Saturday, 22 December 2018

Biggest Global Macro Misses of 2018

As another year comes to a close, it is time to review how the macro consensus forecasts for 2018 that were made a year ago fared. Each December, I compile consensus economic and financial market forecasts for the year ahead. When the year comes to a close, I take a look back at the forecasts and compare them with what we now know actually occurred. I do this because markets generally do a good job of pricing in consensus views, but then move --  sometimes dramatically --  when a different outcomes transpire. When we look back, with 20/20 hindsight, we can see what the macro surprises were and interpret the market movements the surprises generated. It's not only interesting to look back at the notable global macro misses and the biggest forecast errors of the past year, it also helps us to understand the macro drivers of 2018 investment returns and to assess whether they are sustainable.

Real GDP

In 2018, forecasters accurately forecast global real GDP growth. Weighted average real GDP growth for the twelve countries we monitor is now expected to be 3.7%, exactly matching the consensus forecast of 3.7% made a year ago. While the global growth forecast was bang on, the individual country GDP forecasts were not. In the twelve economies, real GDP growth exceeded forecasters' expectations in just three and fell short of expectations in nine. The weighted mean absolute forecast error for the twelve countries was 0.4 percentage points, about the same as the 2017 error.

Based on current estimates, 2018 real GDP growth for the US exceeded the December 2017 consensus forecast by 0.5 percentage points (pct pts). Growth also slightly exceeded consensus expectations in Australia and China. The biggest downside misses on growth for 2018 were for Brazil (-1.5 pct pts), Japan (-0.7), Russia (-0.6), the Eurozone (-0.3), and India (-0.3). On balance, a big upside miss on US growth was offset by downside misses in other economies.

CPI Inflation

Just as for global growth, the consensus forecast for global inflation for 2018 was very accurate. Average inflation for the twelve countries is now expected to be 2.4% compared with a consensus forecast of 2.4%. And just as for growth, upside misses just offset downside misses. Six of the twelve economies are on track for higher inflation than forecast, while inflation was lower than expected in six countries. The weighted mean absolute forecast error for 2018 for the 12 countries was 0.4 percentage points, down from a 0.6% average miss last year.

The biggest downside misses on inflation were in India (-1.9 pct pts), and the UK (-0.3). The biggest upside miss on inflation were in Mexico (+1.1 pct pts) and the Eurozone (+0.6%).

Central Bank Policy Rates

In 2018, economists' forecasts of central bank policy rates were, on balance, slightly too high. Four central banks hiked their policy rate by more than expected while six central banks hiked less than expected.

In the DM, the Fed hiked the Fed Funds rate four times, one more than the consensus expected. The ECB and the BoJ met expectations by leaving their policy rates unchanged. The Bank of Canada and the Bank of England hiked slightly less than the consensus expectation. The Reserve Bank of Australia remained on hold instead of hiking once as the consensus expected. In the EM, as usual, the picture was more mixed. Brazil's central bank was able to cut its policy rate more than expected. Russia was expected to cut its policy rate but was unable to do so. In China, the PBoC stayed on hold, as expected, but did cut reserve requirements as the economy struggled to meet the government's growth target. India's RBI was expected to remain on hold in 2018, but had to raise its' policy rate. Mexico extended the trend of late 2016-17, tightening more than expected as inflation rose in response to the weakening of the Mexican Peso. 

10-year Bond Yields

In nine of the twelve economies, 10-year bond yield forecasts made one year ago were too high. 

In all six DM economies that we track, 10-year bond yields surprised strategists to the downside. The weighted average DM forecast error was -0.30 percentage points, the same as for 2017. The biggest misses were in Australia (-0.74 pct pts), Canada (-0.57), the Eurozone (proxied by Germany, -0.55), the UK (-0.35 pct. pt.). In the EM, the picture was mixed as bond yields were lower than forecast in Brazil (-1.78 pct pts) and Korea (-0.75). However, bond yields rose more than expected in Russia (+1.91), Mexico (+1.20) and India (0.36).

