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December 2016

Financial Outlook 2017

What's in store for the economy, the markets and your money?

Financial Outlook Looking back, 2016 has been one of the most unpredictable years for politics around the world, and by extension, the global economy. In June, the British people surprised pollsters and voted to leave the EU. In July, Premier Christy Clark surprised the real estate industry with a 15% tax on property purchased by foreign buyers. And in November, the U.S. surprised everyone and voted for a President named Trump.

What has this volatile year taught us when looking forward to 2017? In this article we explore some of the key themes that are likely to influence the headlines, and your finances, in the year ahead.

Global Market Volatility — Buckle up, it’s going to be a bumpy ride

In 2016 there were three shocks to the markets that caused them to fall quickly, then recover. At the beginning of the year, the world reacted to China’s economic slowdown. In June, the British people voted to leave the European Union, sending the markets skidding. Then while almost every poll had Hillary Clinton winning and the markets factored in a Democrat for President, November 8th brought political upset.

Going forward, 2017 may be just as rife with change. Political volatility in Europe, where populism is spreading, doesn’t favour the markets, nor does the lackluster global economy. Stay tuned for Prime Minister Theresa May’s promise to trigger Article 50 (the requirement to leave the EU) by the end of March 2017, putting the UK on a 24-month path to withdrawal, and Europe on course for greater instability. China has stated that it’s “seriously concerned” about some of Trump’s statements, fueling apprehension about future trade and economic ties between those two countries. And the new U.S. President is promising a business-friendly administration. The result? Likely more volatility as the markets adjust to a restructured European Union, strained Sino-American relations and a new U.S. government.

Welcome to Trumpenomics

The impact of the Republican win on stocks and bonds has been as unprecedented as the election itself. Markets like predictability and this result was anything but. On November 8, 2016, the Dow was at 18,332. A month and a half later, it’s hitting unknown territory, flirting with 20,000.

As the markets grapple with the change in administration, the expectations are for the new U.S. President to have an inflationary effect on the U.S. economy. The President-elect comes to office amid growth in the labour market. In 2016, the U.S. economy has created, on average, 180,000 jobs per month. It moved from a 10% rate of unemployment when Barack Obama took office, to one that is below 5%, a rate many economists deem to be “full employment”. The result is an uptick in wages of 2.8% on an annualized basis, and greater pressure on inflation.

With the President-elect stating that he is tearing up the TPP on his first day in office, and promising to revisit the terms of NAFTA, expectations are for higher trade barriers, resulting in higher costs of goods. He’s also promising to cut corporate taxes and regulation and increase spending on infrastructure. Given the Republican-dominated House and Senate, he is in a strong position to succeed with his agenda. But this combination of fiscal stimulus and reduced tax revenue will likely ratchet up the budget deficit. If Trump does turn into the “inflation President” that some are predicting, the Federal Reserve Bank (the Fed) may have only one choice, and that is to continue raising rates in an attempt to offset inflation.

What do all these changes south of the border mean for Canada? A lot.

The Canadian Economy often tends to move in unison with the U.S., usually lagging one or two quarters. Studies have found that since 1930, the annual growth rate of the U.S. economy has been 2% for Republican presidents and 5% for Democratic presidents, while Canada's GDP has grown annually at 3% for Republicans and 4% with Democrats. However this Republican president is different than the others, and the predictability is less predictable.

The Federal government’s fiscal policy will stimulate employment, which also increases the specter of an interest rate rise later in 2017. The price of oil has rebounded, helping the energy sector, and with a lower value of our dollar, non-energy exports are predicted to increase. On the other hand, rising energy costs and higher costs of imports (remember $8 cauliflower?) will put pressure on inflation.

President-elect Trump has stated that he intends to approve the construction of the Keystone XL Pipeline, expanding Canada’s market for oil. However the non-energy sector is concerned, given his talk about ending NAFTA. Policymakers believe that this anti-NAFTA talk may fade once the new President takes office and faces the reality of the extensive integration of the two economies. Overall, the primary challenges to the Canadian economy in 2017 are driven by potential protectionist measures down south and a generally uninspired global economy.

Elsewhere, Central Banks are holding fast

Central banks around the world have focused on unprecedented low interest rates to stimulate growth. On February 1, 2016, the Bank of Japan set its interest rate to 0.00%. One month later, on March 10, 2016, the European Central Bank had a posted rate of 0.00%. The Bank of England cut interest rates to 0.25% on August 9, 2016, as a reaction to the Brexit vote. Following the United Kingdom’s decision to leave the European Union, the exchange rate has fallen and the outlook for growth in the short to medium term has weakened markedly. Given the volatility of the British situation, the expectation is that the BoE will not increase the rate in the coming two quarters.

The first Central Bank to move has been The Fed, which, on December 14, 2016, increased its rates by 25 basis points to 0.75%. That’s just the second increase in ten years. Announcing the decision, Fed officials said they expect to raise the rate three times in 2017.

