Following the election of Donald Trump in November 2016, the outlook for the year ahead held the promise of political volatility and, as a result, economic volatility. It’s fair to say that politically, we’ve been let down, but the market has actually had one of its least volatile years on record, and global markets are all in the black. In this update, we’ll look at the key drivers to this low volatility and discuss whether the trend will persist going forward.
*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Bond Index
Before diving into these key drives, let’s look at global market performance in November. Global developed markets were boosted by the continued trend of strong corporate earnings, a low unemployment rate, and solid GDP YoY growth in the US. In Canada, amplified talks of a potential end to the NAFTA deal detracted from the positive global drag, and bond yields followed suit, retracting from the October close.
Calm Seas Behind Us
Now, let’s take a closer look at the reason volatility has been so muted. Despite a new administration coming into the US and promising change, little economic change has actually happened. For starters, no major campaign promise has passed yet. That looks like it’s about to change with the tax bill, but 2017 policy changes haven’t yet provided fuel to the flame. Central bank policy was closely in line with expectations as well. The Fed continued their tightening policy at a cautious pace and other major developed markets started to follow suit.
Finally, global investors are still relatively risk adverse, and this trend hasn’t changed. Record-high global debt levels, an aging investor, and political uncertainty have kept bond yields at historical lows and are likely to continue to influence the same downward pressure. With low real bond yields and the current low inflation environment, the premium paid for equity investments has stayed consistent. The boat will likely be rocked in an environment where inflation picks up or real yields change course.
Stirring the Pot - Taxes and the FBI
Two major items that have come to light over the past week could disrupt the low-volatility market we’ve settle into. The promised US tax cuts may indeed find their way into the oval office before Christmas this year. While the changes are controversial, potentially adding $1 trillion to the national debt and increasing insurance costs for the average American, a lower corporate and personal tax will stimulate the economy in the short run. Lower taxes mean increased investment, increased innovation, and increased consumer spending. One significant effect of the change may be that inflation rises faster than expected. This would likely place a quickened step to the rate increase program. The major risk with a more aggressive rate hike program is the risk of over or under influencing. The balancing act is tough, and will challenge this low-volatility environment’s run.
Another key risk is the risk of the presidency itself. While it’s too early to tell if the FBI investigation will implicate the White House, a change in presidency is not out of the question. If a change does happen, the immediate effect will likely stir up the market as investors try and make sense of what’s next. Taking a step back from the headlines, it’s clear that the current leadership is unpredictable and even chaotic. The market likes predictability and, all things being equal, a more predictable leader should have a positive impact to volatility and clarity in future policy.
What This Means for Your Portfolio
Although it appears as if more volatile markets are on the horizon, the status quo may prevail and keep the fluctuations at bay. In any regard, it’s best to position for and expect volatility, should we start to see the sleeping giant stir. We do so by holding a well-balanced portfolio and targeting position with lower exposure to volatility so that we can minimize its impact on our portfolios. By keeping calm during these periods and resisting the urge to chase the news, we can ride out the scrambling of activity, stick to a plan that takes advantage of mispricing by rebalancing back to our target, and be better off in the end. Stick to the plan and stick the course, a smart investment strategy is the best and simplest plan to long term success.