Lower Oil Prices Forecast to Spur Global Economic Growth
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Fe b r u a r y 2 0 1 5
Lower Oil Prices
Forecast to Spur
Global Economic
Growth
SENIOR IMF ECONOMISTS SAY
LOW OIL PRICES COULD GIVE GDP
“A SHOT IN THE ARM” WORTH AS
MUCH AS 0.7% IN 2015
The sharp decline in the price of oil in the
second half of 2014 dominated headlines
and drove market volatility. In early
January, a barrel of benchmark West Texas
Intermediate crude oil was trading below
US$50, down from the summer peak of
above US$100. While the decline in oil
prices is a significant market event, we
see the recent market volatility as an
overreaction. Taking a longer view shows
us that oil prices vary significantly over
time—just over six years ago, we saw
prices even lower than those we see today.
MD Financial Management expects ongoing
volatility for global oil prices. However, while
the impact of lower oil prices is unwelcome
news for some economic sectors, the news
is not all negative. Writing on iMFdirect, the Some economists liken lower oil prices to With oil dominating headlines, the ongoing
International Monetary Fund’s (IMF’s) a tax cut that leaves consumers with more economic recovery in the United States
global economy forum, Rabah Arezki and money to spend, save and invest. Inflation was overlooked by many investors when it
Olivier Blanchard make the case that is also somewhat less of a concern if oil is perhaps the most important news for
declining oil prices are a net positive for the prices remain low. investors to focus on. The Bank of
global economy. Canada’s latest monetary policy
It is important to keep this more positive announcement highlighted that: “The U.S.
“Overall, we see this as a shot in the arm perspective in mind as we look ahead into economy has clearly strengthened,
for the global economy. Bearing in mind 2015. While lower oil prices certainly particularly business investment, which
that our simulations do not represent present challenges for Canada’s energy has benefitted Canada’s exports.”2 The
a forecast of the state of the global sector, manufacturing and other areas of Bank also noted that Canada’s economy is
economy, we find a gain for world GDP the economy could start to deliver gains. showing signs of a broadening recovery.
between 0.3 and 0.7 percent in 2015, Even with lower oil prices, the S&P/TSX
compared to a scenario without the drop Composite index was up 10.6% at the end The Bank of Canada acknowledged,
in oil prices.”1 of 2014. however, that growth in the rest of the
Highlights
••Central Bankers Still Playing a Critical Role in Sustaining Markets
••U.S. Economic Growth Outlook Spells Good News for Canada
••MD’s Tactical Asset Allocation: A Refresher
world continues to face headwinds, despite
prominent stimulus from policy-makers
like the Bank of Japan and the European
Central Bank (ECB). Although the U.S.
economy is growing at a reasonable rate,
we share the Bank of Canada’s concerns
about the uneven nature of global growth.
Moreover, weaker growth in important
markets (such as Europe, Japan and
China) remains a concern.
The fourth quarter of 2014 marked the
worst quarter in over a year for the
eurozone economy, according to Markit’s
Purchasing Managers’ Indexes. The
indexes highlighted continuing downturns
in Italy and France and a faltering
performance by Germany, the region’s
economic leader. Europe and Japan also
face the threat of deflation—falling prices
for goods and services, which may only be
exacerbated by lower oil prices.
CENTRAL BANKERS STILL PLAYING
A CRITICAL ROLE IN SUSTAINING MARKETS
Encouragingly, central bankers in key
markets such as China, Japan and Europe
appear to be committed to stimulus
programs to support economic growth and
financial markets. In November, the central
banks of all three economies took steps to sector. This suggests that regulators The key question facing the ECB is
loosen monetary policy that included will keep up pressure on off-balance- whether it should launch a more
lowering short-term interest rates and sheet lending and shadow banking. aggressive program of quantitative easing
increasing asset purchases. The general Both of these activities have been blamed that would potentially include buying
consensus among market watchers is that for market volatility. bonds issued by eurozone members.
these three central banks will continue to Critics say this would amount to printing
do more to inject stimulus into their On October 31, the Bank of Japan money by stealth to bailout countries.
respective economies early in 2015. increased the annual pace of its asset Germany remains opposed. However,
purchases from ¥60–70 trillion to on January 8, 2015, ECB President
The People’s Bank of China lowered its ¥80 trillion. Japan’s Nikkei stock index Mario Draghi repeated earlier assertions
benchmark lending rate by 0.4 percentage rose on the news. This move to inject yen that the ECB was ready to start “full-
points to 5.6% and its benchmark deposit into the economy is aimed at fixed-income blown” quantitative easing. European
rate by 0.25 percentage points to 2.75% securities held by commercial banks. It stock markets closed sharply higher
on November 21. Most investors and serves to raise the price and lower the on the news.
