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Market Update. Economy is hot, even as trade talks freeze over

July 16, 2018

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Market Update. Economy is hot, even as trade talks freeze over

Market Insights

Donald Trump has trolled US trade partners with tariff talk, but the market still has plenty of true believers. Or, as I put it to the Globe & Mail shortly before Canada Day, “Despite trade tensions, the global economy is robust… We are in the midst of a prolonged equity bull run.” Yes, there is higher volatility now. But overall, markets have certainly bounced back (and then some) since 2009.

There’s plenty of good news overall, though volatility is creeping up again. Trade wars are looming (or in full effect, depending on who you ask). As such, companies looking to expand globally are holding off. They’re taking a wait-and-see approach.

Outside the trade war commentary bubble, the rest of the world turns. Here are some of the market movers this month:

  • Stocks have been outperforming. However, volatility is rising.
  • US interest rates rose in June 2018. We are expecting them to rise in Canada in July.
  • The high price of oil continues to grease the wheels for Canada and the globe.
  • Tesla powers through some bad press. Tech stocks go sideways.
  • In emerging markets, the price may soon be right to invest.
  • What does all this mean for your investments?

ETF Portfolios

Clients enjoyed higher returns in June than they did in the previous month.

ETF Safety Portfolio was up 0.32% in June. It’s up 2.99% for the past year.

With this portfolio’s significant weighting in the two Canadian bond ETFs (VSC & VSB), the flat performance of these ETFs resulted in a relatively subdued June performance. The main goal of these holdings is to provide stability and minimize losses. As a result, any gains or losses in the equity markets will be captured less. Having said that, the portfolio still received some gains from being exposed to Canadian equities and real estate.

ETF Conservative Portfolio was up 0.40% in June. It’s up 4.65% for the past year.

With increased exposures to Canadian and S&P 500 equities, this portfolio was able to capture more of the positive performance in these asset classes. At the same time, there is still a significant portion of the portfolio dedicated to diversification and risk reduction.

ETF Balanced Portfolio was up 0.59% in June. It’s up 6.39% for the past year.

The majority of this portfolio’s positive performance can be attributed to the greater exposure to Real Estate, Canadian & S&P 500 equities. The performance of the Dow Jone Index ETF (ZWA) and the International equities ETF (XEF) dragged down the portfolio’s performance, as these funds underperformed. However, these holdings continue to be a good source of diversification.

ETF Growth Portfolio was up 0.74% in June. It’s up 7.45% for the past year.

This portfolio mainly increased its exposure to HXS, which is the ETF that tracks US equities, specifically the S&P 500 index. HXS was the best performing ETF in our portfolios this month. As a result, the gain in this portfolio higher than the ETF Balanced Portfolio.

ETF Aggressive Portfolio was up 0.90% in June. It’s up 8.59% for the past year.

We saw good returns in Real Estate, Canadian & S&P 500 equities. This portfolio has the highest weighting in all of these asset classes. As a result, it had the highest monthly return across all of our portfolios. Dow Jones and international equity ETFs underperformed. However, they still provided a good source of diversification.

Private Investment Portfolios

Safety Private Portfolio was up 0.70% in June. It’s up 4.77% for the past year.

The additional diversification to asset classes such as mortgages, commodities, real estate and private equity not only mitigated risk but generated positive returns. Canadian Bonds and mortgages continued to reduce the volatility of the portfolio.

Balanced Private Portfolio was up 1.08% in June. It’s up 7.28% for the past year.

The additional diversification to asset classes such as mortgages, commodities, real estate and private equity not only mitigated risk but generated positive returns.

Aggressive Private Portfolio was up 1.26% in June. It’s up 6.88% for the past year.

The additional diversification to asset classes such as mortgages, commodities, real estate and private equity mitigated risk and generated positive returns. There is additional exposure to real estate through the NWM Real Estate Fund & NWM US Tactical High Income Fund. That greatly improved the overall return over the Balanced Private Portfolio.

