Q3 2016 | Market update
Sadiq S. Adatia
Chief Investment Officer
Opinions as of Oct. 7, 2016
Markets moved sharply higher in Q3
Unlike previous quarters, there really wasn’t much in the way of significant headline news. Even so, markets moved sharply higher and this was a bit alarming because there was no real reason for such a big move.
International and emerging markets played catchup in the quarter and were among the stronger markets. The impact of the British decision to leave the European Union continued to be a wildcard, but investors seemed to realize that in the short term at least it should have minimal impact. At the same time, emerging markets benefitted from the U.S. Federal Reserve’s decision not to raise interest rates, which helped the value of their currencies move higher.
Canadian economy still struggled
Despite a boost at quarter-end, the price of oil remained close to where it started at nearly US$49 a barrel – which is still not high enough to create jobs in the oilpatch. And the impact of high consumer debt levels started to show, with spending slowing down. So no one was surprised when the Bank of Canada left interest rates unchanged.
Despite some of these negatives, three quarters of the way through the year the S&P/TSX Composite Index continued to be one of the better performers among developed equity markets, finishing up 4.7%. (Chart 1)
Third quarter returns on the S&P/TSX Composite Index, however, were less about energy and materials and more about other sectors. (Chart 2)
International and emerging markets lead
Uncertainty surrounds U.S. political situation
Most of the attention is now focused on what happens to the U.S. economy following the presidential election. As we’ve mentioned in the past, we don’t think the election of Democratic candidate Hillary Clinton or Republican Donald Trump will be great for the U.S. economy, but the market appears to be reacting calmly to Clinton’s candidacy. This is because she is unlikely to move the ship too far off the current course, which the market seems to be content with. Trump on the other hand provides a less certain path, and markets do not like uncertainty. The noise surrounding this is just starting to pick up, so tighten up your seat belts for a bumpy ride.
The Fed continued to stay on hold and the dot plot (a survey of Fed governors on the timing of interest rate increases) is now indicating that interest rates will remain low for a longer period. There is still an expectation that rates will move up slightly by end of the year. And the U.S. political situation will just add more variables to the mix. Overall though, the U.S. economy continues to hold up well with the S&P 500 moving higher during the quarter. (Chart 1)
Canadian bond yields head even lower
Canadian bond yields remain quite volatile and ended the quarter even lower. Canadian 10-year bonds started the quarter at 1.06% and ended at 0.99%. And uncertainty surrounding global markets should keep them low for most of the year.
With the expectation that the Fed will raise rates later this year, we saw U.S. 10-year treasury yields start to move higher from 1.47% to 1.59%. We expect U.S. yields to continue to move slowly higher as the Fed raises rates over the coming years.
Canadian equities move higher
Despite many issues facing Canada, as we noted, the S&P/TSX Composite Index moved higher, but unlike previous quarters it was not the index-dominating commodity sector that led the charge. (Chart 2).
Non-commodity sectors push higher
Given that oil prices didn’t rise from where they started the quarter, it’s probably not surprising that the Canadian dollar was little changed. And with the BoC and the Fed holding the line on interest rates, it kept the dollar range-bound. At this point we believe the Canadian dollar is fairly valued and do not expect much change from here.
While there are many reasons to worry about Canada’s economy longer term, we are less concerned in the short term. For example, in the key energy sector, stabilizing oil prices will be helpful for energy companies, but it won’t necessarily create any new jobs. But OPEC ‘s proposed cut in production, if enacted, would help keep oil prices from moving significantly lower, though not all the details are out yet.
On the positive side, we also think lower interest rates will continue to keep Canadian housing prices elevated and consumers spending – even though it may not be as strong as it was in previous years.
U.S. job numbers rebound
As we predicted, the weak job numbers posted in the U.S. last quarter were an anomaly, with the number of jobs being created rebounding. That said, job growth could slow down a bit in the coming quarters, and that is another reason we believe the Fed will remain cautious.
Eurozone/U.K. divorce gets underway
Both the U.K. and eurozone markets held up relatively well despite their pending Brexit divorce. However, this is not too surprising with the process taking time to play out and both economies were improving just prior to the vote.
We still believe that over the longer term, Brexit will potentially trigger uncertainty and slower growth for the eurozone and more so for the U.K. We were correct in stating that the market overreacted when it fell sharply over the two days following the vote beforebouncing back. With that being said, until we get more clarity on the divorce, we think investors should be cautious.
Very strong quarter for emerging markets
As markets moved higher emerging markets really stood out, and were helped when the Fed left interest rates unchanged and their currencies rose in value. Even the BRIC countries (Brazil, Russia, India and China) saw momentum.
Outlook: Investors should continue to be cautious
The U.S. economy is still is one of the better developed markets out there, but there are signs of a slowdown. Furthermore, there remains uncertainty on the future of interest rates and who will be the next President.
The realignment of the U.K.’s trade relationship with the EU will also add 0 market volatility. And while the recent market rebound in Europe was justified, any significant move higher from here may not be.
At home, we still have serious longer-term concerns but are less worried in the short term. Yes, real estate is a big issue, but with rates remaining low for some time to come, we still see the sector holding at these lofty levels. As such, consumers will think they are better off than they actually are. So spending will still happen, but not at the same pace.
Stable oil prices are badly needed and will help energy companies plan for future growth, but they will still face an uphill battle until prices move much higher.
As for the Canadian dollar, which finished the quarter at almost US$0.77 cents, we do not see it moving significantly in either direction. We don’t expect Canadian bond yields to change much over the next quarter, but to trend slightly higher in the U.S. And this likely means that North American bond markets will have limited upside.
Overall, the current market still requires a cautious approach and the patience to wait for the right opportunity to invest.
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.