By Kurt Reiman, Director, Chief Investment Strategist for Canada
One of my favorite definitions of risk and uncertainty comes from a book by
Nate Silver entitled The Signal and the Noise. He defines risk as
the grease that facilitates economic activity, whereas uncertainty grinds
things to a halt. According to a popular index developed by Professors
Baker, Bloom, and Davis, Canada’s economic policy uncertainty has moved to
new highs in 2018 after rising for the past several years (see the Chart 1
below). No wonder the Bank of Canada (BoC) has been sounding so cautious
even though Canadian economic data remain firm.
The most pernicious of these uncertainties has been the escalation of trade
tensions in the wake of the 2016 U.S. presidential election. The heated
NAFTA renegotiations and threats of a unilateral U.S. withdrawal were
uncertain enough. Now, Canada finds itself ensnared in a larger ideological
trade battle between the U.S. and China over the Trump administration’s
broad imposition of tariffs that includes imported Canadian steel and
aluminum and that has prompted Ottawa to retaliate.
The potential for more tariffs, this time on automotive imports into the
U.S., and the Trump administration’s tendency to respond to trade
retaliations can keep tensions high from here. Of course, there’s already a
good reason for the BoC to go slow to avoid rattling a highly
rate-sensitive economy, but even more so given the unpredictable path of
trade negotiations and the impact protectionism could have on highly
integrated global supply chains.
In that spirit, Governor Poloz seems to be abiding by the Hippocratic Oath:
at first do no harm. One could easily make the argument that there’s
nothing wrong when looking at the S&P/TSX Composite Index posting new
highs, but this would be ignoring the signals coming from the Canadian
dollar, which is probing new cycle lows.
Two things stand out. First, in Canadian dollar terms, the Canadian stock
market is one of the worst performers in the developed world in 2018 (see
the Chart 2 below). Second, compared to other currencies, the loonie is one
of the only major currencies following short-term interest rate
differentials (see the Chart 3 below). For now, high oil prices don’t
matter to the loonie – these days it’s not behaving like a petro currency.
The Bank of Canada’s raised rates last week, and we think Poloz is right to
highlight uncertainty at this stage. The economic outlook has become more
uncertain, financial conditions have tightened, and consequently we think
investors should build more resiliency into portfolios. As a result, we
recommend taking shorter-duration postures in fixed income with an
up-in-quality bias in credit. As well, we have focused on taking exposure
in equity markets with the greatest earnings growth like U.S. equities and
the technology sector. And we have recently begun to stress the importance
of companies with solid balance sheets and ample cash flow generation
Director, is BlackRock’s Chief Investment Strategist for Canada and is
a member of the BlackRock Investment Institute (BII).
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