analysts were surprised by the move. yield on these investments, which in turn U.S. ECONOMIC GROWTH OUTLOOK SPELLS
The announcement sparked large gains helps stimulate the economy. Notably, GOOD NEWS FOR CANADA
in currencies, stocks and commodities relative to the size of Japan’s economy, the The consensus among economists is for a
linked to Chinese economic demand. bank’s asset purchase program is much modest pickup in global economic growth
bigger than similar programs at other in 2015 and 2016. The pickup will be led by
Previously, the central bank had tried to major central banks. At its mid-December the strengthening U.S. economy, which is
reverse China’s economic slowdown meeting, the bank made the decision to good news for Canada’s export-oriented
through other means, such as by injecting maintain this ¥80 trillion annual pace. economy with its close ties to the United
a reported 769.5 billion yuan into the States. Job creation in the U.S. is higher
economy through loans to commercial The ECB has begun purchasing both today than at any time since 1999.
banks in September and October. While covered bonds and asset-backed Unemployment fell to 5.6% in December.
these loans were greeted as positive securities as part of its stimulus program. Private employers have created more than
moves by investors, the bank’s actions Covered bonds are debt securities backed 10 million jobs since 2010, the longest
were criticized for being opaque. In by cash flows from mortgages or public uninterrupted period on record.
response to mounting criticism that it was sector loans. Asset-backed securities are
not acting transparently, on January 9, the financial securities backed by a loan, lease Stronger-than-expected third-quarter
central bank said it would quicken the or receivables against assets other than corporate earnings in the United States
pace of market-oriented interest rate real estate and mortgage-backed support an optimistic view of the North
reforms to allow for more transparency. securities. Buying these kinds of securities American economy. Strong U.S. corporate
The People’s Bank of China also helps increase their price and reduce their profits were especially welcome given the
announced it would take further steps to yield in hopes of stimulating broader global geopolitical turmoil in places like
prevent systemic risks in the financial economic growth. Ukraine and the Middle East. The ability of
FEBRUARY 2015 MDPERSPECTIVES 2
U.S. corporations to deliver strong
earnings in the face of ongoing economic
reflected in sales of key value-added
products like cars and trucks. According to
“The hoped-for
uncertainty in Europe was another piece the Ontario government, the provincial
of positive news. economy grows by 0.1 to 0.3 percentage rotation of growth
points for every $10 drop in the price of a
LOWER OIL PRICES POSE A CHALLENGE, BUT
CANADA’S ECONOMIC GROWTH APPEARS TO
BE BROADENING
barrel of crude oil. away from a reliance
LOOKING AHEAD IN 2015
The Bank of Canada points to the sharp
drop in the prices of oil and some other MD expects central bankers and other
policy-makers to continue to underpin
on household
commodities as a threat to Canada’s
economic growth and the growth of
other commodity-producing countries.
economic growth. The IMF forecasts
3.5% global GDP growth in 2015 and spending may finally
Despite this threat, the Bank of Canada’s 3.7% in 2016.
December Financial System Review points
MD remains cautiously optimistic that
have begun.”
to signs of a broadening economic
the global economy will continue to be
recovery. The report cites stronger exports,
biased toward growth as 2015 unfolds.
which are beginning to be reflected in
We also continue to expect long-term
increased business investment and
opportunities to arise as lingering effects
employment. The bank argues that this
from the global financial crisis recede
suggests that “the hoped-for rotation of
and economic output progresses toward
growth away from a reliance on household
full capacity.
spending may finally have begun.”3
For individual investors, looking beyond
Canada’s GDP grew 0.3% in October,
the headlines and focusing on investment
after a 0.4% increase in September.
fundamentals remains the proper
Manufacturing output grew 0.7% in
approach. We encourage you to work
October, after rising 0.8% in September.
closely with your MD Advisor to focus on
Non-durable goods manufacturing rose
your portfolio’s purpose and time horizon,
0.9% as most major industrial groupings
with a view to rebalancing so that your
posted gains. Unemployment remained
current mix of investments reflects your
low at 6.6%. Most of last year’s job gains
long-term strategic asset mix.
were seen in the second half of the year.
Sliding oil prices hit oil-rich provinces like Now is an ideal time to revisit your long-
Alberta and Newfoundland and Labrador, term financial plan and ensure that you are
but Canada’s manufacturing heartland in up to date, with the appropriate strategic
Ontario stands to benefit thanks to asset mix. To make sure you are in the best
increased demand for overall exports. position to keep your financial future on
Lower oil prices will also keep downward track in the face of emerging economic
pressure on the Canadian dollar. This is opportunities, talk with your MD Advisor, or
good news for Canada’s export-oriented call MD at 1 800 267-2332 to be put in
economy. Demand is already being touch with an MD Advisor near you. •
INDEX RETURNS
12 MONTHS ENDED 3 MONTHS ENDED 1 MONTH ENDED
INDEX
DECEMBER 31, 2014 DECEMBER 31, 2014 DECEMBER 31, 2014
S&P/TSX Composite 10.6% –1.5% –0.3%
S&P 500 24.0% 8.5% 1.3%
MSCI World 15.1% 4.7% –0.1%
MSCI EAFE 4.2% –0.2% –2.0%
MSCI Europe 2.9% –1.0% –2.7%
MSCI Emerging Markets 7.1% –1.1% –3.0%
FTSE TMX Canada 8.8% 2.6% 0.6%
Universe
FTSE TMX Canada 7.6% 1.9% 0.3%
Corporate
FTSE TMX Canada 9.3% 3.0% 0.7%
Government
Sources: State Street, MSCI
(All returns are in Canadian dollars.)
