April 2017 Monthly Market Commentary & ForecastMarket Commentary
Commentary Date: May 12, 2017
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From Our Founder
As we’ve stated previously, markets need to be navigated, not timed. We continue to believe that it’s important to remain invested, while remaining aware that technological advances and geopolitical undercurrents will test investors’ resolve through higher degrees of volatility.
In April, first-quarter earnings reports were in full swing, with certain fundamentals remaining constructive and geopolitical posturing continuing to cause higher levels of market turbulence. For Canada, a brewing storm of factors internally and abroad are set to drive down the dollar and economy.
For this commentary, we assess the growing market concerns impacting Canada, along with our portfolio positioning as a result. We also review the ongoing struggle within the White House, continuing growth in the US and major market considerations worldwide, particularly in Europe.
Richard G. Stone
Chairman & Chief Investment Officer
|* In Canadian dollar terms as at April 30, 2017|
Canadian Home Capital shares plunge
Domestically, an acute amount of market turbulence struck alternative lenders in Canada as Home Capital shares plunged. This was driven by heavy deposit withdrawals, similar to a run on a bank, which signaled a lack of confidence in management and the associated regulatory policy shifts in response to management’s recent behaviour.
Stone does not have exposure to alternative lending sectors, and are inclined to avoid that area given that it’s ripe for higher regulatory scrutiny. Characteristically, regulatory change has not been associated with stock price appreciation nor profit margin expansion. These events could spark the creation of a more stringent regulatory environment for the sector, with a high probability for margin compression. As a result, we prefer to stay on the sidelines and watch, as we believe there are more attractive places to invest.
Brewing storms converging for Canada
Our long-held belief is that the Canadian dollar is poised for weakness – a position that is starting to bear some fruit. The combination of diverging Canadian and US central bank policies and the knock-on effects of having a petrodollar have resulted in a 2.5% decline in the domestic currency during the past month. We have been anticipating this for several months, and the weakness in the price of West Texas Intermediate crude to below US$50 per barrel has helped accelerate that pace.
The US brewing storm also poses challenges for Canada on several fronts. They are projecting an environment of US-biased fair trade versus free trade, particularly through the renegotiation of NAFTA. It’s been argued that Canada is a large and easy target, which allows the US to demonstrate its ability to enact policy. Whatever the political reasons, these new measures by the US have already begun to negatively impact Canada’s softwood lumber industry, with farming and automotive sectors in the crosshairs. Ultimately, this new environment could affect Canada’s economy in ways that go beyond NAFTA renegotiations.
The China storm – free trade agreements?
In response, if the Canadian government aligns itself more closely with China through free trade agreements, the long-term negative consequences could outweigh the short-term benefits. China is known as an aggressive exporter of products and a manipulative importer of intellectual property. China has been known to impose weak business, environmental and human rights laws. The unintended consequences of structuring a free-trade agreement could negatively impact our US trade agreement
Canada’s struggles are also compounded by the US’s internal political struggles and paralysis of the White House to enact laws. There are disagreements at three levels: first, among Republicans in the White House, second, within the Republican Party and third, between Democrats and Republicans. As a result, the White House’s introduction of legislation has failed to pass and struggled to get approval by Congress and Senate. Health care, immigration and tax policy are highly complex issues. While tax policy is focused on tax reduction to stimulate the economy, the White House is merely providing simplistic solutions, which have the unintended consequences of compounding the complexity of the issue.
Focus on compelling Canadian pockets
Canada represents approximately 5% of the world’s stock market of which 70% of our stock market is comprised of the financial, energy and materials sectors. These ongoing issues limit your choices and incentives to remain exclusively invested in Canada. We do believe the structure of eligible dividend tax credits is an advantage in Canada. We also believe there are compelling pockets of the Canadian marketplace, specifically through the innovations of energy and financial companies, along with specialized technology. As a result, we continue to hold the Canadian economy in a highly concentrated and commoditized way.
Canada aside, we continue to believe that the Fed is positioned to execute two more interest rate increases this year, with the meeting in May to be fairly innocuous. Our portfolios have been positioned for rising US interest rates for quite some time. Fundamentals are the most compelling story, as corporate earnings and revenue growth continue to look positively constructive into the first quarter of 2017.
US growth trumping White House incapacity
Stock buyback activity is lower, but business investment is up in the US, which reflects a higher degree of quality to the recent surprise in earnings reports. The shifting use of capital toward investment will impact the economy positively, as it trickles down to other sectors and drives broader GDP growth. In short, corporate fundamentals are trumping White House incapacity.
From a global perspective, GDP is looking better after years of being weak. This is supported by the mild recovery of emerging markets. Fund flows toward Japan and Europe are
increasing, while financial institutions in Europe are using Brexit as a reason to cut costs.
Confidence lacking in French ‘Ni Ni’ election
All the while, the election in France is fast approaching and the candidacy is now down to two members, Emmanuel Macron and Marine Le Pen. The French election is an interesting, yet politically complex event. Increasing in popularity is the ‘Ni Ni’ constituent, which loosely translates to ‘neither nor.’ Historically, this stems from the election of former President of France Francois Mitterrand in 1988, basically signifying that ‘I’m neither happy with this candidate nor am I happy with the other candidate.”
This constituency in France suggests that the country is not entirely confident with either candidate’s ability to bring about real structural change. Despite the volatility exacerbated by political events, corporate fundamentals are looking considerably better throughout Europe than in previous years, and that is supportive of the fund flow activity in France.
When we look at places to invest, irrespective of the French election and Brexit, we still believe that Europe should be an overweight investment in client portfolios, while complemented with global and some modest emerging markets exposure.
However, we maintain that the most meaningful overweight position should be the US market. They continue to navigate an environment of low interest rates, low inflation, and expanding corporate earnings and are entering an inflection point of change, leading to higher interest rates and inflation. We expect this change will not be a smooth line.
Therefore, we continue to hold an underweight position in fixed income securities and an overweight position in equities. We’ll be particularly focused on high-quality businesses with strong balance sheets that demonstrate free cash flow growth and expanding profit margins.
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Information contained in this publication is based on sources such as issuer reports, statistical services and industry communications, which we believe to be reliable but are not represented as accurate or complete. Opinions expressed in this publication are current opinions only and are subject to change.