Year in Review
The calendar year 2016 was a year of, at times, unexpected and profound changes in the market. Despite growing investors’ anxiety about the health of global economy in the past few years and stretched valuation of almost all financial assets, with twists and turns, risk assets managed to march upwards, with many global stock indices setting new record highs in 2016. US Federal Reserve announced the second rate hike post-financial crisis in December, indicating its confidence in the pace of economic recovery. Political events, most notably the UK’s vote to leave the European Union and the election of Donald Trump as the president of the United States, delivered bouts of market jitter. The market has to re-price real and financial assets based on the new set of domestic and international policies, for instance on trade relations, adopted by the UK and US. The potential long-term effects of these new policies on the global economy are yet to be fully determined. We anticipate the continued presence of political risk in 2017 to affect financial markets in near-term, although with less impact than in 2016 as the focus turns to economic fundamentals.
Canadian economic growth in 2016 was 1.4%, in real terms, recovering from the anemic 0.9% real growth rate experienced in 2015. The unemployment rate, which stood at 7.1% in December 2015, fell to 6.9% by the end of 2016. The Bank of Canada maintained its policy interest rate at 0.5% through 2016 to support the economic recovery. The US real GDP growth slowed down, from 2.6% in 2015 to book a 1.6% growth rate in 2016. The labour market, however, steadily improved, reaching a 4.7% unemployment rate at the end of 2016, from 5.0% a year earlier. Wage growth, measured by average hourly earnings, which stood at a 2.5% annual growth rate in December 2015, rose to end 2016 at a 2.9% annualized growth rate. The US Federal Reserve embarked on its second rate hike in over a decade at its December 2016 meeting. The Fed also signaled a more hawkish monetary policy stance as further signs of a tight labour market and rising inflation in the US emerged in 2016. Both Japan and the Eurozone grew modestly in 2016, at rates slightly below their 2015 annual real GDP growth rates. China continued in its growth slowdown trajectory as the country undergoes a transition towards a consumption-led economy, less capital intensive.
The recovery and stabilization of crude oil and energy prices helped buoyed Canadian equities, with the Canadian S&P/TSX Composite Equity Index enjoying a 21.1% total return for the year ending December 31, 2016. The Canadian dollar appreciated 2.9% versus the US dollar in 2016. In addition, the FTSE TMX Long-Term Canada Government Bond Index posted a positive 1.3% total return.
It is AIMCo’s thesis that the major developed and emerging economies will continue on the path of a synchronized normalization in terms of growth and inflation, albeit at a moderate pace given the maturing business cycle. AIMCo’s long-term view suggests that the US, Euro-area, Japan and Canada will continue to experience a boost to nominal economic growth. While China pursues its efforts in reducing domestic leverage, stabilized Chinese demand will provide brighter prospects for emerging markets via global trade. Further catalysts of the global cyclical economic recovery, such as fiscal stimulus, should help somewhat to mitigate economic inequalities and populism over the medium term.
In the footsteps of more balanced growth globally, central banks are now preparing to leave the accommodation centre stage by gradually increasing policy interest rates and unwinding their balance sheets. As such, we might be on the cusp of a reversal of secular declining bond yields and normalization of central banks’ monetary policies at a time of slightly diminished liquidity, as attested by the US Fed interest rate hiking cycle. This should provide a thriving environment for actively managed investment strategies.
Equities should generate better annualized real return relative to the fixed income spectrum in the longer-term investment horizon, given the mild inflation trend and the current level of government bond yields. Interest rate increases, however, will allow bond re-investment at higher yields over time. With thin credit spreads, the potential for spreads to decline further is limited. Private credit investment strategies, with better terms on offer, are providing attractive pockets of opportunity for AIMCo’s clients. And while equity markets currently might seem slightly over valued, AIMCo foresees a return to underlying fundamentals, continued improving corporate earnings and greater dispersion as drivers of positive value-add.
AIMCo continues to anticipate a constructive value-add environment for clients in private real assets, such as real estate and infrastructure, where cash yields should respond to inflationary pressures. Private equities should display attractive returns relative to public markets beyond plain-vanilla strategies.
Through the increased market noise, in particular due to politics, the confluence of better prospects for growth, inflation and a cautious removal of unconventional monetary policy point towards an economic cycle that has further to run. In this transitioning environment, diversified equities should continue to outperform bonds. Moreover, AIMCo’s patience, discipline and focus on capital preservation should also sustainably impart profitable, risk-adjusted investment opportunities within private markets. AIMCo remains well-positioned to add value in a cost-efficient manner for the benefit of Albertans.