Frédérique Carrier, Director, Head of Equities at RBC Wealth Management looks at the year ahead
Ever since the Great Recession ended in 2009, our view on the outlook for financial markets has been informed by several underlying assumptions:
• Major central banks would remain ultra-accommodative until the major economies were on a sustained growth footing;
• The outlook for the U.S. economy was of the greatest importance due to its influence on the rest of the world through trade; and
• Until a renewed global economic downturn, in particular a US recession, was on the horizon, equities should be given the benefit of the doubt.
While we still believe these factors will shape the investment landscape, their interpretation has become more nuanced in recent months. The policy unanimity of central banks is breaking down. The Fed has signalled an intention to raise rates further. By contrast, none of the central banks of Canada, the UK, the eurozone, and Japan have ruled out additional easing. This divergence is likely to play out most visibly in currency markets, where we expect the USD to strengthen, while introducing more volatility in financial markets than investors have been used to in recent years.
For fixed income we recommend holding short duration instruments in portfolios as long-term yields could rise moderately and yield curves could steepen further due to rising inflation expectations. We prefer corporate credit, but opportunities are limited following significant spread tightening. Select 5- to 7-year investment-grade corporates are attractive. We remain positive on US financials and global consumer issuers which benefit from improved growth prospects.
We remain constructive on global equities. Developed economies are firming, led by the U.S. and Germany. The new administration in Washington appears set to pursue policies that could boost US GDP growth for at least a couple of years. However, its protectionist stance so far may mean that improved growth comes at the expense of others.
In Europe, June’s Brexit vote has not only raised questions about prospects for the British economy, it has also put the future existence of the EU as currently constituted into doubt. Those doubts could grow over the next several quarters due to scheduled general elections in France and Germany in particular. This points to an extended period of business and investment uncertainty.
We conclude the outlook for US equities has improved while that for other markets has become more clouded, and we would tilt portfolio holdings accordingly. U.S. corporate earnings growth should accelerate in Q4 and reach high-single digits levels in 2017 while appearing more durable. Our preferred sectors are financials and health care. The former could benefit if the Treasury curve continues to steepen, expanding net interest margins, while loan growth is expected to remain robust, helped by first time home buyer demand from Millenials. A potential roll back of regulation could also underpin the sector whose valuation on a price to book value relative to S&P 500 basis is well below its long term average. Within Health Care, for which the risk of drug price regulation has diminished following the Republican victory, biotech is trading below its cycle average, yet it should grow faster than pharma and the S&P 500. At the same time, transformative treatments are in the works.
Elsewhere, for the U.K. and Continental Europe, where valuations are fair and Brexit and political risks could upset markets, we prefer to remain underweight for now. In the U.K., our expectations of GBP weakness and soft domestic demand direct us to favour U.S.-dollar revenue earners and be cautious on domestic sectors such as retailers. They have tended to suffer during periods of GBP weakness, as higher raw material prices tend to erode margins. In Europe, we prefer to stick to our strategy of investing in well-capitalized, quality companies, with world-class franchises and strong cash flows, and which pay and grow dividends.