FEBRUARY 2015 MDPERSPECTIVES 3
MD’s Tactical Asset
Allocation: A Refresher
UNDERSTANDING THE QUANTITATIVE
NATURE OF THE TAA
When it comes to asset allocation for
MD Private Investment Counsel and MD
Precision Portfolios™, MD takes a two-
pronged approach: we consider long-term
positioning—also known as our strategic
allocation; and short-term positioning,
known as tactical asset allocation (TAA).
In both instances, the decision-making
process is highly sophisticated, involving a
disciplined investment methodology.
At the core of MD’s investment process is a
solid strategic overview designed to meet
the longer-term goals and needs of our
clients. This strategic asset allocation, which
is tied to each client’s specific goals and
time horizon, forms the bedrock of MD’s
investment approach. It relies on a steady
investment philosophy and, by its nature, is
less reactive or prone to sudden change or Counsel and MD Precision Portfolios™. The factors that QS Investors has
adjustment. This is where TAA is a crucial This involves specific advice from QS identified can be categorized in three
component of our process. While the bulk of Investors, MD’s sub-advisor focused on overall “themes”:
MD’s portfolio returns are expected to be asset allocation. IMS has the ultimate
derived from our strategic asset allocation,
the active decisions within the portfolio,
responsibility for approving and • long-term valuation
implementing these TAA decisions.
including TAA, are expected to improve • mmacroeconomic
edium-term cyclical or
portfolio performance at the margin. WHAT ASSET CLASSES ARE COVERED
IN THE TAA PROCESS?
Together, MD’s strategic and tactical Our TAA model is customized for the • ssentiment
horter-term behavioural or
driven
approaches serve to capture both following asset classes within our portfolio
short- and long-term return potential structures: Canadian equities; U.S. equities; Importantly, the investment process is not
for investors. Europe, Asia and the Far East (EAFE) anchored in any one of these themes
equities; Canadian short- and mid-term because the factors driving financial
This article focuses on TAA, given the bonds; Canadian long bonds; cash. market returns are constantly changing.
frequently asked questions about this MD HOW ARE TACTICAL DECISIONS MADE? This is similar to diversification in a
investment process. The aim is to provide The MD approach to TAA is grounded in portfolio: by taking a balanced approach to
useful information to MD clients and insights from modern behavioural finance integrating the intuition behind our tactical
advisors that will serve to illustrate how and traditional macroeconomic and views, we reduce the risk of narrowing in
tactical decisions are used to adjust MD capital markets research. QS Investors on any one factor and expect to improve
portfolios to take advantage of constantly systematically captures these insights risk-adjusted returns as a result.
changing financial market conditions. using a proprietary quantitative approach
that varies portfolio positioning over time Understanding our TAA process serves to
WHAT IS TAA AND WHY DOES MD HAVE IT?
according to changing market conditions explain why there is often no simple, linear
TAA is implemented quarterly, or as market
and opportunities. explanation for a tactical move. Within
conditions dictate, and allows us to take
each of the three themes are specific
advantage of shorter-term or time-sensitive
The quantitative approach applies advanced signals, or factors, and every tactical
opportunities that are expected to add
statistical techniques to create a model that decision involves comparing a series of
value to investment portfolios.
evaluates the market environment, and the these signals against each other, often in
WHO OVERSEES TAA? factors potentially driving returns, to identify an offset position as in equities versus
MD’s Investment Management and mispricing both within and across global fixed income. So, for instance, recently we
Strategy (IMS) team reviews the tactical asset classes in order to generate strong decided for the first time since 2009 to
positioning of MD Private Investment risk-adjusted returns. overweight fixed income based on
FEBRUARY 2015 MDPERSPECTIVES 4momentum and risk factors that favoured
bonds at this time. These factors
countered our valuation signals, which
still favour stocks relative to bonds.
The result was an underweight position
in equities relative to fixed income.
Ultimately though, 52% of our portfolio
remains invested in equities.
TIMING FOR THE TAA
TAA decisions are based on our analysis
of signals that help to provide direction
for the upcoming six to 24 months. They
are not designed to capture day-to-day
changes in market behaviour, but broader
trends that offer meaningful opportunity
to add value to investment portfolios.
Market conditions are constantly
changing and, as they do, our TAA
process is designed to adapt and
position accordingly.
TAA is one of a number of strategies
that MD employs to enhance returns from
its investment portfolios and ultimately
improve the probability of meeting our
clients’ financial objectives. •
1
R abah Arezki and Olivier Blanchard, Seven Questions About The
Recent Oil Price Slump, iMFdirect, December 22, 2014
2
Interest rate announcement, Bank of Canada, December 3, 2014
3
Financial System Review, December 2014, Bank of Canada
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