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Briefing highlights

  • An optimist’s guide to the economy
  • Stocks, loonie, oil at a glance
  • Higher mortgage rates short-lived
  • Netflix tumbles after earnings
  • Bank of Korea eases
  • Morgan Stanley results top estimates
  • What to watch for today
  • Required Reading

‘Optimist’s guide’

Eric Lascelles has his worst- and base-case scenarios for how this economic expansion plays out.

He also has what he calls “the optimist’s guide to the business cycle.”

The chief economist at RBC Global Asset Management this week provided readers of his research reports with the latter, which suggests there’s still room to run.

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It’s a topic oft discussed by market players given that we’ve just crossed into what is now the longest expansion ever. And, thus, there has been increasing speculation the United States may be headed for a recession, based partly on what has occurred in the bond market, among other things.

“Our business cycle scorecard and the inverted yield curve both argue that this is a late point in the U.S. business cycle,” Mr. Lascelles said in his report, distinguishing between the business cycle and the economic forecast.

“That is our base-case scenario,” he added.

“But the vagaries of the business cycle are such that we cannot speak with precision. How else might the cycle play out?”

The worst-case scenario would see the expansion end soon, Mr. Lascelles said, with a thud that could be due to “an Iran-induced oil shock, a further bout of tariffs, or simply the consequence of a drum-tight economy bumping up against its natural growth limits.”

That scenario has been the subject of “ample attention,” while the more optimistic view has not. This best-case version would mean two, three or even more years of economic expansion.

There are several arguments to support this, he said.

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1. Among them is that the recent inversion of the yield curve, which some observers see as a signal of a recession, isn’t an issue at all.

2. The “structural downward pressures on inflation are intense” because of the aging population and fast-paced technological change in this globalized world: “To the extent that inflation usually rises to problematically high levels at the end of the business cycle, contributing to the economy’s eventual decline, this threat seems unusually small this cycle.”

3. There are many “special factors” that have already aided in a prolonged cycle, including the fact that expansions can run longer after a crisis, a wider social safety net, stricter financial regulations, “increased adherence” to Keynesian policy, and the service sector’s widening share of the economy.

4. “With the U.S. Federal Reserve now on a rate-cutting trajectory, it is entirely reasonable to make the claim that more stimulative monetary policy should translate into more economic growth, that additional growth should reduce the risk of recession, and that a diminished recession risk should lengthen the business cycle.” The devil’s advocate side of this could suggest that rate cuts end the good times by overheating the economy.

5. “It is possible that the U.S. economy is not quite as tight as it currently looks, arguing for more tolerance before the economy overheats.”

6. There are often catalysts to recessions: “The prior cycle was brought to a close by a housing bubble that ignited a debt crisis. The cycle before that ended in large part because of a tech stock bubble. The current expansion is hardly without vulnerabilities – leveraged loans are a prominent risk – but the magnitude of these risks seem smaller.”

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What should investors make of all this?

“The bottom line is that there are a variety of coherent arguments that support the current economic expansions continuing for several additional years,” Mr. Lascelles said.

“This is not our base-case forecast, but it needs to be acknowledged, and represents one reason among many why abandoning risk assets altogether could prove unwise.”

Asked about his base-case view, Mr. Lascelles said the late-stage cycle is “actively getting later,” and you can see this through several data points.

“While the risk of recession is materially higher than normal, and arguably in the 30-per-cent to 40-per-cent range over the next year, that still leaves a greater than 50-per-cent chance that the expansion persists,” Mr. Lascelles said.

“Thus, we continue to budget for economic growth over the next year as per our base-case growth forecast.”

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At this point, expansion is still more likely than contraction, he added.

“Of course, as investors, we have to factor in the mean expectation – considering the weighted probability of all the possible outcomes,” Mr. Lascelles said.

“As such, our allocation toward risk assets like equities and credit has steadily decreased over the last few years, reflecting the growing risk of a downturn and what the business cycle is telling us.”

Read more

Higher rates short-lived

Those renewing or about to renew their mortgages can breathe a sigh of relief: The era of higher interest rates appears to have been short-lived, The Globe and Mail’s Matt Lundy writes.

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Markets at a glance

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Bank of Korea eases

The Bank of Korea got in on the dovish act today, trimming its key interest rate by one-quarter of a percentage point to 1.5 per cent.

The central bank also forecast the economy will expand by 2.2 per cent this year, and 2.5 per cent next.

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“The pace of increase in consumption is forecast to slow somewhat, while the fiscal expansion continues,” it said.

“Investment and exports are expected to be sluggish. Korea’s economic growth will be strengthened in the next year thanks to an easing of the slowdown in the private sector.”

Tuuli McCully, Bank of Nova Scotia’s head of Asia-Pacific Economics, said she doesn’t expect further easing any time soon.

“In line with a regional - and increasingly global - trend, the BoK has become increasingly concerned about the economic outlook, which is weighed down by persistent trade uncertainties,” Ms. McCully said.

“Simultaneously, inflationary pressures remain muted, allowing for looser monetary conditions.”

Ticker

Netflix shares tumble

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From Reuters: Wall Street brokerages stuck to a positive outlook on Netflix Inc., betting that a strong content slate for the rest of 2019 would reverse shock losses in U.S. subscribers in the second quarter that sank its stock price. Shares in the company fell sharply in early trade, as investors worried over lower-than-expected global growth and signs of trouble in its U.S. base.

Formal talks begin

From The Canadian Press: Prime Minister Justin Trudeau and European Council President Donald Tusk have begun formal talks that will centre on the comprehensive trade agreement between the European Union and Canada.

Morgan Stanley tops estimates

From Reuters: Morgan Stanley reported a drop in quarterly profit but beat analysts’ expectations on slim gains in its wealth management business and lower expenses.

Officials urge digital currency regime

From Reuters: Digital currencies like Facebook’s Libra must be held “to the highest regulatory standards” to ensure they are not used to launder money and that users are protected, a Group of Seven task force urged. The conclusions came as G7 finance ministers meeting in Chantilly, France, agreed to address tax challenges raised by the digital economy and to push ahead with plans for a minimum corporate tax level, according to a draft summary of the two-day meeting seen by Reuters.

Carney appears out of IMF race

From Reuters: The governor of the Bank of England, Mark Carney, is unlikely to succeed Christine Lagarde as the boss of the International Monetary Fund, European officials said, as the European Union was considering four other names for the job.

Iranians turn to Bitcoin

From The Associated Press: Iranians feeling the squeeze from U.S. sanctions targeting the Islamic Republic’s ailing economy are increasingly turning to such digital currencies as Bitcoin to make money, prompting alarm in and out of the country.

What to watch for today

Microsoft Corp. and West Fraser Timber report quarterly results.

Required Reading

Threat to sever ties

Mexico’s leading airline is threatening to sever ties with Canada’s Aimia Inc., opening a second front for the Canadian loyalty-plan provider to fight after a board battle erupted over the past week. Tim Kiladze reports.

Money for McInnis Cement

Caisse de dépôt et placement du Québec is pouring more money into McInnis Cement after efforts to sell the controversial Gaspé Peninsula project last year failed to result in a deal, Nicolas Van Praet writes.

Not what’s needed

Premier Jason Kenney’s overhaul of the Alberta Energy Regulator isn’t what the AER really needs, columnist Jeffrey Jones argues.

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