Financial Outlook 2018
What to watch in the economy and the markets in the year ahead.
From Bitcoin to cannabis, North Korea to the Trump tax cut, there were lots of stories that had people talking in 2017. The world economy turned in its best performance since 2011, a lift in optimism tacking over $9 trillion in value to equity markets globally. Canada turned 150 and BC changed governments. What’s more, there was just no quit in Metro Vancouver real estate. What could 2018 have in store? Here are some key themes to watch.
Global economy firing on all cylinders
The world economy entered 2018 in a synchronized global expansion. Last year marked the first time since 2007 that all 45 nations tracked by the OECD reported real GDP growth; a feat set to be repeated.
Unemployment rates are touching fresh lows in Canada, the United States, the United Kingdom, Germany and Japan. The output gap – which measures the difference between actual and potential economic output – is closing rapidly across the majority of the G7, indicating most developed economies are running near or at full capacity.
Consumer confidence in the European Union now stands at its highest level in ten years, accompanied by rising industrial output and retail sales. Even emerging economies are starting to shine on the back of stronger fundamentals and structural reforms which appear to be finally taking hold.
Not surprisingly, the optimism has found its way into equity markets. In 2017 the MSCI All Country World Index celebrated its best annual performance since 2013. In the US, the S&P 500 Index hasn’t seen a 5% correction since June 2016 as market volatility clings to record lows. One reason? Healthy corporate profits. So far, three-quarters of S&P 500 companies reporting 2017 earnings have beat estimates.
End to easy money draws closer
America’s rosy economic picture has put all eyes squarely on the Federal Reserve and interest rate policy. The consensus view is we’ll see three 25 basis point increases to the federal funds rate this year in anticipation of building wage and price pressures. And, there’s a chance of further hikes if tax reform boosts the economy more than expected.
While the Fed steps up rate increases, major central banks are also making a concerted effort to ease monetary stimulus as economic indicators turn up.
By one estimate, growth in major central bank balance sheets will drop by $1.4 trillion in the next year, as the Federal Reserve shrinks its balance sheet, and the European Central Bank (ECB) and Bank of Japan (BoJ) slow their bond buying programs1. Expect the ECB, BoJ and Bank of England to lag the US and Canada in raising interest rates. While Britain deals with Brexit, in the Eurozone and Japanese economies soft inflation and spare capacity linger.
Bank of Canada faces a delicate balancing act
After coming out on top of the G7 in 2017, Canada’s economy is predicted to grow at a slower pace this year, as leadership shifts its focus from the housing market and consumers; to government infrastructure spending, exports and business investment. A key question for households and investors alike: how far will the Bank of Canada raise interest rates in 2018?
Policymakers are juggling a myriad of factors. In its October Monetary Policy Report, the Bank projected growth to reach a respectable 2.1% this year – that’s better than the UK, France and Japan. With economic activity pushing full capacity, inflation should approach 2%. Rising energy and commodity prices are welcome news, especially for Alberta. Plus, the labour market is hot. With BC leading the way, the jobless rate fell to 5.7% nationally in December, the lowest since 1976, strengthening the case for a move on interest rates sooner rather than later.
That said, there are reasons for the Bank to be wary. On one hand, the uncertainty surrounding the outcome of the NAFTA negotiations is a huge wildcard. On the other, consumers are dealing with record debt levels at the same time the housing market navigates new mortgage stress-tests imposed on buyers.
Metro Vancouver real estate: still a seller’s market
Metro Vancouver’s real estate market had another strong year in 2017, as low interest rates, a vibrant economy and constrained supply combined to fuel price growth. While numbers from the Real Estate Board of Greater Vancouver show the residential benchmark price was up 15.9%, that figure masks a broad divergence among market segments.
Prices for detached homes, most impacted by eroding affordability and the provincial foreign buyer tax, rose just 7.9%. Some communities, including the North Shore, even saw a decline in the back half of the year. As single-family homes moved further out of reach for the average buyer, the relative value in multi-family housing helped trigger a sharp increase in demand. Condominium prices soared nearly 26% across the region.
