The first theme in our 2020 Global outlook, Growth edges up, heralds a modest pickup in global growth. This provides a decent tailwind to Canadian economic activity after a year of steadily slowing global growth. Our BlackRock Growth GPS for Canada rose throughout the second half of 2019, even as growth weakened elsewhere, and indicates consensus estimates for Canadian economic activity may be too dour. A cheap currency boosted exports at a time when geopolitical uncertainty weighed on business investment and indebted households showed some signs of fatigue. We think Canadian growth can remain steady next year, especially if industrial production and manufacturing have reached a bottom and trend higher.
Our second theme, Policy pause, calls for economic fundamentals to drive global markets, rather than monetary surprises or fiscal stimulus. We think the same frame broadly applies to Canada, but would note that Canada has greater monetary and fiscal policy flexibility than other developed markets in the unlikely event the economy hits a rough patch. The Bank of Canada (BoC) now boast the highest policy rate in the developed world and never resorted to balance sheet expansion. This gives the BoC much more ammunition to respond to soft economic readings at a time when global financial conditions have already eased. Moreover, the newly formed Liberal minority government may tinker with new spending initiatives on priorities it shares with the New Democratic Party, after most political parties shelved balanced budgets for the foreseeable future.
After 2019’s banner year for bonds – a year when we stressed the benefits of Raising resilience – we’ve debated just how much ballast fixed income securities provide with yields having fallen back to near cycle lows. Our third 2020 theme, Rethinking resilience questions the opportunities in European and Japanese government bond markets where yields are already near the lower bound. By contrast, Canadian government bonds would likely still offer some protection against declines in risk assets. They offer comparatively compelling yields across the curve, like those in the U.S., and an even rarer triple-A credit rating. That said, an improved cyclical outlook would tend to bias yields higher and weigh on government bond performance at a time when an inverted Canadian yield curve already makes longer-maturity bonds less attractive.
Our expected improvement in the cyclical outlook supports a moderately pro-risk stance, which we express through a modest global equity overweight and a preference for emerging market (EM) debt within fixed income. We have also raised our EM and Japanese equities allocations thanks to higher operational gearing to improving growth next year as well as less demanding valuations. We funded these moves by downgrading the U.S. to neutral and Europe to an underweight. We also retain our preference for the quality style factor for its exposure to healthier balance sheets and stronger return on equity. Even though growth appears to be bottoming, there is a certain comfort that comes from tilting towards financially stronger companies during the latter stages of the business cycle.
We have been skeptical of Canadian stocks and their potential to outperform the U.S. in recent years, but now take a more constructive view. The improved global cyclical backdrop, ample fiscal and monetary policy space (and a willingness among policymakers to use it), very reasonable valuations (in this edition we also upgrade value to neutral) and a conservative estimate for 2020 Canadian earnings suggest potential for Canadian equities to outperform next year. We would also note that the dividend yield of the S&P/TSX Composite Index is twice the level of the 10-year Canadian government bond yield, which further enhances the allure of equities.
Stable-to-firmer oil prices, a modest uptick in global economic growth and a moderately pro-risk investment stance would tend to support the Canadian dollar. However, there’s a chance the Bank of Canada could cut rates if it viewed currency appreciation as a threat to the economy. Therefore, we expect the Loonie to trade in its long-standing range between the mid to upper 70 cent level. Given this, we retain our preference for unhedged currency exposure to global stocks as a structural volatility dampener for Canadian investors.