Exchange Rates

All of the major currencies were weaker than expected against the US dollar. The weighted mean absolute forecast error for the 11 currencies versus the USD was 7.5%.

The USD was expected to strengthen following the election of Donald Trump as President. In 2017, however, USD unexpectedly weakened reflecting early delays in implementation of Trump's promised tax cuts, hesitation to tighten by the Fed, unexpected tightening by some other central banks and ebbing political uncertainties in emerging economies. In 2018, as Trump's tax cuts took effect, the Fed hiked four times and shrank its' balance sheet, and Trump began his strategy of raising tariffs to pressure trading partners into more advantageous trade arrangements, the USD outperformed all expectations.

The biggest FX forecast misses for the DM economies were for the Canadian Dollar (which was 11.4% weaker than expected), the UK Pound (-9.3%), the Australian Dollar (-8.5%) and the Euro (-8.0%). EM currencies also weakened sharply against USD, led by the Russian Ruble (-17.2%), Brazilian Real (-15.5%) and Indian Rupee (-6.7%). 

Equity Markets

News outlets gather equity market forecasts from high profile US strategists and Canadian bank-owned dealers. A year ago, equity strategists were optimistic that North American stock markets would turn in a modest, if unspectacular, positive performance in 2018. This call was far off the mark. As shown below, those forecasts called for 2018 gains of 5.7% for the S&P500 and 4.9% for the S&PTSX Composite.

As of December 21, 2018, the S&P500, was down 9.2% year-to-date (not including dividends) for an error of -14.9 percentage points. The S&PTSX300 was down 14.0% for an error of -18.9 percentage points.

Although global real GDP growth, global inflation and major central bank actions were close to consensus forecasts, the divergences from consensus expectations across countries proved a toxic mix for equities. Stronger than expected US growth and a slight uptick of inflation were met with a slightly quicker normalization of the US policy rate and a steady reduction in the size of the Fed's balance sheet. As the Fed persisted with plans to continue tightening amid slowing growth in Europe, Japan and Emerging Markets, equity markets fell like dominoes. Declines began in EM, spread to Europe and Japan, and finally reached US equity markets in the final two months of 2018. 

Globally, stock market performance (in local currency terms) was horrible.  The Eurozone and Canada led declines in DM equity markets. China, Korea and Mexico led decliners in EM markets. Brazil and India, bucking the global trend, posted gains.  

Investment Implications

In 2018 global macro forecast misses were once again quite different from those of recent years. The accuracy of global growth and inflation forecasts masked unexpected divergences in growth and inflation from expectations for individual countries. Stronger than expected US growth, faster than expected Fed tightening and Trump's tariff increases saw the USD strengthen against all of the major currencies. This mix was particularly difficult for EM economies, including China, with large amounts of USD-denominated debt. As EM economies slowed, crude oil and other commodity prices fell sharply, dimming prospects for countries like Canada and Australia. 

Stronger than expected growth had US stocks outperforming bonds for most of the year. Market concerns that the Fed would continue tightening even as growth outside the US was faltering contributed to the sharp fall in global equity prices in 4Q18. By year end, both US equity and bond prices had fallen, but bonds outperformed as risk aversion took hold.

For Canadian investors, the depreciation of CAD against the USD meant that returns (in CAD terms) on government bonds denominated in US dollars were boosted if the USD currency exposure was left unhedged. The only slight positive returns for Canadian investors came in Canadian and unhedged foreign bonds. The outperformance of globally diversified portfolios over stay-at-home Canadian portfolios continued in 2018. 

As 2019 economic and financial market forecasts are rolled out, it is worth reflecting that, for a variety of reasons, such forecasts have been a poor guide to investment decisions for several years running. While forecasters' optimism about global growth remains in place, cracks are now forming. 2019 will undoubtedly once again see some large consensus forecast misses, as new surprises arise. 

