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Here’s What We Are Thinking

04/20/17

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

Market Watch: Global Update

02/17/17

Big Picture

By Andrew Trimble

 

Global growth gains momentum 

It was an eventful week filled with encouraging news about global economic growth. In the U.S., data released Wednesday showed better-than-expected retail sales for January, firming inflation and factory production rising. Taken together, the data points extend an upward trend in real economic activity south of the border. Coincidentally, the prints came in the same week Fed Chairwoman Janet Yellen indicated the bank’s willingness to raise interest rates due to the progression in jobs gains and inflation. The chances of a Fed rate hike in March have now doubled to 1 in 4 according to futures tracked by CME Group. Turning to China, consumer prices increased 2.5% in January from a year earlier, the fastest pace in two years. The Producer Price Index also notched a five-year high as factory prices jumped 6.9% versus a 5.5% rise a year ago. The releases point to stirring inflation in the world’s second largest economy which gives the PBOC some wiggle room when it comes to stimulus measures. Elsewhere, the European Union on Monday raised economic forecasts for 2017 predicting growth across the bloc despite political risks and uncertainties. The EU estimates the 19-country single currency union will grow 1.6% this year, an increase from 1.5%. If current, longer-term projections hold through 2018 it will mark the first time since 2008 that all member states have recorded increases in GDP. When it came to the U.K., growth is expected to rise to 1.5% for 2017 versus a previous estimate of 1.0%. Finally, the European Parliament green-lighted the Canada-European trade pact Wednesday with it now moving to European national Parliaments and the Canadian House of Commons for final approvals. Looking ahead, U.S. and Canadian stock markets are closed Monday, February 20.  

 

Markets

Stocks march higher

Major North American stock benchmarks extended their record-closing streaks this week although some – the S&P 500 and Nasdaq – lost steam over the course of Thursday’s session. For the four days covered in this report, the Dow added 350 pts. to close at 20,619, the S&P 500 moved ahead 31pts. to settle at 2,347 and the Nasdaq rose 80 pts. to end at 5,814. The TSX finished 135 pts. higher to close at 15,864 Thursday, a record high for the fifth day in a row. 

 

Equities/Strategy

Reloading on equities on material pullbacks

Strategy: Year-to-date major stock indices have ground out healthy gains amidst generally tight trading ranges and low volatility (S&P500: +4.8%, TSX: +3.8%, MSCI EAFE: +4.5%). In fact, the equity implied volatility index (better known as VIX) hit a near-10 year low on February 1st at 9.97.  The quiet that has fallen over markets stands in stark contrast to the growing uncertainty and unpredictability in the stance of the new U.S. administration on key policy issues such as geopolitical alliances, import tariffs, immigration, tax cuts, infrastructure spending, etc. In particular, political momentum seems to have waned recently as the President’s popularity suffers from recent controversial actions and comments which are weighing on tax reform prospects (a key to market expectations for stronger earnings growth this year and next). As well, investors are contending with rising geopolitical risks in Europe with nationalists, hoping to follow Britain out of the EU, leading in polls heading into elections in the Netherlands (March) and France (April). Rising headline risks combined with profit-taking pressures may leave the market vulnerable to near-term disappointment to U.S. policy or geopolitical developments. However, given economic data trends remain positive, with recession risks relatively muted over the coming year, we would view any material pullback (5%-10%) in equity markets as another opportunity to reload on equities and cyclical exposures for those who had missed out earlier.

Investment Fees and Costs

02/07/17

The investment fees and costs you pay will depend on the types of investments you make and how you purchase them. The costs will have some impact on your returns, so it is important to understand how much you are paying and what for. You can then decide whether the service is worth the cost.

Most fees and costs relating to investments fall into five categories:  costs to buy an investment;  costs when you sell an investment;  investment management fees;  financial advisor fees;  administration fees for registered plans.  Not all types of costs apply to all investments. In some cases, costs such as sales commissions are included in the price you are quoted to buy the investment. This is generally the case for bonds.

Costs to buy an investment

If you buy investments such as stocks and exchange-traded funds, you will usually pay a trading fee every time you make a purchase. For this reason, it is better to limit the frequency of your purchases. Brokerages and investment firms set their own fees, so the amount will depend on the company you use.

