• David Cockfield & Arthur Salzer

A Constant State of Change


While there are times when Canadian investors are almost afraid to watch the news and the world seems full of events that could have a negative impact on whole economies, it’s usually best to step back and look at the broader and longer-term issues that may affect a family’s investment portfolio.

In Europe we are seeing political challenges in countries like Italy due to voter push-back relating to the flood of immigrants from Africa. In Britain, Brexit negotiations have stalled and resignations of key ministers from the ruling conservative party have weakened the negotiation position of the British government. With only months remaining in the scheduled negotiation period, a positive outcome from Britain seems far away.

Closer to home, Canadian investors received a number of unpleasant surprises in the previous quarter. The previous cancellations of 3 pipelines over the past couple of years combined with the recent decision by Kinder Morgan to exit Canada and sell their pipeline to the Canadian government for $4.5 billion illustrates to the world that Canada may not be open for private business. This combined with the potential for a trade war between Canada and the United States in the steel, aluminum and auto sector creates some challenges to the Canadian economy. While we do think rational heads will prevail, and some form of agreement will take place, it won’t likely be addressed until after the congressional mid-term elections in November.

China was also hammered with tariffs on billions of Chinese exports to the U.S. China retaliated with its own counter tariffs. With the U.S. tariffs on European goods as well, we appear to be in the beginning of a full-scale trade war with the U.S. against the rest of the world. One of the strengths that the U.S. has over many other countries is its service sector, representing a significant proportion of the economy; it is therefore less exposed to tariffs than many other countries.

Switching to monetary economics, over the past decade global central banks have made massive purchases of bonds as part of quantitative easing polices. However, as economies are beginning to grow we are observing a reduction in bond purchases by central banks. This is known as quantitative tightening. As this $9 trillion of QE reverses itself, markets will likely react in the opposite manner to what we have been experiencing. This means rising interest rates, higher volatility and ultimately lower asset valuations. Using prudence, the Fed is taking a gradual approach to this unwinding. The challenge remains that even with this gradual approach, the 10-year US Treasury bill climbed to 3.10% in May, the highest since 2011.

Offsetting this monetary tightening is close to $10 trillion of fiscal stimulus that is coming mainly from the United States and China. The US has reduced the corporate tax rate from 35% to 21%, which thus far has resulted in wage increases and bonuses for employees at over 500 of the largest employers in the country. In addition, the personal tax rate was reduced slightly to 37% and allows companies for the next 5 years to fully deduct capital expenditures in property, plant and equipment in the first year, as opposed to depreciating them over 20 years. This has had an immediate impact on US manufacturing and other sectors, which in turn has promoted job creation.

Not to be forgotten is China’s “One belt, one road” policy which is designed to rebuild the old Chinese Silk Road trading paths on both land and sea. This is monumental policy as it covers 65% of the world’s population, 75% of global energy resources, 25% of worldwide goods and services and 40% of the world’s GDP. As of January 2018, 71 countries are taking part in this project with anticipated investments of between $4 trillion to $8 trillion.

From a public market perspective, in Canada the TSX has recently provided more positive returns as energy stocks moved higher, reflecting rising oil prices. Second quarter corporate earnings reports are expected to be excellent, but U.S. equity markets, in light of the trade war, will likely continue to move sideways until after the midterm elections. The TSX will benefit from continuing strength in the energy sector since it is a major component of the TSX index. Likewise, we continue to favour modest emerging markets exposure to access the growth due to China’s infrastructure policy.

Lastly, we believe there are complementary opportunities for investment portfolios found by investing in alternatives that focus on the “real economy” rather than the “financial economy”. Simply stated, we are seeing favourable return vs. risk in supplying growth capital for companies (private debt), hard asset lending (mortgages) and critical infrastructure. To complement this area, we view multi-family real estate as having good potential because rent growth still has strong upside, which should compensate for higher interest rates. For investors with long-term horizons and a limited need for liquidity, private equity (both in the growth equity and secondary sectors) have the potential to create value in excess of the public markets over time.


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