A Tiger of a Quarter
It was approximately a decade ago since Tiger Woods won a major golf tournament, and global stock markets staged a rally this large. Equity markets in North America that had plunged by almost 10% in December abruptly turned upward in the last week of the year. The Canadian and the US broader market experienced gains of more than 12% for this past quarter, with Europe and the emerging markets showing slightly less impressive, albeit strong gains.
What caused this abrupt market reversal? Very oversold markets combined with the unexpected policy reversal by the US Federal Reserve created a monumental shift in the investment environment. The Federal Reserve ended its projected policy of increasing future interest rates or tightening to a few, if any, increases. Forecasters who saw a recession as the final result of the tightening were now forced to redo their projections on a more positive note. Investors who had moved to the sidelines in anticipation of slower growth returned to markets with enthusiasm and bid equity prices sharply higher.
Another positive development was the indication of progress between the US and China on their trade dispute. US tariffs on China have had a negative impact on the US economy as China responded with tariffs on US farm products. It would appear that both the US and China are committed to reaching an agreement that would be positive for both sides. A settlement of this dispute would be very positive for financial markets and would boost US economic activity as 2019 progresses.
In terms of the overall economic background, both the US and Canada are still experiencing reasonable economic growth. In the US, perhaps due to tariffs or the cold winter weather, the first quarter GDP growth while positive, is at less than 2% on an annualized basis. However, the concern which was caused by initially poor first quarter job growth has been offset by good March numbers, which showed an increase in non-farm employment of 196,000 jobs along with upward revisions to previous monthly data.
Canada on its part continues to suffer from a slower rate of growth than the US. The Alberta energy sector is an ongoing drag on the Canadian economy. Recent increases in oil prices, particularly in Western Canadian Select heavy oil will help Alberta, but the lack of pipeline capacity due to political intervention will remain a problem. Further production cuts by OPEC combined with the humanitarian crisis in Venezuela due to the communist policies of the Maduro government, and the social unrest in Libya which continues 8 years after the departure of Col. Gaddafi are further positives for future oil prices.
Ontario on its part continues to benefit from US economic growth. Ontario normally does well if the US is doing well. Concerns about the housing market have not as yet materialized with housing prices stabilizing, however sales volumes are down sharply. The new Conservative government in Ontario has stepped forward with a GTA major transit expansion program. While Ontario’s deficit will expand, we view this as ‘good debt’ as the expenditures will be directed into infrastructure assets, which are sorely needed and will be stimulative for Ontario’s economy not only initially but over time.
Canada had recent disappointing new job statistics, showing a 7,200 jobs decline. The trade side is still an open question for Canada. NAFTA 2 has yet to be ratified by the now divided US Congress. The tariffs on steel and aluminium remain despite Canada and Mexico protests. The Democratic dominated House of Representatives has already raised doubts that the trade deal will pass without alterations. In the meantime, the old NAFTA remains in place – not such a bad thing!
The ongoing political uncertainty in the US is being matched in Canada. The ruling Liberals have shot themselves in the foot with the SNC Lavalin affair. While the recent budget has all the bells and whistles of an election budget for this fall, it may not be enough. Canada could soon have a new federal government in Ottawa.
Looking ahead, it would be nice to predict further financial market improvements. However, recent history has shown unpredictability is a basic element of markets. Possible positives would be a continuation of low interest rates – no rate increases, low inflation and positive economic growth in the US and Canada. A trade deal between the US and China would be a big step forward. In Europe, the Brexit issue has been kicked down the road until October 31st, with a further trade dispute between the EU and the US still being a possible threat.
In the equity portion of portfolios we favour the utilization of ETFs to gain a low-cost and diversified global exposure, and which utilize a combination of indexing along with a low-volatility factor based approach. For investors with long-term horizons and a reduced need for liquidity, private equity (both in the growth equity and secondary sectors) has the potential to create value in excess of the public markets over time.
Our strategy in the fixed income asset class continues to favour opportunities that focus on the “real economy” rather than the “financial economy”. The areas where we see the greatest return vs. risk are in the area of supplying growth capital via private debt for companies, private mortgages secured against hard assets such as real estate, and lending against infrastructure.
As a complement to fixed income and equity asset classes, we view multi-family real estate as having good potential, as strong rent growth should compensate for higher interest rates.