Last year in this space, I said: 
The 2017 macro surprises, higher than expected growth and lower than expected inflation, are now being built in to 2018 views. This actually increases the chances of disappointments that are negative for equities and other risk assets. 
Although it took until late in the year, those disappointments did arrive in 2018. This has left the global economy and financial markets in an uncertain and somewhat precarious position heading into 2019. With central banks focussed on "normalizing" monetary policy, the buoyant financial market performance that accompanied massive expansion of central bank balance sheets is increasingly looking like it's going into reverse.

Wednesday, 18 July 2018

For Canada, Full Capacity Is Not Full Potential

The conventional view serves to protect us from the painful job of thinking. 
                                                                 John Kenneth Galbraith

The Bank of Canada hiked it's policy rate by 25 basis points to 1.5% on July 11, in a move that was widely anticipated by the consensus.

As the C.D. Howe Institute's Monetary Policy Council (of which I am a member) said on July 5,
All but one of the nine MPC members who attended this meeting called for an overnight rate target higher than the current one at the upcoming meeting on Wednesday 11 July. The near unanimity reflected the group’s view that Canadian economic data in the second quarter have rebounded from a sluggish beginning to 2018.  Output has risen since April, with the Business Outlook Survey suggesting we are at or above productive capacity. The labour market is also showing signs of tightening with growth in average hourly earnings at its highest level since 2008.
This is the conventional wisdom which nearly everyone with an educated opinion accepts. It is based on the notion that the economy has reached or exceeded its' full capacity. The unemployment rate, which ticked up last month, had previously fallen to its lowest since comparable data became available in 1976. Wage growth, as measured by average hourly earnings of permanent employees reached 3.9% in May, the highest since 2008. 

One analyst, who I have high regard for, recently wrote,
The Canadian economy is in an interesting position approaching the middle of 2018. Growth has slowed in recent quarters, after a very strong 2017H1. There are convincing signs, however, that this slowing reflects the economy hitting capacity constraints, rather than a sudden fall off in demand. Consistent with this, genuine inflation pressures have become more evident. Canada is the only G7 country to experience a significant acceleration in wage inflation as the unemployment rate has fallen below traditional estimates of NAIRU.All these factors suggest that the Bank of Canada is behind the curve on its policy of rate normalization.
When I read such analysis or the financial press, the message that comes through is that: 

  • Because growth of demand (or GDP) has been stronger than potential, Canada's economy has reached or exceeded it's full productive capacity; and 
  • Because the labour market has reached a 40+ year tightness, wage growth is accelerating and putting upward pressure on inflation; 
  • The Bank of Canada should play catch up in "normalizing" it's policy rate.

I believe that neither of the first two points is an accurate description of the current situation in Canada and therefore, that the conclusion about Bank of Canada policy does not follow.

Why is Canada facing capacity pressures?

I don’t share the view that growth has slowed because of capacity constraints that have pushed up wages. I believe the latest acceleration in wages in a slowing economy was driven by sharp increases in minimum wages in several provinces, which began in 2017. 

Across Canada's ten provinces, the minimum wage rose by a weighted average 4.1% in 2017 (led by an 11.5% hike in Alberta) and by 11.0% in 2018 (led by a 20.7% hike in Ontario). Minimum wage hikes, not excess labour demand, have forced employers to raise wages not only for minimum wage employees, but also for employees who had moved to above-minimum-wage status, to maintain some equity and premium for experience. With 15% of employees affected directly or indirectly, these minimum wage hikes are sufficient to explain the majority of the acceleration average hourly wages for the total workforce. The sharp increase in early 2018 is probably also partly responsible for employment having declined 50,000 in the first five months of 2018.

I would characterize capacity utilization reaching cyclical highs even as growth has slowed as being caused by insufficient business non-residential investment. The chart below compares Canada and US real nonresidential business investment to GDP.