Market movers, at a glance

Let’s take a closer look at some of the market movers in June-July. First, we take a tally of the trade war. Tesla powered through some bad press. Oil is dripping upwards. The European Union is looking more and more like less of a thing. Emerging markets are benefiting from a time of risky business. Now, let’s get to it.

This trade war might not be over by Christmas

The Canadian government has already imposed $16.6 billion in tariffs against American goods, to counter the US’s tariffs on foreign steel and aluminum. As we can see, the war is officially on. No deal is better than a bad deal, but a good deal is needed for the sake of both economies.

That’s notwithstanding that Canadians who were staunch free traders all of five minutes ago seem eager to retaliate with targeted tariffs against US products.

There’s a patriotic groundswell. However, Canadians who want to shoot back may not see the downside of escalating the conflict. For instance, one senior economist noted that tariffs on Canada’s auto industry alone could put 160,000 Canadian workers out of a job.

Meanwhile, sober-minded analysts are already calculating the harm the US is doing to its own economy. The bad news starts with the loss of hundreds of thousands of good-paying jobs. That’s why it’s important for negotiators to get back to the table and hammer out a good deal that works for both countries. Unfortunately, Trump is reportedly wanting to put off any deal with Canada and Mexico until after Congressional elections in November. For now, it’s a waiting game.

As a result of the uncertainty, the Canadian dollar weakened in the month of June. On a positive note, this led to better a performance in our unhedged US Equity ETF (HXS).

As the economy rises, so do interest rates

Interest rates rise again

The surprising flip side of all the trade talk? With the economy nevertheless roaring ahead and stocks continuing to push upwards, it might not matter. “A rebound in energy shares expected to drive Canadian stocks 4.9% higher by year end,” touts one Financial Post analysis predicting the TSX could close at above 18,000 by the end of 2018.

As well, jobs data is looking firm. In the USA, the jobless rate is at just 3.8%, an 18-year low. In Canada, while growth has stagnated slightly, it would seem we are effectively at full employment (or 5.8% unemployment. Virtually everyone who wants a job has one). That leaves little room for improvement. And with an accompanying surge of confidence in the economy overall, we can expect higher interest rates as well.

Will interest rates rise even more? Probably

According to a recent Globe & Mail report, “chances of an interest rate hike at the July 11 announcement have jumped to nearly 80 per cent from about 50 per cent before hawkish comments by Bank of Canada Governor, Stephen Poloz, at a news conference last week.” It would seem a further rate hike is coming up in July.

Trade war worries mentioned above could still sink our recent oil-fuelled confidence in Canada. But rate hikes that have already been put in place have had their effect on the economy, for better or for worse. High household debt levels will slow consumer spending. However, higher interest rates also have the potential to trigger a stronger currency. That would reduce the value of exports.

Taking advantage of higher rates is tricky

At this time, some investors may be looking to take advantage of niche strategies like GIC laddering. But that’s not what we would recommend. As I noted to the Globe & Mail, this can hurt an investor’s liquidity. “If you are invested in a GIC, you are subject to its terms, which may prevent access to the initial capital until maturity,” I said.

It’s better to focus on short-duration, high-yielding, low-risk investments such as high interest savings accounts, mortgages, short duration corporate and government bonds. That has been our strategy. It protects investors’ capital while maintaining cash flow.

Rising interest rates can be a good thing in some ways. However, it does tend to reduce boldness in retail investors. After all with the US fed rate increase to 1.75%, closing in on a roughly 2% inflation rate, some will find it safer to just keep their money in the bank. This convergence is happening just as trade volumes have hit typical summer drawdowns, as traders head off to the cottage.

With the inevitable rise of interest rates, we have positioned our portfolios with fixed income ETF’s like VSB and VSC. These can weather the impact better than typical fixed income products when rates rise.

