Here s What We re Thinking 10/3/2018

Transcription

1 10/3/2018 Investment Strategy We continue to recommend overweight exposure to equities and underweight exposure to fixed income, relative to our long-term strategic asset allocation model. The United States-Mexico-Canada Agreement (USMCA), announced Sunday, helped reduce some of the near-term pressures facing the trade-dependent Canadian economy. Leaders from Canada, Mexico and the U.S. are expected to sign the new agreement before the end of November, at which point the agreement will be sent to the U.S. Congress for approval. The agreement to revamp the trilateral trade agreement firmed investor expectations that the Bank of Canada (BoC) would raise interest rates as many as four times by the end of 2019, consistent with the strength of recent economic data releases. We share the same upbeat view of the Canadian economy but reiterate our bias toward the U.S. market in light of its more stable and diversified corporate earnings profile. Given the maturity of the current business cycle and the prospect of higher near or medium-term financial market volatility, we continue to recommend that investors manage risk through diversification across asset classes and geographic regions. Equities We remain overweight equities with a particular emphasis on U.S. stocks. In our recent publications, we have highlighted our preference for U.S. equities over those in other jurisdictions. This recommendation has worked out well, as equity markets in the two regions have moved in opposite directions of late. In Canadian dollar terms, Q3/2018 equity market performance was as follows: U.S. +6.0%, Canada -0.5%, International -1.3%, and Emerging Markets -2.5%. Such performance divergence is not unusual during seasonally weaker summer periods or U.S. Federal Reserve tightening cycles. While we acknowledge a mean-reversion opportunity exists going into year end, we advocate a more conservative approach for most investors and recommend a U.S. tilt to equity portfolios given the U.S. equity market s relatively higher earnings quality and growth profile. We concede equity investors have no shortage of worries, including the maturity of the current bull market, monetary policy tightening, U.S.-China trade tensions, fragile nations (Italy, Turkey, South Africa, and Argentina), crude oil price strength, U.S. dollar strength and pending U.S. midterm elections. However, our constructive equity outlook remains intact, supported by reasonable valuations, low nearterm recession risk and robust EPS growth. Fixed Income Our high quality credit bias remains intact as spreads compress. We expect U.S investment grade corporate bonds to continue trading at tight spreads on the back of solid economic data, rising U.S. Treasury yields, and healthy credit fundamentals. As Q3 earnings season kicks off in mid-october, we will focus our attention on operating costs as inflationary pressures could bring rise to higher expenses, which could potentially have a negative impact on credit metrics. With respect to our bond strategy, we maintain our high quality credit bias despite high yield bonds outperforming investment grade bonds over the last few months. We remain cautious on U.S. high yield bonds as much of the recent credit spread compression (outperformance) has been driven by riskier high yield issuers, particularly those rated CCC by credit rating agency Standard & Poor s and Caa by Moody s. In Canada, the Coalition Avenir Québec (CAQ) won a 1 Global Portfolio Advisory Group Registered trademark of The Bank of Nova Scotia, used under licence. Trademark of The Bank of Nova Scotia, used under licence. Scotia Wealth Management consists of a range of financial services provided by The Bank of Nova Scotia (Scotiabank ); The Bank of Nova Scotia Trust Company (Scotiatrust ); Private Investment Counsel, a service of 1832 Asset Management L.P.; 1832 Asset Management U.S. Inc.; Scotia Wealth Insurance Services Inc.; and ScotiaMcLeod, a division of Scotia Capital Inc. Wealth advisory and brokerage services are provided by ScotiaMcLeod, a division of Scotia Capital Inc. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada.

