ECONOMIC & CAPITAL MARKETS COMMENTS
World — modest growth but improving; low commodity prices a net benefit for the big three but a source of stress for some emerging economies like Brazil; strong U.S. dollar hurts countries that have borrowed in American funds and exporters pegged to the dollar
U.S. — modest growth but improving; recovery from the financial crisis evidenced by solid consumer spending and employment gains, policy normalization underway (low government spending and Federal reserve interest rate increase)
Eurozone — low growth with small improvement; still early in the debt reduction process; exports benefiting from decline in euro; monetary and fiscal policy stimulus- European Central Bank has negative interest rates (banks have to pay to deposit funds) and a large bond buying program-most governments are running deficits; weak consumer spending and high unemployment
China — strong growth but deteriorating; debt has increased to fund the huge investment in infrastructure, housing and manufacturing that has occurred over the past fifteen years however, it remains manageable; reduced spending on fixed assets as policymakers seek to expand the services side of the economy is having a negative impact on demand and prices for raw materials; services now account for about 50% of the economy and are expanding at a faster rate than manufacturing; implementing both fiscal and monetary policy stimulus in attempt to stabilize economy with lots of flexibility to add more
Capital Markets Expectations
Thus far in 2016, the TSX Composite and other world stock markets have experienced relentless selling pressure. Reasons for this include: 1. Decrease in oil and other commodity prices which could lead to more bankruptcies of resource companies (not good for lenders). 2. Increased geopolitical turmoil. 3. Some recent data indicating a U.S. slowdown caused by the strong dollar and higher interest rates. 4. Latest indicators suggest a more severe slowing in China and other emerging countries. While all these issues have been on the radar screen for some time, recent developments have raised the risk of one or more of these events coming to pass. In light of this, we have reduced our earnings estimate for the TSX by 10%. The decline in profitability is concentrated in the resource sectors. Our target for the TSX Composite is down to 14,200 which still represents substantial upside from the current level. A rebound in oil and steady growth in the U.S. and China could make our target too conservative.
Bonds will likely have negative returns this year if the Fed goes ahead with more interest rate increases. This will put upward pressure on both U.S. and Canadian yields. As bond yields rise, bond prices fall. Canadian short term interest rates are likely to remain stable. If the economy weakens, the Bank of Canada could lower the bank rate from the current .50%.
