• David Cockfield, Arthur Salzer

A Look Ahead at 2018


After 10 years the slow and sometimes halting recovery from the Great Recession of 2008 seems to be coming to an end. 2017 saw the beginning of a worldwide surge in economic growth that has continued into 2018. The return to a historically normal economic environment has broad implications. More robust world economic growth will increase demand for basic commodities and put upward pressure on commodity prices. The recent rise in oil prices to over $60.00 may well be an example of things to come. Rising basic prices will generate inflationary pressures that will in turn put upward pressure on interest rates. Central Banks will react by raising bank rates. Essentially world economies will return to the type of economic cycles experienced in pre-2008 days.

While the growth momentum of 2017 has carried on into 2018 - what are the chances of a recession? A recession is not likely in 2018, but beyond that, rising interest rates coming into an environment now accustomed to historically low rates, with higher levels of debt, has increased the risk of a recession.

As we look towards the remainder of 2018 we are optimistic regarding the future of economic growth for North America. The U.S. economy is on a roll due to the repeal of many of the anti-growth government regulations of the previous administration combined with ground breaking reductions in both personal and corporate tax rates. American companies have begun repatriating profits back to the U.S., with headlines being made by Apple who will be paying $35 billion in taxes, bringing back $380 billion, with plans to create 20,000 new jobs. Unemployment is now 4.1%, with unfilled job opportunities increasing. Wages have begun to move upward and consumer confidence is high. The U.S. Housing industry is struggling to meet increasing demand, as the shortfall in new housing created during the Great Recession has yet to be filled. A buoyant housing sector creates a demand for a broad range of products and skills within the U.S. economy.

The Canadian economy continues to surprise on the upside - instead of the consensus estimate of a 1,000 gain in employment December saw a gain of 78,000. The unemployment rate fell from 5.9% to 5.7%. A significant contributor to Canada’s overall GDP growth has been the recovery in the Alberta and Saskatchewan economies. In Alberta the GDP growth estimate for 2017 was revised up to 4% from the initial forecast of 2.6%. Rising oil prices and production helped create 70,000 full time jobs in Alberta since mid 2016. Ontario and Quebec also saw steady growth in the 2½ to 3% range.

Interest rates continue to be low by historical standards. We think that that recent Bank of Canada increase of the bank rate should not have a significant impact on economic activity. However, a couple of more rate hikes during 2018 would likely change our view. As for the overheated real estate markets in Toronto and Vancouver, these have begun to cool due to tougher qualifying requirements for mortgages. We anticipate a sideways or slightly downward move in housing prices in 2018 in Vancouver and Toronto.

Despite a positive economic outlook, we are less sanguine regarding the financial markets. With a number of potential headwinds facing investors in 2018, prudence dictates some caution. Over the past twelve months U.S. equity markets have had a spectacular run to the upside. Price earnings multiples are very high on a historical basis. While the economic picture in the near term is good, 2019 could be a very different case. Buying a high P/E stock is done with the expectation that the present high earnings growth will continue into 2019 and perhaps beyond. The Federal Reserve in the U.S. is expected to raise rates up to 3 times in 2018. Rising interest rates causes fixed income securities to fall in price, but higher coupon returns will begin to offer a viable substitute to dividends from stocks for investors who want predictable cash flow.

For Canadian investors the risks are more political than economic.

With posturing and new demands coming from both sides between Canada and the United States, there is potential that NAFTA may not be renegotiated. Although a potential negative, the economic impact may be offset by a fall back to treaties previously negotiated between the U.S. and Canada. The markets may not be expecting this and the short-term effects could produce a negative impact to both the Canadian equity market and to the Loonie.

We believe that a broadly diversified portfolio which includes not only equities and fixed income, but exposure to alternative asset classes such as real estate, private debt (e.g. mortgages) and absolute return strategies (e.g. hedge funds), has the potential to outperform on a risk adjusted basis in this type of market environment. In layman’s terms, create a portfolio that has a ‘sleep at night’ factor.

#ArthurSalzer #DavidCockfield

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