When you reach the end of your rope, tie a knot in it and hang on.”

– Franklin D. Roosevelt

Momentum Wavers as Tensions Rise

The long running bull stumbled in 2018 – while January continued 2017’s momentum, February saw a 10% drop in major indices over the course of but a few days. Theorized triggers for the correction range from the announcement of higher average wages to the subtle change in the Federal Reserve’s stance on interest rate hikes. Regardless of the cause, investor confidence took a hit, and while markets recovered, bullish forecasts now face headwinds from spreading protectionism. America’s trade spat with China expanded to a multi-front tariff offensive against Canada and the EU, threatening the positive economic developments seen in North America.

In the U.S., GDP output pushed past its potential level for the first time since 2007. While this is typically consistent with a late economic cycle, consumer confidence remains high, supported by Trump’s tax cuts, still-low interest rates, and a strong labour market that reached its lowest working age unemployment level ever this year.

Things aren’t so bad here either. Canada saw a narrowed trade balance, wage growth, and a solid unemployment rate of 5.8 per cent this year. While tariffs on steel and aluminum will surely hurt a number of industries moving forward, only 0.3 per cent of the country’s gross production is expected to be lost as a result. The prospect of further tariffs is, however, keeping investors on their toes, and with Trump claiming he won’t sign a trade deal until after the November midterm elections, it may be a while before we see an end to the discord.

As 2018 has demonstrated thus far, economic and market performance can deviate when investors fear for the future of their holdings. While risks are certainly present, we must remind ourselves that it is during times like these that disciplined investors can truly separate themselves from the pack. By focusing on sustainable, high-quality businesses, we can reduce the impact of short-term volatility while securing long-term returns.

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

Equities

The Canadian stock market had a rough start to the year, falling steeply in January and February. While the S&P/TSX Composite Index ($TSX) did recover, it ended the six months up a meagre 0.4 per cent; total return (dividends included) was a slim 1.9 per cent. The slow aggregate performance came from a mix bag of sector performance – while information technology achieved an impressive 22.3 per cent (total return) over the six months, rate hike expectations weighed on high-yielding sectors such as utilities and telecommunications, which fell 6.2 per cent and 5.0 per cent, respectively. Energy caught a bit of a break, however, recovering 4.8 per cent on the back of rising oil prices.

Performance south of the border was mediocre in U.S. dollar terms. While it reached its highest level yet in January, the S&P 500 Index ($SPX) ended the first half of 2018 up only 2.6 per cent (total return), compared to the 9.5 per cent it earned over the same period last year. Taking into account the appreciation of the U.S. dollar, however, pushes the S&P500’s total return to 7.2 per cent in Canadian dollar terms.

The Eurozone also saw a sluggish start to the year, with France and Germany both experiencing a slowdown in economic growth. Slowing trade flows are partly to blame – with 48 per cent of the area’s GDP relying on trade (compared to just 12 per cent of America’s GDP), souring trade relations have taken their toll. This has also garnered a negative reaction from investors, with global markets, as proxied by the MSCI EAFE Index ($MSEAFE) down 2.4 per cent on a total return basis so far this year, with concentrated weakness in Asia.

Fixed income and interest rates

Oil prices have seen strong momentum this year, continuing their recovery from the second half of 2017. Canada’s merchandise trade gap narrowed to $1.90B in April 2018 on the back of falling imports and growing exports, though soured trade relations have yet to fully reflect in collected data. The Bank of Canada followed expectations and increased its policy rate by 0.25 basis points in January, pushing the domestic yield curve upward; the 2-year and 10-year Government of Canada benchmark bonds both moved higher to 1.91 per cent and 2.17 per cent, respectively. While more policy rate hikes are expected, the economic uncertainty poised by Trump’s tariff offensive may slow down monetary tightening.

Despite these recent economic challenges, the bond market is reflecting an expectation for rates to continue their climb. The FTSE TMX Canada Universe Bond Composite Index finished the first half of 2018 up a mere 0.6 per cent, a dampened return reflecting the negative correlation between interest rates and bond prices.

The U.S. Federal Reserve had two rate hikes so far this year, bringing the federal funds upper bound target rate to 2.00 per cent. With inflation pushing past its 2.00 per cent target, the Fed has hinted at more rate hikes to come this year. The U.S. yield curve has shifted upward accordingly, with the 2-year and 10-year U.S. benchmark bonds both increasing to 2.53 per cent and 2.85 per cent, respectively.

Currencies

The Canadian dollar ($CDW) lost a bit of its growth against the U.S. greenback, ending the first half of 2018 at $0.76 USD/CAD, down 4.2 per cent from the start of the year. While the strong recovery of oil prices and the interest rate hike in January certainly supported the loonie, the threat of tariffs has increased the downside risk of investments in Canada while simultaneously strengthening the greenback, with some investors exchanging their foreign currency for U.S. dollars to help offset the risk of American protectionism.

Almost ironically, a weaker Canadian dollar should support demand for Canada’s exports, making them “cheaper” to buy for foreign consumers (ignoring tariffs, that is). This seems to be reflecting in the country’s merchandise trade gap, which narrowed from $3.93B in March to just $1.90B in April. Data has yet to cover the full extent of soured trade relations, however – with the U.S. making up over 75 per cent of our export demand, we can expect lowered exports should tariffs persist.

Commodities

West Texas Intermediate ($WTIC) light crude oil continued its recovery into 2018, partly the result of re-imposed sanctions on Iran and the continued perils of Venezuela. The price per barrel increased 22.7 per cent from 2017 to $74.15, the highest closing price seen by the commodity since 2014. OPEC announced in June that it would increase oil production as a result.

Despite rising geopolitical tensions, growing investment downside risk and sluggish growth, gold’s price ($GOLD) ended the first half of 2018 down year-to-date. Gold is considered a “safe haven” investment, something investors tend to buy in the presence of investment uncertainty, yet despite fluctuating above $1,300.00 throughout most of the year, the commodity fell in June to $1251.13 per ounce.

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.