Here are the latest comments on the investment markets from our Portfolio Managers and the Louisbourg investment team for the third quarter of 2019. 

Equity Markets

Analysts Red with LogoEquities have been able to add to their gains from earlier in the year. Investor sentiment continues to be challenged by trade tensions and evidence of slowing global growth. Late cycle concerns of a recession are prevalent, but the economy continues to be resilient. Central banks are generally easing monetary conditions to sustain the economy. All major equity markets delivered solid results during the quarter. US equities were the strongest while Canadian equities also offered a solid performance.  EAFE equities didn’t perform as well, offering only a marginally positive return.  

After experiencing a strong first half of the year, Canadian equities added to their gains in the third quarter with a 2.5 % return.  Breadth was strong with nine of eleven sectors posting gains during the period. Interest sensitive sectors offered abnormally high returns with Utilities (+10%) and Real Estate (+9%) leading the way. Consumer Staples (+6%) and Financials (+5%) were also notable performers. Health Care (-30%) and Industrials (-1%) were the weaker performers while Energy (+1%) and Materials (0%) didn’t contribute much. The sector performance breakdown highlights how investors shifted to a more defensive stance within equities.

Despite the lack of meaningful progress in US-China trade negotiations and the corresponding weakness in economic indicators, the S&P 500 continued to find its way higher, posting a 1.7% return in USD. The market was (and still is) hoping for additional monetary stimulus to help offset this and the Fed did not disappoint as it cut interest rates twice, offering support to equity valuation. The loonie weakened modestly, leading to a 3.0% return for Canadian investors.  Strength was led by interest sensitive sectors with Utilities (+9%), Real Estate (+8%) and Consumer Staples (+6%) as the main drivers for the Index. Energy (-6%) was the biggest laggard as global growth concerns continue to put pressure on oil prices, along with Health Care (-2%), which continued to underperform despite its defensive nature as investors are becoming increasingly concerned about the impact of a Democratic administration in 2020.

Following a strong first half, EAFE equities ended up range bound this quarter with the MSCI Index finishing the quarter up 0.2% in Canadian dollars. Themes remain mostly the same as previous quarters with sluggish macro-economic data, Brexit uncertainty after Boris Johnson became the UK’s new prime minister and continued back and forth between the US and China as negotiations go nowhere fast. While the market generally welcomed the European Central Bank’s decision to provide further monetary stimulus, the focus quickly came back to slowing economic growth with defensive sectors being in favour again. Sectors like Health Care (+4%), Utilities (+4%), and Consumer Staples (+3%) led the index as they benefit from lower interest rates. On the contrary, global growth concerns have put pressure on commodity prices leading to Energy (-5%) and Materials (-4%), to both underperform the index. The Canadian dollar generally strengthened versus other major currencies in the index which negatively impacted the return.

We can remind ourselves of the weakness of late 2018 when markets were concerned that increasing interest rates would tip the economy into a recession. The equity rally of 2019 reflects increasing confidence by investors that the cycle can extend as the Fed is now relaxing monetary conditions as opposed to tightening. Equity valuations do remain reasonable from a historical and interest rate perspective, but we must be mindful that we are in a slower growth environment with trade tensions adding to the uncertainty. We are also mindful that we are progressing towards the 2020 US elections when Trump will want to show trade progress. 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

Fixed income markets returned to the now familiar tune of heightened warnings of a global slowdown, recession risk and the need for central bank intervention. The catalyst for the deteriorating outlook is a bit different this time around, however, as interest rates are already low with businesses benefitting from spending and tax cut measures as well as low finance rates. In contrast to prior slowdowns, the primary driver this quarter has been negative impact of intensifying trade conflicts and geopolitical risks that has weighed on business and investor confidence. As a result, central bankers are limited going forward in the levers available to them for addressing further economic slowdown and instability. Despite this, central banks marched forward with a united front and introduced easier monetary conditions through overnight rate cuts and including the re-introduction of QE during the quarter. Fixed income assets rallied extensively during the month of August as the market started to price in further central bank measures as the 30-year Canada bond yield reached a record low of 1.298% on August 15. Since then, markets remain increasingly volatile as trade and event risk including speculation surrounding future central bank measures become drivers of market performance rather than economic fundamentals. A symptom of some of the problems with increased dependence on central bank policies was illustrated in September within the US repo market. The repo market supports much of the short-term borrowing and lending that financial institutions carry out to manage their daily cash flow and is essential to the proper functioning of the financial system with trillions of dollars being exchanged every day. In the middle of September, the functioning of the US repo market was destabilized, and rates spiked to unsustainable levels, requiring funding by the New York Federal Reserve. While technical factors largely drove this event, the Fed will be required to continue to support this market until a longer-term solution is addressed.

During the quarter, the Bank of Canada maintained their policy rate of 1.75% as core inflation remains near target at 2.1% (September) and housing has shown a sharp recovery, thereby, reducing the probability for a rate cut in Canada over the near term. Unemployment remains stable at 5.5% while GDP growth in Canada is expected to slow to 1.5% for overall 2019 as commodity and trade conflict weigh on growth. In contrast, the US has already largely unwound their most recent tightening in policy with two consecutive rate cuts, including a 25-basis point cut in July and another 25-basis point cut in September with a federal funds target rate currently of 1.75 - 2.0%. Unemployment in the US remains at a record low of 3.5% and GDP growth is expected to be 2.3% this year. During the quarter, the Canadian yield curve twisted as shorter-term bonds ended higher in yield, while longer term bonds ended lower in yield versus the previous quarter. Such a twist is unusual as strong inflation and economic data have kept rates higher than the decline in the outlook expressed by the move down in longer term bond yields. Over the period, two-year Canada bond yields increased 11 basis points to 1.58% while five-year yields were unchanged at 1.39%. Ten-year Canada yields declined 10 basis points to 1.36%, while thirty-year bonds were lower by 15 basis points at 1.53%.