A cautious overweight to equities
With the global quarterly earnings season nearly complete, the three major equity regions (Canada, the U.S., and international) continue to deliver robust results. While headline risks abound and volatility could remain on the high side, I believe fundamentals remain supportive for now and investors need to look through the noise.
|May ’18||YTD||1 Year||3 year||5 year||10 year|
|S&P/TSX Composite||+ 2.91%||– 0.91%||+ 4.64%||+ 2.27%/yr.||+ 4.89%/yr.||+ 0.8%/yr.|
|S&P 500 (C$)||+ 3.20%||+ 4.65%||+ 7.54%||+ 10.09%/yr.||+ 15.72%/yr.||+ 9.66%/yr.|
|S&P 500 (U$)||+ 2.16%||+ 1.18%||+ 12.17%||+ 8.68%/yr.||+ 10.65%/yr.||+ 6.81%/yr.|
|MSCI EAFE (C$)||– 1.82%||+ 0.17%||+ 0.75%||+ 2.83%/yr.||+ 7.86%/yr.||+ 1.88%/yr.|
* Source: Equity Index and Currency Data: Bloomberg. Data as of May 31, 2018
|Positive Surprise||Growth (YoY)|
Although the breadth of earnings and revenue beats in North America is wider than it is internationally, international stocks are showing the strongest YoY growth due to base effects. The strength in the international sector is not atypical late in the business cycle. Despite the impressive numbers, the May risk-off narrative stemming from European geopolitical concerns is driving investor flows out of international equities and toward the perceived safety of U.S. securities. I am mindful of the risk that rising commodity prices and wages pose to corporate profit margins and remain on the lookout for early signs of a business cycle downturn. In the interim, however, a cautious preference for equities relative to fixed income remains. International and Canada are favoured over the U.S currently.
Currencies and Commodities
OPEC and allies mull raising supply caps; trade uncertainty continues to weigh on CAD. Weakness in the price of crude oil over the last week likely has contributed to the recent decline in the Canadian dollar (CAD), compounding trade-related concerns. Those include the new U.S. tariffs on imports of steel and aluminum, a U.S. investigation of the national security threat posed by auto imports (which could lead to new tariffs), and, of course, the ongoing NAFTA negotiations.
The Bank of Canada (BoC) announced May 30th that there would be no change to the policy interest rate. Inflation remains near the bank’s 2% target and full-time employment and wage growth remain strong. The one-year market-implied policy rate, as calculated by Bloomberg, suggests the bank will tighten an additional one-half of a percent over the next 12 months. Should progress be made on trade negotiations and Canada’s constructive economic data continue, this would hasten the Bank of Canada’s decision to raise its policy interest rate.
Recent experience suggests that political risk tends to be overrated and relatively short-lived – recall Grexit, Brexit, and Trump election. Scotia Wealth Management’s Global Portfolio Advisory Group place low odds on the Eurozone being fractured by populism and believe such an outcome would be difficult to time and best managed through diversification.
Equities are likely to outperform fixed income securities as developed market central banks gradually tighten monetary policy, it is important to maintain fixed income or alternative investment exposure to mitigate risk. The U.S economy is strong, it enjoys full employment and consumer confidence is high. President Trump’s continued attacks on its trading partners through the implementation of trade tariffs may well turn out to be inflationary for the U.S. If Canada’s economy continues to be attacked by its largest trading partner, the Canadian Dollar is likely to go down in value. Globally diversified portfolios benefit from a lower Canadian Dollar. Canadian sectors that are likely to benefit from higher interest rates and this portion of the economic cycle include Canada’s banks, insurance companies and infrastructure companies.
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Senior Wealth Advisor
Director, Wealth Management
Mailey Rogers Group