2018 Global Market Outlook – Q4 Updat

Maximum Pressure: Will The Tax Reform Tide Soon Ebb?

As Fed-tightening aims above 3%. the upside for the U.S. dollar looks limited given its expensive valuation and crowded long positions

The Russell 2018 Q4 Outlook – Strategist Remains Modestly Positive on Canadian Equities Relative to the U.S. as the Fourth Quarter Begins. Read the entire report here.

September 27, 2018 — TORONTO–(BUSINESS WIRE)–Russell Investments released its 2018 Global Market Outlook – Q4 Update today, offering economic insights and market forecasts from its global team of multi-asset investment strategists.

While the Canadian economy has benefited in 2018 from strong U.S. economic growth, and those conditions remain firm as the fourth quarter begins, the report suggests reasons to be cautious. In the “Canada Outlook” segment of the report, Shailesh Kshatriya, director, investment strategies at Russell Investments Canada Limited, explains that trade negotiations with the U.S., high household indebtedness and the generally wide and volatile discount of Canadian crude oil prices are three factors clouding the outlook for Canadian growth.

Federal tax reform and fiscal stimulus may fade over 2019

“While U.S. economic conditions remain firm, the beneficial impact of U.S. federal tax reform and fiscal stimulus may fade over 2019, potentially leading to softening U.S. demand,” Kshatriya said. “This would have direct implications for Canadian exports going south. Moreover, both the U.S. Federal Reserve (the Fed) and the Bank of Canada are projecting “gradual” normalization of their policy rate. Therefore, over the next 12 months we anticipate these headwinds continuing to manifest as interest rates tick higher.”

For the balance of this year, however, Kshatriya expects U.S. strength to remain a pillar of support as Canadian households are tested with higher rates.

Considering the team’s investment decision-making building blocks of cycle, valuation and sentiment, Kshatriya assesses the current state of Canadian equities as follows:

  • Cycle: Modestly positive. Economic growth is expected to settle into a 1.5% to 2% level for the balance of the year, while headline inflation at 3% is not alarming as Kshatriya believes certain transitory effects will fade, and he expects inflation will moderate to 2% early next year.
  • Valuation: Neutral to modestly positive. Regarding sectors, the team finds relative attractiveness in energy and pockets of cheapness in materials, notably gold.
  • Sentiment: Neutral. Momentum has moderated as Canadian equities have generally downshifted since mid-year, however contrarian signals are not oversold at this point.

Excerpt from the Russell Investments’ 2018 Global Market Outlook – Q4 Update

Maximum Pressure
Markets are adjusting to U.S. President Donald Trump’s aggressive trade war stance, and it’s been another tough three months for emerging markets. The challenging questions to answer are how much further trade tension will rise and its impact on trade, economic growth, corporate profits and inflation. Wage pressures in the U.S. are finally picking up and this is being reflected in a slightly more aggressive outlook for the Fed.

Our cycle, value and sentiment investment process is holding us at a broadly neutral weighting on global equities. The process favors Europe and Japan over the U.S., although this gap has narrowed as positive price momentum supports U.S. sentiment. We like cycle and value for emerging markets, but are waiting for a stronger sentiment signal from oversold indicators. Inflation pressures mean the cycle is becoming a headwind for government bonds, and we think the U.S. dollar has limited upside.

  • Paul Eitelman sees strong U.S. economic growth and strong corporate earnings coming at the price of a more assertive Fed. Recession risks appear low for now, but he expects the clock will start ticking once the yield curve becomes inverted.
  • Andrew Pease argues that the pessimism on Europe is overdone. The risks that dominated the past quarter seem to be getting smaller, the economy is likely to beat low expectations, and earnings forecasts have potential for upside revision.
  • Graham Harman and Alex Cousley agree that trade war uncertainty adds a note of caution to the Asia-Pacific outlook, but think that most of the bad news is now known. They expect China stimulus to largely offset tariffs and see inflation pressures slowly starting to build in Japan.
  • Van Luu and Max Stainton reiterate their view that the U.S. dollar rally is running out of steam. They believe rising Fed rates are dollar supportive, but that the greenback is expensive and speculative investors are very bullish, which is usually a good contrarian sign.

The U.S. business cycle index model estimated by Kara Ng and Abe Robison continues to signal that recession risks are relatively low for the next 12 months. Their model for U.S. equities versus fixed income favors equities, with the momentum component providing the strongest support.

