MARKET REVIEW OCTOBER 2018

STOCK MARKETS (as of October 12th, 2018)

 

 

 

 

Canadian Equities

• This year, the TSX60 (the 60 largest market capitalizations) is down -2.7% as of October 12, 2018.
• The poor performance of the S & P / TSX was not due to the weak economy. In fact, the Canadian economy continued to hold positive surprises and earnings per share (EPS) of the S&P/TSX index exceeded expectations. So what has affected the Canadian benchmark? It is the contraction of the price/earnings ratios (P/E). Canadian market has experienced a sharp decline in P/E ratios since the beginning of 2018. The adoption of a new trade agreement and possible tax breaks for businesses in the next federal economic update could provide support for the price/earnings ratios of key sectors that are trading at a discount to the historical average.

 

U.S. Equities

• US stocks hit new highs in September, just as we marked the 10th anniversary of the Great Financial Crisis, raising doubts about the sustainability of what is now known as "the longest bull market in the world." 'history".
• This year, the SP500 (500 largest market capitalizations) returned 3.5% in US dollar as of October 12, 2018.

 

World (ex-US)

• During the month of October, Asian equities dropped to a 17-month low, and those in Europe, to the level they were six months ago, and this came after a downward revision by the International Monetary Fund (IMF) of its global growth forecasts for 2018 and 2019.
• Since the beginning of the year, the MSCI EAFE Index (Europe, Asia, Far East) which excludes North American stock markets has returned -7.2% in US dollar.

 

Canadian bond market

• The bond universe index (FTSE Universe) is down -0.8% this year as of October 12, 2018.  Interest rates in Canada and the US have risen for more than a year, which continued to put pressure on the value of fixed-rate bonds such as those held in our portfolios.
• We continue to expect rate hikes by the Bank of Canada on October 24 and three more in 2019.

 

ECONOMIC HIGHLIGHTS

 

Canada

After months of negotiations, Canada finally agreed to a revamped trade deal with the U.S. and Mexico. The “United States-Mexico-Canada Agreement” (USMCA for short) will replace NAFTA. Our Canadian GDP growth forecast for 2019, which had assumed a deal would be reached, is unchanged at 1.9%. But with this earlier than- expected agreement, we’ve brought forward the timing for C$ appreciation, now expecting USDCAD to reach 1.25 by the first quarter of next year.

USMCA! No, the Village People are not making a comeback with a new hit song. This is instead the name of the revamped trilateral trade agreement between the U.S, Mexico and Canada. Details are thin at this writing, but it’s being reported Canada was able to preserve tariff-free market access in the U.S. and the impartial arbitration panel for dispute resolution (akin to Chapter 19 of NAFTA).

 

In return, Canada reportedly had to give in on several fronts including agreeing to cap auto exports to the U.S. and accepting a variant of the sunset clause ─ the trade pact will come up for review every six years. The dairy industry, once a sacred cow, has been turned into a sacrificial lamb as Ottawa agreed to give U.S. farmers more access to the Canadian market.

While Canada seems to have gotten the short end of the stick, the outcome should not be surprising. With 75% of Canada’s exports going to the U.S. and less than 20% of U.S. exports coming to Canada, it was clear from the outset who stood to lose the most from trade barriers. But a deal is better than none, especially if it allows Canadian exporters to ship most of their wares tariff-free to the world’s largest market.

 

The fact that the agreement will come up for review every six years is arguably among the worst of the concessions Canada had to make. The U.S. could, after six years, decide to cancel the agreement, the latter then expiring ten years later. Firms may be reluctant to invest or expand operations considering market access to the U.S. could potentially be cut off in the future. But it’s always possible.

 

United-States

A sixth consecutive quarter of above-2% real GDP growth is in the cards for the U.S. economy. Consumption spending remained strong in Q3 buoyed by a healthy labour market and personal income tax cuts.

 

Investment was also supportive of growth during the quarter thanks in part to elevated business confidence. All in all, the data does nothing to change our view that 2018 real GDP growth will be close to 3% and well above potential. Encouraged by a buoyant U.S. economy and rising inflation pressures, the Federal Reserve will continue to normalize policy in 2019, albeit at a slower pace than this year.

 

World (ex-US)

After a promising first half of the year, the world economy now seems to be losing momentum. Declining commodity prices and composite purchasing managers indices point to softer GDP growth, the latter not surprising amidst rising trade barriers and the ensuing deceleration in global trade volumes. Export focused emerging markets remain under pressure, although related corporate defaults have potential to rattle global financial markets and hence advanced economies as well.

