Where Canadian interest rates, China, and fintech are headed
While there’s no surefire way to make economic predictions, peering into the mind of Sébastien McMahon might be the next best thing.
In his position as senior portfolio manager, diversified funds and economist at Industrial Alliance Financial Group, Sébastien has written numerous articles on economic issues affecting Canadians. So we asked him to provide some insights on where he thinks the economy is headed in the next five to 10 years with respect to recession risks, interest rates, and investing trends. Here’s what he had to say.
1. What compelled you to pursue a career in economics, and how do you see this profession evolving in the digital age?
Growing up, I always sought a deeper understanding of the world. I wanted to know why humans behave as they do and how society, as whole, manages to work cohesively when it’s often hard to cooperate – even with your loved ones! Economics kind of crept up on me, as I saw it as a field where I could at least understand the way the world works a little better. The heavy use of mathematics also became very important to me, because of the math geek that I am.
In my opinion, the field of economics, like other social sciences, is undergoing a very profound and positive transformation with the advent of “big data.” Social sciences aim to explain the behaviour of human beings, which is one of the most complex things to narrow down in the known universe. I always joke with my friends working in so-called “hard” sciences that while water boils at 100 degrees Celsius, not every human being will react the same under a set of circumstances. Economics did its best in previous centuries to build models and theories which can help us understand how the masses are behaving, and we finally have the data to test these hypotheses at the micro level. Important new discoveries are being made, and for us financial economists, a better understanding of human behaviour helps us be better investors.
2. What recent developments have been the most influential in shaping your current perspective on the economy?
No question, the rise of populism, which led to the election of a president like Donald Trump in the U.S. and the trade tensions that came with it.
The recent history of economic growth is actually quite simple. In the last 70 years, growth came from three sources: first, a booming demography, second, the rise of important new technologies that tremendously changed our daily lives and how goods are produced and transported, and third, globalization.
The first two engines of growth are now contributing less and less, as demographic growth in the developed world is slowing to a crawl and the low-hanging fruit that dramatically raised our productivity has been reaped.
Globalization, meaning the specialization of the production of goods and services and a deep reliance on trade, has now started to move in reverse. Globalization led to stronger growth, yes, but also to a rise in inequalities and unethical production, which in turn led to populism rising in the developed world.
As a human first, and economist second, I completely understand the root of populism and how everyone needs to benefit from growth. But I am worried about populism leading to nationalism, and the old wounds that are resurfacing (the relationship between Japan and Korea particularly comes to mind) worries me. The economic consequences could become deeper and deeper if collaboration between nations turns to conflict, if trust is deeply damaged and, consequently, this third former engine becomes a headwind to growth.
3. What are the recession risks for Canada, the U.S. and Europe in the near future? What would a new recession look like?
A recession in the near future is not our base case, but the risks are rising. We do expect Germany to soon confirm being in a technical recession, with output contracting in both Q2 and Q3.
It’s always risky to say this, but I still don’t feel that some sort of profound financial imbalance, which could lead to a repeat of 2008, is building right now. We are now in a slower growth world, meaning that the boom-bust pattern we saw in decades past is not how the current world operates. This means risks of seeing the economy overheating, leading to a deep contraction, are pretty low. I expect the next recession to be a soft one (if there is such a thing), and not one that will leave a trace in the history books like the previous one.
4. What role do you see China playing in the global economy over the next decade, regardless of how the trade war with the U.S. plays out?
Over the next ten years, China will become the world’s largest economy. This means that, like it or not, it will take over global leadership. I expect China to slowly bring about a different world order, with a different vision than what us westerners are used to. China operates a controlled economy, with less emphasis on the short- term.
Expect China to take a more pronounced leadership role on geopolitical issues, and try to extend the influence it already has over Asia to the rest of the world.
5. How much could the central banks lower interest rates, and what would it look like if rates went too low or started climbing too quickly?
Hard to tell where the bottom is, but it looks like a consensus is building about a “reversal rate,” meaning a rate below which harm would be done to the economy, being somewhere not too far below current levels. So it’s becoming more and more accepted that central banks might be relatively out of ammunition at these levels.
If interest rates started to rise in a disordered way, the impact on markets would probably be negative, as it would hurt investor psychology. Investors would have to review their valuation models for every asset class, including equities, and the risk premium could become overwhelming. So a rise to more sustainable levels could be a good thing, but it needs to happen in an ordered fashion.
6. Which top investment trends do you think will shape global markets in the next decade?
The rise of ETFs and other passive vehicles is here to stay. This means that only managers that can offer sustainable outperformance will last.
Our job as managers is to make the best asset allocation decisions and implement them in the most efficient, cost effective ways. So don’t be surprised if you see managers like us using more and more derivatives in our funds.
7. We hear a lot about Trump affecting the economy. To what extent do politicians really influence what happens in the markets?
Trumpism is creating uncertainty. When uncertainty is rising, entrepreneurs become less willing to invest and hire, leading to real damage being done over time to the economy. As investors, you’re always probably five minutes away from a market- moving tweet, so you have to be doubly careful about the trades you put in place.
8. To what extent does the U.S. economy affect Canadian markets?
A lot! The U.S. is still Canada’s most important trading partner, and it’s true that when the U.S. sneezes, Canada catches a cold. The Canadian stock market is still heavily weighted in energy and financials, two sectors that are sensitive to the state of the global economic cycle. The S&P/TSX is a very risk-on/risk-off index, and the strength of the U.S. economy is even more important than Canadian data.
9. Where is energy investing headed, and what are your views on oil?
With the importance set on ESG, the sector might be under-owned structurally. Especially Canadian oil sands, which are perceived as being dirtier than other global producers.
With the rise of shale oil production, the oil market is more likely to be oversupplied than undersupplied in years to come, meaning prices are likely to stay at or below current levels. Add to that the rise of electric cars and legitimate questions can be asked about the terminal value of an investment in the energy sector.
10. What should investors keep an eye on in the tech sector?
Many themes are driving the tech sector right now. In my opinion, there are four major ones to watch.
First, the “software is eating the world” theme is a very important one, as big players like IBM are moving towards services rather than hardware. Second, the 5G cycle should be a big driver of capex and investor interest next year. Third, fintechs are an important theme right now, as they’re slowly taking away profits from large banks. Fourth, semi conductors and the rise of the electric cars is a theme that should have legs for years to come.
Sébastien Mc Mahon is senior portfolio manager, diversified funds and economist at Industrial Alliance Financial Group. He also acts as a senior economist and is a member of the firm’s asset allocation committee. Additionally, he is a member of the board for Quebec’s association of economists and other local financial
This article was published in Leon Frazer’s Strategies newsletter, Volume 1, Issue 1. Read the full edition here.