Economic Outlook

Andrew Sweeney, Vice President & Portfolio Manager

Phillips, Hager & North Investment Management

Central Banks to the rescue!!!

2

Key macro themes

Source: RBC GAM

Risk assets rebounded as central banks

came to the rescue

Headwinds: Protectionism, cycle age,

fading U.S. fiscal

Tailwinds: Central banks, global fiscal

stimulus, U.S. speed limit rising

Late in business cycle

Recession risk substantial, but not

happening yet

China slowing but government stimulus

to provide temporary relief

Brexit delayed; uncertainty highCanada limited by oil, housing,

competitiveness

3

In spite of trade fears, stock market still near highs

4

2200

2300

2400

2500

2600

2700

2800

2900

3000

Jan-17 May-17 Sep-17 Jan-18 May-18 Sep-18 Jan-19 May-19 Sep-19

S&

P 5

00

In

de

xStock market roiled by trade fears again

Note: As of 8/30/2019. Source: WSJ, Haver Analytics, RBC GAM

Smooth and happy equitiesin 2017

Extreme volatility

Concern about rates, growth,

tariffs

Centralbanks to

the rescue

2

4

6

8

10

12

1980 1984 1988 1992 1996 2000 2004 2008 2012 2016 2020

%

S&P 500Net Margin

Linear trendline

Source : RBC Capital Markets, RBC GAM

Corporate margins running above trendTend To Mean Revert During Economic Contraction

5

How have margins expanded so much?

30%

19%15%

12%

24%

S&P 500 Index ManufacturersSources of Profit Margin Improvement Since 2000

Decline in

Interest Rates

Wage Savings

from OffshoringWage Savings from

More Efficient

Domestic Plants

Use of Tax Havens

Declines in

Developed World

Effective Tax Rates

6

Bond yields falling globally

0.0

1.0

2.0

3.0

4.0

5.0

2007 2010 2013 2016 2019

10-y

ea

r G

ove

rnm

en

t o

f C

an

ad

a Y

ield

(%

)

Canada 10 year yield has fallen dramatically

Source: Bloomberg

Developed Country Yields (%)

Source: Bloomberg As of August 31, 2019

Country 5 Year 10 Year 30 Year

Canada 1.19 1.16 1.43

U.S. 1.33 1.46 1.95

U.K. 0.27 0.38 0.92

Japan -0.73 -0.28 0.11

Germany -0.92 -0.74 -0.21

France -0.75 -0.40 0.44

Spain -0.35 0.09 1.00

Italy 0.31 0.88 1.93

7

Yield curve inverted: recession risk warning

-5.0%

-4.0%

-3.0%

-2.0%

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

1979 1983 1987 1991 1995 1999 2003 2007 2011 2015 2019

Yie

ld S

pre

ad

(%

)

Recession

Yield curve signals rising recession risks

Source: Bloomberg

Falling inflation

artificially

taming long

term yields

Fiscal

surpluses and

undersupply of

bonds

Global savings

glut artificially

depressing

long end of

yield curve

Quantitative

easing

distortions

8

Cyclical economic trends: Economic deceleration

47

48

49

50

51

52

53

54

55

56

57

58

2012 2013 2014 2015 2016 2017 2018 2019

Ma

nu

factu

rin

g P

MI

Global manufacturing activity is falling again after brief stabilization

J.P.Morgan Global PMI Developed markets PMI Emerging markets PMINote: As of Jun 2019. PMI refers to Purchasing Managers Index for manufacturing sector, a measure for economic activity. Source: Haver Analytics, RBC GAM

Contraction

Expansion

9

U.S. is “Late Cycle”

Start of Cycle Early cycle Mid cycle Late cycle End cycle Recession

Consumer

Leverage

Business Investment

Employment

Corporate Profitability

Credit

Inventories

Prices

Housing

Economic Trend

Volatility

Sentiment

Economic Slack

Equities

Cycle Age

Monetary Policy

Bonds

Scores for each stage

of the business cycle0 0 5.5 13 8.5 1.5

Note: Dark shading indicates the most likely stage of business cycle (full weight); light shading indicates alternative interpretation (0.5 weight)

U.S. business cycle scorecard

10

U.S. achieving longest expansion / cycle is old

12 15 13 8 35 12 19

4

30 40 24 400

10

20

30

40

0

10

20

30

40

1945-4

8

194

9-5

3

195

4-5

7

195

8-6

0

196

1-6

9

197

0-7

3

197

5-7

9

198

0-8

1

198

2-9

0

199

1-2

001

200

1-0

7

200

9-P

rese

nt

Cu

mu

lative

% c

ha

ng

e

Du

ratio

n o

f e

co

no

mic

exp

an

sio

n (

qu

art

ers

)

Current economic expansion in historical context

Employment gain (RHS) Real GDP per capita (RHS)Note: Duration of economic expansion up to Q2 2019, cumulative employment gain as of May 2019, cumulative change in real GDP per capita as of Q1 2019. Source: NBER, Macrobond, RBC GAM

U.S. economic expansion (LHS)

11

Structural headwinds to economic growth

Human factors Economic structure Post-crisis

• Demographics:

• Slower pop. growth

• Rising retired %

• Decelerating gains in:• Education

• Health

• Urbanization

• Rising complacency:• Low labor mobility

• More segregated

• Less risk-taking

• Falling societal trust

• Higher inequality

• Fading globalization

• Declining creative

destruction:

• Lower firm turnover

• Higher firm concentration

• Goods services

• Maturing EM economies

• Populism/protectionism

• Secular stagnation:

• Diminished expectations

• Less business

investment

• Skill decay

• Debt excesses:

• Servicing

• Deleveraging

Technology

• Running out of big

new innovations?

