Knowledge Centre

During the first quarter of the year, investor optimism has been freckled with plenty of worries. Still, the world’s financial markets have been buoyant. While a bullish mood can be a self-fulfilling prophecy and lead to continuing gains, the opposite is just as true. Certainly there are numerous harbingers of fear to dampen the hearts of investors and ultimately inflict pain on the easily swayed. Fear mongering has become an art form with no expiry date. But astute investors focus on their long term goals and ignore the short term hype.

The Canadian economy kicked off the year with stronger than expected growth. It is expected that monetary policy will continue to remain very accommodative as the Bank of Canada remains extremely careful about reducing liquidity and impairing future prospects. As the Canadian dollar has been remarkably resilient, inflation remains very weak and retail and manufacturing sales are buoyant. Still the impressive beginning to Canada’s 150th birthday should be taken in stride as risks to the economy remain. Consider that while promising data over the past three years turned out to be mirages, so could this year’s start.

The U.S. continues to be incredibly consistent, with moderate and steady economic growth. Unemployment is less than 5%, down from 10% in 2009 and inflation is on target. Corporate profits are rising again after stumbling due to the decline in oil prices. The possible future stimulus from the new administration, as it attempts to lower taxes and boost public spending, could act as the ideal inducement to further accelerate a rebound in corporate profits and drive the economy to renewed heights.

The global economy is in the midst of a synchronized rebound as greater optimism about the sustainability of this recovery has provided a meaningful boost. Factories across Europe and Asia posted solid growth, rising to almost a five year high. Japan’s economy has continued its moderate recovery trend. Emerging market growth has accelerated to its fastest pace in six months. The prospects of higher short term interest rates remain a long way off and investor confidence has jumped to its highest level since the global financial crisis. The biggest uncertainties that could throw the rebound into disarray are political developments and U.S. trade protectionism.

The current bull market is still going strong after eight years and volatility is nowhere to be found. With corporate profits expanding rapidly, especially in Europe after seven years of stagnation, the future remains promising. Emerging Markets led the way with the best returns in the quarter at 10.5% (all figures in Canadian dollar terms). International stocks, paced by Asia thrived as well, up 6.4%. U.S. stocks were close behind, gaining 5.3%. Unfortunately, Canadian stocks were amongst the laggards only climbing 2.4%; although it was the TSX’s fifth straight quarterly advance and longest streak of gains since 2007. Even bonds got into the act gaining 1.2%.

While the second longest bull market in history has been very rewarding, the fact that it is long in the tooth has grabbed the attention of the skittish who need very little motivation to jump ship. However there is very little evidence that the markets are running out of steam or that a topping out process has even begun. In fact it is just the opposite. While it is always good to be cautious, it is prudent to remember that the finale to a bull market is usually more drawn out, marked by a rounding type top versus a sharp reversal. As always, time will tell.

Since the collapse of energy and commodity prices, which was followed by Brexit and Trumpism, there have been plenty of reasons for jittery investors to be cautious but those who stayed invested globally did well as world markets have proven once again to be resilient to the string of uncertain events. However Canadian investors were less rewarded with a weaker 2.4% total return over the quarter versus the world benchmark return of more than 5.5%. The Canadian economy kicked off the year with a stronger than expected 0.6% GDP growth in January, which was double the average estimate. The jobs numbers beat expectations in January and February and the unemployment rates as of February dropped to 6.6%, the lowest level in more than two years.

The great start for the economy in the first quarter is a sign that it has moved beyond the oil crisis that began over two years ago. Gross domestic product grew primarily because of expansion in goods and services industries. Retail, wholesale and manufacturing sales were stronger than expected as was international trade and job creation. In fact, the Organization for Economic Co-operation and Development has increased its outlook for the Canadian economy this year. Despite this outlook, as is generally the case, there are concerns for growth. This time the focus is about the overheated housing market and the uncertainty of potentially new protectionist policies by our largest trade partner.

With the faded performance of Canadian markets in Q1 due to energy prices, which appear to show no sign of stabilization in sight, sectors such as Financials and Materials are expected to take leadership on the back of a stronger economy. The biggest risk to the economy and markets remains the potential for increased protectionism south of the border which will constitute a serious impediment to some highly U.S. dependent industries. However Prime Minister Trudeau’s diplomatic efforts to reach out to the U.S. and outline the mutual benefit of our close relationship will hopefully minimize any serious damage to the economy.

During the first quarter of 2017 the Canadian FTSE TMX Universe Bond Index gained 1.24% and the Bank of Canada’s target for the overnight rate remained unchanged at 1/2 of one percent, which is where it has been since July of 2015. In the U.S. the Federal reserve increased its benchmark interest rate in December and again in March. Each of the two increases was for a 1/4 point and marked rising confidence that the U.S. economy is poised for more growth.

A majority of economists polled by Reuters expect the Bank of Canada will wait until 2018 before raising rates. Uncertainty about the potential increase in trade protectionism by the Trump administration presents a downside risk to growth going forward and reason to keep Canada’s interest rate policy very accommodative.

Corporate bonds were among the best performers in the Canadian fixed income market. Steady spread compression since February 2016 drove outperformance in investment grade Corporates versus Provincials and Canada bonds. Over the course of 2016 Corporates returned 3.7%, Provincials were up 1.8% and Canada bonds lost 0.3%. The trend continued into the first quarter of 2017 with Corporates returning 1.8% versus 1.4% for Provincials and 0.6% for Canadas.

