Clouds of uncertainty hanging over Canada

Ongoing trade negotiations, the spectre of debt, and a reinvigorated US bull market all pose threats

Clouds of uncertainty hanging over Canada

Canada’s economy and stock market showed encouraging signs of life through the second quarter of the year, but there are several uncertainties that cloud the outlook for Canadian growth.

That’s the position taken by Russell Investments in its 2018 Global Market Outlook for Q4. Focusing on the economy, the report noted a second-quarter rally in Canada’s GDP, rebounding at a 2.9% annualized rate after a weak first quarter.

But supportive trends are starting to diverge. External strength has grown based on improved export strength, but slowing retail trade points to decreasing internal strength. Higher household debt-service obligations driven by increased interest rates are expected to weigh on consumption, as could the disappointing August employment report — which showed slowing wage growth and an uptick in unemployment — if it turns out to be more than a temporary slip.

“[T]he beneficial impact of tax reform and fiscal stimulus may fade over the subsequent year, potentially leading to softening US demand [for Canadian exports],” the report said. Gradual normalization of policy rates by the Federal Reserve and the Bank of Canada could also pose headwinds over the next 12 months, though the report added that US strength may lend valuable support for the rest of 2018.

Shifting to the equity-market side, the report noted how Canadian equities outperformed their US counterparts from February to June because of their relatively “defensive” characteristics. But the US bull market regained its vigor in July, and the domestic outperformance disappeared.

Based on moderating US economic strength, headline inflation levels of 3% that “should not be too alarming,” and prospective rate hikes by the BoC, the report read the business cycle as modestly positive. Valuations in the Canadian equity market were neutral to modestly positive, while the pot-stock frenzy offset a general downshift in momentum for Canadian equities. “Contrarian signals, however, are not oversold and therefore we are neutral on sentiment,” the report said.

“The late-cycle push supporting resource-oriented domestic equities has not played out thus far,” it continued. But attractive valuations of Canadian relative to US equities, along with a possible shift in sentiment away from the US, support a modestly positive outlook.

 

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