In the 1993 movie Groundhog Day, the main character, Phil Connors, played by Bill Murray, is doomed to repeat February 2 over and over again until he experiences personal growth and finally learns to be a better person. You’re probably wondering why I’m raising this now, since we’re well past February 2. Well, when you look at the prospects for capital markets and the economic outlook for Canada and globally, it seems that we’re stuck in our own Groundhog Day, where we’re doomed to live the past for yet another year.
2016 is shaping up like 2015, and 2014 before it – tepid growth, relatively low inflation, modest expectations for equity markets (mid-single digits), possibly increasing interest rates (or not…), continued geopolitical concerns and market volatility. Europe and Japan are still pursuing “easy money,” with excess deposit rates in negative territory. The U.K. is dealing with a potential “Brexit,”while Brazil, about to host the Olympics, is a political and economic mess.
Read: Dismal start to 2016 signals more challenges ahead
With low oil and material prices, Canadian unemployment has risen over the past six months, most notably in the Western provinces and particularly in Alberta where it has reached 7.4%.
The Canadian dollar, responding to the decline in oil prices and reduced prospects for economic activity has been mixed for Canadians. Exporters have seen some improvement in their ability to sell our products abroad – though for many manufacturers, the decline is too little too late. Importers of food, services and other goods have seen their costs go up. In fact, inflation in Canada has hit 2% for the first time in a while, which has enabled the Bank of Canada to leave interest rates unchanged given the implied tightening caused by a lower dollar.
Forecasted growth for Canada in 2016 is approximately 1.5%, steady but not enough to create substantial jobs. While many companies have done a pretty good job of getting their balance sheets in order, concern remains about the level of consumer debt, which is estimated at 165% of income when mortgages and other forms of consumer debt are considered.
Read: How the oil bust could be ballooning your benefits costs
Weighing on the global economy is China’s prospects going forward. Growth is currently being measured at around 6.5%, well below the average in the first 10 years of this century. It’s expected to decline to 6% in 2016 as the Chinese economy slows further and credit conditions deteriorate. Bad debts issued by state-owned banks related to real estate deals, and loans to steelmakers, coal miners and manufacturers, have continued to increase over the past three years and have reached levels not seen since 2006.
These debts need to be restructured and/or written off, with recent proposals suggesting conversion to equity. A key challenge for the Chinese government is to manage this transition and relax capital controls at the same time as Chinese businesses are being asked to improve product quality and safety and achieve productivity gains. There is a large potential for policy errors which would impact the global economy.
Read: China, other Asian markets fall after Wall Street’s decline
Low oil prices are not just affecting Canada. Emerging market countries such as Brazil, South Africa and Saudi Arabia are reliant on oil and other commodity revenues to fund government spending and debt financing. As an example, Saudi Arabia relies on oil revenues to fund 70% of government spending. Lower oil and commodity prices are not just deflationary, they have potential social implications, as we are seeing in Brazil.
While there remains positive growth in the U.S., U.K. and Germany, as well as modest growth in Canada and Australia, risks remain the downside. The question remains how to invest in such an environment? With the sell-off in equity markets and an increase in credit spreads, equity and credit markets are closer to fair value than before. However, depending on your view of risk, they may not be sufficient to compensate for potentially adverse outcomes. Many have taken refuge in illiquid, alternative asset classes, such as infrastructure, real estate and private equity. However, even these asset classes are at fair value, if not overpriced. In such an environment, security selection and a broadly diversified portfolio can help mitigate, but not prevent, negative losses.
It’s important to ensure investors have as many potential sources of return as possible. Using a baseball analogy, going for bunts and singles rather than home runs. And this brings us back to Groundhog Day, since this is pretty much the advice I have been providing clients for the past couple of years.
Read: How investing in emerging markets is getting more complicated