Market Commentary – Q1 2018

In January we experienced the first correction in the stock markets for over a year, after experiencing a year of abnormally low volatility combined with strong returns in the US, international and emerging markets equities. The TSX dropped 10% from January 4th to February 9th and the S&P 500 fell 11.8% from January 23rd to February 9th; since then, we have experienced numerous occasions of massive point swings from one day to the next.

Besides the markets being at very high valuations and needing a rest, Trump’s tweets regarding tariffs are at least partly to blame for the increased volatility. Trump imposed tariffs on solar panels and washing machines on January 23rd and the stakes were raised again on March 1st with Trump’s tweet about 25% tariff on steel and 10% on aluminum. Recklessly calling trade wars easy to win and targeting Chinese imports with $50 billion in tariffs does nothing to help market confidence and conjures up fears of the Smoot-Hawley tariffs of 1930 that many blame as exacerbating the effects of the Great Depression.

We believe there is high probability of continued volatility in the coming quarters, however, given the numerous risks the market faces it is difficult to assess if we will stay in the current trading range or if we may make new lows.

Canada – The S&P/TSX Composite gave up all of its Q4 gains in the first quarter, falling 4.5% with small cap leading the down, falling 7.7%; value fell 4.8%, large caps fell 4.6% and growth stocks fell 4.2%.

United States – What a difference a quarter makes! Last quarter’s strong returns were replaced with increased volatility and significant market declines and advances. US stocks as a whole lost 0.6% while value stocks were the worst hit dropping 2.8%; large caps lost 0.7% and growth fell 0.2%. The only bright side were small caps which were up 1.5%. When converted to Canadian dollars, stocks advanced 2.3%; large caps were up 2.2%, small caps gained 2.7% and growth returned 4.4%, while value broke even.

International & Emerging Markets – International and emerging markets posted small gains in Canadian dollar terms. Both international stocks and large caps were up 1.4% each, with small caps up 3.2% and value advancing 1.0% Emerging markets was the best performer this quarter up 4.4%.

Alternative Fixed Income – The alternative fixed income funds shone this quarter as the outlook for at least three further rate increases from the Fed over 2018 weighed on bonds. Canadian bonds barely rose, advancing just 0.1% while SAIF lead the way up 2.4%, followed by Trez up 2.2%, Productivity Media up 1.7% and Cortland up 1.4%.

Gold – We continue to hold gold as a hedge as we feel there continues to be multiple risks that warrant a small allocation: The nerve agent row between the UK and Russia that has so far resulted in dozens of diplomatic staff expelled in many countries; the Syrian chemical gas attack that will most likely result in a military response from Western powers and the Russian threats if that happens; the apparent US-North Korea summit, the high potential for its failure and the extreme risks that could result now that Trump’s National Security Advisor advocates preemptive strikes against North Korea.

Economic News

Canada – 2017 was a great year for Canada which saw real GDP grow 3%, however, 2018 has been off to a slow start, which could see the projected 2.5% growth for this year scaled back. The good news is that growth is expected to pick up considerably in the coming quarters, but with the caveat of a favourable outcome to NAFTA.

Inflation is starting to pick up as February’s core number came in higher than expected at 2.03%, which is a 6-year high. This is not a surprise as rising wages, including the effect of higher minimum wages in several provinces, will force companies to raise prices on their goods and services. This puts inflation right at the Bank of Canada’s target of 2% and should prompt a couple of rate increases this year, although NAFTA will certainly have an impact as to the degree and timing of such increases.

US – The US economy had a strong finish to 2017 and averaged 3.0% growth in GDP in the last 6 months, but Q1 has slowed to likely less than 2.0% annualized growth. The slowdown is expected to be short lived as growth should pick up again in Q2 and Q3.

Inflation finished 2017 at 2.1% and is forecasted to increase above 2.5% in mid-2018. As a result, the Federal Reserve will likely raise the Fed’s Fund Rate two more times to end the year at 2.25% from the current 1.75%. Th

However, the immense budget deficit that is projected to surpass $1 trillion in 2019 will eventually come home to roost in the form of spending cuts and tax cuts that will have negative effects on future growth. This will bring real interest rates back into positive territory, but shouldn’t have a profound negative impact on the economy. However, things are not all rosy given the unpredictability of the government and especially the recent talk of tariffs and trade wars. There is a risk that a weak and disorganized Congress may not resist Trump’s impulses to dismantle international trade deals and impose tariffs based on ignorant opinions about trade deficits. Americans are insatiable consumers and the only sure way to lower trade deficits is a sharp recession that lowers consumption and boosts savings – something that is possible if the current trade rhetoric degrades into a full-blown trade war that puts millions of US jobs that are dependent on trade in jeopardy.