Capital Markets Outlook

Spring 2016

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Key Highlights

• Despite significant challenges, the rate of economic deterioration has slowed and deep recession fears appear to be in the past. However, growth outlooks remain uninspiring as the number of global economic and geopolitical risks continues to mount.
• Economic data coming out of the U.S. came in below expectations towards the end of 2015, but lately we’ve seen more of a balance between positive and negative surprises. This balancing out started around the same time that the plunge in oil prices stopped and, as a result, some confidence was restored.
• Three months ago the U.S. Federal Reserve (Fed) highlighted six inflation measures, most of which are converging on the Fed’s 2% target. Deflation should always be a concern, but the U.S. sustaining a 2% inflation rate shows a relatively robust underlying economy.
• The Fed faces a number of challenges as they weigh rising inflation and falling unemployment rates against risks in the global economy. We see leading indicators pointing to at least the beginning of rate hikes, and expect they will raise rates by 25 basis points once or twice by year end.

• The U.S. 10-year Treasury Bond yield, at around 1.8% to 2.0%, is near the fair value level in our equilibrium bands, meaning they are around where they should be based on inflation and real interest rates. Moreover, as the economy normalizes, yields will slowly move higher as we continue to avoid recession.
• After a tough start, there has been a surprising rebound for equity markets in 2016. On a pure valuation basis, lack of progress in markets and the decline in January have increased the attractiveness of stocks globally, where they are still almost 20% below fair value. We are looking for a growth in corporate profits, and if the U.S. economy can sustain 2% growth, we may get what we are hoping for.
• Our asset mix still favours stocks over bonds, but we have trimmed slightly as we believe there are more challenges to the equity bull market than there were previously.