 

The People’s Bank of China cut the amount of reserves that it requires domestic banks to hold with the central bank by one percentage point, a move equivalent to injecting $110 billion into the economy. This decision came amid growing concerns of a slowdown in economic activity. According to official statistics, real GDP growth slowed one tick to 6.7% in Q2 from a year earlier. Although the pace remained comfortably above the government’s 6.5% annual growth target, there are areas of concern. Fixed investment, for instance, rose at its lowest pace ever in the quarter (data collection began in 1999). The picture was even bleaker regarding government investment, which includes investments made by state-owned enterprises. The latter progressed just 3.0% on an annual basis, down from 12.0% the year before.

 

What is particularly concerning is the fact that this slowdown in growth has been compounded lately by an intensification of trade tensions with the United States. Last month, the Trump administration imposed tariffs on a further $200 billion of imports from China, bringing the total amount of goods subject to levies to $250 billion. The CSI 300 stock index duly tanked, extending its losses since late January to nearly 30%. The yuan has not fared much better this year, shedding roughly 10% of its value against the USD.

 

Commodities

The oil price (Brent) rose 5% or so in September, for a 12-month gain of 45%. The oil price rise has contrasted sharply with the movement of other commodity prices. The CRB metals index, for example, is down 7% from the beginning of the year.

 

What has allowed oil to buck the trend is excess demand. Venezuela’s declining production and U.S. sanctions on Iran do nothing to ease this supply-demand imbalance. True, the sanctions on Iran are not slated to come into effect until November. But some of the country’s trading partners have opted to reduce oil imports immediately, forcing it to cut back production.

 

Foreign Exchange

After months of negotiations, Canada finally agreed to a revamped trade deal with the U.S. and Mexico. The “United States-Mexico-Canada Agreement” (USMCA for short) will replace NAFTA. Our Canadian GDP growth forecast for 2019, which had assumed a deal would be reached, is unchanged at 1.9%. But with this earlier-than-expected agreement, we’ve brought forward the timing for C$ appreciation, now expecting USDCAD to reach 1.25 by the first quarter of next year.

 

Buoyed by safe haven flows stemming from emerging market woes and tighter monetary policy by the Federal Reserve, the trade-weighted U.S. dollar has done well this year. It’s unclear, however, if USD can maintain momentum over the longer term especially when investor attention eventually turns to the bloating U.S. budget deficit and fading impacts of the fiscal stimulus. Barring another round of stimulus from Congress, the greenback could lose steam. Of course, for USD weakness to be sustained, trade tensions between the U.S. and major trade partners such as China and the European Union will need to abate.

 

While the euro remains grounded by the European Central Bank’s loose policy as well as internal strife (e.g. Brexit, Italian politics), the common currency has potential to bounce back over the coming year when investors start to expect an end to Fed tightening.

 

A LOOK BACK ON LAST QUARTER AND OUR PORTFOLIO POSITIONNING

At the end of June, we adjusted downward the duration of our bonds to be positioned more defensively against a backdrop of rising rates. In fact, our duration has been shortened a few times since 2017. These successive adjustments have enabled our portfolios to better withstand the adverse effect of rising rates.

 

During the month of August, we traded again in the fixed income part of the portfolios. This time, the goal was to add an investment that offers features different from the traditional bonds we have. Our choice was based on an actively managed preferred exchange-traded fund (ETF) with a dividend yield of 3.95%.

 

Like bonds, preferred shares have recurring revenues, but the main attraction of this type of investment is in the high after-tax return (when held in a taxable account). This is because the distributions are in the form of a dividend on which there is a tax credit. Thus, this investment compares favorably on an after-tax basis.

 

Preferred shares have characteristics that equate them with both debt and equity securities. The advantage of combining this type of investment with traditional bonds is that their behavior is different. For example, certain types of preferred shares will go up when rates go up while bonds fall.

 

Our more defensive positioning was tested during volatility episodes in September and early October. Our portfolios held up better than index portfolios of the same profile. Our portfolios contain quality investments and their levels of diversification are important, which has a direct impact on volatility and risk. We believe that caution is required at this stage of the business cycle. We have just spent the 10th anniversary of the Great Financial Crisis, and we have a doubt about the sustainability of what is now called "the longest bull market in history".

 

I hope you enjoyed our newsletter.

 

Do not hesitate to contact us at sounda.ladouceur@bnc.ca or cathy.duval@bnc.ca

514 871-3474

 

Disclaimer: The opinions expressed herein do not necessarily reflect those of National Bank Financial. The particulars contained herein were obtained from sources we believe to be reliable, but are not guaranteed by us and may be incomplete. The opinions expressed are based upon our analysis and interpretation of these particulars and are not to be construed as a solicitation or offer to buy or sell the securities mentioned herein. National Bank Financial is an indirect wholly-owned subsidiary of National Bank of Canada. The National Bank of Canada is a public company listed on the Toronto Stock Exchange (NA: TSX). National Bank Financial is a Canadian Investor Protection Fund member (CIPF)

 

Sources :

Forex October 2018

Weekly economic watch October 12th 2018

Monthly economic monitor October 2018