2 majority government on October 1 st, despite polls indicating a minority government was the more probable outcome. This event may put pressure on provincial bonds as the CAQ aims to cut taxes but vowed to add new public services. The outgoing Liberal government was able to steadily reduce debtto-gdp during their tenure, but the change could pose a threat to the province s fiscal stability. Preferreds The Canadian preferred share market continues to provide investors with attractive yields and remains well supported at current levels by the recent movement higher in Canadian bond yields. However, despite the recent rally in underlying bond yields (5-year Government of Canada bond yield has reached levels not seen since 2011), the Canadian preferred share market has yet to move notably higher. This could be the result of widening in credit spreads over the same period. Nevertheless, we remain constructive on underlying credit fundamentals and believe that we could see spreads tighten over the medium-term. Currencies and Commodities Upcoming U.S. sanctions on Iran send the price of crude oil to a four-year high. Price volatility and uncertain market dynamics underscore our preference for energy infrastructure stocks relative to their energy producing peers. Global crude oil prices hit a four-year high earlier this week as U.S. sanctions on Iran, OPEC's third largest producer, are expected to remove ~1mm barrels per day of supply from the global market by year end. India and China, who rank among the largest purchasers of Iranian crude oil, have been steadily reducing their import volumes ahead of November 4 th, when the U.S. will reimpose sanctions on Iran that include restrictions on Iran s sale of crude oil and transactions with its central bank. The expected volatility in benchmark crude oil prices reinforces our preference for energy infrastructure equities over producer stocks. USMCA and rising oil prices drive Canadian dollar (CAD) rally. Diversification remains the best way to manage global macro-related developments. Sunday's USMCA announcement removed a major overhang on the CAD. Meanwhile, favourable global oil market fundamentals continue to drive crude oil prices higher. Both factors supported the loonie s ~0.7% rally this week relative to the U.S. dollar (USD). Further supporting the CAD, LNG Canada, a five-way joint venture, decided in favour of building a ~$40B liquefied natural gas export facility in Kitimat, British Columbia. Despite the positive trade and commodityrelated developments, we continue to stress the importance of portfolio diversification, by both asset class and geography, to manage ever-present investment risks. Economics The U.S. Federal Reserve to continue tightening its monetary policy. As widely anticipated, the U.S Federal Reserve raised the funds rate target range by 25bps to 2.00%-2.25% last week. Most members of the Committee expect one more 25bp rate hike before the end of the year and three rate hikes in 2019 as indicated by the median dot plot projections. In our view, one important takeaway from this Fed meeting was the removal of the word accommodative from the statement, suggesting that interest rates are moving closer to the neutral level. However, Fed Chairman Powel highlighted during his press conference that the removal of the word accommodative does not represent a change in the rate of the current path. Indeed, the median dot plot projections indicate to some extent a hawkish tone, suggesting to us that the U.S. Federal Reserve is on track to continue tightening its monetary policy. Looking beyond the Federal Reserve meeting, the U.S. labour market report for September will be released this Friday. U.S. employers are expected to have added 181k jobs last month, and the unemployment rate is expected to drop further, to 3.8% from August s 3.9%. Wage gains and the impact of trade policy on employment will be followed closely by market participants.

3 Geopolitics While the USMCA is a positive for global risk appetite, ongoing U.S.-China trade conflict remains a significant impediment to a sustained improvement in investor sentiment. Financial markets are also grappling with stalled Brexit talks and an Italian government that initially tabled a much-higher-than-expected budget deficit target (2.4% of GDP for three years), before reducing budget deficit targets to 2.1% in 2020 and 1.8% in 2021, respectively. While the targets are below the European Union s maximum guideline for member states, there are concerns that the budget does little to address Italy s US$2.67 trillion debt burden, the second-highest figure in the EU behind Greece. Officials from both sides will continue discussions until the October 15 th budget submission deadline. Meanwhile, according to a survey published by the British Chambers of Commerce, 62% of British firms have yet to carry out a no-deal Brexit risk assessment. Of the 2,500 firms surveyed, 21% said they would cut investment spending if the United Kingdom were to exit without a trade deal. The political turmoil across Europe has taken a toll on the Pound Sterling and Euro currencies, helping to propel the U.S. Dollar Index (DXY) to a two week high.

