July 5, 2019

Financial letter, Summer 2019, 48^th edition

The bumpy road to a US-China trade deal

Until tensions deescalate. the US-China trade negotiations will generate volatility and aggravate fluctuations on the financial markets. Discussions and negotiations continued on the sidelines of the G20 Osaka summit held on June 27 and 28. Politically. Donald Trump and Xi Jinping share a common interest: maintaining economic growth.

Therefore. predictions of a recession are premature. While it’s tempting to worry about Trump’s America today and the potential for a trade war. it’s important to stake stock of the positive impact of public policy. Barring any unforeseen developments. like a major breakdown in trade negotiations that would drain consumer. business and investor confidence. the current economic cycle should persist beyond 2020.

Fixed income

In fixed income. the monetary policy pause signals that interest rates will remain low until political and trade tensions cool off and inflation manages to stay on target. Assuming cooler heads prevail in the US-China dispute and global economic growth subsequently picks up the pace. interest rates should gradually return to their 2018 peak.

In Canada. despite encouraging signs about the economy. it is still too early to anticipate a rise in interest rates. Not only do substantial risks remain. it’s still not clear if we’ve factored in the full impact of past interest rate hikes on the Canadian economy. Therefore. the status quo is expected to prevail for several more months.

South of the border. the latest indicators reveal that the US created just 75.000 new jobs in May. following gains of 224.000 in April and 153.000 in March. The unemployment rate held steady at 3.6%. The weak job creation numbers in May disappointed observers. It now remains to be seen whether a rebound will materialize in the coming months or if the US economy and job market are effectively slowing. In the event of a slowdown. the Federal Reserve (Fed) would be more inclined to listen to the financial markets. which are eager to see interest rate cuts. The Fed will also be constrained by the political agenda. meaning it may tolerate a faster pace of economic growth and/or inflation.

We are adjusting the fixed income allocation with the aim of optimizing returns. Several months ago. we increased the duration of the bonds in the portfolios. We’re also underweight to fixed income securities.

Currencies

Amid new worries. the greenback’s slide will probably come to an end in the coming months. But changing monetary policy isn’t likely to help the U.S. dollar. and we expect to see rate cuts in July and September. Meanwhile the Canadian dollar could edge slightly higher in the coming months. but for now we don’t foresee any interest rate cuts in Canada this year or next. Desjardins predicts that the CAD/USD exchange rate will fluctuate between 0.74 and 0.77.

Portfolio strategy

The pace of economic growth is expected to slow. but absolute growth will continue. In view of the excellent start to the year. we are currently adopting a more defensive approach for the coming months.

Over the past quarter. we performed several tactical transactions with the aim of safeguarding the gains made in Q1. Alternative investments in real assets are now an integral part of the portfolios. These investments are increasingly necessary in an environment of low interest rates and volatile stock markets. The aim is to invest in assets that are weakly correlated with market trends and capable of delivering stable and attractive returns through different economic cycles. This type of investment is rarely accessible to retail clients. who typically have limited liquidity and are often tied to pension funds. Such alternative investments will help us enhance risk-adjusted returns.

Geographic allocation

According to the OECD. leading indicators continue to point to a slowdown of growth in most of the world’s major economies. However. the outlook differs from country to country. a fact we take into account in our geographic allocation strategies.

United States: Overweight

US GDP grew by 3.2 % in the first quarter. exceeding expectations. Going forward. consumer spending should continue to be bolstered by job market momentum and its positive impact on wages. However. with Trump’s tariffs potentially slashing $750 off the annual purchasing power of an average family of four. the pace of growth will be slower. Desjardins Group anticipates overall US GDP growth of 2.6 % in 2019 and 2.2 % in 2020. Outlooks suggest the current cycle will continue. albeit at a more moderate pace. Investors will be closely watching how the China-US talks unfold. We recommend tactically overweighting US equities.

Canada: Underweight

Like in the United States. households in Canada will benefit from a robust job market coupled with the monetary policy pause. which will help absorb last year’s increase in financing costs. Desjardins Group anticipates overall Canadian GDP growth of 1.4% in 2019 and 1.7% in 2020. Forecasts suggest the current cycle will continue. but at a more moderate pace. Given the heavy volatility of the Canadian market and its excellent start to the year. we decided to take profits. The recovery of banks is not expected to move forward at the same pace. Meanwhile. it’s hard to imagine that the concerns about the situation of Canadian households and the real estate market will dissipate. Finally. the energy sector remains incapable of increasing production despite profitable valuations due to the absence of adequate transport. In summary. after a positive start to the year. an underweight position to Canadian equities is definitely advisable.

Europe: Underweight

OECD leading indicators continue to point to positive growth in the eurozone. though it should be on the modest side in Germany. France and Italy. In another positive sign. the unemployment rate dropped to 7.8% in March. which is 2.2 percentage points lower than its average since 2008. Overall. economic growth was positive in Q1 at 0.4%. a result that surprised observers still reeling from the gloom of 2018.

The 0.4% rise in Germany’s GDP in Q1 sent waves of optimism across the eurozone’s economy. In France. the preliminary announcement of 0.3% GDP growth in Q1 suggests that the “yellow vest” movement is having only modest repercussions. And in Italy. the financial markets are feeling the pinch as concerns mount about the nation’s budget situation and the potential for renewed confrontation with the European Commission if Italy fails to abide by the 3% budget deficit ceiling in 2020. Italy’s first-quarter GDP growth stood at 0.2%.

In the United Kingdom. Brexit is proving to be a constraint on economic activity. While a dynamic UK job market continues to support domestic demand. the uncertainty surrounding the country’s departure from the EU is weighing down on business confidence and outlooks for investments and exports. Desjardins Group anticipates overall UK GDP growth of 1.0% in 2019 and 1.2% in 2020. Against this backdrop. economic results should be positive in 2019. In 2020. the European index may be a leading performer. We are underweighting European equities for now. but we’re prepared to increase our exposure to this region if growth outlooks improve and better-than-expected economic data starts piling up.

Conclusion

For now. a large majority of growth indicators are positive. While geopolitical tensions threaten to spoil the momentum and cause volatility. the world’s most powerful economies can at least agree on one thing: ensuring the continuity of the current economic cycle. 2020 will be a pivotal year for Donald Trump. as 2020-2021 will be for Xi Jinping.

In our view. our active management approach will enable you to maximize your returns over the long term. We hope that this information helps you better understand the markets. Please don’t hesitate to contact us if you’d like to discuss our investment strategies in more detail. We’d like to reiterate our commitment to keep working hard to help you meet your long-term financial goals by seizing the best opportunities offered on the markets.