September 2017 Monthly Market Commentary & ForecastMarket Commentary
Commentary Date: October 13, 2017
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From Our Founder
It was a temperate September, providing everyone with more opportunity to enjoy the great outdoors. The market climate, however, was far from temperate as performance continued to grind higher at an impressive clip. Traditionally, September tends to be the worst month for performance from a seasonal perspective.
The markets were led on the upside by Energy and Financials – the twin driving forces behind the outperformance of the S&P/TSX Composite Index (“S&P/TSX”) versus its US counterparts.
In this commentary, we review the various contributors to market outperformance. We also contrast the equity markets in Canada and the US, and examine the rationale behind the Bank of Canada’s (“BoC”) current course.
Richard G. Stone
Chief Investment Officer
|* In Canadian dollar terms as at September 30, 2017|
Contrasting Canadian and US market performance
The S&P/TSX’s recent rally was to be expected when considering the disconnect between Canada’s strong economic numbers and robust dollar compared to Canadian equity returns. Yet, even after a strong month and third quarter, Canadian equities continue to trail most global equity markets on a year-to-date (“YTD”) basis. The reasons for this are apparent when comparing the US and Canadian markets. The US market outperformed the Canadian market on a YTD basis because of its overweight positions in the Information Technology and Health Care sectors and underweight positions in the Energy and Materials sectors. For the S&P 500 Index (“S&P 500”), the Information Technology and Health Care sectors were up 27.4% and 20.3% YTD, respectively. By contrast, Canada’s S&P/TSX had minimal exposure to these sectors and did not participate as fully in the rally.
The US market, as measured by the S&P 500, recorded its longest streak of record closes in 20 years. This has been a broad-based rally with every sector up for the year except for Energy and Telecommunication Services. Strong corporate earnings have supported stocks for months and a recent run of positive global and US economic data added to equities’ momentum. Even though these markets are expensive relative to historic levels, equities continue to be the most attractive asset class.
We are monitoring the recent moves in oil and gas carefully as it could be one of the catalysts that allows the S&P/TSX to catch up to its southern peers.
Solid footing for Fed’s path forward
From a performance and positioning perspective, we are more constructive on the US dollar of late. This is due to the tone coming from the US Federal Reserve Board (“the Fed”) and economic data reflecting some “green shoots” of inflation and continued positive economic traction. The manufacturing sector’s Purchasing Managers’ Index (“PMI”) came in at 60.8 and the Manufacturing Prices Paid Index finished at 71.5 – both above economists’ expectations. US auto sales also recorded their third-strongest month on record with 18.6 million units sold. These readings should bode well for the Fed’s continuing path toward higher interest rates.
In addition, this run of solid economic data has resulted in a healthy backup in US 10-year yields from their low of 2.0% to their current level of 2.4%. Global economic data also stepped up with China’s official factory PMI at its highest level in five years, eurozone PMI at its highest level in six years and Japan’s Tankan at a 10-year high.
Putting Canada’s growth into perspective
In Canada, the economic data has also been impressive. Much of the economic growth experienced came from unsuspecting places. Quebec, for the first time in decades, is experiencing tremendous consumer-driven economic growth related to an increasing number of dual-income households. In addition, while it is too early to confirm empirically, there have been anecdotal observations that real-estate-oriented foreign capital has “found a new home” in the province of Quebec. This is in the wake of foreign-ownership tax policy changes in British Columbia and Ontario. Despite the recent upbeat economic data points for Canada, there remain several unanswered questions: 1) Canada’s growth prospects vis-à-vis the North American Free Trade Agreement (“NAFTA”) renegotiations and 2) its consumer debt-servicing capacity, amid rising interest rates.
The interest rate increases this year from the BoC were justified to reverse the emergency measures taken in 2015 to cut rates during the energy slump when West Texas Intermediate crude oil traded below US$30/barrel. It has been a catch-up trade and we have seen less daily currency volatility since the increases. This is consistent with the view that the global economy is starting to reveal signs of inflation.
What’s behind the BoC’s current course?
At this point, the BoC knows that the economic growth being observed lately cannot be sustained in perpetuity. As a result, raising interest rates serves two purposes: 1) to cool down a hot housing economy and 2) to make room for a period when growth does become weak.
There has been speculation on whether Canada is in a housing bubble. While we concede that there is some runaway price appreciation in certain markets, we do not think that the banks are facing great risk because much of their mortgage books of business are insured by the Canadian government. Now, the government could be at risk because they effectively provide the insurance to the banks, but they too would have direct influence on interest rates. It is difficult to envision a scenario where the government of Canada would willingly induce a housing crisis. We expect the BoC to continue its pace of interest rate increases and keep the absolute cost of capital reasonable in order to allow average Canadian households to manage their debt service appropriately.
As stewards of our clients’ capital, we continue to position our portfolios to participate in sectors that will benefit them the most. We continue to see a moderate improvement in global growth that bodes well for equity ownership. And lastly, we remain confident that central banks will adjust monetary policy in a manner that is friendly to consumer spending and corporate profitability. As such, our team is committed to participate in the sectors and companies that are poised to benefit from this environment.
CELEBRATING 150 YEARS WITH CANADIAN FACTS
October 25, 1923
Frederick Banting and J.J.R. Macleod are the first Canadians to win a Nobel prize, for their work that led to the discovery of insulin.
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