Following a particularly volatile start to the year in the first quarter, many global equity markets delivered somewhat steadier returns in the second quarter. The MSCI World Index finished the period with a gain of 1.9% in U.S. dollar terms, while the S&P 500 Index, a broad measure of U.S. stocks, rose about 3.4%. Overseas results varied, with gains for equity indexes in England, France and Japan offset by losses in Germany and several Asian markets.
In Canada, the S&P/TSX Composite Index performed well, registering a broad-based advance of 6.8% for the quarter. Stronger oil prices buoyed energy shares, and the health care, information technology and financial sectors all added to performance. The Canadian benchmark has gained nearly 2% year-to-date.
The Canadian dollar, meanwhile, declined in value relative to the U.S. dollar over the quarter, enhancing returns for Canadian investors with assets priced in U.S. currency. The MSCI World Index, for example, returned 4.1% for the quarter when expressed in Canadian dollars, the S&P 500’s gain was 5.6% and the loss for the MSCI Emerging Markets Index was reduced to 5.9%.
Steady growth and firming inflation will likely lead central banks to continue rising interest rates to dial back monetary accommodation. The U.S. is the furthest along, with the U.S. Federal Reserve having raised rates seven times this cycle and is actively shrinking its balance sheet at a measured pace.
The macro environment has been dominated by the three “Ts”: Trump, Tariffs, and Trade. The U.S.-led trade war has counteracted healthy earnings and economic fundamentals, resulting in Price/Earnings multiple compression. The trade war poses mounting risks for Canada, as a breakdown in NAFTA negotiations would weigh more heavily here versus the U.S. The worst-case scenario for Canada should not be ignored as the consequences of a breakdown in trade terms is material, especially to a few key industries such as automotive.
Should protectionist behaviour intensify, we would expect the market to turn defensive. Defensive and interest sensitive equity sectors and Treasuries would likely outperform in this scenario, while cyclicals such as industrials, financials, and resource sectors would underperform. The alternate scenario where trade tensions ease would support the cyclicals sectors, and defensive sectors would likely underperform. Diversification has never been more important.
Despite early signs of a peaking cycle (remember the two 1000-point drops in the DOW in February?), the broad economic environment, base macro view and market fundamentals (earnings growth and valuation) remains moderately positive. However, we encourage patience and discipline to take advantage of opportunities and accept that longer-term return expectations are likely to be less robust.
Your portfolio is invested in high quality funds and your assets have been allocated according to a plan that takes your financial goals and risk tolerance into consideration. If you have any concerns about your account or if there have been any changes to your personal circumstances, I would be very happy to discuss them with you – please do not hesitate to contact my office.
I wish you and your family a safe and pleasant summer.
Charts of Interest
Market Returns as of June 29, 2018. Note the continued outperformance of the U.S. index (S&P 500), the underperformance of fixed-income indexes, rising bond yields, rising oil prices, and rising USD relative to CAD.
TSX rises. After being down 6% at the end of the 1st quarter, the rise in energy prices helped the TSX rally to an all-time high on June 20. The up-and-coming cannabis sector provided some strong support as the federal government passed legislation legalizing it by Fall 2018. The end of the second quarter was the strongest the TSX has experienced since the last quarter of 2013.
U.S. market flat. After a strong month in May, the U.S. stock market closed the month flat, climbing from beginning to mid-month, but then declining by month’s end as fears of possible global trade wars haunted the market
Dominance of the IT Sector. Market returns over the last few years have been primarily driven by high growth technology stocks. Returns within the Information Technology sector have been very strong compared to the other 10 sectors and the overall S&P 500 index. Over the last 3 years, the IT sector has contributed to over 41% of the S&P 500 returns in local currency and is up 135% year-to date.
Rising Bond Yields. The ascent in global bond yields that began in mid-2016 paused late in the quarter. The yield on U.S. 10-year bonds rose briefly above 3.0% for the first time in nearly five years. The forecast is still for yields over 3% in the next year. Of course, rising yields means declining bond prices. For example, let’s look at someone who bought a U.S. 10-year government bonds almost two years ago yielding 1.50%. Originally purchased at $100, that bond is now worth just over $90.
Entry Point Matters. The chart below shows the S&P 500 Index’s subsequent 10-year compound annual return resulting from different price-to-earnings (P/E) valuations. The point is to show that future returns are inversely correlated to valuations and that investing today is not as ideal compared to the bottom of the Financial Crisis in 2009.
Asset Allocation. Courtesy of RBC Global Asset Management. There continues to be a bias towards equities over fixed-income. From RBC: “Solid global growth should support higher interest rates and corporate profits. The former will act as a headwind to bond returns and the latter should support equity prices”
Sources: CI Investments, Dynamic Funds, RBC GAM, Edgepoint Funds
This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.