Over the past two decades, Canada has lagged the United States in business investment in plant, equipment and intellectual property. Canada's real investment rose as a percentage of GDP in the periods leading into 2008 and into 2014 when global crude oil prices were strong, boosting investment in Canada's oil and gas industry, led by growth of oil-sands production. Since the collapse of crude oil prices in 2014, followed by aggressive new government regulations and taxes in pursuit of climate change objectives, Canadian business investment fell to recessionary levels in 2016-17. While US business investment as a percentage of GDP has risen to a 20-year high, Canada's investment has fallen toward two decade lows.

The mix of Canada's business investment also demonstrates weakness. The charts below show Canada-U.S. comparisons of business spending on machinery and equipment, nonresidential structures and intellectual property.

US spending on machinery and equipment reached 6.5% of GDP in 1Q18, its' highest level in over 20 years. Meanwhile, Canada's spending on M&E was one-third lower at just 4.1% of GDP, still below the level reached prior to the Great Financial Crisis. 

US business spending on intellectual property has been rising strongly and reached 4.5% of GDP in 1Q18. This was well over double Canada's spending of just 1.8% of GDP.

Canada's business spending on non-residential structures rose to 5.5% of GDP in 1Q18, well below the peak level of 7.5% reached in 2Q14.  The decline in crude oil prices slowed energy investment after 2014 and increased regulation stalled investment in pipeline building. Canada still devotes almost double the US investment to nonresidential structures.

Canada's mix of business investment, which has been heavily skewed toward energy investment is a disadvantage when crude oil prices are weak and when governments prioritize environmental concerns. Canada has badly lagged the United States for decades in investment in machinery and equipment and intellectual property, but in both cases the US is opening up a widening gap.

What's Behind Canada's Weak Business Investment?

To some extent, Canada's lagging business investment is the result of differences in the industrial structure of the two countries. Canada has abundant natural resources and has long been a leader in capital investment in the extraction and transportation of these resources. When natural resource prices weaken or when governments adopt taxes and regulations that discourage resource development Canada's business investment can weaken quite dramatically. The United States has long been a leader in high technology industries and in the implementation of new technologies to increase business productivity and efficiency. As the pace of technological development accelerates, the US seems to be widening and deepening its advantage in business investment in both machinery and equipment and intellectual property.

While industrial structure is important, the influence of government policies can also be very important. Some recent policy developments in the US and Canada clearly seem to have tilted incentives toward higher investment in the US and weaker investment in Canada.

  • Corporate Tax: The Trump Administration has lowered corporate tax rates and encouraged repatriation of foreign profits. Canada has, so far, left its corporate tax rates unchanged. In 2017, the federal government raised the ire of small business by suggesting that they were not paying their "fair share" or taxes, before backing down on proposed changes.
  • Carbon Tax: The Government of Canada introduced a carbon tax of C$10 per tonne in 2018, rising to C$50 per tonne by 2022. The Trump Administration has pulled out of the Paris Climate Accord and the President has tweeted "I will not support or endorse a carbon tax!"
  • Regulation: President Trump has instructed the Environmental Protection Agency to cut regulations on industry and speed up decisions on permits. In Canada, environmental regulations have been tightened and the process to gain approval for pipelines and other energy projects has been made more complicated and time-consuming (see here).
  • Trade Policy: The Trump Administration has: 
    • demanded major changes to NAFTA which are unacceptable to Canada (and Mexico), thereby leaving negotiations in limbo; 
    • imposed a 20% duty on Canadian softwood lumber after the US Commerce Department ruled that Canada was unfairly subsidizing the industry (a claim made many times in the past but never upheld under WTO or NAFTA dispute settlement procedures); 
    • implemented 25% tariffs on steel and aluminum imports on "national security" grounds, refusing to exempt Canada, a close ally; 
    • threatened 25% tariffs on all auto imports, using the same "national security" justification.        

