THE GLOBAL INVESTMENT OUTLOOK - RBC GAM

THE GLOBALINVESTMENTOUTLOOKRBC GAM Investment Strategy CommitteeSPRING 2019

THE RBC GAM INVESTMENTSTRATEGY COMMITTEEThe RBC GAM Investment Strategy Committeeconsists of senior investment professionalsdrawn from all areas of RBC GAM. The Committeeregularly receives economic and capitalmarkets related input from internal and externalsources. Important guidance is provided by theCommittee’s regional equity advisors (NorthAmerica, Europe, Asia, Emerging Markets) andfrom the Global Fixed Income & Currenciessub-committee. From this, the Committee buildsa detailed global investment forecast looking oneyear forward.The Committee’s view includes an assessmentof global fiscal and monetary conditions,projected economic growth and inflation, as wellas the expected course of interest rates, majorcurrencies, corporate profits and stock prices.From this global forecast, the RBC GAMInvestment Strategy Committee developsspecific guidelines that can be used to manageportfolios.These include: the recommended mix of cash, fixed incomeinstruments, and equities the recommended global exposure of fixedincome and equity portfolios the optimal term structure for fixed incomeinvestments the suggested sector and geographic make-upwithin equity portfolios the preferred exposure to major currenciesResults of the Committee’s deliberations arepublished quarterly in The Global InvestmentOutlook.

CONTENTSEXECUTIVE SUMMARYThe Global Investment Outlook2RECOMMENDED ASSET MIXRBC GAM Investment Strategy Committee4REGIONAL EQUITY MARKET OUTLOOKUnited States556Brad Willock, CFA – V.P. & Senior Portfolio Manager,RBC Global Asset Management Inc.58CanadaCAPITAL MARKETS PERFORMANCE10Sarah Neilson, CFA – Portfolio Manager,RBC Global Asset Management Inc.Irene Fernando, CFA – Portfolio Manager,RBC Global Asset Management Inc.13EuropeMilos Vukovic, MBA, CFA – V.P. & Head of Investment Policy,RBC Global Asset Management Inc.GLOBAL INVESTMENT OUTLOOKCentral banks to the rescue60Dominic Wallington – Head, European Equities &Senior Portfolio Manager,RBC Global Asset Management (UK) LimitedEric Lascelles – Chief Economist,RBC Global Asset Management Inc.Eric Savoie, MBA, CFA – Associate Investment Strategist,RBC Global Asset Management Inc.Daniel E. Chornous, CFA – Chief Investment Officer,RBC Global Asset Management Inc.62AsiaChris Lai – Analyst, Asian Equities,RBC Investment Management (Asia) Limited64Emerging MarketsGLOBAL FIXED INCOME MARKETSThe bond-market outlookLaurence Bensafi – Portfolio Manager and Deputy Head,44Soo Boo Cheah, MBA, CFA – Senior Portfolio Manager,RBC Global Asset Management (UK) LimitedTaylor Self, MBA – Senior Analyst,RBC Global Asset Management (UK) LimitedDirection of rates49Dagmara Fijalkowski, MBA, CFA – Head,Global Fixed Income and Currencies,RBC Global Asset Management Inc.Daniel Mitchell, CFA – Portfolio Manager,RBC Global Asset Management Inc.Eric Savoie, MBA, CFA – Associate Investment Strategist,RBC Global Asset Management Inc.Daniel E. Chornous, CFA – Chief Investment Officer,RBC Global Asset Management Inc.ECONOMIC & CAPITAL MARKETS FORECASTSRBC GAM Investment Strategy CommitteeCURRENCY MARKETSThe time is not ripe for a U.S.-dollar bear marketRBC Global Asset Management (UK) LimitedRBC GAM INVESTMENT STRATEGY COMMITTEE6646Soo Boo Cheah, MBA, CFA – Senior Portfolio Manager,RBC Global Asset Management (UK) LimitedSuzanne Gaynor – V.P. & Senior Portfolio Manager,RBC Global Asset Management Inc.THE GLOBAL INVESTMENT OUTLOOK Spring 2019 I 1

EXECUTIVE SUMMARYEric Savoie, MBA, CFAAssociate Investment StrategistRBC Global Asset Management Inc.Daniel E. Chornous, CFAChief Investment OfficerRBC Global Asset Management Inc.Central banks pivot to adovish stance, dampeningconcerns over rising ratesand providing support for riskassets. But headwinds fromprotectionism, fading fiscalstimulus and less favourablefinancial conditions continueto weigh on global growthtrajectory.Global growth decelerates tostill-decent ratesAfter strong growth in 2017 and 2018,economic momentum has wanedand we expect this trend to continuethis year and next. The decelerationwas largely incorporated into ourforecasts from last quarter, but thehit to confidence from financialmarket volatility, and the extendedU.S. government shutdown, whichwas not part of our base-case aquarter ago, had negative economicimpacts. Globally we look for 3.50percent growth in 2019 and 3.25percent growth in 2020, down fromnearly 4.00 percent from the pasttwo years. Further deceleration in2020 seems likely as economic slackhas diminished and the U.S. willencounter fiscal headwinds next year.The outlook for emerging markets isslightly better but, here too we expecta moderate slowdown, with 5.25percent growth penciled in for 2019and 5.00 percent growth for 2020.To be clear, we are expecting growthto moderate, but these rates remainquite good by post-crisis standards.Risks to our outlook areconstantly evolvingThe three main risks to our outlookare protectionism, Chinese growthand the U.S. business cycle. Althoughprotectionism is no longer activelydeteriorating, the actions taken thusfar are starting to inflict economicdamage through slowing globaltrade. The U.S. is leading the chargeon tariffs and we continue to budgetfor a negative scenario where mostof the tariffs already in place remainactive, with a possibility of furtherescalation between the U.S.-China2 I THE GLOBAL INVESTMENT OUTLOOK Spring 2019relationship or in the auto sector. InNorth America, the USMCA deal thatwas struck last fall may still representa challenge and we place a smallchance that the deal is not ultimatelyapproved. Moreover, moderatingactivity in China is a particularconcern as the country is now theworld’s second-largest economyand biggest contributor to globalgrowth. The Chinese government hasannounced a variety of fiscal andmonetary measures to counteractslowing growth, but in doing so it hasrenewed concerns over potential debtproblems.U.S. business cycle is lateand advancingOur scorecard approach continuesto situate the U.S. business cyclein late stage, with some underlyingmovements from last quarter. The 17inputs in the scorecard rarely agree,but ‘late cycle’ is still the best guess.Interestingly, the second-best guesshas shifted to ‘end of cycle’ from ‘midcycle’ in the past quarter. Supportingthe notion that the U.S. businesscycle is in late stage is that the U.S.economy is now extremely tight,delinquencies on auto loans are at ahigh and still-rising level and the yieldcurve is extremely flat. The fact we arein late cycle doesn’t mean investorsshould necessarily avoid risk-taking,but the risk-reward case is not asstrong as compared to earlier pointsin the cycle, and volatility will likely begreater in this environment.U.S. dollar strength likelyholdsSeveral factors continue to supportthe U.S. dollar versus other key

