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Here’s What We Are Thinking


The Investment Committee of the Portfolio Advisory Group meets regularly to formally discuss markets, sector allocation and investment recommendations. Below is a brief synopsis of our current views. For specific investment strategy relating to your investment portfolio, please contact us.

Investment Strategy: Global market backdrop remains constructive; shifting to overweight growth sectors

Global markets since early March have continued to trade with a mildly cautious tone following strong gains of the past year. A period of consolidation should be expected as profit-taking sets in, economic forecasts catch up to the recent firming in activity data, anticipated timelines for President Trump’s pro-growth legislative agenda lengthen and geo-political noise picks up on a multitude of fronts.  Given this bout of market volatility has been quite mild (S&P500: -2%; TSX: -1.7% from their late February – early March peaks) and orderly thus far, there is scope for further modest consolidation over the remainder of the second quarter within the normal bounds of this late-stage bull market. To be sure, economic fundamentals remain on solid footing
with the global recovery broadening out to Europe and Asia with particularly encouraging data out of China in recent weeks. Thus, the medium-term backdrop for global markets remains constructive and we see any second quarter market pullback as an attractive opportunity to put cash to work.

Equities:  The expectations for the current reporting season are for the strongest YoY earnings gains since Q3’11 for the S&P500 index. (Q1’17 expectations: EPS +9%, Rev +7%) The lack of downward revisions by analysts leading up to the earnings season leads us to believe the actual earnings surprise should be less than usual (average 5yr surprise is roughly 4%). The
year-to-date weakness in the U.S. dollar is expected to give a boost to large cap (multi-national) earnings going forward as evidenced by the recent strength of large cap stocks over small caps. In our opinion, the macro backdrop (rising global PMIs, improving confidence, rising wages, improving utilization rates) is still supportive of the case for stocks over bonds.
As for the market, the recent rise in the VIX Index (volatility measure)  has created an opportunity for sidelined money to get invested as we still hold on to our bullish multiyear view. Although the pullback might not be as large as some would have liked, the market in our opinion has worked off a decent amount of the near term excesses as illustrated by various sentiment indicators (bond short positioning, equity put-call ratio etc.).

With the US 10-Treasury yield tracing back a portion of the massive move from 1.35% (July’16) to 2.60% (March’17), we believe the consolidation has been orderly and mostly technical in nature. Any setback in the reflation trade is a benefit for growth investors, hence our previous neutral stance. We are now formally raising growth sectors (tech, consumer discretionary, health care) to an overweight but still hang on to our value bias as the recent weakness has created an ideal entry for those that missed the initial run from the summer. We don’t see any deflationary threats and will continue to underweight defensive/interest-rate sensitive sectors.
Regionally, we still prefer International markets over North America, as discussed in several of our recent publications, despite uncertainty surrounding the French elections which has noticeably kept investors on the sidelines. As a result, European markets now trade even cheaper with fundamentals continuing to improve (better earnings growth, stronger PMIs, better economic surprises indices, stronger Euro).
 Fixed Income: Once again, the fixed income market is telling a tale of two sectors. Over the past two weeks, government rates have traded in risk-off fashion on a mixture of soft data, comments from U.S. President Trump and geopolitical events.  However the Canadian corporate market didn’t notice as spreads continue to fall. Spreads on A and BBB-rated corporate debt keep making new 1-year lows. In fact, the BBB sector is approaching the lowest government spread level of the past five years, and when compared to A-spreads is the lowest since at least 2007. Thus we believe A-rated Canadian corporate debt could provide better value at the moment, especially if rates increase as expected. We would also recommend keeping cash available to purchase BBB debt if a correction takes place as we continue to believe corporates will outperform as the output gap continues to close.

Preferreds: Up until this week, the preferred share market had all but ignored the plummet in underlying bond yields over the last month. Investors seem to have ignored the recent yield weakness, and focused on the more medium-term outlook for further tightening monetary policy action in the U.S., an improving global economic backdrop and recent stronger-than-expected data out of Canada.  However, with the 5-year Government of Canada bond yield breaking below the 1.00% level this week touching its lowest point (0.98%) this year, the market has started to weaken over the last several trading days. We see weakness in the market as an attractive buying opportunity for the medium to longer term investor as we still think that yields will be higher by year-end and through 2018. This should help to bolster rate reset prices going forward as investors start to price in a higher base rate.  However, that is not to say that lower yields in the
short-term are not to be expected alongside heightened geopolitical risks surrounding European elections and/or North Korea. We still favor rate reset preferred shares for the medium to longer-term investor with the expectation of higher yields in Canada over the next 12-18 months.

