dollar has been largely rangebound against major currencies, including the U.S. dollar, over the last 4 years. We don't expect a major breakout in either directions against international currencies in 2020 as oil and interest rates could be relatively neutral influences.

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

^{Sources: 1. FactSet 2. Bloomberg}

Important economic data being released in Canada include manufacturing sales on Tuesday, inflation and the Bank of Canada rate decision on Wednesday, and retail sales on Friday. U.S. markets are closed on Monday in observance of the Martin Luther King Jr. holiday.