Canada is a very different story than the rest of the world. The U.S. tax
overhaul and public spending plans have boosted growth and earnings
forecasts at a time when the U.S. economy is already humming, as we write
in our outlook. This injects uncertainty into the global economic outlook:
potential for greater capex and productivity growth, but also a risk of
overheating and increased risk premia across asset prices. Yet we see the
overall environment as positive for global risk assets, albeit with more
muted returns and higher volatility than in 2017. The risks? U.S.
protectionism (very real for Canada) and a renewed surge in global bond
yields (a less immediate concern).
The Bank of Canada’s (BoC) decision in March to pause in its normalization
campaign reflects economic risks that now skew to the downside. Gains from
the global recovery in the energy and materials sectors look to have played
out already. Our BlackRock Growth GPS for Canada points to lower growth
ahead, which is consistent with consensus estimates (see chart below).
Domestic oil prices trading at a steep discount to global benchmarks
because of pipeline limitations, and the uncertainty overhang from NAFTA
negotiations alongside the risk of steel and aluminum tariffs (Canada is
the world’s largest supplier of both metals to the U.S.) has restrained
investment activity. As a result, the BoC may raise rates only once more in
We view the U.S. trade actions so far more as an opening gambit for
negotiations than the start of a trade war, as we write in our outlook. We
expect China to try to address its trade deficit with the U.S. by opening
up its markets in the medium term. We take some comfort that talks are led
by seasoned trade pros on both sides. We also see a decreased chance of the
U.S. withdrawing from NAFTA. Yet things could spin out of control. Things
to watch for include the U.S. announcing and implementing harder-hitting
trade measures or the trade pros losing control of negotiations.
We see up to three more U.S. rate increases this year, decreasing the
chances of any strengthening in the Canadian dollar. The loonie has already
weakened against the U.S. dollar so far this year, whereas most other
developed market currencies have appreciated. In addition, the loonie could
struggle under the weight of trade tensions and weak domestic oil prices.
Loonie weakness isn’t necessarily bad: Investors with unhedged exposure to
international stocks tend to benefit, as do the earnings of multinational
companies with sales outside Canada.
Decelerating economic activity and a slower pace of monetary tightening
should help limit any weakness in Canadian fixed income as inflation
recovers and global rates head higher. We don’t see Canadian rates across
the curve coming under as much pressure as in the U.S., where inflation
risks are higher because of the procyclical boost of the fiscal stimulus.
Holding some duration and emphasizing credit makes sense at this point in
the cycle for Canadian fixed income investors, in our view. Investors
should also consider unconstrained strategies in global bond markets, we
believe, as a way to increase the opportunity set and protect capital
during a period of rising interest rates.
Canadian stocks have underperformed global stocks each of the past five
consecutive quarters inclusive of the current one (see the chart below).
Canadian earnings have held up reasonably well, pulling valuations versus
U.S. and global equity markets to three-decade lows. Clearly, a lot of bad
news is already reflected in the price. As long as conditions don’t get
materially worse (a rather herculean assumption perhaps, given the trade
tensions along the southern border), we believe Canadian stocks could start
to post some better numbers on the boards.
We prefer emerging market (EM) equities, and we recently upgraded U.S.
stocks given the robust earnings prospects post tax cuts. We also favor the
global technology sector, which happens to be underrepresented in the
Canadian equity market but is the single largest sector weight in EM, the
U.S. and the momentum factor. We like U.S. and Canadian banks, which offer
decent earnings growth at relatively cheap multiples.
Kurt Reiman is BlackRock’s Chief Investment Strategist for Canada.
Aubrey Basdeo is BlackRock’s Head of Fixed Income for Canada, and both are regular
The BlackRock Blog.
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