Safe to say that political risk – that is, when government changes or instability has the potential to affect investment returns – will be the economic story of 2017. That’s obvious to anyone with a newspaper or cable TV subscription. Federal elections in Europe featuring anti-establishment populists and a new like-minded U.S. president with an America First agenda both have a potential impact on financial markets around the world.
Remember though, risk is neither good nor bad. It can produce both positive and negative returns. The trick is to recognize risk, understand it as best you can and make decisions that are right for you based on your risk appetite and financial plan. When we avoid risk, we usually fail to save enough for our long-term goals.
Chhad Aul, Vice-President, Portfolio Management at Sun Life Global Investments, says Canadian investors should pay close attention to Washington.
“We’re fairly optimistic about the 1st half of this year,” he says. “There will be a concentration coming out of the U.S. in particular on pro-growth measures with the new government coming in. Tax cuts should get through Congress relatively easily. Further fiscal stimulus probably comes next in terms of infrastructure spending.”
Aul is less sure that President Donald Trump will be successful in implementing his aggressive infrastructure program. Republicans tend not to favour big government spending and so success will require some politicking, even within Trump’s own party.
If the new president fails to execute fully on his stimulus plan, we could see stock markets in the U.S. and Canada soften in the 2nd half of the year. Add to that a round of national elections across Europe and there’s an even greater potential for a 2nd-half pullback.
“Many of the largest economies in the eurozone are holding national elections,” says Aul. “The Netherlands, France and Germany. Italy could very well have one as well. In each of those cases, there is another populist anti-establishment element. The question is whether or not the markets will be resilient.”
Markets rebounded after initial concerns about Britain’s vote to leave the European Union, and President Trump’s surprise election win in 2016. This year could be different, though. Another 1 or 2 populist victories could lead to trouble. “If we were to have some of these forces come to power, there’s a much more direct line to market risk in terms of a breakup of the euro currency union,” says Aul.
Our global economy
This all matters because the global economy is so tightly interconnected. Consider 3 of our main economic drivers, for example. First, with oil selling at close to $50 a barrel, we’re not seeing the level of capital investment in oil sands projects we saw when prices were up above $100. Second, manufacturers who expected to see a boost from the drop in the Canadian dollar relative to the U.S. greenback were disappointed to find that their global competitors’ currencies also fell, negating any potential advantage. And third, housing – one area where we have seen strong demand – is likely to slow this year as government policy-makers work to cool the market down.
“It’s not great timing because it’s one of the few areas that has been firing on all cylinders,” says Aul. “It does look fairly poor for Canada going forward this year. There aren’t many engines of growth.”
That’s not to say there aren’t opportunities. Here are 5 predictions for 2017:
- Pick your spots on the domestic stock market. “We continue to expect oil prices to move higher,” says Aul. “Canadian financials are going to continue to benefit from higher yields and a steeper yield curve.”
- Canadian bonds are a good bet. “We expect Canadian yields to stay lower for longer given that we’re in an earlier phase of the recovery here,” says Aul. “That means Canadian bonds should do better than other global bonds.” (Bond yields and bond prices move in opposite directions.)
- The Bank of Canada will hold firm on the overnight rate, currently at 0.5%. During its latest rate announcement on Jan. 18, our central bank predicted that the Canadian economy would reach full capacity in mid-2018. Don’t expect a rate hike before then.
- Offsetting trends mean the Canadian dollar probably stays where it is relative to the U.S. As noted, short-term rates will stay low here while the U.S. Federal Reserve looks ready to continue increasing rates south of the border. But while that’s making the greenback more expensive for us, rising oil prices should give our loonie a boost in 2017.
- Gross domestic product growth will continue to “muddle along,” says Aul. Expect something south of 2%.
Nothing too surprising there. But that is not to say 2017 won’t throw us a curveball or two. So much rides on President Trump’s success. If he’s able to drive real growth with his stimulus plan, and we’re not hit too heavily by protectionist measures that adversely affect Canada-U.S. trade, we could have a good year. Politics aside, the U.S. economy is well down the road in its post-financial crisis recovery. All things being equal, we stand to benefit from that strength.
On the other hand, the political risks are real. Just as Canadian policy-makers are working to encourage international trade outside of the U.S., it makes sense for investors to think along similarly diversified lines.