The U.S. Federal Reserve raised its benchmark rate in mid-March for the second time in three months, so it is now in a range of between 3/4 of one percent and 1%. The Fed is closing the chapter on its nine year old economic stimulus campaign which was launched as a response to the financial crisis. The Fed’s chairwoman, Janet L. Yellen, suggested that the Fed would have plenty of time to adjust its plans should President Trump and Congress cut taxes or spend massively on infrastructure. She does not share the focus of stock market investors and some business executives solely on the improving economic outlook. The Fed, which had made eliminating the risk of deflation a central objective in response to the financial crisis, said that it was now focused on stabilizing inflation. Ms. Yellen noted that inflation has risen a bit above 2%, just as it has been below 2% over the last few years. “It’s a reminder 2% is not a ceiling on inflation,” she said. “It’s a target.”

he Standard & Poor’s 500 index climbed 6.1% in U.S. dollar terms and 5.3% Canadian dollar terms over the first quarter of 2017. In March, the U.S. bull market celebrated its eighth birthday and while it has been a long run, the longest post war bull market lasted for nearly 10 years until March 2000. Not including dividends, the S&P 500 index has risen 250% between the closing low on the 9th of March 2009 to the end of the first quarter of this year. To put that rise in perspective, during the financial crisis the index fell 57% from the closing high on the 9th of October 2007 through to the closing low.

The main source of concern for the U.S. equity market had been the potential for dramatic shifts in policy under President Trump’s new administration. The long term negative implications of an economy achieving the President’s growth targets are a stronger U.S. dollar and higher government borrowing costs. A strong dollar could undermine the new administration’s efforts to revive export based manufacturing. The President has also promised to spur growth with corporate and personal tax cuts, as well as to use tax credits to fund infrastructure projects. These initiatives could help the economy but would increase the fiscal deficit and likely lead to increasing bond yields.

Consumers are more confident with current conditions as the Consumer Confidence Index hit 125.6, its highest level since December 2000. The glaring problem is that the Trump bump has not been as pronounced on the economy as many were hoping. It’s not that the economy is stalling, far from it, but the growth in the first few months of the Trump administration is looking much the same as it did under President Obama. Economists are only expecting first quarter GDP growth to come in at around 1% on an annualized basis, which is less than half the pace in the second half of 2016, and a long ways from the President’s 4% target.

U.S. industrial companies are facing challenges at home and overseas as demand in many sectors is only growing modestly, if at all. Employers are adapting by using more technology but that requires employees with a high level of competence in computers and math. There is growing evidence that finding workers with the technical skills employers need is getting more and more difficult as the economy reaches full employment. Nevertheless the U.S. economy is expected to expand by about 2% in 2017, which is in line with the rate of recovery during the previous administration.

The steadfast recovery that is underway in the global economy is at risk from economic nationalism and diverging central bank policies. With economic nationalism being a very big wildcard (one that has not yet been translated into actual policy), it still hangs over the head of financial markets. However, all things being equal, relaxed monetary policy and some fiscal policy easing should continue to allow for steady growth this year and next. Markets, to a certain degree, are becoming disconnected from economic reality as consumer spending and business investment remains weak.

Businesses across Europe spent the first quarter ramping up activity to the fastest pace in five years to meet increasing demand. This has led to broad based strengthening such that the economy finally appears to be firing on all cylinders. After years of unprecedented stimulus, the seemingly never-ending stagnation could be now giving way to a new period of prosperity. Of course, now that things are just starting to look up certain segments of the marketplace are calling for an end to easy money and tougher fiscal measures. Thankfully the European Central Bank has pledged to extend its bond buying program and negative interest rate policies for the foreseeable future. Conversely the U.K. economy, which finished 2016 strongly, may have reached a high watermark as uncertainty clouds the future due to Brexit.

Activity in China’s manufacturing sector expanded during the first quarter. Still the Chinese economy, the world’s second largest, expanded by 6.7% last year which was its weakest showing since 1990. In fact, the future target for growth has once again been reduced to around 6.5%. Growth is slowing due to many salient challenges facing China and could spill into the growth prospects for other Asian economies. However the government appears to be comfortable with the country’s trajectory as they have repeatedly said that they will maintain a neutral monetary policy this year and work to grow the economy through domestically focused initiatives.

Increased capital expenditures in Japan’s private sector buoyed the country’s economic growth in 2016, although growth still remains far behind its potential. On a perversely positive note the government’s extraordinary fiscal and monetary measures have finally been successful in causing an uptick in inflation. Unfortunately private consumption growth is non-existent which is reflected in the stock market’s 0.3% gain in the quarter.

Investors have been piling into Emerging Markets as they are drawn to the improving global economy and attractive valuations. The Emerging Markets stock index rose to a world beating 11.2% gain in the first quarter (all figures in U.S. dollar terms) led by rallies in China, Korea and India, its best showing in nearly two years. International stocks as a whole rose 7.4% as all sectors outside of commodities were in positive territory. Asian stocks climbed 8.1% and European stocks lagged with gains of 6.7%.

Global equity valuations do not appear to be overly stretched, especially since 2017 should see healthy earnings growth for all major markets. This upturn in earnings is the first since 2010 and is very much welcomed. Much of the future optimism for international stocks stems from this heightened earnings outlook as global growth continues to gain traction.