For “no load” mutual funds, there is no fee to purchase units.

Other mutual funds charge “front-end load” fees when you buy them. The fees are generally a percentage of your purchase price.

 Costs when you sell an investment

With some mutual funds, instead of paying a fee when you buy the investment (“front-end load” fee), you pay a fee when you sell. This is known as a “back-end load” fee.

The fee is generally a percentage of your selling price. It is normally highest in the first year after purchase and gradually decreases for every year you hold the investment. If you hold the investment long enough (often for several years), the fund dealer might agree to waive the fee. Think carefully before agreeing to buy funds with back-end load fees because the fees come out of the selling price of the investment and can be as much as seven percent if you want to sell in the first year.

 Investment management fees

Investment funds, including mutual funds and segregated funds, charge a fee for managing the fund. The fees are called the Management Expense Ratio (MER) and may include an ongoing commission paid to advisors who sell the fund to their clients. The MER is paid regardless of whether the fund makes money. It is deducted before calculating the investor’s return.

Advisor fees (how advisors are paid)

Advisors are paid in different ways, depending on the type of service they provide. For example, an advisor helping you put together a financial plan might be paid an hourly fee, whereas an advisor making trades on your behalf might be paid per trade.

If you plan on using the services of an advisor, it’s important to know exactly what kind of services the advisor provides and the cost as well as how the advisor is paid.

While most advisors strive to give good advice, advisors who are paid by commission have an incentive to encourage you to invest where they will earn the highest commission. Those who are on salary, on the other hand, may have an incentive to promote what their employers offer. Ask for information on your investing options and fees before you purchase any investment product.

Administration fees for registered plans

When a bank, brokerage firm or other financial institution sells a registered product such as a registered retirement savings plan (RRSP) or a tax-free savings account (TFSA), the Income Tax Act requires the product to have a trustee.

Investors generally have to pay an administration fee (also known as a “trustee fee”) for the services the trustee provides—for example, filing the necessary documents with the Canada Revenue Agency. In certain cases, if the overall value of a portfolio is above a certain amount, the company that holds your plan may waive the fee.

 

Source: Financial Consumer Agency of Canada

Client Relationship Model

02/07/17

ScotiaMcLeod®, a division of Scotia Capital Inc.

In recent years, a number of countries, including England, Australia and the United States, have changed the regulatory framework that governs their financial institutions. Included have been changes to formalize client communications and create greater transparency in fees. In part, these changes were the outcome of the global financial crisis of 2008-2009 – and while institutions in Canada faired relatively well, we will be implementing similar reforms here at home. Some changes have already been made with the remainder being phased in over a three year period.

Building upon existing requirements that help to ensure fair and honest dealing with clients, the Investment Industry Regulatory Organization of Canada (IIROC) has introduced the Client Relationship Model (CRM). At its core are three key principles designed to enhance investor protection and strengthen the client-advisor relationship:

Transparency regarding the relationship between the client, service provider and firm (e.g. information on account types, services provided, transaction and account fees);

Transparency surrounding performance of the account;

Disclosure of any conflicts of interest.

Additional information on CRM, including its history, can be found on the IIROC website (www.iiroc.ca), link on page bottom

What will this mean for you?

Because the fundamental principles of CRM are a core part of the way we have always tried to serve our valued clients, many of the changes may not be perceived. While in other cases the changes may be apparent, but will not fundamentally change the advisor and client relationship at ScotiaMcLeod. How this affects you will depend upon your specific situation, include your account types and the securities that you hold.

Significant changes have already occurred in the areas of understanding your risk profile and investment suitability. In some cases, paper work and documentation requirements have increased, but in general the challenges in implementing the new regulations are operational in nature that are borne by the institution.

Your advisor is the best point of contact to explain how CRM relates to you and your specific portfolios and accounts. As the components of CRM are implemented over the next three years, additional information will be provided in person and in writing.

We are proud of the depth of expertise and wealth management service we provide. Furthermore, we expect the core principles of CRM will be a benefit to investors and will enhance the ongoing relationship between clients, advisors and ScotiaMcLeod.

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