2016 Market Volatility – and maybe beyond?

2016 started much the way 2015 ended, with fear-induced volatility high. Oil prices were searching for a bottom and equities followed suit as investors’ appetite for risk-on assets faltered further still.

While many potential worries overhung the markets, the most prescient one to resurface early was the slowing growth picture in China. With a stubbornly fragile global recovery, a hard landing for the Chinese economy could tip the scales towards a full scale recession. Canadian equities fell over 7 per cent by mid-February, and the previously resilient U.S. market was headed toward bear market territory, as investor sentiment soured. It was a rough time.

In markets sentiment can shift even though nothing major changes. Scepticism over China’s economic future hasn’t really gone away, just out of focus. The uncertainty surrounding many other key economic drivers such as the price of oil and interest rates all add to the mix. Even though the landscape is little changed, economic optimism returned and markets recovered. Compressed interest rates surely play a leading role as investors’ appetite for riskier assets seemed to return in full force. The surprise United Kingdom referendum result (aka “Brexit”) saw market confidence re-tested in late June. Would the U.K. economy tip into a recession? Could the Eurozone withstand such uncertainty on top of its other woes? After remarkably few days, though, these concerns were mostly swept aside. North American markets –TSX and S&P 500 – both regained their pre-Brexit levels by month’s end.

Stock valuations push higher daily, despite future risks to global growth and corporate profitability. On the flip side markets are easily alarmed and overly sensitive to short-term noise. Given this pattern it is easy to see why one would expect to see further volatility in the financial markets. Times like these are when long term investors should have an edge as patience can be an investor’s greatest advantage over the market. And yes, successfully investing is boring.

As always, we thank you for your support and continued confidence in WDS.

Equities:

2015 was a lost year for the Canadian market as it acted more like a proxy for oil than a gauge of the broader economic landscape. Once recovered from early year jitters, the S&P/TSX Composite Index ($TSX) ended the first half of 2016 among the top performing developed markets up 8.1 per cent. Include dividends in the mix (total return) and the TSX delivered 9.8 per cent. The stabilization of oil prices was, of course, a key factor in the Canadian market’s recovery; as the energy sector gained 19.3 per cent (total return). Another dynamic at work, though, is investors’ relentless search for reliable income. Without real alternatives in fixed income securities, money shifts to the equity side of the balance sheet to deliver that yield. Utilities and telecom stocks were the main beneficiaries of this pursuit with 17.3 per cent and 14.8 per cent gains on a year-to-date basis (including dividends).

While 2015 was not stellar for the U.S. market, it presented a bright spot relative to Canada’s and many other countries’ markets. Not immune to the correction in the first two months of 2016, the S&P 500 Index ($SPX) ended positive in domestic terms. The S&P switched places with her northern neighbour at 3.8 per cent (U$) total return for the first six months of 2016. But that trailing return was compounded by our dollar’s rebound leaving U.S. equities at negative 4.0 per cent in Canadian-dollar terms.

June will be known as the month where “Brexit” turned from a fear to a reality. The future of the European Union is more uncertain; the risks in China may be temporarily out of the spotlight but remain. Little wonder then that the broader global picture, captured by the MSCI EAFE Index ($MSEAFE), was down 4.0 per cent (U$) so far this year.

Fixed income and interest rates:

The Bank of Canada benchmark interest rate remains steady at 0.5 per cent. Concern over the far-reaching effects of low oil prices has yet to dissipate, and the desired bump in exports has not materialized, meaningfully. Remarkably interest rates declined further across the yield curve with the 2-year and 10-year Government of Canada benchmark bonds at 0.55 per cent and 1.13 per cent, respectively. Funny enough, North America has become a “high yield” zone compared to negative interest rates in effect in the Eurozone, Denmark, Sweden, Switzerland and Japan.

Uncertainty-driven investor demand ensured fixed income returns remain positive to date as the FTSE TMX Canada Universe Bond Composite Index finished up 4.05 per cent. Going longer on the yield curve added extra return as the Long Composite Index closed out June at 8.26 per cent.

Currencies:

With oil prices recovering, after a bottom in February, it is no surprise that the Canadian dollar finished the first half of 2016 stronger than it had started, with each loonie able to fetch $0.77 versus the U.S. dollar. Despite this 7 per cent uptick, the loonie may have limited upside without further strength in oil and commodity prices.

While the low Canadian currency is unpopular with snowbirds and cross border shoppers, hopes ran high that it would bolster exports and drive growth in our manufacturing sectors. The most recent data available shows Canada with a larger than expected trade deficit of $3.28 billion in May, indicating that the devaluation has had no material impact. Fortunately, hope is not lost. The disruptions from the Alberta wildfire are expected to diminish in the second half of the year. With a low loonie and continued strong U.S. demand – the latter part of 2017 could see Canada’s export picture begin to improve.

Commodities:

West Texas Intermediate (WTI) light crude oil, which opened the year at US$37.07 per barrel, continued its slide early in 2016 prompting speculation for oil to reach as low as US$18 per barrel. Although not quite hitting that bottom, oil broke down to US$28 per barrel range in January, and again in February, before the price started to stabilize. By the end of June WTI closed out at US$48.40 per barrel, up 30 per cent. Even with steady demand, there’s plenty of inventory and production ready to come back online. This leaves the price of oil in the $50 per barrel range for now, unless of course an extreme event leads to a supply disruption.

Out-of-favour gold closed 2015 at US$1,060 an ounce. In quick response to renewed uncertainty and fear in global markets in 2016 – this safe haven asset shot up early in the year (over 17 per cent by mid-February). While the majority of the upside was concentrated in those first two months, gold continued to rally strength as it closed out June at US$1,324 per ounce. Commodities, in general, retraced lost ground from 2015 as the Dow Jones Commodity Index ended the first half of 2016 gaining nearly 11 per cent. This was led by stabilizing silver, zinc, and platinum prices.

This report is provided for your information. Conclusions and opinions given do not guarantee future events or performance. Facts and data provided are from sources we believe to be reliable, but we cannot guarantee they are complete or accurate. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any securities. Before making an investment or adopting an investment strategy, each investor should review his investment objectives with their investment advisor. Watson Di Primio Steel (WDS) Investment Management Ltd. and individuals and companies who are related may, at any time, buy or sell securities that are hereby described in this report.