4 Disclaimers This material does not include or constitute an investment recommendation, and is not intended to take into account the particular investment objectives, financial conditions, or needs of individual clients. Before acting on this material, you should consider whether it is suitable for your particular circumstances and talk to your investment advisor. The author(s) of the report and the supervisors of the Global Portfolio Advisory Group may own securities of the companies included herein. Scotia Capital Inc. is what is referred to as an integrated investment firm since we provide a broad range of corporate finance, investment banking, institutional trading and retail client services and products. As a result we recognize that there are inherent conflicts of interest in our business since we often represent both sides to a transaction, namely the buyer and the seller. While we have policies and procedures in place to manage these conflicts, we also disclose certain conflicts to you so that you are aware of them. Please note that we may have, from time to time, relationships with the companies that are discussed in this report. The Global Portfolio Advisory Group prepared this report by analyzing information from various sources. Information obtained in the preparation of this report may have been obtained from the Equity Research and Fixed Income Research departments of the Global Banking and Markets division of Scotiabank. Information may be also obtained from the Foreign Exchange Research and Scotia Economics departments within Scotiabank. In addition to information obtained from members of the Scotiabank group, information may be obtained from the following third party sources: Standard & Poor s, Morningstar, Bloomberg, Credit Suisse AG, Macrobond and FactSet. The information and opinions contained in this report have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. While the information provided is believed to be accurate and reliable, neither Scotia Capital Inc., which includes the Global Portfolio Advisory Group, nor any of its affiliates makes any representations or warranties, express or implied, as to the accuracy or completeness of such information. Neither Scotia Capital Inc. nor its affiliates accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents. This report is provided to you for informational purposes only. This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation or particular needs of any specific person. Investors should seek advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Nothing contained in this report is or should be relied upon as a promise or representation as to the future. The pro forma and estimated financial information contained in this report, if any, is based on certain assumptions and analysis of information available at the time that this information was prepared, which assumptions and analysis may or may not be correct. There is no representation, warranty or other assurance that any projections contained in this report will be realized. Opinions, estimates and projections contained herein are those of the Global Portfolio Advisory Group as of the date hereof and are subject to change without notice. For that reason, it cannot be guaranteed by The Bank of Nova Scotia or any of its subsidiaries, including Scotia Capital Inc. This report is not, and is not to be construed as: (i) an offer to sell or solicitation of an offer to buy securities and/or commodity futures contracts; (ii) an offer to transact business in any jurisdiction; or (iii) investment advice to any party. Products and services described herein are only available where they can be lawfully provided. Scotia Capital Inc. and its affiliates and/or their respective officers, directors or employees may from time to time acquire, hold or sell securities and/or commodities and/or commodity futures contracts mentioned herein as principal or agent. Sharpe Ratio is the measure of risk-adjusted return of a financial portfolio. A portfolio with a higher Sharpe Ratio is considered superior relative to its peers.

5 Standard Deviation is a statistical measurement calculated to indicate the extent of deviation for a group as a whole. The greater the standard deviation of an investment, the greater the investment may range in price. Trademarks are the property of their respective owners. Copyright 2018 Scotia Capital Inc. All rights reserved. This report is distributed by Scotia Capital Inc., a subsidiary of The Bank of Nova Scotia. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund and the Investment Industry Regulatory Organization of Canada. Registered trademark of The Bank of Nova Scotia, used under licence. Trademark of The Bank of Nova Scotia, used under licence. Scotia Wealth Management consists of a range of financial services provided by The Bank of Nova Scotia (Scotiabank ); The Bank of Nova Scotia Trust Company (Scotiatrust ); Private Investment Counsel, a service of 1832 Asset Management L.P.; 1832 Asset Management U.S. Inc.; Scotia Wealth Insurance Services Inc.; and ScotiaMcLeod, a division of Scotia Capital Inc. Private banking and International private banking services are provided in Canada by The Bank of Nova Scotia. Estate and trust services are provided by The Bank of Nova Scotia Trust Company. Portfolio management services are provided by 1832 Asset Management L.P. and 1832 Asset Management U.S. Inc. Insurance services are provided by Scotia Wealth Management Insurance Services Inc. Wealth advisory and brokerage services are provided by ScotiaMcLeod, a division of Scotia Capital Inc. International investment advisory services are provided in Canada by Scotia Capital Inc. Financial planning services are provided by The Bank of Nova Scotia, 1832 Asset Management L.P., and ScotiaMcLeod, a division of Scotia Capital Inc. Scotia Wealth Management consists of a range of financial services provided, in The Bahamas, by Scotiabank (Bahamas) Limited and The Bank of Nova Scotia Trust Company (Bahamas) Limited. International private banking services are provided in The Bahamas by Scotiabank (Bahamas) Limited, an entity registered with The Central Bank of The Bahamas. International investment advisory services are provided in The Bahamas by Scotiabank (Bahamas) Limited, an entity registered with The Securities Commission of The Bahamas. International wealth structuring solutions are provided in The Bahamas by The Bank of Nova Scotia Trust Company (Bahamas) Limited, an entity registered with The Central Bank of The Bahamas. Scotia Wealth Management consists of international investment advisory services provided, in Barbados, by The Bank of Nova Scotia, Barbados Branch, an entity licensed by the Barbados Financial Services Commission. Scotia Wealth Management consists of a range of financial services provided, in the Cayman Islands, by Scotiabank & Trust (Cayman) Ltd. International private banking services, international investment advisory services and international wealth structuring solutions are provided in the Cayman Islands by Scotiabank & Trust (Cayman) Ltd., an entity licensed by the Cayman Islands Monetary Authority. Scotia Wealth Management consists of international private banking services provided, in Peru, by Scotiabank Peru S.A.A, an entity supervised by the Peru Superintendence of Banking and Insurance.