Currencies and Commodities: U.S. production concerns weigh on WTI; CAD weaker, but range bound

West Texas Intermediate (oil) has taken a turn lower following today’s inventory numbers, wiping out its ~4% gain since our last report (April 4). The U.S. Energy Information Administration (EIA) reported this morning that oil inventories declined 1.03 million barrels last week, which was in line with consensus expectations and follows up the previous week’s better-than-expected
2.2 million barrel draw (vs consensus of -772k). The consecutive weekly drawdowns are two of just three declines this year, which in our view, is constructive for WTI. However, investors appear to be focusing on the rise in U.S. gasoline supplies, which rose for the first time in nine weeks as well as U.S. production that continues to increase. U.S. oil production reached 9.25 Mbbls/d as of last week, outpacing the EIA’s production forecast which expects U.S. oil production to exit 2017 at 9.6 Mbbls/d. While we admit oil prices may remain volatile over the nearterm given the continued rise in U.S. production, the supply/demand imbalance continues to improve on the back of improving global demand and the OPEC/non-OPEC member supply cuts. The committee monitoring OPEC’s supply agreement reconvenes in late April and could possibly recommend extension of the supply curtailments, with a final decision to be made by the group on May 25.
The Canadian dollar has displayed some weakness since our last report, down ~70 bps relative to the USD. Despite the move higher in crude over the last two weeks (until today’s decline that is), a slightly more optimistic sounding Bank of Canada in its latest Monetary Policy Report released last week, and a better-than-expected manufacturing sales print for February, it appears recent trade related headlines (dairy regulations, softwood lumber), along with weaker base metals prices (since Apr 4 – copper down 3%, nickel down 5%, zinc down 7%) may be weighing on the CAD quote. Nonetheless, the CAD/USD remains within our near-term $0.725 – $0.775 range.

Economics: The Bank of Canada remains cautious despite revising up growth and inflation forecasts.

The Bank of Canada left rates unchanged at its meeting last week, but sounded less dovish at the press conference after the rate decision. The central bank is getting a bit more optimistic about the overall economy, and it upgraded its growth and inflation forecasts and brought forward the timeline for the output gap to close to 2018 H1. The Canadian economic growth in 2017 was revised up sharply to 2.6% from 2.1% previously, however the growth in 2018 was revised down to 1.9% from 2.1%. Scotia Economics is seeing an expansion of the Canadian economy of 2.3% this year and 2.0% next year.  Despite revising up its growth forecasts, the central bank remains cautious about the sustainability of recent growth as the BoC expects a more balanced growth from exports and business investment which we are still far away from. The inflation forecast for Canada was revised up as well to 1.9% and 2.0% in 2017 and 2018 respectively (Scotia Economics projects 2.1% and 2.0% for this year and next).  Although the central bank revised its forecasts for the country’s key economic indicators, the BoC remains cautious as it said “it is still too early to conclude that
the economy is on a sustainable growth path”.  Although the probability of a rate cut diminished, according to Canada Overnight Interest-Rate Swaps, we are also not seeing a rate hike anytime soon at least not until Q2 next year as expected by Scotia Economics.

Geopolitical: North Korea in Focus

On April 5th, U.S. President Donald Trump hosted Chinese President Xi Jinping for a two day meeting.  However rather than discussing China’s activities in the South China Sea or China/U.S. trade relations, the focus was North Korea. The communist country was front of mind as it had just completed its third ballistic missile test of the year, only nine months after performing its latest underground nuclear test.  The action has prompted China and the U.S. to work together to find a solution. China has turned back cargo ships from North Korea and said it is open to “strict limitation” of oil exports to the country. In return, the U.S. has backed away from its claims of currency manipulation by China (a stark contrast to its previous stance). Complicating the matters further was a tweet by the U.S. President indicating his country would be willing to “solve the [North Korea] problem” unilaterally. This statement has certainly been backed up with evidence of recent U.S. military action in Syria and Afghanistan but also the dispatch of a carrier strike group to the Korean peninsula. At this point, the world will be watching North Korea for any further military action, and the potential response from the U.S. and China.
If the U.S. “goes alone” with military force, it has the option for a single strike on North Korean military infrastructure or a wider-ranging campaign. However if the Chinese and Americans continue to work together in earnest, not only are the outcomes more complex for the target country, but the rest of the world. Co-operation could change the landscape for trade between the two countries and in turn the global marketplace. In the meantime, U.S. Vice-President Pence is on a 10-day tour of East Asia to – among other things – ease any uncertainty among U.S. allies. Next steps will likely be dictated by the North Koreans, but any threat of military action and global intervention would be grounds for risk-off moves in markets.

Recommended Strategic Asset Allocation

60% Equities: 30% Canada, 25% USA and 5% International

40% Fixed Income: 20% Government, 5% Provincial, 10% Corporate, 5% Preferred Shares

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