What Canadian investors should do as the outlook darkens for global growth

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That hissing sound you hear is the air going out of the global growth story.

This week, Germany announced its economy unexpectedly contracted in the third quarter. Japan also reported its economy shrank during the July-to-September period.

Meanwhile, Britain stumbled even deeper into its self-imposed Brexit nightmare, Italy continued its budgetary stare-down with the European Union and China reported disappointing growth in retail sales as its trade spat with the United States showed no signs of easing.

On a brighter note, the United States and Canada continue to expand at a healthy clip. However, both countries face their own issues. The U.S. economy is widely expected to gear down next year as the stimulus from Washington’s tax cuts begins to fade. Canada must deal with a cooling housing market and recession-level prices for Alberta oil.

For investors, this is – cue the understatement alert – a daunting time. The core of the problem is that global growth is slowing and that the biggest challenges ahead are more political than financial. There is no reliable way to predict what will happen next.

Money managers typically rely on mean reversion – the notion that no matter how crazy markets may appear right now, they inevitably come back into line with fundamentals. However, there is no similar assurance when it comes to U.S.-China trade, the politics of oil pipelines or the euro zone’s future. This is, after all, an age dominated by Donald Trump, autocratic Chinese and Saudi leaders, shambolic Brexiters and fragile Italian political coalitions. The course of events from here will hinge on egos and national sensitivities and could easily lurch even further into chaos.

Stock markets around the world reflect the growing tension. While Canadian investors obsess over the pain close to home, the misery in recent months has been a truly international affair. In fact, stacked up against the carnage in Chinese stocks (down 20.7 per cent since the start of the year in Canadian dollar terms) or the injuries sustained by big European shares (down 9.7 per cent), the damage to Toronto’s S&P/TSX Composite (down 6.5 per cent) has been relatively minor.

Despite their recent angst, U.S. stocks have actually performed well, with a 7.2-per-cent gain since January. Still, if there is one overarching message to the year so far, it’s that reality isn’t living up to what investors had expected only a few months ago.

Charlie Bilello, director of research at Pension Partners, a New York money manager, published a table this week that showed how much stocks in each of the Group of 20 countries have fallen from their highest points in the past 52 weeks. The declines range from 7.4 per cent for the United States to 47.7 per cent for Turkey. (All returns calculated in U.S. dollars.)

Some other respected voices are also sounding dour. Simona Gambarini of Capital Economics says the S&P 500 Index of big U.S. stocks will fall by 14 per cent in 2019 “and we don’t think that equities in the euro zone will generally do much better.” Didier Saint-Georges, a managing director at European money manager Carmignac Gestion, told a Reuters investment conference this week that investors should stock up on U.S. dollars and defensive stocks.

Yet, for all the prevailing gloom, there are reasons for hope.

The single biggest reason for optimism is that stocks outside of the United States do not appear obviously overvalued. In Europe and Asia, shares are typically trading for 14 times or less estimates of next year’s earnings. In Canada, they’re only slightly more expensive. This is in line, or even a bit below, historical norms. If earnings don’t falter, stocks are a good deal.

Another positive sign is that central banks are likely to be cautious in raising rates. Policy makers don’t want to topple their economies into recession, and given the political uncertainties, they have strong motivation to take rate hikes slowly.

Capital Economics predicts the U.S. Federal Reserve, the world’s most important central bank, will stop hiking rates in mid-2019 in response to slowing growth. Similarly, the Bank of Canada is likely to temper its rate-rise resolve given the difficulties faced by the Alberta oil patch. Continued low rates would help stocks since they would keep a lid on companies' borrowing costs and ensure that stock dividends still look attractive to investors when stacked up against bond yields.

On top of that, the recent spate of downbeat economic news could go into reverse. In Japan, for instance, the third-quarter downturn was in large part the result of floods in the western part of the country and an earthquake in Hokkaido. Barring a fresh outbreak of natural disasters, growth should flicker back to life in the fourth quarter.

Similarly, Germany’s surprise economic contraction in the latest quarter – its first shrinkage since 2015 – owed a lot to German automakers’ difficulty in proving they can meet new emission standards that came into effect on Sept. 1. The enormous backlog of unsold vehicles that resulted from the regulatory shift should ease in coming months.

What should Canadian investors do? You can start by making sure you’re comfortable with the level of risk in your portfolio. If a 15-per-cent decline in the stock market over the next year would seriously damage your life, consider pruning some of your more daring bets.

Vigilance is also in order. Keep an eye on the Italian 10-year bond yield, a good measure of the political stresses in the euro zone. And watch the CSI 300 index, which tracks Chinese stocks and offers a sense of how the China-U.S. trade conflict is proceeding. Both indicators are signalling high levels of concern, but have stabilized in recent weeks. That, at least, offers hope that next year will offer better returns than this one so far.