Commentary October 2019

Reblogged from First Sovereign Investment Management

As summer turned to fall the US trade negotiations with China took centre stage since a scheduled October negotiators’ meeting was fast approaching. Onto that was layered the President Trump impeachment possibilities stemming from President Trump and his footmen’s discussions with Ukrainian leadership.

Bonds and Interest Rates

Contagion is likely the best word to describe the bond market’s focus. With respect to US economic statistics, there seems to be a smattering of both positive and negative signals. Bond market participants are trying to assess the extent of the contagion from US trade wars on the US consumer and other economic segments around the world.

Over the summer there was concern that the US consumer was getting “exhausted” i.e. consumer confidence faltering and consumer spending faltering along with it. Often the investment media talk about “Risk on” and “Risk off” trades. By “Risk on” they mean investors shifting from bonds to equities and “Risk off” refers to an investor trend to sell equities and buy lower volatility bonds. You can see in Figure 1 that early in the summer bond prices rose up as the “Risk off” mood dominated. Then the White House, worried about the consequences, released an increasing number of positive tweets regarding the China negotiations’ progress. Suddenly the investment community became more at ease. The result: bonds sold of dramatically from about August onwards. Skittish short-term traders became believers again. Notice the muted effect in high yield bonds because those bonds are not nearly as effective as the others for de-risking in moments of trader hesitancy.

Now (as of the time of writing) there is apparently a first stage deal in the offing between the US and Chinese governments. Indications are that this really doesn’t amount to much of a deal at all, with China merely agreeing to some agricultural purchases and the US agreeing not to continue raising tariffs for the moment. Essentially it looks like a “deal” to let the Trump administration save face and claim some sort of victory as the US elections approach. In reality there seems to be little substantive progress on the major issues of concern to corporate America and to the US government in the broader sense (i.e. intellectual property protection, Chinese government involvement in business, etc.)

If the “deal” is enough to ease any concerns of US consumers then there is a chance for continued economic growth however given the trade tensions Corporate America has essentially put their investment spending on ice and they can certainly look beneath the surface. Even though corporate investment spending is not as much of an economy driver as the consumer, I expect that corporate spending will remain muted and therefore it will be tricky for the economy to muster much of a growth mode from here. Although the Federal Reserve is hinting that interest rate cuts are done for now, I don’t see any increases on the near horizon. Cutting to the chase, this means that with respect to bond investing, there will likely be an opportunity to re-enter the bond market (or fixed income proxies) during the current bond pullback.

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


The US Dollar has been strengthening against the Canadian Dollar and against a basket of other currencies (see Fig. 2 below) for a couple of years now. In 2019, however the US Dollar trend has roughly flattened against the Canadian Dollar. To a certain extent this has been because the US Federal Reserve has had to lower interest rates while the Bank of Canada has been more able to stand pat on rates. This changing interest rate differential between the USD and the CAD provided some support for the CAD remaining steady vs the USD while other currencies have continued to struggle against the USD.

Looking around the corner, we could see renewed strength of the CAD versus the USD because there is more of a tilt toward boosting interest rates in Canada than there is in the US. Nonetheless, the impact will not be significant enough for it to be driving investment portfolio decisions.

Fig. 2: US Dollar Index and Canadian Dollar versus the US Dollar – 2 years

Stock Markets

The rebound from Dec 2018 experienced by most markets around the world took a breather from about June onwards. While the US market has risen higher, as of mid-October we had not seen much progress in equity markets in Canada, the UK, Japan, or Germany. There is potential for the US success to spread more broadly but it would really take a reinvigorated Europe for meaningful acceleration of markets around the world (since Europe and the US combine to dominate global demand for many goods). The challenge is even more evident when considering that in the US some highly successful technology stocks have dominated overall stock market returns. This is an industry where some American goliaths dominate global commerce with few rivals around the world. Hence the challenge of economic strength spreading to Europe (where tech counterparts are few and far between) seems a long shot.

At the same time we are witnessing a fading of auto sector performance. After recovering from the 2008 trough, worldwide car sales rose to 77 million units in 2016, peaked at 79 million units in 2017 and are expected to fade back to 77 million in 2019. That fading certainly impacts German exports of cars and also exports of factory equipment from Germany, Japan, and other places where this industry dominates. Thus it seems the economic strength will not spread globally and to industrial sectors any time soon.

Fig. 3: Equities: USA-purple, Canada-blue, Japan-red, UK-yellow, Germany-green – 2 years

Despite auto sales weakness, the US consumer seems to be holding up in other parts of the economy such as housing. Thus we should expect strength in some sectors in the months ahead.

Respectfully submitted,

Paul Fettes, CFA, CFP
Portfolio Manager, RN Croft Financial Group
CEO, First Sovereign Investment Management Inc. and Efficertain Corp.

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