June 30, 2019

2019 Second quarter update

Record highs...

It’s always surprising to see how fast the winds can shift when it comes to the economy. Looking back, you may recall that as recently as last December having patience and sticking to the game plan were the two most powerful drivers of growth for investment portfolios. The recent surge in stock market indexes confirms this. Many investors were tempted to throw in the towel during December’s retreat but today’s mid-year results prove that that would have been a mistake.

May was a challenging month, but soon after we saw the markets rebound and rally across all asset classes. The rebound stems on the one hand from a (hopefully sustainable) warming of China-U.S. relations, and on the other hand from a dovish U.S. Federal Reserve. The tone from the world’s most powerful financial institution was restrictive until only 9 months ago; it has since changed dramatically. After hinting at monetary tightening, the Fed is now talking about easing conditions, presumably to hedge against a possible downturn in global growth.

With signs pointing to a slowdown, central banks are lowering rates and stock markets are reacting favourably, posting all-time highs. Oil is up 27.4% over six months ago, gold is at a five-year high and interest rates have fallen across the curve, with the Canadian and U.S. 10-year benchmarks dropping 49 and 69 basis points, respectively. A solid showing among all asset classes boosted performance across different investor profiles, exceeding expectations.

Ironically, the financial and economic factors that triggered the 2018 year-end drop, and pushed investors away, are still in place. But the comeback has been bumpy.

What’s the key takeaway?

Keep in mind the surprise rebound from December’s low suffered a setback in May. Global economic worries cast a shadow over the current cycle, leading investors to cash in their stocks and seek refuge in government bonds. Leading the way, the sharp decline in emerging markets (-7.23%), China (-7.12%), S&P 500 (-6.35%) and MSCI World (-5.69%). The TSX meanwhile was down 3.06%. The plunge in interest rates is one of this year’s biggest shockers. Since January, Canada's 10-year rates have declined by 48 bps, from 1.97% to 1.49%. Two-year rates followed suit, slipping from 1.86% to 1.43%. The gap between the ten and two-year rates has gone from 11 bps to 6 bps. In the same period, U.S. 10-year rates shed 56 bps, from 2.69% to 2.13%. Two-year rates then dropped from 2.49% to 1.92%. The gap between the ten and the two remained stable at 20 bps, indicating an ongoing appetite for safer assets.
With less than 18 months before the next U.S. election, we expect to see periods of volatility moving forward. The current occupant of the White House will likely keep us on the edge of our seats as we watch the never-ending “2019 Trade War” show. Still, we believe a recession in the coming 12-18 months is unlikely. While a recent poll suggests economists fear clashes between China and the U.S. could trigger a recession, we expect a rapprochement by the time voters go to the polls. It’s hard to imagine a president being re-elected after plunging his economy into recession.

Our current position…

We remain committed to our May 2018 strategy, based on active management and a conservative stance while promoting growth. As record highs continue to be broken, we remain cautious with our asset mix, adding positions that will further diversify our portfolios. We held a day of meetings with various alternative investment providers with that goal in mind.

Why the new assets? First, because alternative investments represent an asset class with very different risk/profitability profiles compared to traditional vehicles.

Furthermore, they aren’t as tightly linked to the stock market but provide regular revenue streams. We intend to follow through on this strategy in the coming quarter.

Did you know…

Canada and New Zealand are the economies most vulnerable to a housing bubble burst. Bloomberg reports that in both these countries the cost of a home remains highest relative to household income. If you look at the three other metrics shown below, Canada’s situation is sobering. All levels of governments have taken steps recently to cool the overheated sector. But the recent flip-flop by central banks, and the idea that rising rates may be coming to an end, could add more fuel to a bubble that’s about to burst. We’re following the situation closely.

Summer’s here! We hope you enjoy the warm sunny days in the company of family and friends. We’ll be taking time off too, but you can always count on someone from our team to be available any time you have questions.