Authored by Keith Allan, Harness Investment Management

As 2019 comes to an end and we move forward to 2020, investors reflect on a few dominant themes that have captured the news in recent weeks.  Four words that can’t seem to elude consumers are ‘World Economic Slow Down’. Ostensibly, we hear that, and we are overwhelmed with visions of 2008. Automatic trepidation creeps into the spending and investment habits of consumers. Truthfully, ‘slow down’ is the wrong phrase to use. We are currently experiencing disinflation – where there is effectively no upward pressure on prices – thus, ‘World Economic Calming’ is a more appropriate description of the present economic environment.

Between 2017 and the beginning of 2019, global economic growth was very robust at around 3%. Increasingly, it became more evident the primary factor weighing on this continued growth was not economic or financial uncertainty, rather it was political instability.  Nationalism has gradually reared its ugly head and become more prevalent amongst some of the largest players in world trade. Be it with Brexit, the ongoing trade dispute between the US and China, or a rapid rise in population movements because of civil unrest, political events have slowed world economic growth. Canada has not been immune to the residual effects of this protectionist agenda by both US and China. By showing support for the US on several occasions, Canada has effectively erased any diplomatic traction it had gained with China over the past decade. As a result, China has severely restricted Canadian agricultural purchases, which has negatively impacted the balance of trade.

In the case of the US-China trade war, the entire global market is feeling the effects of their ongoing trade dispute. Regardless of how President Trump wants to spin it – limited, or heavily stunted global trade is bad for the economy. Until this standoff between the US and China is resolved markets will continue to stay flat. Should the US and China reach a deal (a tentative Stage 1 deal is supposedly close to being finalized) then we could certainly see equity markets take off.

Currently, we are in the longest economic expansion in US history. Given it is the late stages of a business cycle, and our current low interest rate environment has created economic distortions, it is easy for one to hypothesize that we are on the verge of another recession. While we may see moderate pull back, I am hesitant to suggest a recession is imminent. Historically, central banks will cut interest rates between 4 and 5% when a recession is on the horizon. The Bank of Canada has left the target overnight rate at 1.75%; therefore, cutting rates by the traditional 4% is incredibly unlikely. Sweden and Denmark currently have implemented negative interest rates and have shown that an economy can function when rates are in the red (Denmark has negative mortgage rates; they will pay the consumer to borrow money to buy their house). However, Canada’s central bank, along with the Fed in the US, have all but ruled this out as a possibility. Furthermore, we have recently seen upward pressure on the 10 year US yield curve – the trajectory of expected interest rates in the future – which is generally a strong leading indicator of continued growth. In addition to the steepening of the US Treasury curve, we are also seeing less global debt carry a negative yield. This would suggest optimism has percolated into bond markets, which is generally a good sign for the economy.

When President Trump took office at the beginning of 2018, the US economy got an immediate surge from tax cuts he implemented for corporate America. This instant fiscal stimulus allowed markets to skyrocket and gave investors a false sense of security. What we are seeing now, in addition to the political uncertainty, is the US economy fundamentally slowing down because the lack of fiscal stimulus; thus, the market imbalances that were always there have become increasingly transparent.  None of these developments, however, equate to a repeat of what we saw with subprime mortgages in 2008, nor do they represent the pullback we saw from tech stocks in 2001. The current calming of economic growth is not driven by an overheated financial sector fueled by derivative instruments. What this means is that 2020 will likely provide us with mild growth while financial markets navigate their way through some of the inequalities caused by ongoing political turbulence.