Trump’s tax and regulatory moves and the uncertainty generated by his trade policies have discouraged business investment in key Canadian goods producing industries. Meanwhile Trudeau’s attempts to tighten small business tax rules and the introduction of new regulatory obstacles to pipeline building and other energy projects have curtailed Canada’s future ability to get oil to export markets, depressed prices of Canadian crude and discouraged investment

The net result has been to tilt incentives to invest away from Canada and in favour of the United States. The comparative charts shown above of US and Canadian business investment-to-GDP provide strong evidence that this is the case. Further supporting evidence is provided by the chart below, which shows Canada's foreign direct investment flows.

The chart clearly shows that while Canadian direct investment abroad is near its' 20-year highs, foreign direct investment flows into Canada have fallen toward 20-year lows. US, Canadian and other foreign companies have a choice as to which side of the border to invest. They are increasingly choosing to invest in the US. The attraction of lower corporate taxes and reduced regulation combined with punitive US tariffs and uncertainty over the future of NAFTA provide powerful incentives to make capacity-expanding investment in the US, not in Canada.

What is Canada's Response?

So far, Canada has not responded effectively to Trump's tax and regulatory moves. On corporate taxes, the 2018 Federal Budget provided neither action nor a plan to revise Canada's corporate income tax, which prior to Trump's changes, had been relatively attractive. 

The federal government has not budged on its' plan to enforce a Canada-wide carbon tax, but provincial governments in Saskatchewan and Ontario oppose the plan and a change of government in Alberta would add a third important opponent, making it difficult for the federal government to implement its' carbon tax plan. Uncertainty over the future of carbon taxes remains a negative for business investment.

On regulatory measures, the Trudeau government, after allowing a dysfunctional regulatory process to cause the Northern Gateway Pipeline and the Energy East Pipeline projects to die, approved the Trans-Mountain Pipeline. However, because of protests by the Government of British Columbia, environmental activists and indigenous groups, the private investor, Kinder Morgan, shelved the project. The Federal Government kept the project on life support by purchasing the Trans Mountain Pipeline from Kinder Morgan for C$4.5 billion and promising to build it. Opponents will still make strong efforts to block the project, leaving Canada with insufficient capacity to get its' oil to world markets.

On trade policy, the federal government has chosen to retaliate against Trump's steel and aluminum tariffs with and equal value of tariffs on a range of US imports, a move which could provoke Trump into further escalating the trade war. Trump has shot Canada in one foot with his tariffs and duties on lumber, steel and aluminum and his threats of tearing up NAFTA and imposing tariffs on autos. Trudeau has shot Canada in its' other foot by imposing tariffs on US goods consumed by Canadians and his rhetoric that Canada "will not be bullied", which has contributed to the standstill in NAFTA negotiations. Let's be clear: Trump's trade policies and threats are dangerous and, if carried out, pose a clear risk to the global growth. But retaliation by US trading partners only increases that risk.

Is Canada Operating at Full Capacity?

It seems clear to me that Canada's economy is suffering from an investment drought. While unemployment is low by historical standards, weak business investment is resulting in many Canadians working at jobs well below their potential. Self employment is at a record level. Young people have great difficulty finding jobs that match their education and qualifications. Higher levels of business investment would surely create more full time private sector employment and stronger GDP growth. Traditional measures may suggest that Canada is near full capacity, but in my view, it is nowhere near full potential.

I am hopeful, however, that the next few years will see Canadian voters electing governments more attuned to the necessity of building a positive investment climate. Change is already underway in Ontario and is pending in Alberta. Only when federal and provincial governments begin working together on a comprehensive strategy to improve the climate for business investment will Canada reach its' potential.

In the meantime, tightening monetary policy is unlikely to improve Canada's economic prospects. Bank of Canada tightening in response to politically motivated spikes in minimum wages or to temporary upward pressure on Canadian inflation from US and Canadian tariff hikes is clearly inappropriate. Until Canada is able to bring about a lasting improvement in its' investment climate, a Bank of Canada monetary policy strategy of standing pat while the  US Fed tightens monetary policy more aggressively would tend to weaken the Canadian dollar, thereby providing a boost to our export competitiveness and a needed adjustment cushion the blow from US protectionism. 

