What investors should expect for 2017

Canadians can look forward to firmer and more geographically balanced growth in 2017, but the economy still faces major downside risks stemming from the incoming Trump administration, says a new report by CIBC Capital Markets.

In particular, these risks will impede the Bank of Canada’s ability to tighten monetary policy, the report notes.

Avery Shenfeld, chief economist for CIBC, says, “We would need a huge and unlikely upside surprise to push the Bank of Canada into a rate hike this year. […] The Trump administration’s trade-policy-by-Twitter and a Republican-backed corporate tax reform plan biased against import content both represent a major downside risk if Canada gets caught in the crossfire.”

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In that more negative scenario, Shenfeld expects the Canadian dollar to come under pressure. “The shock to U.S.-bound exports would engender a much steeper slide in the Canadian dollar; well beyond the 1.39 Canadian dollars per U.S. dollar we expect to see on monetary policy differentials.”

Still, CIBC forecasts Canada’s real GDP growth at 1.8% in 2017 and 2% in 2018. Says Shenfeld, “A modest rebound in energy sector capital spending and ongoing oil output gains will add a full percentage point to growth, [with] a lot of that showing up in Alberta’s climb out of recession.”

The growth in the energy sector will offset the reduced contribution from housing and consumption. The report says the indebted household sector faces higher inflation and a tightening in mortgage borrowing conditions.

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As for equity markets, Canadian stocks are unlikely to have the same edge relative to U.S. stocks. But Shenfeld says “This could still be a wild ride for investors. There are some significant skews to the risks around the bland base case.”

Additional highlights

Energy and gold prices look to be range-bound, with the former constrained by inventories and rebounding U.S. drilling, while industrial metals lack the sustained demand needed to build on the prior year’s gains.
U.S. stocks have already priced in a lot of good news, mostly on the cost side, and Shenfeld says that if Trump delivers on lower corporate taxes and a lighter regulatory burden, high-single digit earnings growth looks achievable.
The report forecasts 2.3% growth for the U.S. economy in 2017 and 2.1% in 2018, noting that uncertainty is “extremely high” surrounding Trump policies. Shenfeld explains, “We’ve lifted our U.S. growth forecast slightly for 2017, reflecting economic momentum already in place more than any new policy developments. Wage and jobless data suggest that slack is diminishing, with the U.S. on target for full employment by next year.”
We could see a steeper climb in Fed hikes to keep inflation at bay, the report says. A situation with a greater fiscal ease in the U.S. would prompt increases in borrowing requirements and inflation, and Fed hikes that will lift bond yields at a sharper pace.
Shenfeld suggests looking for opportunities to hedge against events such as a pullback in commodities, a weaker Canadian dollar and a rise in long term rates.

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