Capital markets update April 2017
Avg % change on previous year The economy Economic growth has improved in both developed and emerging market, with most countries managing some improvement in recent months. RBC GAM is encouraged by this improvement, but does not see it as a permanent escape from the slow growth environment. Growth forecasts are slightly upgraded, but assume some of this vigour will be shed in the second half of the year and into 2018. 4.0 Weighted average consensus real GDP Growth estimates for major developed nations 3.0 2.0 1.0 2011: 1.4% 2012: 1.2% 2013: 1.2% 2014: 1.6% 2015: 1.8% 2016: 1.6% 2017: 1.8% 2018: 1.8% 0.0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Consensus Economics As of Mar. 15, 2017 2 April 2017 Capital markets update
The economy The Purchasing Managers Index (PMI), a measure of manufacturing strength, was comfortably above 50 for both emerging and developed markets. The Eurozone PMI reached a five-and-a-half year high. 65 Global purchasing managers' indices 60 ISM Peak Feb 2011: 59.3 55 50 45 40 35 30 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 Source: Haver Analytics, RBC GAM JPMorgan Global Mfg. PMI U.S. ISM Mfg. PMI China Mfg. PMI Euro Area Mfg. PMI As of Mar. 15, 2017 3 April 2017 Capital markets update
Policy rates Globally, many central banks are still focused on delivering prior quantitative-easing commitments. The one exception is the U.S. Federal Reserve which continues to press forward with its plan to nudge the fed funds rate higher. Current: Mar. 31 2017 Forecast: Feb. 2018 U.S 1.00% 1.38% Canada 0.50% 0.50% Europe -0.40% -0.40% United Kingdom 0.25% 0.25% Japan 0.00% -0.10% Rate definitions: U.S.= Fed Funds rate; Canada= Overnight rate; Europe = Eurozone policy rate; United Kingdom= Base rate; Japan= Overnight call rate. 4 April 2017 Capital markets update
% % Fixed income The yield on U.S. 10-year Treasuries peaked at 2.65% in December and has been trading in a narrow range since then. Bond yields followed a similar pattern in other major regions, but to a lesser extent. 16 14 12 10 8 6 4 U.S. 10-year T-Bond yield Equilibrium range Last Plot: 2.40% Current Range: 1.74% - 3.52% (Mid: 2.63%) Feb. '18 Range: 2.54% - 4.32% (Mid: 3.43%) Feb. '22 Range: 3.75% - 5.53% (Mid: 4.64%) 18 16 14 12 10 8 6 4 Canada 10-year bond yield Equilibrium range Last Plot: 1.63% Current Range: 1.52% - 3.06% (Mid: 2.29%) 2 2 0 0 1980 1985 1990 1995 2000 2005 2010 2015 2020 1980 1985 1990 1995 2000 2005 2010 2015 2020, RBC CM As of Mar. 15, 2017, RBC CM 5 April 2017 Capital markets update
Fixed income The financial crisis has depressed real rates of interest to levels that are not likely to persist. The combination of both a bit more inflation and a higher real rate of interest would act as a headwind to fixed-income returns in general and pose a risk to sovereign-bond investors, in particular. Long-term interest rate forecasts March 31, 2017 Forecast: Feb. 2018 U.S. 10-Year Bond 2.39% 2.50% Canada 10-Year Bond 1.62% 1.75% Germany 10-Year Bond 0.33% 0.75% United Kingdom Gilt 1.14% 1.50% Japan 10-Year Bond 0.07% 0.10% 6 April 2017 Capital markets update
Equity markets Currently the valuation of the S&P/TSX is moderately lower than that of the S&P 500. This seems justified given the energy-price forecast and the outsized contribution of financial-company earnings to the overall profit pool. Our own RBC GAM multi-factor model, which incorporates current levels of inflation, interest rates and corporate profitability, suggests U.S. stocks are actually a bit below fair value. However, we do recognize that stocks are not as cheap as they were, so a continued improvement in earnings is needed to fuel further equity gains. 5120 2560 S&P 500 equilibrium Normalized earnings & valuations Feb. '17 Range: 1895-3164 (Mid: 2529) Feb. '18 Range: 2065-3448 (Mid: 2756) Current (28-February-17): 2364 25600 12800 S&P/TSX Composite equilibrium Normalized earnings & valuations Feb. '17 Range: 15358-23269 (Mid: 19314) Feb. '18 Range: 15208-23042 (Mid: 19125) Current (28-February-17): 15420 1280 640 320 6400 3200 160 1600 80 800 40 1960 1970 1980 1990 2000 2010 2020 400 1960 1970 1980 1990 2000 2010 2020 Data as of March 15, 2017. The fair value calculation is the product of the equilibrium price/earnings ratio and the current estimate for normalized earnings. The resulting price level is then standardized by a factor representing the historic relationship of the actual market to its equilibrium level. This generates the fair value estimate or mid-point of the band. The bands boundaries capture one standard deviation of movement above and below this value. Fair value is the minimum price level consistent with mild inflation/low interest rates in a growing economy. Above-average price appreciation remains a possibility in an environment where normalcy is restored. Moreover, opportunity exists as valuations in some big markets still lie below their minimum expected levels. Corrections are always a possibility and valuations will not limit the risk of damage from systemic shocks, but the outlook for equity market returns is generally superior when stocks lie below fair value at the bands midpoint. 7 April 2017 Capital markets update
Equity markets Surprisingly strong economic data, surging consumer and business confidence, and better-than-expected earnings have propelled stocks higher. Although stocks have enjoyed a solid rally, we don t think that valuations are as stretched as some investors believe. Equity market forecasts Current: March 31, 2017 Forecast: Feb. 2018 S&P 500 Index 2363 2525 S&P/TSX Composite Index 15548 16125 MSCI Europe Index 129 135 FTSE 100 Index 7323 7550 Nikkei Index 18909 19975 MSCI Emerging Markets Index 958 1000 8 April 2017 Capital markets update
Asset mix RBC GAM models continue to suggest that equities will outperform fixed income through the forecast horizon as well as over the longer term. Our models continue to suggest that equities will outperform fixed income through the forecast horizon as well as over the longer term. Our recommended asset mix for a global, balanced investor is 60% equities (strategic neutral : 55%), 38% bonds (strategic neutral: 43%) and 2% in cash. Global Asset Mix Benchmark Past Range Summer 2016 Fall 2016 New Year 2017 Spring 2017 Cash 2.0% 1%-16% 3.0% 3.0% 1.0% 2.0% Bonds 43.0% 25%-54% 37.0% 37.0% 38.0% 38.0% Equities 55.0% 36%-65% 60.0% 60.0% 61.0% 60.0% Asset mix as of March 15, 2017. 9 April 2017 Capital markets update
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