Investment risks for the second half of 2018

Investors experienced more volatility in the first half of 2018, but market volatility obscures a fundamentally sound investment picture, says HSBC in a monthly outlook report for Canada.

While trade tensions and geopolitics are important factors to consider, “they need to be kept in perspective,” says the report, which focuses on Canada’s strong economic outlook.

In fact, strong economic performance puts Canada close to the top-performing countries like the U.S., says the report.

As a result, Canadians equities offer good valuations supported by solid earnings, with HSBC forecasting corporate earnings growth of about 15% for 2018.

Corporate Canada’s fixed income market also appears healthy based on credit metrics like balance sheet strength and default rates, says the report.

The main risk to financial markets in the coming months is an inflation shock in the U.S., says the bank.

“If the U.S. Federal Reserve overreacts and triggers a steeper rise in interest rates to curtail growth, there would most likely be a knock-on effect on the world’s economies,” says the report.

The HSBC report downplays such a scenario, however, saying Fed rate hikes will likely be measured and well-communicated. “We still maintain that the risk of recession remains effectively zero in Canada and the U.S.,” it says.

Overall, it expects global equity markets to outperform global fixed income in the second half, although expected return differentials are now closer to historical averages. Trade risk requires ongoing monitoring of asset allocation, it adds.

Read: Why bond yields will continue their upward trend

“A lack of progress in ongoing NAFTA negotiations, limited dialogue between the EU and U.S., and a breakdown in talks with China are all risks to the outlook,” the report says.

Recent posted commentary from Kevin McCreadie, president and CIO at AGF Investments, suggests likewise.

“The extent of future gains will be determined by the potential impact of escalating tensions between the United States and its key trading partners on the global economy,” he says in the commentary. “This is particularly true when it comes to the growing dispute between the U.S. and China.”

Most recently, Bloomberg News, citing three unidentified sources, reported that the Trump administration would propose imposing 25% tariffs on a US$200-billion list of Chinese goods targeted in a new round of penalties, up from the planned 10%.

Following the report, China’s government warned it will retaliate if Washington imposes new trade penalties.

A foreign ministry spokesman, Geng Shuang, said Beijing was ready for “dialogue and consultation” to defuse the escalating dispute.

“If the United States takes further measures that escalate the situation, China will definitely fight back,” said Geng. He gave no details of possible measures but said, “we are determined to safeguard our legitimate and lawful rights and interests.”

Any potential fallout from trade will be felt by investors, warns McCreadie in his commentary, written before this latest threat.

If negotiations “go completely off the rails,” he says, “then chances of an economic slowdown will increase significantly and an extended pullback in stocks should be expected.”

For more details, read HSBC’s midyear report and McCreadie’s commentary.

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