Q2 2016 | Market update
Sadiq S. Adatia
Chief Investment Officer
Opinions as of July 4, 2016
Brexit vote is the story in Q2
The possibility of the U.K. voting to leave the EU on June 23 was always there, but most investors (and pollsters for that matter) did not really see it happening. The resulting shock sent equity markets around the world into a tailspin, at one point erasing over US$2.5 trillion in value.
Not surprisingly, it was the European markets that felt the biggest pain, dropping almost 9% the day after the vote. While the impact of the U.K.’s decision to leave is still not fully known, the short-term outlook is uncertain and the long-term view is not very promising.
Canadian GDP scorched by forest fires
The raging forest fires that destroyed parts of Fort McMurray were the main story in Canada, and their negative impact will likely be felt in lower Q2 GDP numbers. But with oil production coming back on line, along with the economic stimulus from the rebuilding of Fort McMurray, it may help improve GDP numbers in the second half of the year.
A timely surge in oil prices has helped stabilize Canada’s economy, giving energy companies and the Bank of Canada some much needed breathing room.
Half way through the year the S&P/TSX continues to be the bright star among equity markets up 5.1% in Q2. The rebound in the energy and materials sectors was the main reason for the strong performance this year (see Chart 1).
S&P/TSX Composite Index stands out
The Fed may be on hold for now
The Fed’s dot plot (a survey of Fed governors on the timing of interest rate increases) indicated that there could be as many as four rate hikes in 2016. But we’re half way through the year and we still do not have one, and when the negative fallout from the U.K. vote is factored in, this may not necessarily be a bad thing. However, the uncertainty around rate hikes adds more confusion to the markets, and we still hold the belief that at most, one U.S. rate hike may be all we get this year.
The U.S. economy continues to hold up well, but some of the economic data remains mixed with the S&P 500 ending the quarter up 2.5% in U.S. dollars.
And it’s hardly a surprise that the MSCI EAFE Index ended the period with a loss of 1.2% in U.S. dollars. The EURO STOXX 50 Index also declined 1.9% in local currency.
The MSCI Emerging Markets Index ended up 0.8% in U.S. dollars. Chinese (H) stocks increased by 0.3% in U.S. dollars and India had a positive return of 7.2% in local currency.
Canadian bond yields go lower
North American bond yields continue to be quite volatile and ended the quarter lower again. Canadian 10-year government bonds started the quarter at 1.22%, and were as high as 1.55%, before ending the quarter at 1.06%. The uncertainty around global markets should keep them low for most of the year.
With the Fed still pausing on raising rates, we saw U.S. 10-year government bond yields decline from 1.76% to 1.44% during the quarter. We expect yields to slowly move higher as the Fed raises rates over the coming years.
Canadian equities holding their own
Once again when adversity hit world markets, Canada stood out. While our economy may not be what it once was, our safe-haven assets like precious metals have helped us stay on top of world markets. That, and an oil-price rebound pushed energy stocks higher, helping the S&P/TSX Composite Index into positive territory in Q2 (see Chart 2).
Materials and energy sectors continue to shine
Even though oil prices continued to move higher by more than $10 a barrel, the Canadian dollar was little changed. This highlighted the fact that for the dollar to move higher, oil prices need to move significantly higher or interest rates in Canada and the U.S. have to move in a different direction. We still feel that the Canadian dollar is fairly valued and so do not expect much change from here.
As noted, the Fort McMurray fires will have a negative impact on the economy in Q2, but it will likely bounce back in Q3 and Q4.
While we are not convinced that Canada’s economy is out of the woods yet, we do see some stabilizing and the rebound in oil prices will be helpful. We are now actively looking for opportunities outside the energy sector, but as usual we need to ensure the risk/reward tradeoff meets our criteria.
Political risks could impact the U.S. economy
U.S. equity markets could not avoid the downturn brought forward by the Brexit vote. But, like most other markets, U.S. equities rebounded two days later, recouping most of what was lost by quarter end. The economy remains mixed with job numbers disappointing last month. Though we feel that this was more of an anomaly than a trend, we still feel that the economy is slowing down a bit. Because of this, we think the Fed will continue to remain cautious and our expectation is that one rate hike (if that) might be all that the markets will get this year.
The biggest uncertainty still surrounds this fall’s U.S. presidential election. The outcome will determine what’s in store for the U.S. in coming years, but we think that whoever wins will likely impact growth in a negative way.
All bets off for eurozone and U.K.
Whatever happened prior to June 23 is no longer relevent. Everything now will be focused on how the U.K. and the eurozone deal with their divorce.
While the Brexit triggers uncertainty and slower growth for the eurozone (and more so for the U.K.), it will take some time for all this to play out. Hence there may be some short-term opportunities given the pullback. However, the dust needs to settle first and moving slowly may be the right approach.
Not the time to be bullish on emerging markets
With a risk trade somewhat mixed at the moment, emerging markets will have a difficult time moving significantly higher in the short term. Even though they held up relatively well in Q2, we’re not sure where they are headed in Q3. As well, China should be back in the news and likely not in a good way.
Outlook: Opportunities will emerge
Significant volatility emerged just as the quarter ended sending markets down sharply for a few days before letting up by quarter end. We think some markets have overreacted and that will likely create some good buying opportunities for longer-term investors. However, in the short term we could see markets head lower again.
We have not changed our view that the U.S. economy is still on solid ground. The eurozone and U.K. will now have to deal with their divorce, and unfortunately, this will cost both economies some growth. However, we think the magnitude of the pullback that occurred may have been too severe, but this is an unprecedented event so one can never be sure of its full impact.
At home, things continue to be improving but that does not mean things are great yet. As we head into the second half, we do see some potential opportunities within Canada.
The Canadian dollar is valued close to US$0.77 cents and we do not see this moving significantly in either direction.
Though we feel the opportunities are better now than before the last quarter, it still does not mean there are screaming buys across the board. As such, careful analysis needs to be done before we deploy cash. There is no rush and we will continue to keep protection at the forefront of what we do.
This commentary contains information in summary form, for your convenience, published by Sun Life Global Investments (Canada) Inc. Although this commentary has been prepared from sources believed to be reliable, Sun Life Global Investments (Canada) Inc. cannot guarantee its accuracy or completeness and is intended to provide you with general information and should not be construed as providing specific individual financial, investment, tax, or legal advice. The views expressed are those of the author and not necessarily the opinions of Sun Life Global Investments (Canada) Inc. Please note, any future or forward looking statements contained in this commentary are speculative in nature and cannot be relied upon. There is no guarantee that these events will occur or in the manner speculated. Please speak with your professional advisors before acting on any information contained in this commentary.
© Sun Life Global Investments (Canada) Inc., 2016. Sun Life Global Investments (Canada) Inc. is a member of the Sun Life Financial group of companies.