What can we expect in local real estate in 2018?
Central 1 Credit Union forecasts Greater Vancouver home prices will lead the province and, depending on the property type, this could indicate a seller’s market is poised to continue. Real estate demand remains anchored by a robust provincial economy and the Lower Mainland’s growing appeal as a place to live, work and own a home.
Still, there are headwinds. Higher borrowing costs are on the way. The Bank of Canada recently raised its benchmark rate which will affect lending rates moving forward. Low supply is favourable for prices, but limits opportunities to get into the market or trade up. As of January 1st, homebuyers seeking uninsured mortgages from federally-regulated financial institutions must meet a new qualifying standard: the Bank of Canada five-year benchmark rate, or their contracted rate plus 2%, whichever is greater2. This new measure looks certain to take potential buyers out of the market, with first-timers among those affected the most.
What could cool the enthusiasm?
It’s easy to see why financial markets are upbeat. Economic output and corporate profitability are trending higher. Deregulation and tax cuts in the United States are helping spur confidence globally, while inflation remains below target, here, in the U.S., and in developed markets abroad. But, that doesn’t mean there aren’t potential pitfalls which could turn the current optimism on its head.
Bad news and black swans. Financial markets are pricing in plenty of good news, leaving asset valuations stretched, particularly in U.S. equities. That could make investors jumpy in the face of any negative headlines or unexpected events, whether economic or geopolitical.
Central banks miss the mark. The major central banks are walking a tightrope when it comes to monetary policy. Any miscalculation could throw a wrench in the economy’s positive momentum. Will the Bank of Canada or Federal Reserve overshoot with interest rates increases, choking off growth and hastening the next recession? Or, do too little, too late, and see inflation run ahead? Could the ECB pull back stimulus prematurely while the continent’s economy still needs a lifeline? For all concerned, there’s unpredictability around reigning in historic levels of quantitative easing.
Trade friction boils over. The end of NAFTA would be an ominous sign for the North American economy and could have a ripple effect on global trade. So would a wrong turn in Brexit negotiations or further cracks in U.S.-China relations. If protectionism takes root, it spells trouble for the world economy.
China hits a speed bump. A rejuvenated Chinese economy was a key catalyst for global growth in 2017. But China is also a nation tackling broad financial reforms as it transitions from a manufacturing-based to consumer-driven economy. A serious misstep by the country’s leadership could send a shiver through financial markets and inflict a costly blow to economic growth far beyond China’s borders.
Positioning your portfolio and finances
How should you prepare your investments and finances for the year ahead? Here are four ideas to start with.
1. Go international. If your investment portfolio is underweight overseas exposure, there are good reasons to look beyond North America for investment opportunities in 2018. Many foreign economies are in earlier stages of the business cycle so equity valuations are lower, offering potential upside. You’ll also enhance diversification. Equity markets globally are experiencing their lowest average correlation in two decades.3
2. Look at rebalancing. Equities have been on an extended winning streak. Those gains may have created an outsized allocation to stocks and left too little exposure to bonds and cash in your portfolio. Now’s the time to consider rebalancing your investments to get back to your target asset mix.
3. Assess your debt. Interest rates are on the way up. Work with your advisor on your own personal stress-test of your debt to see how well your finances can cope with higher borrowing costs. Remember, paying down what you owe will let you put the interest you save to better uses.
4. Expect the unexpected. Financial markets are riding a wave of positive sentiment. That means they’re highly vulnerable to any bad news. Have a strategy for dealing with market volatility before it strikes, so you can stay focussed on your long-term goals through thick and thin.
Your BlueShore Financial advisor has the skills, knowledge and experience to position you properly for the year ahead, and beyond. Contact us for a review of your financial plan and make 2018 your most successful year yet.