Big oil enjoys a bonanza while Tesla powers through tough times

Energy companies and their investors are enjoying a summer of high prices. We hear growing calls for Iran sanctions, which are adding to supply strains. We could soon be looking at $85 per barrel over the next six months. Saudi Arabia, Russia and other big producers will undoubtedly do what they can to pick up the slack. But of course, it is in their interest to keep prices high:

“Morgan Stanley acknowledges that Saudi Arabia is currently raising output and will likely produce an average 10.8 million bpd in the second half, up from its prior expectation of 10.1 million bpd. It also expects Russia, the United Arab Emirates and Kuwait to pump more oil, but says that will not be enough to balance the market.”

Canadian producers still have no pipeline to the west coast. As such, energy sales to the US go at a discount. Still, passing the $75 per barrel benchmark has been great for domestic energy producers.

Tesla in trouble while Facebook and Amazon forge ahead

Meanwhile, Tesla, the famous company that has banked on an electric future for automobiles, is getting stuck in production potholes of its own making. The company is struggling to maintain production of 5,000 Model 3 vehicles per week. It continues to burn through cash by the billions. As a result, Wall Street made its pronouncement clear. Tesla’s stock dropped 4% in a single day. The share price is down 6%, below $300, since January.

More digital-oriented tech stocks are having better luck lately. Facebook, which faced its own hurdles earlier in the year, rose thanks to positive signs for Instagram’s engagement. And Amazon’s stock is up an astonishing 40% this year. Clearly, tech’s titans continue to push stocks up.

With the positive outlook on oil, our Canadian equity ETF (HXT) have seen a nice uptick this past June. Along the side of outperforming US technology growth stocks, our US equity growth focused ETF, HXS enjoyed some nice gains as well.

Europe and Japan see higher volatility

Europe is still hobbled somewhat by uncertainty over Brexit. That uncertainty has increased volatility. But luckily for the UK itself, a weakening pound may actually boost equities listed on the FTSE 100 “as its multinational companies generate most of their sales in foreign currencies,” according to MarketWatch. The Paris Stock Exchange saw volatility and lower returns for the latter half of June. However, it also saw some recovery of losses in the next few weeks.

Rising US-China trade tensions are destabilizing equities in Asia as well. In particular, the Nikkei (Tokyo stock market) fell about 800 points in the final days of June. However, a bump up in July indicates investors are not too worried by bad trade news.

Emerging markets may soon punch above their weight

Meanwhile, emerging markets are popping up on investors’ radar. Certaintly, returns may currently be underperforming. However, it could be a very convenient time to buy in. As the analysts at Research Affiliates have noted:

We feel the fear. To decide if we ought to abandon our EM equity positions, we examine the risk of a broad EM funding crisis with our frontal cortex rather than with our limbic system. Is the panic peddled by pundits today justified? We think not, for several reasons: First, the global economy has become more stable. Second, EM countries have become wealthier and financially healthier. Third, countries that are under threat, and thus making headlines, compose only a small fraction of the value of EM equity markets. Fourth, the relative valuation of EM stock markets is discounting quite a bit of bad news, especially relative to the valuations of US stocks. And fifth, the instinctive reaction to a 10% correction in the US market is to “buy the dip,” while the instinctive reaction to a similar decline in EM is contagious fear.

The global decline of risk

Investing abroad isn’t as much of a risky business as it used to be

The key point here is that risk is a different animal than in the 1980s. Back then, a corrupt Banana Republic could wipe out profits with a stroke of an executive pen. They could nationalize industries or default on IMF loans. Today, more countries seem to understand the incentives of playing by global rules of economics and trade. That’s notwithstanding the current position of the USA.

And as the old saying goes, buy low, sell high. Think about the volatility we’ve seen lately. Understand that we may be in the latter stage of an economic cycle. As such, now may be precisely the time for investors to buy into up-and-comers. Think about Latin America, Eastern Europe and elsewhere. Certainly, we are looking at diversifying holdings in certain emerging markets.

Market update. Conclusion

With the recent tariffs and trade noise, volatility has predictably ticked up. However, we continue to manage our portfolios with the goal of reducing risk through diversification. That’s a proven strategy to preserve capital while growing wealth over the long term.

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