Edmonton Private Enterprise 24/7 Speaker Series 2018 Spring Economic Outlook

EDMONTON

2018 SPRING ECONOMIC OUTLOOK:

SPEAKER: Drummond Brodeur, CFA Senior Vice-President and Global Strategist Signature Global Assets Management

Drummond Brodeur started off MNP’s Edmonton’s Private Enterprise 24/7 Speaker Series with a positive 2018 spring economic outlook.

A Strong Global Economy

“We are in a very strong economic backdrop,” Drummond told the audience. “As long as oil, interest rates, etc., can adapt, we can’t be too negative on Canada. If the global economy does well, we’ll be dragged along.” Drummond believes the world is two years into a global synchronized economic recovery that hasn’t been seen in 30 years. He predicted Canada would be more likely to see severe overheating over the next two years than a recession because of balanced, global growth.

Although inflation is picking up, it’s still below central bankers’ targets and it has been for a decade. Monetary policy of central bankers is still stimulating the economy, he said. While the Big Five banks are raising rates, they’re doing so at the slowest pace seen in a tightening cycle and at a level that much supports economic growth and investing in risk assets, he noted

Since seeing the start of recovery in global economies, “We went from 70 percent defensive assets (cash, gold, government bonds) over 30 percent risk assets (predominantly equities and credit) to the other way around,” Drummond said.

Zero Real Rates Require Active Asset Allocation

Drummond emphasized the current zero-real-interest-rate environment demands a different way of investing. For the past 30 years, bonds — the “risk-free asset” — required little thought as they paid investors a two-to-four percent return above inflation. With record low interest rates and inflation sitting around two percent, bond investors lose money in purchasing-power terms. “Tactical, active asset allocation decisions have become more important than any time in the past 40 years,” Drummond said. Today, he says, long-term savers (10-plus years) must look at the rate they can expect to compound or grow their savings at. They should talk to their advisors about the rate of return required to meet their objectives and then focus on the most likely strategy for achieving that rate over a longer timeframe.

He warned against accepting the financial industry’s past equating of risk with volatility, which can do much harm in a zero real-interest-rate world.

“Think about it: an investor who is worried about not having sufficient funds to live on after retirement may think they’ll need about a five-percent return over time. That’s how they define their risk and they want to minimize that risk. They tell their trusty robo-advisor, ‘I want a low-risk solution.’ But the advisor hears, ‘I want a low-volatility solution,’ because we have defined risk as volatility.

So, Mr. Robo obediently puts the client in a low-volatility solution with heavy exposure to safe government bonds and an expected return of 2.5 percent. For an investor that needs 5 percent to live, a guaranteed 2.5 percent return is a guaranteed failure. For many investors in today’s world, a low-volatility solution can be a very high-risk proposal. “As an industry, we need to change the conversation.”

Invest in risk assets

Invest in risk assets Speaking for his asset management firm, Drummond believes Canada will continue to see “incredibly easy” financial conditions as capital markets are still wide open and continuing to fuel economic growth. In his recent market outlook for 2018 for Signature, he wrote: “This is still a time to be engaged in risk assets as economic growth will continue to drive earnings and cash flows. With inflation still broadly benign, and only expected to begin to gain traction in 2018/19, central bankers will remain cautious when raising rates and withdrawing QE. We probably need to see another 100-basis point increase in interest rates before monetary policy begins to bite and it becomes prudent to begin shifting to a more neutral balance between bonds and equities. For now, equities reign as the preferred asset class, although I caution not to expect the same lack of volatility as in 2017—we should have a few 5–10% pullbacks in the market. That would be a normal market, and those pullbacks will remain dips that represent buying opportunities.”

He says corporate credit should perform OK as the strong economy and strong cash flows keep default risks subdued (idiosyncratic risks such as digital disruption in retail notwithstanding). However, with tight spreads and rising interest rates, “it’s a lower ‘clip your coupon’ outlook versus the tightening spreads of 2017. As for government rates, they remain uninteresting given low absolute levels… and the headwind of slowly rising rates, but add another 100 basis points and it will be time to consider moving back into the rates square.”

Cutting through the noise (and Trump’s midnight tweets) Although much has been reported about U.S. President Donald Trump’s

Although much has been reported about U.S. President Donald Trump’s disruptive politics, Drummond believes the economy will have the final say. “Investment returns over time are driven by investment and economic fundamentals. They are not driven by politics. They are not driven by the media,” he said. “Politics only matter when politics becomes policy. Understand what’s happening to fiscal policy, monetary policy, trade policy, regulatory policy… these things matter.”

In summary

Financial conditions globally remain very accommodative. Real interest rates globally are still close to zero and North America remains in the early innings for inflation, with limited need to raise rates. In short, the world economy remains strong and ripe for investment.