Equity Markets

Equity markets felt differently based on which region you were in this quarter. Certainly, the United States plays a central role in the world economy and investors felt comfortable buying more shares in its market. Investors were wary of other regions, which can in part be attributed to constant trade negotiations and frictions between the world’s largest economies. For most Canadian investors, this resulted in good returns from US equities but negative returns for Canadian and EAFE equities.

Canadian equities drifted slightly lower during this period after bouncing around more significantly in the first two quarters of the year. The S&P/TSX Composite was down 0.6% as it deals with lack of interest and concerns by foreign investors. The concerns revolve around trade discussions getting resolved and our country’s inability to bring significant projects to fruition. To our chagrin, cannabis momentum investing continued to work as we approach legalization. Aside from that, market breadth was weak with only six of eleven sectors posting gains. The gains in Health Care (+31%), Industrials (+6%) and Financials (+4%) were the most significant. Materials (-13%), Consumer Discretionary (-9%) and Energy (-6%) were difficult areas for investors this quarter.

The S&P 500 index recorded strong absolute performance during the summer quarter, returning 7.7% in USD terms. The loonie strengthened in the quarter, leading to a 5.8% total return in CAD terms. Global trade concerns rose through the quarter, with tariffs being imposed on many Chinese goods followed by some retaliatory measures. As the quarter ended, a new NAFTA deal (rebranded USMCA) was reached. This leaves US-China trade as the remaining economic wildcard for the US market. Despite this, market economic fundamentals remain solid, with strong Q2 corporate results spurring investor confidence. Interest rates continue to tick higher but have yet to put a damper on investor sentiment towards equities. We saw Apple become the first trillion-dollar listed US company, and Amazon soon followed. The mega cap tech and consumer discretionary space remains very lively and, in general, growth stocks continued to outperform value. Health care (+15%) and Industrials (+10%) performed well, along with the new Communication Services (+10%) segment, which includes Alphabet and Facebook. We have seen WTI oil remain at recent highs, but Energy equities have lagged (+1%), along with interest rate sensitive sectors (Real Estate +1%, Utilities +2%).

This was another soft quarter for EAFE equities with the index posting a -0.5% return in Canadian dollars, and significantly underperforming its US peers year-to-date. Several factors are behind this quarter’s underperformance including trade tension between the US and China, fears of a no-deal Brexit, political uncertainty in Italy & Turkey, and general softer economic indicators. On a regional basis, Switzerland (4%) and Japan (2%), were the two positive outliers with the first helped by its currency performing well and both countries benefiting from their perceived defensive characteristics in an uncertain environment. On the contrary, the UK (-3%) and Germany (-2%) both dragged down the overall return due to fears of a hard Brexit impacting equity returns and the British pound, and weak sentiment on the German auto sector given some corporate profit warnings. The Canadian dollar was generally stronger (1% - 4%) versus the major currencies in the index which negatively impacted the return. On a sectoral basis, the weakness generally came from the defensive sectors: Real Estate (-5%), Utilities (-2%) and Consumer Staples (-2%). The Energy (2%) sector rally continued this quarter as oil price continued to trend higher on supply uncertainty with Iran. Finally, the Healthcare (4%) sector performed strongly, led by pharmaceuticals, which we believe would be viewed as a defensive play in the context of a trade war escalation.

Generally, we feel investors should continue to emphasize equities. We do note that we are in the later innings of this economic cycle. Valuations are reasonable. Equities continue to look attractive, but we note that as interest rates continue to rise, the relative attractiveness versus bonds will gradually diminish. We will continue to monitor trade tensions sparked by the Trump administration. However, as we see them achieve a tentative new deal with Canada and Mexico, we again conclude that the bark is harsher than the bite. 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

Trade talks and the threat of further tariffs served as an overhang to risk sentiment and kept bonds in a stable trading range. Overall, interest rates ended the quarter higher then where they began due to strong economic data and indications that the Bank of Canada and US Federal Reserve will continue to hike rates. As a result, the yield curve flattened further and the likelihood for an inverted yield curve increased as the central banks indicated their need to “normalize policy rates” and their intention to continue hiking to the end of 2019. During the quarter, two-year bonds increased 30 basis points to 2.21% while five-year Canada bonds increased 27 basis points to 2.34%. Ten and thirty-year Canada yields closed the quarter at the same level of 2.42%, with ten-year bonds increasing 26 basis points and thirty-year bonds up by 22 basis points. While NAFTA negotiations continued throughout the period, a September 30 deadline produced a rebranded USMCA trade agreement which reduced market uncertainty, also contributing to higher bond yields across the curve.

Fundamentally, economic data has continued to strengthen with third quarter GDP growth in Canada forecasted at 1.8%, while US growth is expected to be 3%. The powerful effects of tax reform, strong equity markets and the highest consumer confidence levels in 12 years has promoted a highly optimistic landscape in the US. In contrast, consumer confidence levels in Canada hit 12-year lows as growth has been led by infrastructure spending and international trade. An unemployment rate of 6% in Canada and 3.9% in the US (the lowest reading since the 1950s) could also help explain the relative difference in consumer confidence levels between the two countries. The Bank of Canada held the short-term policy rate stable at 1.50% at the September meeting, although market expectations are for a 25-basis point hike in October and three more rate increases in 2019. Similarly, the US Fed continues to raise short term interest rates with a policy band of 2-2.25% currently and expectations of further steady increases throughout 2019. Inflation has remained in check with August producing a Core CPI rate of 2.1% year-over-year in Canada and 2.2% year-over-year in the US. This has helped promote a flatter yield curve as inflation pressures are more directly correlated with rising long bond yields.