Wednesday, 3 January 2018

Global ETF Portfolios: 2017 Returns for Canadian Investors

For the first time in seven years, the global economy outperformed expectations and the result was solid returns for Global ETF portfolios held by Canadians. At the end of 2016, the consensus among global strategists was for quite modest equity and bond market returns, consistent with consensus views that the US Fed would push up interest rates, thereby depressing expected bond returns, and skepticism that newly-elected President Trump could get his election promises through Congress, depressing expected equity returns.

The focus of this blog is on generating good returns by taking reasonable risk in easily accessible global (including Canadian) ETFs. To assist in this endeavor, we track various portfolios made up of different combinations of Canadian and global ETFs. This allows us to monitor how the performance of the ETFs and the movement of foreign exchange rates affects the total returns and the volatility of portfolios. 

Since we began monitoring our Global ETF portfolios at the end of 2011, we have found that the global portfolios have all vastly outperformed a simple all-Canada 60/40 portfolio. In 2016, we saw a reversal, but the trend resumed in 2017.

A stay-at-home Canadian investor who invested 60% of their funds in a Canadian stock ETF (XIU), 30% in a Canadian bond ETF (XBB), and 10% in a Canadian real return bond ETF (XRB) had a 2017 total return (including reinvested dividend and interest payments) of 7.0% in Canadian dollars. This was half of the 13.9% gain generated by the same portfolio in 2016. Two of our global ETF portfolios outperformed the all-Canadian portfolio, while two others underperformed. 

Global Market ETFs: Performance for 2017

In 2017, with the CAD appreciating almost 7% against USD but depreciating almost 6% against the Euro, the best global ETF returns for Canadian investors were in global equities. The worst returns were in US bonds. The chart below shows 2017 returns, including reinvested dividends, in CAD terms, for the ETFs tracked in this blog. The returns are shown for the full year (green bars) and for the "Great Unwind" period following a coordinated move by central banks in early-June to signal a reduction in the extraordinary monetary ease that had been in place since the Great Financial Crisis of 2008-09.

Global ETF returns varied widely across the different asset classes in 2017. In CAD terms, 14 of 19 ETFs posted gains over the full year, while 5 posted losses. 

The best gains were in the Emerging Market equity ETF (EEM) which returned a robust 28.4% in CAD terms. The Japanese Equity ETF (EWJ) was second best, returning 16.9%, followed closely by the Eurozone equity ETF (FEZ), which returned 16.8%. The S&P500 ETF (SPY) returned 13.9% in CAD terms, while the Canadian equity ETF (XIU) returned 9.6%. 

The worst performers were the US Inflation-linked government bond ETF (TIP),  which returned -3.7% in CAD terms. Other losers were the Long-term (10-20yr) US Treasury Bond (TLH), the US High-Yield Bond (HYG) and the US Investment Grade Corporate Bond (LQD). The losses on these bond ETFs occurred in the period of the Great Unwind.

Global ETF Portfolio Performance for 2016

In 2017, the global ETF portfolios tracked in this blog posted solid returns in CAD terms when USD currency exposure was left unhedged and even stronger returns when USD exposure was hedged. In a November 2014 post we explained why we prefer to leave USD currency exposure unhedged in our ETF portfolios.

A simple Canada only 60% equity/40% Bond Portfolio returned 7.0%, as mentioned at the top of this post. Among the global ETF portfolios that we track, the Global 60% Equity/40% Bond ETF Portfolio (including both Canadian and global equity and bond ETFs) returned 10.4% in CAD terms when USD exposure was left unhedged, and 13.4% if the USD exposure was hedged. A less volatile portfolio for cautious investors, the Global 45/25/30, comprised of 45% global equities, 25% government and corporate bonds and 30% cash, gained 8.2% if unhedged, and 11.4% if USD hedged.

