The first quarter of 2016 was a trying one for investors. Buffeted by dire predictions of a slowing of the world’s economy, the growing potential for a recession in the U.S. and the prospect of rising interest rates in the U.S., global equity markets fell sharply in early January. A short recovery was then followed by another sell off. Finally in mid February equity markets again rallied to end the quarter with modest gains. As we saw through most of 2015, fear dominated market thinking with a wide range of doom-sayers predicting catastrophe. What investors should realize is that many negative predictions are from people who have sold short the market and are betting on market declines to make a profit.
As the quarter progressed, it became apparent the U.S. Federal Reserve was in no hurry to raise rates and that the U.S. economy was generating encouraging statistics. The U.S. job market continued to produce 200,000 plus new net jobs per month. Even more encouraging for the U.S. was that the participation rate began to rise, indicating that discouraged workers were returning to the job market. The U.S. housing market continued to improve with an interesting twist. Previously a significant part of housing starts were multiple unit starts which included large multi-story condo or rental units. Many U.S. newly married couples have been afraid to enter the housing market because of the housing price collapse after 2008. Recently ,single unit starts have picked up, indicating demand from this group has returned as confidence in the recovery has firmed. Another measure of consumer confidence in the U.S. has been U.S. motor vehicle sales, which recently hit a 15 year high.
It should be recognised that the initial impact of low oil prices had a significant immediate negative effect on the U.S. economy as their energy sector contracted. The benefits of lower energy costs were slower to come, but are now appearing as individuals begin to spend the money they have saved on gasoline and heating expenses. American corporations are still in excellent shape with the exception of the energy sector. Earnings have continued to beat forecasts even after recognizing the tendency of corporations to set easily met objectives. The U.S. trade weighted dollar appears to have peaked which will help the multinational corporations who sell their products in foreign currencies.
The near term Canadian outlook is not as bright as the U.S., but not as bad as many expected; it is looking better with each passing month. The most recent indicator of growth in Canada saw the month- over-month growth in Gross Domestic Product up 0.6% - much better than expected. The low Canadian dollar has finally impacted non-energy exports which in the most recent 3 month period were up at a 26% annual rate in price-adjusted volume terms.
The main hurdle remains Alberta, where low energy prices have caused a significant economic decline. Unemployment has risen sharply as energy companies cut expenses to survive declining cash flow. However, the declines in Alberta have been at least partly offset by increases in B.C., Ontario and Quebec. Recent budgets in those provinces and at the Federal level have been stimulus oriented. While there should be concern about government deficits, significant new expenditures on infrastructure, such as public transit tend to have positive economic benefits. To offset some of this spending, the Federal government has imposed a substantial increase in tax rates for small and family business owners – we believe this will create unforeseen negative consequences over time in Canada. Lastly, there is also the prospect that commodity prices have bottomed, which would be a major benefit for Canada.
Looking ahead at factors that will potentially impact financial markets, some areas stand out. China again will be an area of concern, but recent statistics indicate problems but not collapse. European numbers also show some improvement, indicating fiscal stimulus may not be necessary. The Federal Reserve has become more dovish and a potential interest rate increase has been pushed off to the future.
We remain positive on the prospect for continued but slow economic growth in the U.S. and Canada. The U.S. could reach a 2.5% GDP growth rate as 2016 progresses, while Canada will likely grow at a slower 1.5% rate. Financial markets will continue to be volatile but with positive returns. Interest rates will remain low or could drift slightly higher.
We are cautiously optimistic as we see opportunities in North American and European credit, private debt such as mortgages and mid-market lending as well as select areas in private equity. In addition we remain comfortable with core investments in private real estate both in Canada and the U.S. along with public equities in Canada, the U.S. and Europe which exhibit lower than average volatility combined and dividends.