The year is off to a busy start; January was a volatile month fueled by geopolitical developments and a world health emergency. While we expect geopolitical events to continue to drive short-term volatility, our outlook remains positive for stocks fueled by accommodative central banks and positive fundamentals.
*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Bond Index based on end-of-day data for the Total Return Index as at market close January 31, 2020.
Military escalations in the middle east between the US and Iran were a source of uncertainty in the markets at the start of the year following the US’s decision to kill an Iranian general. Iran responded by launching missiles at a US military base in Iraq. No further escalations have taken place since these strikes and fears of further escalation have recessed at this time. The relationship between the US and Iran is still very fragile and could be cause for further volatility throughout the year.
The larger driver of volatility throughout the month was the appearance of the coronavirus that originated in China. The virus has been declared a global health emergency by the World Health Organization. Market participants fear that the virus will negatively impact global supply chains, dampen consumer demand and slow global growth. As cities in China are being locked down and businesses closed, it is important to be able to distinguish the difference between a permanent shock to the economy and a temporary one. Although epidemics in the past have had their differences in terms of symptoms and timing in the economic cycle, if we look back to past epidemics, we can see that markets promptly recovered within six months of the outbreaks.
In the US, earnings season has kicked off and corporate profits have been positive. The Federal reserve has signaled that they are comfortable keeping rates steady at its current low levels and that no increase is on the horizon. As unemployment remains at a multi-decade low, this suggests that the economic growth that has heavily been attributed to the consumer will likely continue.
In Canada, the macroeconomic picture has some similarities to the US. Wages are growing, mortgage rates are low, and home prices have been steadily rising. However, the average household is carrying excessive amounts of debt which will act as an anchor on further growth. The lack of diversification on the TSX and high household debt are the main reasons we recommend a portfolio with a neutral allocation to the Canadian market. This will allow us to avoid a home country bias.
After years of negotiation and little progress the UK has finally left the EU. Little will change now in terms of trade arrangements; however Prime Minister Boris Johnson will face the difficult task of negotiating new trade deals with the EU by the end of 2020 before the old deals expire. We can expect some volatility due to trade uncertainty during this time.
Elsewhere in Europe, the data shows that France and Italy are approaching contraction territory. Major drivers of these slowdowns can be attributed to social and political influences rather than a change in economic fundamentals. The outlook for the EU’s leading economy – Germany – is improving as the outlook for global trade has been improving. The European Central Bank is also pursuing accommodative monetary policy. Accommodative central banks and improving trade relations provide a case to expect growth out of the European markets.
GDP growth, interest rates, and corporate profitability are the primary driver of stock valuations, and as these fundamentals are currently at healthy levels it is reasonable to expect continued growth. There is also a healthy balance of risks present in the form of geopolitics, climate events, and other exogenous shocks such as viruses. As we are deep into an over decade-old expansion, we believe investors will be more prone to human bias and this will guide certain investors towards overreacting to financial news.
To counter-act bias and achieve better investing outcomes we recommend a policy of investing as frequently as you can with the use of pre-authorized contributions, having pre-determined rebalancing rules, and investing in a portfolio that matches your financial goals. By following this approach, we can tune out short-term noise and focus on our future goals.