The most significant development since my last quarterly update has to be the Canadian Loonie taking flight after the Bank of Canada abruptly changed its tune on interest rate policy last month. Prior to the middle of June, the Bank of Canada had been consistently telegraphing the markets to expect no interest rate increases until the back half of 2018. Then, seemingly out of nowhere, they floated the idea over a lunch presentation that it may be time to start thinking about raising interest rates. A couple of weeks later, the Bank of Canada did just that which seemed to have caught the greatest amount of market participants on the wrong side of the trade resulting in a buying stampede into the Canadian dollar. At the same time, the USD has been experiencing some weakness of its own, especially against the Euro but against other currencies also. All of this has conspired to carry our Loonie higher by some 8% in just a few weeks which has been a breathtaking development.

 

The Bank of Canada cited “robust” consumer spending as proof of an improving Canadian economy. This despite the fact that Western Canada is still suffering from weak oil prices that have yet to recover from the collapse that occurred 3 years ago. So what is behind the robust consumer spending? I strongly suspect that it can be traced back to what many are quick to label a housing “bubble”. Too much ink has been spilled on this topic already so I will be brief. For the record, I am in the camp that house prices, particularly in and around Toronto, have gone way beyond what the growth in household income would support. Therefore it seems hard to deny that low interest rates have contributed to the home price increases as more debt is assumed for the same square footage. This, together with an influx of aggressive foreign buyers, has conspired to inflate every homeowner’s paper net worth which has spurred some spending. But higher interest rates run the risk of popping the bubble in an uncontrollable fashion and the spending will stop very quickly if this happens. With almost 30% of Ontario’s economy currently dependent on home construction, a lot is riding on this so let’s hope the Bank of Canada gets this right and provides better transparency going forward.

 

While a recovering Canadian economy based on strong consumer spending was the “headline” support for the rate increase, I think there was another motivating factor at work which I am surprised nobody is talking about. Next month the Trudeau government sits down to start discussions around renegotiating the North American Free Trade Agreement. Going into those meetings with a $0.80 dollar versus one closer to $0.70 should decrease the risk of being labelled what President Trump is quick to call a “currency manipulator”. After all, he has not hesitated to point a finger at almost every other country such as Germany and China and cries foul regarding the exchange rates against the USD.

 

I also think that the US Federal Reserve is leaning on other central banks to join them in their attempt to slowly wind down the “easy money” party that started after the 2008 financial crisis. Up until 2 weeks ago, the USA was the only country raising interest rates and therefore money had been moving into the USD which irked President Trump and thwarted his promise to bring home jobs. So a coordinated effort to raise interest rates around the world is likely in the works and Canada decided to be one of the first to make the move perhaps due to the upcoming NAFTA negotiations. It all fits (in my mind at least)!

 

In the “positive” column, we have quite a few items this quarter. 1. President Trump’s deregulation efforts have spurred on corporate America to start making investments without the fear of government for the first time in many years. 2. US corporate earnings which have been coming out fast and furious these days have been for the most part, excellent and have exceeded expectations including revenue growth which has been hard to come by lately. 3. American banks have recapitalized sufficiently over the last few years and have now been given the approval to start returning capital back to shareholders by way of dividend increases and share buybacks. It took 9 years but better late than never! 4. France overwhelmingly elected a “pro Europe” leader which solidifies France’s membership in the Euro and makes its continuing survival that much more likely (and less financial contagion risk is a good thing!). 5. China reported 6.8% GDP growth and India continues to reform and grow with their pro-business leader, Modi. In fact, this is the first time in about 7 years that we may actually have a synchronized global expansion which would be great. I am sure this list is not exhaustive but these are the positives that I am focussed on.

 

In the “negative” column, there are just a couple but they bear mentioning. 1. Italy will go to the polls later this year or early next year and can derail the Euro with an election. I think the chances of that happening are less now that France has voted overwhelmingly to remain the Euro but you know how emotional those Italians can be! 2. US stock and bond valuations are pretty full at the moment. Note that this is not so for many other markets (including ours and much of Europe’s) but the US markets comprise about half of the world market value so they are too big to ever ignore. There are pockets of what could best be described as “irrational exuberance” where current earnings don’t seem to matter as much as the promise of future earnings. There are always parts of the market that get way out in front of their skis (remember my valuation rant about Shake Shack and Valeant 2 summers back?). So we just avoid the froth when navigating and try to not pay too much for any of our holdings. 3. President Trump’s administration is having a very hard time making any progress on health care and tax reform and the longer this goes on the more disappointed the markets will be with no progress.

 

So I am feeling that there are more positives than negatives at the moment and I haven’t been able to say that for some time. Some clients accuse me of being too negative but I prefer to think of myself as a realistic optimist!