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Volatility Normalization_CBRE November 2018

Interest rate hikes, plunging oil prices, unresolved U.S.-China trade tensions and an uncertain Brexit outcome are all factors lifting market volatility from its doldrums of the past face years. However, even as the stock market works through its fourth major rout this year, the CBOE Volatility Index has remained in line with its long-term historical norm this month. According to The New York Times, this period of volatility is likely to persist as the U.S. economy and financial markets become more vulnerable to risks including slowing global growth and higher domestic interests rates.

Back home, falling global oil prices and a wide discount to WTI crude has led to the worst pricing environment for Canadian oil in history. At the same time, the industry is at an impasse on how best to resolve the supply glut. Some producers are calling for mandated production cuts while refiners decry government intervention. Stalled pipeline projects continue to exacerbate the situation.

General Motor’s recently announced global restructuring plan signals a transformation in the auto industry towards electric and autonomous vehicles. While this industry shift has the potential to ripple across one of Canada’s key economic drivers, its impact will likely see some offset from increased capital expenditures. Auto manufacturers will need to repurpose and upgrade their facilities in order to adapt to shifting transportation demands. As well, the $14 billion in corporate tax cuts introduced by the federal government will be of particular benefit to Canadian manufacturers.

The prevailing risk-off mood of investors this month pushed Canadian bond yields down towards their September levels, igniting fresh concerns over the yield curve inverting and the economy being late in the cycle. During a recent presentation at the Toronto Real Estate Forum, two prominent economists called for an impending slowdown of the economy, through each argued for differing levels of its severity. Under either scenario, the need may weaken for the Bank of Canada’s projected interest rate increases in 2019.

Challenges may have risen in some sectors, but the Canadian tech industry continues to benefit from a strong and expanding tech employment base as reported in CBRE’s 2018 Scoring Canadian Tech Talent report. While Toronto still leads the country with top talent, significant growth has also been recorded across emerging markets from coast to coast.

 

Economic Highlights :

  • Retail sales grew 0.2% in September with increases in six of the 11 subsectors
  • Headline inflation rose 2.4% in October and the average Bank of Canada measures rose to 2.0%.
  • The share of highly indebted households in Canada fell to 13% in Q2 2018 from 18% last year.

 

 

 

Benchmark Yields

Viewpoints :


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2016 Outlook – INTEREST RATES – OIL PRICES – CANADIAN DOLLAR

“It’s still a humdrum outlook for the Canadian economy,” says Avery Shenfeld, Managing Director and Chief Economist, CIBC World Markets, “but we can blame the tepid global economy for part of that. The bright spot is that 2016 should be a bit better than 2015, as we move past the steepest declines in oil sector capital spending. And we’ll get the first leg of some federal government infrastructure spending in the latter half of 2016, so the sectors of the economy that benefit from construction spending should be healthy.”

Shenfeld calls investors’ attention to six major factors in planning for this year.

1. The promising U.S. economy. “The brightest spot for Canadian exporters in 2016,” says Shenfeld, “is the big market to the south. The U.S. isn’t as affected by the sluggish pace in emerging markets, because its own domestic market is so critical.” Plus, Americans have been getting jobs so they have newfound income to spend. Shenfeld thinks the American consumer “will provide the engine to drive 2.3% real GDP growth in the U.S. in 2016, similar to the 2015 pace.”

For Canadian exporters, this is good news. Everything from autos to lumber to engineering services will benefit from a continuation of a relatively healthy U.S. economic expansion.

2. The lower Canadian dollar. The lower dollar, which is actually close to its historical norm, notes Shenfeld, is a major reason for the Bank of Canada’s positive outlook on recovery. It’s also a signal that it may hold our interest rates below those of the U.S., to prevent a return to a stronger Canadian dollar. “The evidence is that we need a currency at this level to boost exports,” says Shenfeld, “so we’re unlikely to see much of an appreciation for the year.”

3. Tourism. In addition to the Canadian services exporters who gain from a lower dollar, our tourism sector benefits. For winter sports enthusiasts, the lower dollar makes skiing in Western Canada an attractive alternative to resorts in the U.S. Similarly, for both Canadians and Americans, the Maritime provinces and Newfoundland offer a more reasonable summer vacation than destinations in New England.

4. Interest rates. The Bank of Canada’s only tool is “a blunt instrument,” says Shenfeld. “You’re not going to raise interest rates to cool Toronto and Vancouver housing prices … and then chill the whole economy in the process.” If anything, the burden on the Bank of Canada is to keep interest rates low, to provide off-setting momentum and to fill the hole left by the retreat of capital spending in energy and mining.

The U.S. Federal Reserve has raised interest rates, which could push up Canadian five- and ten-year rates marginally. “But if you’re thinking: When will we get back to the day I earn 5% on a GIC?” says Shenfeld, “The answer is: not soon, and certainly not in 2016.” The economy is showing that it needs low interest rates to achieve even modest economic growth. Not just in Canada, but globally.”

5. Oil prices. Some signs indicate oil prices are too low to be sustainable; U.S. drilling is cooling down, putting downward pressure on supply in 2016. But Shenfeld argues that American shale oil has now jumped ahead of the Canadian oil sands in the queue, so it will be the first to come back onto production as prices rise. One day, the world will need an expanded supply of our more expensive oil. “But that is not likely to be a story for 2016, or perhaps not even in 2017,” says Shenfeld.

6. Emerging markets. Emerging markets, including the BRIC (Brazil, Russia, India, China) countries, had a difficult 2015, although overall long-term growth possibilities are higher than those of established economies. “The growth engines of China are shifting away from industrialization and construction to the service and consumer sector, which doesn’t help to drive our raw material exports,” adds Shenfeld. “China was the world’s largest consumer of base metals when it seemed like they were building a new city every week, but those days are fading fast.”

Opportunities and Challenges

A well-balanced, diversified portfolio always makes sense, particularly so in an uncertain world, says Shenfeld. “Canadian equities have had a rough year in 2015,” he adds, “but we see some upside in the non-energy, non-materials part of the Canadian equity market. It’s been collectively undervalued because there have been question marks in global investors’ minds about Canada. Some see us as another Saudi Arabia with the whole economy resting on oil, and that’s a long way from accurate.”

“In fixed income markets,” says Shenfeld, “long-term bond yields may start to creep higher because they are moving up in the U.S. So we lean toward somewhat shorter-term bonds to avoid the capital depreciation, or price depreciation, that you get at the long end if rates rise.” He recommends talking to your Investment Advisor about fixed income alternatives in 2016, given that yields on government bonds and GICs are so low.

Shenfeld is still cautious on gold. “You need either a material inflation escalation or a plunging U.S. dollar to really get the price of gold moving,” he says, “and we’re not seeing either.”

Shenfeld cautions Canadians not to be totally out of any asset class, nor restricted by a single geography. “Canadians should think of their retirement and travel plans and consider whether they have enough money in countries where they might one day spend a considerable portion of their year. If you’re planning to spend your winters in Florida when you retire, but have no U.S. dollar assets, you’re actually betting that the Canadian dollar will appreciate,” he says. “You can hedge that risk by having some of your portfolio in U.S. currency.”

It’s always a good practice to connect with us early in the year to discuss your financial goals – consider putting a reminder in your calendar for the beginning of the year. As always, if you have any questions about your accounts or any of the information contained in this newsletter, please contact us.

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