How long can the equity rally last?

Central banks signalling their intent to ease monetary policy have lifted stocks to all-time highs, despite broader economic uncertainty.

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“It is a conundrum that equity markets have continued to rally, relative to the trade tensions that seems to be lingering,” said Luc de la Durantaye, chief investment strategist and CIO, multi-asset and currency management, at CIBC Asset Management.

The U.S. Federal Reserve and the European Central Bank (ECB) have indicated their willingness to provide economic stimulus to respond to slowing growth. The Fed is widely expected to cut interest rates by at least 0.25 basis points later this month after chair Jerome Powell told Congress that uncertainties around trade and concerns about the global economy continue to weigh on the U.S.

These signals have lifted risky assets, de la Durantaye said in a July 9 interview, while bonds have also rallied.

The question is how long this will continue. “We’re a bit more cautious from now relative to these expectations for a number of reasons,” he said.

For one, U.S. President Donald Trump is still intent on “correcting” the U.S. trade deficit with China and Europe, de la Durantaye said. It would be in both China’s and the Americans’ best interest to reach a deal, but there’s a large gap in terms of what they want to achieve.

“In the meantime, the lingering impact on consumer uncertainty and business uncertainty will continue to have a sluggish [effect on the] economic environment,” he said. “That will eventually turn into slower profit growth from corporations,” which will impact equity prices.

In a report released last week, CIBC Capital Markets chief economist Avery Shenfeld said the Fed would cut this month and once more this year, stopping at a total of 50 basis points with no further cuts in 2020.

“If so, equities will get some comfort from signs that the expansion has more room to run, but Treasuries investors will give back some of the past year’s winnings,” he wrote.

How Canada is placed

With the new North American trade deal expected to move ahead, de la Durantaye said Canada is in a good position, with exports going predominantly to a strong U.S. economy.

With the Bank of Canada’s overnight rate at 1.75%, Canada—like the U.S.—has more leeway than the ECB or the Bank of Japan to stimulate the economy, if needed.  De la Durantaye also said Canada’s fiscal position is relatively sound on a comparative basis.

“That gives us more policy flexibility to absorb and stimulate our domestic economy,” he said. “So we’re in a decent position at this point in time.”

In last week’s report, Shenfeld said near-term growth was likely to beat the Bank of Canada’s forecasts. For this reason, the BoC won’t be in a rush to follow the Fed’s easing path: CIBC called for one 25-basis-point cut in the second quarter of next year.

Fed cuts and BoC holds will likely make the Canadian dollar a stronger, the report said.

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