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scott barlow

Scott Barlow

Scott Barlow is Globe Unlimited's in-house market strategist and a 20-year veteran of Canadian investment banks, including Merrill Lynch Canada, CIBC Wood Gundy and Macquarie Private Wealth. View more of his columns here that are available to subscribers only. For all investing content exclusive to subscribers, click here.

There are always risks and doubts in markets but the current environment makes investment strategy particularly hard. Global economic growth is anemic, profit growth is terrible, and developed market equities are expensive by historical standards. At the same time, slowly improving employment and wage growth in the United States has the world's largest economy on the precipice of an economic acceleration.

With all of these cross currents, it's a good idea to revisit my fundamental assumptions about the market, to provide a framework for investment decisions.

Here, then, are five key thoughts – subject to change as new data come in – on the economy and markets.

I think there is too much money chasing too little growth

Citi credit strategist Matt King provided a compelling argument that the unprecedented global central bank monetary stimulus has remained trapped in the financial system, and not reached the real economy. Because global economic growth remains tepid – the JP Morgan Global PMI manufacturing index is plumbing post-crisis lows set in 2013 – this means that oceans of investing capital are desperately searching for growth opportunities.

As a result there have been, and likely will be, a series of mini-bubbles. Fund managers chase rising asset prices only to see them fall back as the fundamental growth underpinnings fail to support higher values. The 41.3-per-cent rally in crude prices from March to June, 2015, is a good example of this phenomenon. It's a constant, worldwide game of investment Whac-A-Mole.

I think interest rates will move higher, but not that much

There are few reasons to disagree with the consensus economist view that the Federal Reserve will raise rates one time in 2016. Stagnant economic growth, however, is likely to keep borrowing costs low relative to the past.

This will come as good news to dividend investors as bond yields are unlikely to rise high enough to threaten the attractiveness of real estate investment trusts and other income-oriented equity assets. Still, dividend-paying stocks have been tremendously popular for obvious demographic reasons, so there is an important caveat. An unforeseen threat to dividend investors would cause such large and widespread portfolio pain – and to the exact investors with shorter investment time horizons and less time to recover losses – that volatility is likely to increase in income-based market sectors.

Read more from Scott Barlow: Top strategist suggests caution for Canadian dividend investors

I think I'll believe in a strong U.S. economic acceleration when I see it, and maybe not even then

CIBC chief economist Avery Shenfeld recently wrote about a divergence between stronger U.S. job growth and weaker consumer spending, noting the two data series "have sent out conflicting messages in the last couple of quarters." Mr. Shenfeld believes that stronger labour markets will result in higher spending and subsequently, "markets are going to end the summer with a Fed hike in September, a lot earlier than today's soft bond yields and weaker U.S. dollar are presuming."

Mr. Shenfeld's scenario is the positive one economically (compared with retail spending not recovering), but a potential interest rate hike means that for investors, it's not that great. December's Fed hike caused untold misery in North American equity and commodity markets and caused a big sell-off in high yield debt markets. As the economist notes, markets are not currently priced for a September hike and asset price volatility would almost definitely follow signs of an impending rate increase in 2016.

I think China won't be much help to Canadian investors

China's strong growth has been responsible for 25 per cent to 30 per cent of global gross domestic product expansion in recent years, and been the No. 1 source of demand for almost every commodity on the planet.

The Chinese investment-led growth model is now clearly showing signs of exhaustion as evidence of industrial overcapacity and bad debt piles up.

No country in modern history has managed to restructure its economic focus from manufacturing to consumption without considerable upheaval – the financial crisis among Asian Tiger countries in the late 1990s is only the most recent example. The sheer scale of China's expansion, combined with an estimate by Royal Bank of Scotland that 25 per cent of the country's bank loans are already non-performing, means China is unlikely to escape significant credit-related growing pains.

I think all of this means that the Canadian economy and markets will begin a long 'muddle through' campaign

Oil prices remain low, an export-driven manufacturing renaissance has yet to appear so the domestic economy is being held up by surprisingly strong consumer spending. Bank of Montreal chief economist Doug Porter, however, is openly wondering how long this can go on: "The only concern now is whether these consumer-led gains are remotely sustainable with the underlying softness in trade, manufacturing and, most importantly, jobs," he said.

The combination of factors listed above implies that the economic and investing market will be more boring than bad. Canadian export growth will likely improve at the same slow speed as the U.S. economy, in fits and starts. Oil and commodity prices may rise from current levels, but slower global growth, notably in China, will cap potential gains. Housing market-related credit risks remain for the Canadian banks, but the solidity of profit growth in the Big Five is so far not in doubt, albeit at lower levels.


More from Scott Barlow:

Why bullish bets on gold are at a quarter-century high despite little inflation

Here's why markets have been so volatile of late

A lot more than oil driving the Canadian dollar

Buckle up investors are predicting a rough ride

These 10 U.S. multinational stocks represent a lucrative investment opportunity