Supported by an improving global economy, equity markets continued to rise in May, particularly those in emerging economies and in many Asian countries.
Ups and downs…
- European stocks performed well, as investors were reassured by the unequivocal election of centrist Emmanuel Macron.
- In the U.S., the S&P 500 set a new record, ending the month in positive territory despite negative reactions to many decisions and comments by Donald Trump.
- Canadian stock markets continued to tread water, with the S&P/TSX posting its first negative monthly performance since January 2016.
- In China, excessive debt is becoming increasingly worrisome and the impact on growth in the world’s second biggest economy is generating some uncertainty.
China’s challenge: Controlling the debt without impeding the economy
For the first time in close to 30 years, the Moody’s rating agency lowered China’s credit rating in May, judging that the increase in total debt and slower growth potential is likely to impair the country’s financial strength. It is true that since 2008, China’s overall debt has continued to grow, as shown on the graph below.
At the end of 2016, the country’s debt equalled 266% of GDP and it has risen more to date in 2017, albeit at a slower pace, thanks to measures put in place by the Chinese authorities. These measures, aimed at reducing financial leverage and use of the shadow banking system, could eventually have negative repercussions on China’s economy, as well as the entire global economy.
Bearish sentiment on the loonie
Shorting of the Canadian dollar reached record levels in May, a sign of extreme bearishness on the loonie. Shrugging off the strong performance of Canada’s economy in the first quarter, investors focused instead on the decline in oil prices, the U.S. threat to withdraw from the North American Free Trade Agreement, Moody’s lowering of Canadian bank credit ratings, and the perception abroad that Ontario’s overheated real estate market could seriously impact the country’s economic growth.
The loonie hit a low of US$0.7290 in early May, due primarily to the widening of interest rate spreads between Canada and the U.S. Many analysts believe that this situation is likely to continue, which is moderating expectations of a significant rise in our dollar this year.
FANGMA: Driving U.S. stock market growth
With valuations above the historical average, U.S. equities offer little return potential in the short term. In fact, the year-to-date gain of close to 7% on the S&P 500 is largely due to the excellent performance of FANGMA (Facebook, Amazon, Netflix, Google, Microsoft and Apple), which represent 12% of the index.
For example, online retail giant Amazon topped the symbolic $1,000-mark in May. According to observers, these companies should continue to lead the main U.S. indexes higher, thanks to the development of artificial intelligence, robotization, augmented reality, and other new technologies.
The Trump administration continues to make waves
The month of May was particularly eventful for President Trump, and around the world, doubts are growing about his ability to put in place his economic program. A possible attempt to obstruct justice in the investigation of his former national security advisor, the firing of the FBI director, revelations about sensitive security and information issues, inappropriate comments on Germany’s trade practices, and withdrawal from the Paris climate accord are but a few of the problematic situations he has caused. Instead of acting as a uniter, the U.S. leader is divisive and he represents a major risk that could upset the relative stability that now prevails on the financial markets.
Some risks to consider
Apart from Trump’s unpredictability, here are some other factors that could negatively impact the economy and the markets in the coming months.
- Geopolitical tensions in many regions of the world
- Potential investor disappointment with the growth rate
- Uncertainty about a U.S. tariff on imported goods
- Anticipation of slight increases in bond yields
- Greater than expected tightening of the Fed’s monetary policy
- Elections in Germany (September 2017) and in Italy (May 2018)
- Decelerating growth in China
- The economy’s incapacity to withstand very high borrowing rates
What the fundamentals say
|At May 31, 2017, the risk of recession remains low for the next 18 months, with the following factors in positive territory: purchasing managers’ index, the benchmark interest rate in Europe, new orders, leading indicators, as well as U.S. job creation. Conversely, U.S. stock market valuations, investor complacency and growth of the U.S. money supply could eventually have negative repercussions.|
We remain confident about the economy and the markets and we continue to favour stocks over bonds, with equities now slightly overweighted – by about 1% – in the balanced portfolios.
In our view, stocks currently offer modest return potential, given above-average valuations, but we believe that good stock selection could be profitable.
As always, we will keep you apprised of any changes we may make in the funds you hold with Professionals’ Financial.
François Landry,CFA Senior Vice-President and Chief Investment Officer