Russell Investments’ Strategists’ Outlook – Q3 2015 Update: Currency pivotal to Canadian economic recovery
- Bank of Canada likely on hold as clarity emerges on the Fed rate decision and domestic economic trends
- Canadian GDP growth downgraded to between 1.5%-1.9%
- Lower Canadian dollar critical to manufacturing sector recovery
TORONTO, JUNE 30, 2015
Currency, more than commodities, may ultimately determine if the Canadian economy gets its groove back, according to Russell Investments’ Third Quarter 2015 Strategists’ Outlook.
“We believe that currency will play a pivotal role in the prospects of the Canadian economy over the next decade, explained Shailesh Kshatriya, director, Canadian strategies at Russell Investments Canada, who authored the Canada Market Perspective section of the global report. “Our view is that the Canadian dollar needs to remain low for longer in order to regain competitiveness against the U.S.,” said Kshatriya, “And more importantly, relative to an increasing imposing manufacturing capacity in Mexico, the loonie needs to be more attractively priced for multinational firms.”
The report also notes that the strength of commodity markets in the early 2000s – the oil market in particular – was a boon that came at the cost of lost competitiveness. The negative impact of this was most acute for domestic manufacturers, who saw a strengthening Canadian dollar contributing to a 30% increase in labour costs, while they have remained roughly flat in the U.S.
According to the report, regaining lost manufacturing capacity will not happen overnight. A pre-requisite for bringing greater balance to the domestic economy and tilting reliance away from resources requires the visibility of a weaker Canadian dollar relative to the U.S. dollar for an extended period. “For this reason, we believe the Bank of Canada will be diligent with interest rate moves going forward,” added Kshatriya.
Russell Investments’ strategists also believe that the Bank of Canada’s base case of 1.9% 2015 GDP growth is potentially as good as it can get, and have downgraded their growth prospects for the Canadian economy to 1.5%-1.9% (previously 1.8%-2.1%).
Global Outlook Overview
The global perspectives of the Russell Investments’ strategists focus in large part on anticipation around two key upcoming events: timing of the initial interest rate increase by the U.S. Federal Reserve (the Fed) and negotiations around the Greek bailout. The strategists expect the first rate hike in September—a long-held view— and for Greece to stay in the Eurozone, but acknowledge that uncertainty around these events could lead to market volatility, which they see as an opportunity to add selected risk exposure to portfolios.
To analyze the anticipated Fed rate hike, the strategists compare market conditions before the two previous hikes in February 1994 and June 2004 to current conditions. The standout feature, according to the report, is that equities, bonds and the U.S. dollar (USD) are all relatively expensive now compared to the last two tightening phases, and the corporate profit cycle is far more advanced. However, since the upcoming rate hike in their view is one of the best communicated policy shifts on record, they believe the shift is already priced into the markets. After looking at these factors collectively, the team maintains their favored U.S. market scenario of moderate inflation, moderate jobs growth, and single-digit profit gains.
“It makes sense to expect volatility around the Fed policy shift, but a key question is whether any resulting market setback would represent a turning point or an inflection point," said Russell Investments’ Global Head of Investment Strategy, Andrew Pease. "We believe an inflection point seems more likely, and for equity markets to remain supported over the medium term if the U.S. economy continues to post moderate growth.”
Russell Investments’ strategists employ the firm’s three-pronged “cycle, value, sentiment” investment strategy process to update their outlook forecasts. Currently, their global market perspectives include:
- Business Cycle: Optimism for developed markets
- Valuation: U.S. equities remain the most expensive
- Sentiment: Momentum is a positive driven in most markets
The cycle appears very positive for Europe and favorable for U.S. and Japan. The economic indicators in Europe, for example, are improving, married with potential growth of corporate profit margins. Regarding the U.S. market, corporate profits maintain moderate growth, supported by robust—albeit spotty—economic growth. In Japan, economic indicators are lackluster, but corporate profits are picking up, and there is a strong chance of additional stimulus from the Bank of Japan (BoJ). The cycle score for generally riskier emerging markets remains negative due to the strengthening U.S. dollar, falling commodity prices and slowdown in China.
The strategists view equities in Europe and Japan are moderately expensive, while they see emerging markets equities as moderately cheap. The U.S. currently is still the most expensive major equity market, with a Shiller PE ratio at 27 times and price-to-book value at 2.9 times (according to the U.S. large-cap Russell 1000® Index as of June 24, 2015).
Since markets have been relatively stable, the team points out that many of the overbought contrarian signals have moved to neutral territory. Except for Japan, where the market is solidly in overbought territory, momentum is a positive driver for equity markets.
For more information, please see the “Strategists’ 2015 Global Outlook – Q3 Update.”
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