Commentary October 2018

Reblogged from: First Sovereign Investment Management

This summer markets were heavily influenced by central bank activity, raising interest rate outlooks, as well as continued geopolitics related to the US connections to NAFTA, Iran, and China. Later some stabilization emerged but overhanging factors still linger.

Bonds and Interest Rates

Bond prices trended lower this summer, most notably in government issues (of which we own none). The domestic US economy has been strong, with rock bottom unemployment rates and solid growth. Various factors like this have urged the US Federal Reserve to raise interest rates and when rates rise bonds fall. There had been some sentiment that US rate increases may be subdued relative to initial expectations due to trade concerns. Similarly, in Canada NAFTA worries along with other factors led the Bank of Canada to hold back on interest rate increases but now that NAFTA 2 has been negotiated (officially the USMCA) the interest rate outlook has risen on both sides of the border.

Figure 1: Bond ETFs: Governments (XGB), Corporates (XCB), High Yield (XHY) – 2 years

Will it continue? One remaining big question mark is the US trade situation with China, in two senses. The US government is enacting gradually rising tariffs against China and vice versa. First of all, if there is no budging on either side then those tariffs will put the brakes on global trade and somewhat slow down global growth. Furthermore, because US tariffs against China are intended to rise this January, there has been a massive rush to get Chinese-made goods imported into the US before the tariffs hit. This has shown up in very busy ports, container shipping, and railways in the US. Essentially various industries are stuffing the retailers and US distributors with tons of inventory before January. This “stuffing the channel” as they call it is somewhat “pulling forward” into this summer and fall US industrial activity that should have been happening this coming winter and so no matter what happens with the US-China negotiations we should expect to see US-China trade fall off dramatically in the winter to levels below last year. Thus, the current “strong economy” numbers in the US are likely a little overstated! As a result, the central bank pace of raising interest rates could ease up until there is a little better clarity on the horizon. In the income-oriented investments, our investment grade corporate bond exposure has been challenged while our holding of a structured preferred share exposure to financials has been a very solid and rewarding performer.


After the weakening of the Canadian Dollar (vs. USD) that started back in September 2017 and continued until about June of this year, the Canadian Dollar has gradually found its footing and risen back up from the $0.75 USD mark this summer. Through the summer there were increasing signs of progress on NAFTA and increasing signs some sort of deal would be consummated. The relief in Canada led to brighter economic prospects and thus increased chances of Bank of Canada interest rate increases. Earlier when it looked like the US was raising rates but Canada was not following suit, our Loonie was weakening but as it became more evident that we would be raising rates here just like those south of the border, our Dollar regained some strength.

Figure 2: Canadian Dollar versus the US Dollar – 2 years

Rising global prices for oil, triggered in part by the US government re-imposing sanctions on Iran, were also contributors but that impact became rather muted. The glut of oil in Alberta with no way to escape meant that Alberta oil prices did not participate much in the global rise. If that changes (for example due to re-approval of the Trans-Mountain pipeline or others), the effects on Canada could be significant, including rising activity in Alberta, rising Canadian oil stocks, a strengthening Canadian Dollar, and further increases in Canadian interest rates. Presently our exposure to the global energy sector is primarily through ownership of an oil co., a pipeline, and a methanol producer.

Stock Markets

While the US stock market and more so the Japanese market rose over the summer, the Canadian and the European markets (as illustrated by Germany) both declined. In Canada we can attribute that somewhat to NAFTA negotiations but also to fears that rising interest rates would pour too much cold water on our economy. Whenever the central bank is raising interest rates stock market investors are jittery about the chance the central bank will go too far and trigger a recession. Indeed, that usually happens so those investors are right to be concerned. As a result, markets often have more fluctuations in the later stages of an economic cycle (where we are now) as investors get skittish.

One noteworthy point is that usually late in the cycle industrial metals do well as global growth creates strong worldwide demand for them. The fact that we have not yet seen the global demand that would drive those industrial metals higher is an indicator this economic cycle is not over yet. There are various geopolitical factors holding back global growth including the US-China tensions, Brexit, Iran sanctions, Venezuela’s declining oil production, and recent concerns about Saudi Arabia. If some of these factors were to abate we would see stronger growth overseas and those markets (Europe, China, etc.) still have enough economic slack to allow for growth whereas the US is bordering on overheated already.

Figure 3: Equities: USA-GSPC, Canada-GSPTSE, Germany-GDAXI, Japan-N225, 2 years

With increased market volatility one impact is often that certain stocks get overpriced versus their future prospects and others get underpriced. I would expect that there will likely be more trimming and rebalancing than typical this fall.

Respectfully submitted,

Paul Fettes, CFA, CFP
CEO, First Sovereign Investment Management Inc. and Efficertain Corp.
Portfolio Manager, Croft Financial Group
Registered Agent, Verico Relance Mortgages, FSCO #10357

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