Equity Markets

Equities are progressing higher with below average volatility. This has been the case for some time despite President Trump’s inability to enact significant changes. It is also worth noting that this rather calm period is happening in conjunction with important central banks reducing stimulus for the first time in a very long time. Macroeconomic noise was mild this quarter and discussions mostly centered around the pace of rate hikes. While not new that equities are performing well, the leadership has recently changed from US equities to International equities.

In Canada, equities gave back most of the gains that were accumulated during the first quarter of the year. The weakness was rather mild and gradual but it was persistent throughout the second quarter. For the three-month period, the S&P/TSX Composite returned -1.6% while US and International equities offered stronger results. Investors debated the interest rate raising pace and path, which caused Financials to offer a slightly negative performance (-1%) while all other non-resource sectors generated positive returns. For their part, Energy (-8%) and Materials (-6%) did most of the damage as the sentiment soured for commodity dependent companies. Interestingly, only three of eleven sectors were in the red for the quarter but those three sectors were the largest components of the S&P/TSX Composite.

The S&P 500 index continued its strong run, delivering a 3.1% total return (in USD) during Q2. The loonie also continued its pattern of strength, chewing into returns for Canadian investors. The S&P returned just 0.4% in CAD terms. While the sideshow was very much the lack of progress out of Washington, investors were encouraged by positive signs of a healthy economy globally and pushed equities higher. Earnings growth was exceptionally strong in Q1 2017 (+13%) and 6% growth is forecasted by the Street for the upcoming Q2 reporting season. While strength in Technology names (+4%) endures, the second quarter saw the strongest absolute performance from Heath Care (+7%) and Industrial names (+5%). Financials (+4%) finally caught a bid later in the quarter after the Federal Reserve delivered its second 25 bps hike to interest rates this year. Rising rates has put pressure on interest rate sensitives but this was mostly felt within Telecom (-7%). Energy (-6%) has floundered as US production remains on the rise and OPEC cannot seem to move the price as it once could. In terms of sector performance, we saw nine of the eleven sectors post positive results.

EAFE equities continued from where they left off in the first quarter, outperforming both the S&P/TSX and S&P500 with a positive 3.3% return in Canadian dollar. The highlight of the quarter was clearly Emmanuel Macron’s decisive victory in the French presidential election, eliminating one of the biggest political risk in the eurozone. European countries led the way this quarter with strong performances across all major countries. France (+7%), Germany (+4%), United Kingdom (+3%) and Switzerland (+6%) were all in positive territory after the Macron relief rally and positive economic growth numbers. Asia Pacific performance was mixed with Australia (-5%)

being dragged by weakness in hard commodities, and Japan (+2%) moving sideways with the Yen. On a sectorial basis, Energy (-3%) and Materials (+1%) were the biggest laggards as weakness in commodity prices weighed on the stocks. We have seen a rotation to more defensive sectors with Information Technology (+7%), Consumer Staples (5%) and Utilities (5%) all catching a bid this quarter.

Interest rates are moving higher. We are careful with our duration with our fixed income assets and we are only lightly invested in interest sensitive equities. We are generally constructive on equities given reasonable valuation levels and an improving earnings trend. Stock picking is important. A common thread across our equity strategies is to be invested in two distinct group of companies. We see a group of several strong businesses with attractive long-term fundamentals and solid near-term outlooks. Many of these businesses continue to trade at attractive to fair valuation levels. There is also a group of companies, often related to the resource sector, that operate with challenged near term operating outlooks. These businesses are generally trading at very compelling valuation levels because of these headwinds. When we can identify companies with attractive long-term assets to go along with compelling value, we see an investment opportunity. We have built portfolios that offer exposure to each group of companies. In both cases, our holdings will have attractive long-term assets and a balance sheet that offers the ability to remain patient.

Fixed Income Markets

Fixed income markets remained volatile during the second quarter of 2017 as bond yields declined early in the quarter, hitting year-to-date lows and then rose sharply in mid-June. The rise in global yields late in the quarter was the result of strengthening economic data as well as a dramatic change in sentiment to remove stimulus by almost all the major central bankers, including the US Federal Reserve, European Central Bank (ECB), Bank of England and Bank of Canada (BoC). Most importantly and the most dramatic shift in sentiment was from the Bank of Canada who indicated a policy change to a hawkish stance from a previously dovish stance, bringing forth the likelihood of imminent rate hikes into the Canadian yield curve. This reversal in policy shocked the front end of the Canadian yield curve with two and five-year bond yields rising dramatically. Canadian long bond yields failed to join the rise in global rates as weaker oil and inflation data supported sentiment in the long end of the curve. While the rise in global rates was precipitated by an almost coordinated change in sentiment by central bankers, it was also supported by the continued strengthening in economic data and improving outlook of global growth expectations. In Canada, growth in the first quarter of 2017 came in strong at 3.7% (versus 1.4% in the US), while expectations for GDP growth overall in 2017 is 2.8%, marking the highest level since 2011.

Despite strengthening labour markets and improving economic outlook, inflation data remains weak but at positive levels. Central bankers now seem to be regarding this weakness in inflation as transitory in nature and not a reason for hesitating in their path towards policy normalization and are expected to proceed with their removal of policy stimulus measures. Going forward, The Bank of Canada is now expected to implement two rate hikes this year, with one in July and one in the fourth quarter of 2017.

The Canadian yield curve flattened dramatically over the quarter. The decline in bond yields early in the period reversed and yields rose sharply, led by a rise in shorter term rates as the Bank of Canada took the market by surprise in its move to a hawkish policy stance. The Canadian two-year bond yield increased 35 basis points to 1.10%, while five-year bond yields increased 27 basis points to 1.39%. During the same period, Canadian ten-year bond yields increased 14 basis points to 1.76%, while the thirty-year Canada yield declined by 15 basis points to 2.14%.