“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”
– Peter Lynch
A dovish tone - stocks rally on central bank caution
A seeming demonstration of this issue’s quote, markets in North America hit new highs in the first half of 2019 after experiencing their worst December in 88 years. The rally comes on the back of the central banks’ decision to halt rate hikes, with the Federal Reserve signalling that it may even pivot back to rate cuts, this despite the U.S. economy adding another 224,000 jobs in June (ahead of expectations) and other positive developments. The reason? Inflation figures are falling below targets, and trade protectionism continues to be a concern, with profits from foreign operations seeing dampened growth in the U.S. since Trump’s tariffs were implemented.
Of course, the U.S.-China trade war remains the largest concern here. In May, we saw an escalation as the Trump Administration upped its tariffs on $200B worth of Chinese goods from 10 per cent to 25 per cent, with China retaliating in kind. Despite this dispute, in June the country reported that GDP growth had accelerated to 3.1 per cent (annualized) in the first quarter of the year. Trade admittedly doesn’t contribute much to the country’s GDP level, but with 44 per cent of the S&P 500’s revenue being earned over seas, there remains a lot at stake, even with the recently-struck truce between the two world powers.
Canada saw its own trade tiff with China in 2019. After the arrest of Huawei’s CFO in Vancouver (on America’s behalf, mind you), China banned all canola and meat imports from Canada, allegedly after discovering pests and additives. Canada has, however, seen its economy improve. In May, unemployment hit an all-time low of 5.4 per cent, and exports rebounded in the second quarter. Business confidence has also increased, and should the Canadian and U.S. governments join Mexico in ratifying the USMCA trade agreement, we could see investor confidence return to the North.
The first half of 2019 was an overall positive for investors, but economies continue to provide mixed signals. Yield curves in the U.S. and Canada are flat or inverted, and while trade tensions may soon simmer down, we’ve seen first hand how quickly things can escalate; in May Trump tweeted that Mexico would face tariffs if it didn’t deal with its illegal migrants in 10 days. Only time will tell how the rest of the year will unfold; for now, while we’re happy to see stocks up, we’ll continue to tread with caution.
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Canadian stocks hit new highs in April before inching downwards, with the S&P/TSX Composite Index ($TSX) ending the first half of 2019 up 14.4 per cent (16.2 per cent when taking dividends into account). This impressive return, however, is mostly the result of a low starting point following a dip in the fourth quarter of 2018; the rolling 12-month total return for the index is only 3.9 per cent. On a sector-basis, performance was strong across the board, with all but one sector, Telecommunication Services, achieving double digit positive return. Information Technology and Health Care fared particularly well, achieving remarkable total returns of 44.0 per cent and 35.2 per cent year-to-date, respectively. Unfortunately, these two sectors are among the smallest within the S&P/TSX Composite, with weights of 5 per cent and 2 per cent, respectively.
Performance was strong in the U.S. as well. In U.S. dollar terms, the S&P 500 Index ($SPX) earned a total return of 18.5 per cent, this despite a recent escalation in the U.S.-China trade war. In Canadian dollar terms, the total return came in at 13.8 per cent, reflecting the recent appreciation of the loonie.
Elsewhere in the world, stocks saw a strong return despite a weak economic backdrop. Industrial production in the eurozone seems to have contracted in the second quarter of 2019, the third time in the last four quarters, and global trade volumes fell for two consecutive quarters for the first time since the 2008 recession, coinciding with rising protectionism. The MSCI EAFE Index ($MSEAFE), however, was up 14.5 per cent on a total return basis for the first half of 2019. Countries will be holding their breath in the second half of the year when it comes time for the UK to leave the EU, with or without a deal.
Fixed Income and Interest Rates
The Bank of Canada has changed its tone on rate hikes. After a charge towards the 2.5 - 3.5 per cent range that saw three rate hikes in 2018, the central bank signalled that it will keep the policy rate at 1.75 per cent for the time being. The more cautious tone comes on the back of escalating trade tensions and still-high household debt levels, which make Canadians particularly vulnerable to further rate hikes. The flat yield curve is also likely a factor in the bank’s pause; in June the 2-year and the 10-year Government of Canada benchmark bonds both fell to 1.47 per cent. A flat yield curve is a negative indicator for the economy and presents a head wind for interest-sensitive sectors.
Given the negative relationship between prices and interest rates, bonds have seen a pick up in their return. So far into 2019, the FTSE TMX Canada Universe Bond Composite Index has risen 6.5 per cent, this compared to the 0.6 per cent over the same period last year when it was expected that rates would continue to rise into 2019.
South of the border, the Federal Reserve has actually signaled that it may be changing course completely and cutting its Federal Funds Rate in the near future should economic headwinds persist, this after its two-year rally to the 2.25 - 2.50 per cent target band. A rate cut would help normalize the U.S. yield curve, but its anticipation may have sent yields lower; the 2-year and 10-year U.S. benchmark bonds ended the first half of 2019 at yields of 1.76 per cent and 2.00 per cent, respectively.
As a result of the Federal Reserve’s more dovish tone, the Canadian dollar ($CDW) has made some gains against the greenback, appreciating 4.2 per cent and ending the first half of 2019 at $0.76 USD/CAD. A rate cut for the U.S. dollar would lower its value relative to the loonie. With the Bank of Canada seemingly slow to reverse its own upwards progress, we may see the dollar appreciate higher still, however monetary policy in the U.S. and Canada is 90 per cent correlated; the Canadian central bank may very well follow suit with our southern neighbour.
Part of the reason for keeping pace with the Federal Reserve is that a rising loonie can discourage Canadian exports, making them more expensive to foreign buyers. As of right now, this doesn’t seem to be an issue; in May, Canada experienced a trade surplus of $762 million, it’s first in almost a year, with demand for cars and auto parts from the U.S. driving (no pun intended) the surge. That being said, Canada still needs to ratify the USMCA trade agreement and faces souring relations with China, who buys roughly 4 per cent of our country’s exports.
2019 has been a roller coaster for the energy sector. The year started off with West Texas Intermediate ($WTIC) at its lowest price since 2016, but prices quickly rallied to the high 60s before an escalation in the Chinese-U.S. trade war sent them downwards to just above $50 once again. Since then the benchmark has settled closer to the $60 range, ending the first half of 2019 at $58.47, up 28.8 per cent year-to-date. OPEC has announced that it will extend production cuts until March 2020 in a bid to boost oil prices.
Gold ($GOLD) is starting to see some appreciation on the back of growing economic concerns, with the commodity ending the first half of 2019 up 10.2 per cent at $1,412.30. Investors tend to park their money in gold during periods of market volatility, and many appear to be doing so in 2019; in June the metal hit a 6-year high.
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.