Equity Markets

After experiencing a dramatic recovery in the first quarter, equities maintained a positive, yet less explosive trajectory during the second quarter. President Trump toyed with market sentiment daily with trade progress updates. However, the Fed’s new openness to lowering interest rates later this year continued to spur investor expectations for continued economic expansion. All main equity markets delivered solid results, but Canadian equities performed the best followed by US then EAFE equities. It should be noted that foreign equity returns were tempered for Canadian investors due to a stronger loonie.

Canadian equities performed well with the S&P/TSX Composite delivering a quarterly return of 2.6%. Breadth was fairly strong with seven of eleven sectors posting gains during the period. Technology (+14%) was by far the best performing sector on the back of index heavy weight Shopify. A diversified collection of sectors (Utilities, Materials, Industrials and Consumer Discretionary) also contributed admirably, each returning approximately 5%. The weakest performing sector was Health Care (-9%) as cannabis stocks gave back some of their first quarter gains. The weakness in Energy (-3%) was also impactful given its significant weight in the benchmark.

We experienced another increase in volatility after trade tensions between the US and China ratcheted higher in May. Despite this, US Equities found themselves stronger on the back of potential monetary stimulus. The S&P 500 posted a 4.3% return in USD, but the strength of the loonie resulted in a 2.0% return for Canadian investors. Strength was led by cyclicals with Financials (+8%) catching a bid after a soft Q1 performance. This was followed by Materials (+6%), Technology (+6%) and Consumer Discretionary (+5%) which all outpaced the index. Energy (-3%) was the only sector posting a negative return as oil prices made their way lower. Healthcare (+1%) was also out of favour as investors weighed the impact of a 2020 election putting Democrats in office.

The MSCI EAFE Index ended the quarter up 1.8% in Canadian dollars adding to the strong gain in Q1. Strength generally came from the cyclical sectors like Consumer Discretionary (+4%), Industrials (+4%), Information Technology (+4%) as investors welcomed the idea that accommodating monetary policy will stimulate spending and investments. This was further supported by the confirmation that the US and Chinese governments would meet at the G20 summit at the end of June. The market assumed that any progress made between the two would delay the next round of tariffs, a clear positive for global investment. Defensive sectors, like Real Estate (-4%), Utilities (0%), Health Care (0%), and Consumer Staples (0%), all lagged the benchmark on the sector rotation. It is worth noting that the Canadian dollar generally strengthened versus other major currencies in the index which negatively impacted the return.In late 2018, we suggested that the Fed could act as a positive catalyst by signalling an end to monetary tightening. This played out as expected in the second quarter and investors showed their approval by buying equities. As we head into the summer of 2019, this investor behavior persists. Monetary conditions are now supportive rather than restrictive, which are beneficial for the economy and for equities. Valuations remain reasonable from a historical and interest rate perspective, but we must be mindful that we are in the latter stages of an economic expansion. Conditions for increased volatility are present. However, we remind ourselves that we are progressing towards the 2020 US election. It’s hard to imagine Trump not pushing hard to get a trade agreement in place to please the equity markets, which he uses as his favourite gauge of economic health. We continue to carry a healthy weight in equities but feel that it is important to incrementally favour more defensive business models and stronger balance sheets.

Fixed Income Markets

On the surface, the second quarter of 2019 appeared to be dominated by turmoil as trade tensions intensified against a backdrop of weakening global growth, rising uncertainty and event risks. Underlying this, however, were positive signs that economic fundamentals have now stabilized and the recession risks that pervaded the previous two quarters have been averted, with this period now regarded as an “economic slowdown.” Once again, “green shoots” have emerged within the global economy with early signs of improving economic fundamentals and government stimulus measures in China have taken hold. Market sentiment has also sharply recovered as central bankers have indicated a willingness to support growth and economic stability through policy rate cuts. Most notably has been the sharp turnaround in monetary policy by the US Federal Reserve where it became apparent through the sharp decline in the Q4/18 and Q1/19 data that the rate hiking cycle that began in 2016 went too far and too fast. The risks to growth and price stability we have seen emerge over those last few quarters have resulted in a completed reversal in policy, where the Fed is now expected to implement at least two 25 basis point rate cuts this year and two additional cuts in 2020. Since this pivot in policy by the Federal Reserve, US treasuries have undergone a powerful rally with the decline in yields producing new multi-year lows. The precipitous decline in Treasury yields has repriced global bond yields lower with most central bankers subsequently following the Fed’s lead to consider implementing rate cuts.

In contrast to the US experience, the Canadian economy has already shown signs of stabilizing after two quarters of negligible growth. Canadian GDP growth forecasts were recently revised upward to 1.3 - 1.5% for 2019 and 1.7% for 2020. As a result, the Bank of Canada has not yet indicated a move to a dovish stance and the outlook for similar rate cuts is less probable here than for other markets. It is more than likely that the Bank of Canada may just “hold steady the course” by maintaining their current 1.75% policy rate this year as the need to keep rising housing and inflation pressures (core CPI 2.3%) in check is offset by trade tensions, events risk and the widespread dovish turn by central bankers around the world. As a result, Canadian bond yields have followed the market lower but not by the same degree as the move in US Treasuries yields. During the quarter, the Canadian yield curve declined and flattened as the higher yields offered by the Canadian market have attracted a wave of foreign and domestic buyers in longer term to maturities. Two- year Canada bond yields declined 8 basis points to 1.47% while five-year yields dropped 13 basis points to 1.39%. Ten-year Canada yields declined 15 basis points to 1.46%, while thirty-year bonds were lower by 21 basis points reaching 1.68% at quarter end. The current outlook remains the same as the prior quarter, where a slowing in growth is anticipated to continue throughout 2019 and bond yields will remain low but grind modestly higher as the effects of this move to accommodative monetary policy by central bankers starts to take hold and improve the outlook for global growth.