Source: RBC GAM

12

Adverse demographic trends

-0.8

-0.4

0.0

0.4

0.8

1.2

1.6

2.0

2.4

2.8

2000 2010 2020 2030 2040 2050

De

ve

lop

ed

co

un

trie

s p

op

ula

tio

n g

row

th(a

nn

ua

l %

ch

an

ge

)

Workforce to shrink, retirees to grow

Age 65 and over Working age (15-64)Note: Shaded area represents UN projections. Source: United Nations, Haver Analytics, RBC GAM

Working age population to shrink

Retired populationto grow

13

Composition of aging population to tilt away from savers

6

8

10

12

14

16

18

20

22

24

26

28

30

1980 1990 2000 2010 2020 2030 2040 2050

% o

f to

tal popu

lation

Wealth accumulation trend

Age 45 to 64 Age 65 and over

Note: Population of developed countries. Source: United Nations, Haver Analytics, RBC GAM

Faster saving growth than spending growth

Savers shrink / dissavers grow

Those under 45 are roughly neutral

14

Populism protectionism

Source: RBC GAM

Why populism? Policy implications Economic implications

• Financial crises

• Slow growth era

• High inequality

• Globalization losers

• Less free trade

• Less immigration

• Less economic growth

• More inflation

• Worse market returns

Evidence of populist attitudes

• Brexit

• Populist governments in Greece, Italy, polling elsewhere

• U.S. presidential election

• Rising protectionism, immigration fearsSource: RBC GAM

15

Increasing inequality at national level, falling inequality globally

94%

43%

70%

101%

185%

0

20

40

60

80

100

120

140

160

180

200

Bottom 50% Middle 40% Top 10% Top 1% Top 0.01%

Cu

mu

lative

re

al in

co

me

gro

wth

pe

r a

du

lt,

19

80

-20

16

(%

)

Winners and losers from globalization

Note: Cumulative growth of average income of each income group of the world population. Source: World Inequality Database, RBC GAM

Full population

17

U.S. tariffs in context

0

1

2

3

4

5

6

7

8

9

10

Bra

zil

Arg

entina

India

South

Kore

a

Saudi A

rabia

South

Afr

ica

Chin

a

Russia

Turk

ey

Japan

Indonesia

Fra

nce

Germ

any

Italy

U.K

.

EU

U.S

.

Canada

Mexic

o

Austr

alia

Applie

d w

eig

hte

d m

ean tariff r

ate

, 2017

(%

)

U.S. tariff rate now substantially higher

Note: Applied weighted mean tariff rates for all products. Deutsche Bank estmates for 2018 and 2019 U.S. tariff rates based on additional tariffs announced up to October 2018. Source: Deutsche Bank, World Bank, Haver Analytics, RBC GAM

Increase due to new tariffs implemented in 2018 and 2019

16

China’s current account surplus is nearly gone,but the goods trade surplus remains

-5

-3

-1

1

3

5

7

9

11

1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 2012 2015 2018Ch

ina

cu

rre

nt a

cco

un

t b

ala

nce

(%

of G

DP

)

China's current account surplus has almost vanished

Income Services ex travel Travel Goods Current account balance

Note: As of 2018. Source: Macrobond, RBC GAM

Surplus

Deficit

18

Canadian provinces operating at different speeds

ProvinceCurrent GDP growth rate

(YoY % change)

Manitoba 2.4

British Columbia 2.1

Quebec 2.1

Nova Scotia 2.0

Newfoundland and Labrador 1.9

Prince Edward Island 1.9

Ontario 1.7

Saskatchewan 1.2

Alberta 1.0

New Brunswick 0.8Note: RBC GAM estimate of provincial GDP year-over-year growth rate as of Mar 2019.

Source: Macrobond, RBC GAM

25

Canadian macro challenges

Source: RBC GAM

21

Canada is losing its competitive edge

How Canada stacks up

Measure 2007-2008 2017-2018 Change

Public Policy 93.8 92.2

Labour 92.5 92.0

Innovation 91.8 84.7

Composite 93.0 90.2

Source: GII database, Cornell, INSEAD, WIPO, World Bank, World Economic Forum, RBC GAM

Canada's international ranking (percentile)

Note: The composite ranking is a w eighted average of the three measures. Ranking for each measure is an average of percentile rankings of the underlying

components. Public policy is composed of World Governance Indicators, Ease of Doing Business, and Global Competitiveness Index (GCI). Labour is made up of GCI

Higher Education and Training Subindex, GCI Labour Market Efficiency Subindex, and Global Human Capital Index (GHCI). Innovation comprises GCI Technological

Readiness Subindex, GCI Innovation Subindex, and Global Innovation Index. GHCI 2013 data used in the calculation of the innovation measure for the 2007-2008 period.

22

Canadian households are leveraged

100

110

120

130

140

150

160

170

180

190

1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019

Ho

use

ho

ld d

eb

t-to

-in

co

me

ra

tio

(%

)

Household leverage has climbed in Canada, but declined in U.S.

Canada U.S.Note: As of Q1 2019. Source: Haver Analytics, RBC GAM

23

Canadian provincial elections reveal clear rightward trend

Province Latest election Prior government Latest government Change

Newfoundland and Labrador 05/16/2019

Prince Edward Island 04/23/2019

Alberta 04/16/2019

Quebec 10/01/2018

New Brunswick 09/24/2018

Ontario 06/07/2018

Nova Scotia 05/30/2017

British Columbia 05/09/2017

Manitoba 04/19/2016

Saskatchewan 04/04/2016

Latest provincial elections

Note: Red flag represents left-wing parties (non-BC Liberal, NDP), blue for right-wing parties (Conservatives, BC Liberals, Quebec CAQ, Alberta UCP).

Source: Wikipedia, RBC GAM

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Publication date: July 5, 2019

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