Executive Summary Eric Savoie, MBA, CFA Daniel E. Chornous, CFAcurrencies. The U.S. economy remainsrobust relative to the rest of theworld and interest rates are higher inAmerica versus other major regions.Our model situates the U.S. dollarin overvalued territory, but not to anextreme degree that would call forsignificant economic adjustment inthe near term. In addition, the U.S.dollar’s safe-haven status means thecurrency generally appreciates whenrisk assets struggle. While manyinvestors are questioning whetherthe U.S. dollar is due for a period ofweakness after a nearly decade-longbull market, we think the dollar willlikely follow a choppy topping processthat may continue for a while longer.Central banks on pauseCentral banks are no longer activelytightening monetary policy amid abackdrop of slowing growth, lessinflation and increased financialmarket volatility. We don’t expectrate hikes in any major region overthe next year as economic growthdecelerates, and also because webelieve the neutral policy rate istoward the lower end of centralbanks’ estimates. In addition, wethink central banks will lean towardseasier policies as they focus onstimulating growth rather than curbinginflation pressures. Dovish centralbanks reduce the risk of recession inthe near term, but could encourageincreased risk-taking which raisesthe chance of recession later on. InEurope and Japan, central banks arein an especially challenging situationas no monetary stimulus has beenremoved thus far. It now seemsinappropriate to do so given theeconomic slowdown, presenting a riskthat the European Central Bank and/or Bank of Japan won’t have any roomto deliver meaningful stimulus whenthis cycle eventually comes to a close.Sovereign bond yields declinein all regionsGlobal sovereign bonds rallied in thepast quarter, reflecting the downshiftin economic growth expectations,slightly lower inflation and, perhapsmost importantly, the fact that centralbanks are no longer set to raiserates. Yields on 10-year governmentbonds are now below our estimatesof equilibrium in all major regions,particularly in markets outside ofNorth America. While our modelscontinue to suggest that interest ratesare unsustainably low and thatthe long-term direction for yieldsis likely higher, we recognize thatslowing economic growth and tameinflation could limit upside pressurein the near term. As a result, we havelowered our forecasts for 10-yearsovereign bond yields across majorregions versus last quarter.Equities rallied from depressedvaluations following broadbased sell-offLast year’s equity-market correctionmoved stocks to especially attractivevaluations, boosting total returnpotential and setting up thepreconditions for the subsequentrally. The world’s major stock marketssuffered double-digit declines in2018 and, as the sell-off intensifiedin December, our composite of globalmarket valuations had fallen to itslowest level in seven years. Thepowerful rebound in stocks since thestart of 2019 began from a point ofreduced valuations and was fueledby the recent pivot by central banksand the fact that U.S. and China weremaking progress toward a trade deal.Although stocks have had a good runso far this year, our models suggestthat the rally can persist as long asearnings meet analysts’ expectations.We recognize that the profit outlookfor 2019 is less rosy than last yeargiven the absence of another round oftax cuts and slower economic growth,but against a backdrop of moderateinflation and accommodativemonetary policy, there is plenty ofroom for stocks to move up.Maintaining slight overweightin stocks as economyprogresses at a slower paceOur base case looks for expansionin all major regions and, whilegrowth is moderating, the degree ofexpected deceleration is quite mild.In this environment, central banksare unlikely to raise interest ratesand bond yields will probably becontained. We maintain underweightsto fixed income because, in our view,total returns for sovereign bonds arelikely to be low for or even slightlynegative for a long period. However,that underweight is less than it hasbeen as yields are now at a level thatcould provide a cushion for returnson risk assets if the economy were toencounter a meaningful downshift.In our base case, though, economicgrowth should be sufficient todeliver moderate corporate-profitgains that would sustain mid-tohigh single-digit increases in NorthAmerican equities, and low doubledigit returns in international andemerging-market stocks. Balancingthe risks and opportunities and giventhese superior return expectationsfor stocks versus bonds, we feelthat maintaining slight overweightexposure to stocks is appropriate.For a balanced, global investor, wecurrently recommend an asset mixof 58% equities (strategic neutralposition: 55%) and 41% fixed income(strategic neutral position: 43%), withthe balance in cash.THE GLOBAL INVESTMENT OUTLOOK Spring 2019 I 3