The five indicators I've chosen as most important for Canadian investors are to a great extent just different ways to answer the same, all-important question, "will the U.S. and global economic and profit growth accelerate, or are we faced with a debt-ridden Japan scenario of endless sluggish growth and frequent earnings recessions?"
The answer to this question will determine investor performance because the most profitable portfolio positioning for slow growth and accelerating growth scenarios are almost diametrically opposed. Get it wrong, and returns are likely to suffer mightily. For example, the income-oriented investments that currently benefit from slow growth and low interest rates will get killed in a rising rate, accelerating growth and inflation environment.
U.S. economy/wage and consumption growth: The importance of the U.S. economy to Canadian investors was apparent in a recent International Monetary Fund report that cut estimates for domestic economy growth. The reason for the downgrade was not anything Canadian – it was because the IMF's much larger reduction in U.S. GDP estimates threatened Canada's export-led recovery.
The Canadian stocks that will benefit from a U.S. recovery – auto stocks, industrials, transportation for example – are much different than the defensive, sustainable dividend stocks that will outperform if the U.S. economy falters.
Bond yields: A substantial rise in bond yields would be extraordinarily painful for global markets, affecting not just fixed income investors but equity holders, particularly in dividend-paying sectors (higher, risk-free government bond yields would attract investment away from dividend paying equities).
Ray Dalio, founder of Bridgewater Associates and arguably the most respected hedge fund manager in the world, had this to say in a recent presentation to Federal Reserve members: "[I]t would only take a 100-basis-point rise in Treasury bond yields to trigger the worst price decline in bonds since … 1981."
Domestic unemployment rate: This is more of a two- to three-year issue. Canada's unemployment rate has remained remarkably consistent, near 7 per cent, despite oil-related economic headwinds. Consensus estimates for 2017 GDP growth, however, have already declined from 2.2 per cent to 1.9 per cent since May. A sustained slow growth "Japan scenario" risks an uptick in unemployment at a time when consumer indebtedness has reached all-time highs. A period of unemployment-caused rapid credit deleveraging would cause a host of financial issues for banks, households and public companies.
Cyclicals/defensives: The relative performance of cyclical and defensive stocks is perhaps the easiest way for investors to gauge the "economic acceleration or sluggish growth forever" investing dilemma. Recently, the Vanda cyclicals versus defensives U.S. index (the first chart, below) has shown an encouraging upswing after a year-long period of weakness. This implies that U.S. equity sectors more sensitive to economic activity are outperforming, and is a sign is that U.S. growth, and thus Canada's economic recovery, are on track.
U.S. dollar: Continued strength for the greenback would be good news economically but bad news for investors in commodity stocks and emerging-market growth. A rising U.S. dollar is normally accompanied by a stronger American economy relative to the rest of the world. This implies that the United States is expanding faster compared with emerging markets (on a risk-adjusted basis – nominal growth is likely to remain higher in the emerging markets) and, because the U.S. economy uses fewer commodities per unit of growth than the developing economies, resource prices are likely to be weaker (lower chart). This environment would help domestic export growth as Canadian goods would become more competitively priced in the world's largest consumer market.
There are many way in which unprecedented central bank monetary stimulus means the global investing environment is uncharted water for investors. Historical precedents may not hold, but hopefully this list of market indicators provides a road map for the months ahead. Growth or no growth – it all comes down to that.
Scott Barlow