Equity Markets

Equity markets behaved well in the second quarter, a nice rebound from the first quarter of the year. Canadian investors benefitted from a strong domestic market and from a weak loonie versus the US dollar, which helped US returns be more generous when translated in Canadian dollars. However, the opposite currency impact occurred for EAFE returns as the Canadian dollar strengthened versus other foreign currencies. Volatility levels have fallen from the levels experienced early in the year but remain higher than the unusually steady year we experienced in 2017.

Canadian equities bounced back strongly in the second quarter after stumbling out of the gates into the New Year. The S&P/TSX Composite began to shrug off trade war rhetoric and offered a 6.8% return for the period. Investors were more open to seizing opportunities than in the previous quarter where risk aversion was more prevalent. Certain market participants decided to further push the momentum of some new companies in the cannabis and technology areas. Others gravitated towards an inexpensive resource sector amidst rising commodity prices. Year-to-date, the index is back in positive territory with a 2.0% return. The strength was encouragingly broad with 10 of 11 sectors yielding positive returns. The Utilities sector stood alone with a mildly negative return (-0.4%). Energy, Health Care and Technology all stood out with double digit returns. Given the near 20% weight of the Energy sector, its performance was certainly the most impactful for the quarter.

The S&P 500 index rebounded from a negative start in the first quarter to return 3.4% in USD this quarter. The loonie continued to weaken, leading to a 5.5% total return in CAD terms. Despite concerns around global trade war escalation, the market has largely looked the other way. Driven by the corporate tax cut, company financial results were very strong in Q1. Overall, the market continues to look reasonably valued against the backdrop of earnings anticipated to grow 20%+ in 2018. The theme of growth stocks outperforming value stocks remains in place, as evidenced by strong performance from consumer discretionary and technology names. Energy shares caught a bid as investors began to believe that higher oil prices may not just be temporary. WTI oil finished the quarter around US$73/barrel. Interestingly, some interest rate sensitive stocks performed well (Utilities and REITs), while Telecom and Consumer Staples posted modest losses. Financials and Industrials were the biggest laggards in the quarter, posting consecutive negative quarterly results.

While volatility has remained above a level we have been accustomed to lately, the MSCI EAFE still finished the quarter in positive territory with a 0.94% return in Canadian dollars. Equities generally performed well in April, led by a rally in the Energy sector as oil price continued to trend higher on tighter supply. That being said, the volatility picked-up again in May with the anti-euro movement coming back to investors’ minds given the political uncertainty in Italy. On a regional basis, Australia (8%) was a positive outlier as, like Canada, the country benefited from the stronger resource market.

The UK (4%) also bounced this quarter after a weak Q1 as the country benefitted from the weaker sterling as the Bank of England backed away from an anticipated rate rise. Italy (-5%) was the negative outlier of all the key countries this quarter given the increased political uncertainty in the country. It is worth saying that the Canadian dollar was stronger (2% to 4%) versus all major currencies in the Index which negatively impacted returns. On a sectoral basis, most of the strength came from the resources sectors with Energy (14%) and Materials (3%) leading the index higher. Generally, the more defensive sectors performed well as the expectations of tightening monetary policies have been pushed away as economic data has shown that growth has been slowing down lately. Financials (-4%) was the worst performing sector as the flattening yield curves and the uncertainty related to Italy weighed on the sector.

Generally, we feel the equity markets have it right. We should invest with a certain level of caution as monetary conditions are being tightened. We also pay attention to global trade negotiations being conducted with the use of Twitter. Still, global economies are growing nicely with little sign of significant inflation. While we do have to endure uncertainty around politics, the conclusions have generally been business friendly thus far. On balance, we believe the environment remains positive for equities. Valuations also remain within historical ranges. We are overweight the asset class for clients and we favour cyclical sectors to the detriment of the defensive and interest sensitive sectors.

Fixed Income Markets

The price of fixed income assets has proven to be resilient as the second quarter of 2018 closed with very little change in bond prices/yields despite an improving economic backdrop. Bond yields rose in April as growth and economic data picked up, although this move proved to be temporary as yields declined steadily through May and June, driven by weaker than expected inflation and wage pressures as well as tariffs and global trade war fears taking center stage. The ripple effect of President Trump’s first round of trade tariffs and corresponding series of counter measures by various countries has brought a level of concern and uncertainty for a number of industries and will ultimately weigh on consumer and business confidence as well as investment spending. While $34 billion of goods are now under tariffs, further trade measures are not expected over the near term with the completion of mid-term elections in the US taking place this fall. Despite these trade measures, economic growth has been improving with the added measures of tax cuts and a budget deficit to help propel the US recovery. Canada continues to benefit from the global recovery and has seen a stabilization in the housing sector which should help support consumer spending and confidence. The labour markets in Canada and the US continue to improve with wages rising, which further support consumer spending. The unemployment rates in Canada and the US now stand at 6% and 4% respectively after weakening slightly in June.

Despite the overhang of trade wars on growth, 2018 forecasted GDP growth in Canada has been trimmed only slightly to 1.9% in 2018 and 1.8% in 2019 while growth in the US is expected to steam ahead after a strong recovery in Q2 with projected growth of 2.8% in 2018 and 2.5% in 2019. The output gap in Canada is closing quicker than expected and business confidence remains strong while inflation pressures remain contained at 2.2%. As a result, the Bank of Canada is expected to look through much of the current trade rhetoric and focus on the real impact of current measures and economic conditions which continue to improve. The Bank of Canada is expected to hike by 25 basis points in July to bring the overnight rate to 1.50% and then implement additional 25 basis point hikes each quarter through to mid 2019 in an effort to converge to a “neutral policy rate” which they have indicated is between 2.50-3.50%. The US Federal Reserve is expected to also continue to raise rates at a similar pace going into the second half of 2019.

The Canadian yield curve flattened slightly over the quarter as inflation came in weaker than expected and trade fears brought about concerns on growth. In the second quarter of 2018, two-year yields increased 14 basis points to 1.91% while five-year bond yields increased 10 basis points to 2.06%. During the same period, Canadian ten-year bond yields increased 8 basis points to 2.17% while the thirty-year Canada yields decreased 2 basis points to 2.20%.