Third Quarter 2018
Q3 2018 will long be remembered for the last weekend of the quarter, when most of us had long since given up hope of ever striking a deal with the US, that at the end of a weekend of intense negotiations a deal was had. And not just any deal, but one in which there were no major changes to NAFTA and in particular no change to Chapter 19, the dispute settlement mechanism. Canada was surely forced to make concessions, the most significant giving the US greater access to our dairy market. Overall, the New NAFTA, or USMCA as it has been renamed, is a major relief for Canada and lifted a heavy cloud of uncertainty, especially with respect to investment in this country.
Also noteworthy in the third quarter was the back-up in bond yields, driven in the US by robust economic data, new highs for US equities and a four-year high in oil prices. The rest of the world shared in the back-up in yields, but one of the biggest moves to higher yields was in Canada. After hitting an all-time low of 0.95% a little over two years ago, Gov’t of Canada bonds maturing in 10 years have risen to 2.61% with 18 bps being added post the USMCA agreement. As in the US, solid employment growth, along with the first trade surplus in almost two years supported the move to higher yields.
With respect to Central Bank policy, the upward trajectory of rates is expected to continue in both Canada and the US. The surprisingly optimistic Business Outlook Survey released October 15th, virtually guarantees a rate hike by the Bank of Canada next week. BMO Capital Markets Economics forecasts additional hikes in January, April and June 2019 bringing the rate up to 2.50%. To the dismay of the US President, US Fed Chair Powell has been increasingly hawkish in his messaging , stating that rates could easily be driven above the 3.00% neutral rate.
The Dow Jones Industrial Average hit all-time highs in late September, signalling that investors believe the trade-war fears are overdone. US technology stocks have outperformed every other sector, with Nasdaq up 25% year-over-year, and the S&P 500, which includes technology and consumer discretionary (Amazon and Netflix), up 30% in the past year. This compares to the MSCI World Ex-US index which is down slightly from a year ago.
Then there is Canada! The Canadian Healthcare sector which is comprised almost exclusively of pot stocks, has been on a tear. The overall S&P/TSX, however, has posted a negative return of -0.8% year-to-date. This can be attributed in part to the composition of our market – very little exposure to technology and consumer discretionary, overweight in the extremely depressed energy and materials sectors, and uncertainly with respect to trade policy. Rob Carrick reported in The Globe and Mail that an investor with a 60-40 mix of Canadian stocks and bonds would have returned 0.7 per cent year-to-date. If 40% of the equity allocation had been in the US market, the return in Canadian Dollars would have been heart-stopping 13.6%.
BMO Capital Markets Economics upgraded their Q3 growth estimates for both the US and Canada despite trade wars, tariffs and NAFTA. Consumer confidence rose to a new cycle high in the US underpinning the great American pastime of consumer spending. In Canada a positive trade balance will again add modestly to growth, even though consumer confidence is at its lowest in 15 years. Interestingly, looking out to Q4 GDP, the introduction of cannabis to the National Accounts data is expected to boost growth by about half a point, with smaller increments to growth in the first half of 2019.
Brian Belski, Chief Investment Strategist, BMO Capital Markets, believes Canadian fundamentals are the strongest they have been in several years – earnings are consistently exceeding expectations and hitting new all-time highs, profitability is near peak levels, and estimates have been getting revised higher month after month. Weighing on the TSX, however, have been fears surrounding slowing emerging markets, widening Canadian oil price spreads and trade issues. He continues to believe his base case price target of 17,600 is achievable as many of these fears recede in the fourth quarter and multiples begin to normalize.
In the US, Brian highlights that earnings have been much better than expected, economic growth has surprised to the upside, and price multiples have not contracted as much as anticipated. Nonetheless, even though his year end target of 2950 for the S&P 500 is only marginally above current levels, he is not inclined to make an upward revision at this time. He concedes there is a good chance the S&P 500 could finish the year at a level higher than his target, but does not believe it would be sufficiently substantial to warrant an official target revision.
We remain committed to giving you the very best in investment, financial planning and overall wealth management services, and are delighted to now include the services of a Private Banker exclusively dedicated to working with our clients. If you have an interest in Private Banking services that focus directly on your individual needs in banking, lending and cash flow management, please let us know.
Do not hesitate to give either of us a call at 416 359-7565 or 416-359-7564 or email Sharon Kubicek or Alisa Carli if you have any questions respecting your portfolio and the prevailing investment, economic and political issues at play today.
Sharon and Alisa
BMO Capital Markets Economics “Focus” - September 21, September 28 and October 5, 2018
BMO Capital Markets “AM Notes” – October 16, 2018
BMO Capital Markets Economics “Global Equity Weekly” – September 14 and September 28, 2018
BMO Financial Group “AM Charts” – September 25, 2018
BMO Capital Markets “Canadian Strategy Snapshot” – September 27, 2018
BMO Capital Markets “US Strategy Comment” – September 27, 2018
Rob Carrick, The Globe and Mail – “Brace Yourself….” – October 5, 2018