Risk balanced portfolios underperformed in 2017 if left unhedged, but performed well if USD exposure was hedged. A Global Levered Risk Balanced (RB) Portfolio, which uses leverage to balance the expected risk contribution from the Global Market ETFs, gained a 5.3% in CAD terms if USD-unhedged, but had a strong return of 13.6% if USD-hedged. An Unlevered Global Risk Balanced (RB) Portfolio, which has less exposure to government bonds, inflation-linked bonds and commodities but more exposure to corporate credit, returned 5.8% if USD-unhedged, but 11.0% if USD-hedged.

Four Key Events of 2017

In my view, there were four key policy developments that left a mark on Canadian portfolio returns in 2017. The first was the Bank of Canada's poorly telegraphed decision to raise the policy rate. The second was the loosely coordinated move by central banks in June to signal an unwinding of monetary stimulus (at different speeds), which contributed to divergences in relative equity and bond market performances across the major regions. The third was the US Congress' inability to repeal ObamaCare followed by its surprising success in passing sweeping, business-friendly tax reforms in December. The fourth was the Trump Administration's decision to focus its trade policy attention on its NAFTA grievances rather than its complaints about its unbalanced trade with China and other countries. Geopolitical stress associated with North Korea's defiant pursuit of nuclear weapons capable of striking the mainland US also played a role. The impact of these developments can be seen in the chart below which tracks weekly portfolio returns over the course of 2017. 

After stumbling through Trump's inauguration, portfolio returns were strong into early June. Then "The Great Unwind" began, as within short order the ECB, BoC, Fed and BoE one after another announced less dovish/more hawkish forward guidance and policy rate actions. ECB President Draghi mused about reducing bond purchases. The Bank of Canada, which had talked of the possibility of cutting rates in January, did a quick U-turn and signalled an early rate hike which came in July. In a well-telegraphed move, the Fed raised the Fed Funds target on June 14 and discussed plans to reduce its balance sheet. After cutting rates following the 2016 Brexit vote, BoE Governor Carney signalled the need to raise rates despite the ongoing uncertainty around the Brexit negotiations. The net result of the central banks' Great Unwind guidance was to push up bond yields and push down the US dollar.

The impact on portfolio returns is clearly shown in the above chart. All portfolios suffered from early June through Labour Day. The Canadian dollar surged as much as 10% and bond ETFs faltered. This hit the global risk balanced portfolios hard, with the Leveraged RB portfolio taking the biggest hit. By Labour Day, with North Korean tensions at their peak, with the US Congress' failure to repeal ObamaCare, and with dim prospects for meaningful tax reform, year-to-date returns for Canadian investors in Global ETF portfolios had shrunk from the 6 to 8% range in early June to the +2% to -2% range. 

The final four months of 2017 saw the losses recouped. Trump cut a deal with Democrats to avoid a government shutdown. US-North Korean tensions peaked without further escalation. Global growth continued to surprise on the upside, but inflation failed to accelerate. ECB and BoJ asset purchases continued apace. US tax reform negotiations gained momentum and, though messy as usual, culminated with the passage of the most sweeping tax overhaul since Ronald Reagan.

Meanwhile, after two rate hikes in July and September, the Bank of Canada adopted a more cautious stance. With the economy slowing and NAFTA negotiations going nowhere, the Canadian dollar weakened a bit in 4Q17. The result was a strong recovery in global ETF portfolio returns led by US, Japanese and Emerging Market equities.

Looking Ahead 

As we enter 2018, the interesting question is whether "The Great Unwind" of unconventional monetary policy will proceed and possibly pick up pace. The results of 2017 suggest that in periods when withdrawal of central bank stimulus accelerates, bond yields tend to rise and currency moves tend to reflect how aggressively central banks change their guidance.

With the most optimistic consensus outlook on global growth in years, it is ironic that the best hope for strong Global ETF portfolio performance for Canadian investors in 2018 would be for Canadian growth and inflation to underperform expectations, thereby allowing the Bank of Canada to withdraw monetary ease more slowly than other major central banks.