Interest rates are likely moving up while the Canadian dollar is looking south

Interest rates are headed up in part because bond investors are seeing more signs of coming inflation. The Bank of Canada interest rate, which currently sits at 0.5%, has been untouched since July 15, 2015. The expectation is that the Bank of Canada will lag behind the US Federal Reserve and increase the interest rate in the second quarter of 2017 or later.

The Canadian dollar has been losing value against the US Dollar for the past two years. OPEC’s agreement to cut production should lead to higher oil prices. The boost to the Canadian dollar from the increase in the price of oil will be tempered by the interest rate increases in the U.S. and their impact on the U.S. dollar. The net result will likely be a continued decrease in the value of the Canadian dollar against its U.S. counterpart in 2017.

Real estate is local, mortgage rates are not

Expectations are for a slight uptick in mortgage rates in 2017. Fixed-term mortgage rates are set by the bond market and the yields on bonds are rising. Other factors impacting the mortgage rates are the new rules, brought in by Finance Minister Bill Morneau in October, in an effort to temper overheated real estate markets and keep Canadians from taking on bigger mortgages than they can afford, at a time of historically low interest rates. The changes are also a reaction to concerns regarding foreign ownership, particularly those who flip houses adding greater volatility to the market.

A stress test, applied to new and high-ratio mortgages, means the home buyer now needs to qualify for the lender’s rate and the Bank of Canada’s five-year fixed posted mortgage rate, which is an average of the posted rates of the big six banks. This rate is usually higher than what borrowers can negotiate. Qualifying for higher-rate mortgages means reducing what buyers can afford, softening the upward pressure on prices.

The government is also looking to limit its exposure to residential mortgage insurance. The Federal Government backs 100% of CMHC’s mortgage insurance obligations. The government wants to distribute some of this risk, meaning that the lenders themselves will need to build in the risk to their pricing. Already many of the banks have increased their mortgage rates to reflect this new reality.

Expectations are for an easing of prices in the Vancouver market, due to several factors. In July, Premier Christy Clark announced a 15% tax on all purchases of residential real estate in the Metro Vancouver Area by foreign buyers. The tax came into effect on August 2 and has succeeded in cooling sectors of the overheated market. Going forward, owners of vacant properties in Vancouver will be subject to a 1% tax on the assessed value of their home. Owners of non-principal residences unoccupied for six months or more each year are subject to this new tax designed to address the limited number of rental properties in the city.

Economists from the B.C. Real Estate Association forecast a reduction in home prices in Greater Vancouver of 8.7% by the end 2017, bringing the average home down to $940,000. This easing of pricing pressures would simply return prices to 2015 levels. Yet with the isolationism of Brexit and Trump’s promises, Vancouver is viewed as an island of tolerance in a sea of uncertainty. Thus Vancouver remains an attractive option for foreign investors and immigrants.

Positioning your finances

If 2017 is anything like the current year, expect more than a few twists and turns. Here are some ways to position your finances for uncertainty ahead.

  • Maintain a balanced portfolio: With market shocks like Brexit, which hit stocks the hardest, bonds weathered the storm, demonstrating how balanced portfolios fared better.
  • Work with an accredited advisor: A recent study from the Montreal-based Centre for Interuniversity Research and Analysis on Organizations found that those who seek outside financial advice, over time, see their assets grow by 1.5 – 2.7 times more than those who don’t see advice.
  • Keep your emotions in check: There will be surprises in 2017, just as there were in 2016 and every year previous. The extent of the surprises and the impact on one’s financial position cannot be predicted. But overreacting to one event only results in poor long-term results.
  • Diversify — it’s never been so important: With pressure on commodities, the Loonie and interest rates likely to linger in Canada, having exposure to foreign investments can let you profit from diverse markets while helping protect your portfolio. Take a broad approach to income by looking to a combination of fixed income and equity investments to generate cash flow. Assess how rising real estate prices may have skewed your net worth. It may be time to consider using some of your newly created home equity to fund alternate investments so you can maintain a balanced asset base.
  • Focus on the long term. Market gyrations in 2017 are likely to give you plenty of excuses to deviate from your long-term plan. Don’t, ignore the noise and stay focused on your goals.
  • Right-size your debt. Instead of using current low interest rates as a reason to borrow outside your comfort zone, look at the situation as an opportunity to right-size your debt. Stress test your obligations to ensure you have an income cushion that can handle higher rates when they eventually arrive. Revisit your budget to see if small changes can add up to large savings.

Above all, have a plan.

In today’s global economy there are just too many moving pieces to leave your financial future to chance. Whether you want to better understand the pending tax changes or be more prepared for what financial markets may bring, have a plan and follow through on it.

Speak with us to arrange a comprehensive review and start the new year off right.

The information contained in this report was obtained from sources believed to be reliable; however, we cannot guarantee that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any financial products.

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