Trade wars are escalating and the Fed is settling into a quarterly tightening regime. We believe pessimism on Europe is overdone. Emerging markets appear attractively priced and oversold, but may not rebound until it is clear the U.S. dollar has peaked.

Maximum Pressure
Markets are adjusting to U.S. President Donald Trump’s aggressive trade war stance, and it’s been another tough three months for emerging markets. The challenging questions to answer are how much further trade tension will rise and its impact on trade, economic growth, corporate profits and inflation. Wage pressures in the U.S. are finally picking up and this is being reflected in a slightly more aggressive outlook for the Fed.

Our cycle, value and sentiment investment process is holding us at a broadly neutral weighting on global equities. The process favors Europe and Japan over the U.S., although this gap has narrowed as positive price momentum supports U.S. sentiment. We like cycle and value for emerging markets, but are waiting for a stronger sentiment signal from oversold indicators. Inflation pressures mean the cycle is becoming a headwind for government bonds, and we think the U.S. dollar has limited upside.

  • Paul Eitelman sees strong U.S. economic growth and strong corporate earnings coming at the price of a more assertive Fed. Recession risks appear low for now, but he expects the clock will start ticking once the yield curve becomes inverted.
  • Andrew Pease argues that the pessimism on Europe is overdone. The risks that dominated the past quarter seem to be getting smaller, the economy is likely to beat low expectations, and earnings forecasts have potential for upside revision.
  • Graham Harman and Alex Cousley agree that trade war uncertainty adds a note of caution to the Asia-Pacific outlook, but think that most of the bad news is now known. They expect China stimulus to largely offset tariffs and see inflation pressures slowly starting to build in Japan.
  • Van Luu and Max Stainton reiterate their view that the U.S. dollar rally is running out of steam. They believe rising Fed rates are dollar supportive, but that the greenback is expensive and speculative investors are very bullish, which is usually a good contrarian sign.

The U.S. business cycle index model estimated by Kara Ng and Abe Robison continues to signal that recession risks are relatively low for the next 12 months. Their model for U.S. equities versus fixed income favors equities, with the momentum component providing the strongest support.

While U.S. economic conditions remain firm, the beneficial impact of U.S. federal tax reform and fiscal stimulus may fade over 2019, potentially leading to softening U.S. demand...

Global Forecast Overview

Looking globally, Russell Investments’ strategists expect trade wars, the Fed, China stimulus and the direction of the U.S. dollar all to dominate the near-term outlook. As the fourth quarter begins, the team sees U.S. recession risks as low, European growth set to improve over the next couple of quarters, and emerging markets as oversold.

“For the near term, we like the defensive qualities of U.S. government bonds and Japanese yen exposure,” said Andrew Pease, global head of investment strategy at Russell Investments. “Ten-year U.S. Treasury yields near 3% offer reasonable value amid the current uncertainty. Over the medium term, however, the cycle forces of inflation pressures and central bank tightening will put global government bond markets under pressure.”

He added that the team is neutral on global equities for now, with a small preference for non-U.S. markets. They strategists believe pessimism on eurozone equities looks overdone, and they would wait for more clarity on trades wars, the Fed and China stimulus before leaning into oversold emerging markets.

Other views covered in the report include:

U.S. market: Strong economic growth and strong corporate earnings, the team believes, are coming at the price of a more assertive Fed. They’d expect the clock will start ticking on recession risk once the yield curve becomes inverted.
Eurozone: The team believes the economy is likely to beat low expectations as the political risks that have dominated the past quarter continue to fade, while earnings forecasts have potential for upside revision.

Asia-Pacific: Trade-war uncertainty adds a note of caution to the strategists’ Asia-Pacific outlook, but they think that most of the bad news is now known. The team expects China stimulus to largely offset tariffs and sees inflation pressures slowly starting to build in Japan.

Currencies: The team sees the U.S. dollar rally running out of steam. They believe rising Fed rates are dollar supportive, but that the greenback is expensive and speculative investors are very bullish, which usually is a good contrarian sign.
To read more, please see the 2018 Global Market Outlook – Q4 Update.

 

 

 

About Russell Investments Canada Limited
Russell Investments Canada Limited is a wholly owned subsidiary of Russell Investments Group, Ltd. Established in 1985, Russell Investments Canada Limited has its head office in Toronto.
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