2019 Q2 Commentary

Jul 02, 2019 | Jon Mitchell


2019 Q2 Commentary

Jon Mitchell, Portfolio Manager


The second quarter of 2019 produced some fairly typical results in the equity markets with returns in the 2% to 2.6% range, after starting out the year with gangbuster results of over 14% for just three months. Fixed income markets have done exceedingly well this year as well, particularly medium- and long-term bonds, as interest rates have continued to decline steadily.   The benchmark 10-year U.S. Treasury bond dropped from its year-end value of 2.68% to 1.94% on July 3, its lowest level since July 2016. There is a considerable consensus that the U.S. economy is in the late cycles of its expansion, which suggests that interest rates and equity markets could both move lower in the next year. We are within a few months of our own federal election and the startup of the 2020 U.S. presidential election cycle.

Powell versus Trump

In my last commentary (Q4 2018) I suggested that there was a significant struggle between President Trump and Federal Reserve Chairman Powell with respect to the direction of interest rates. It is clear now that Trump won this battle of the airwaves, as Chairman Powell has recently conceded that interest rates must be lower, sooner than later. The market expects the first cut to the overnight rate in the U.S. to occur at the end of July, and is currently pricing in two to three more interest cuts by next year. So, today, the U.S. overnight rate sits at 2.50% and, in a year, it could be 1.50%. Here in Canada, the overnight rate is 1.75% today and we expect it, one year from now, to be at 1.50%, effectively matching that of the U.S. Federal Reserve.

The troubling issue is that there is over $12 trillion of global bonds that have a negative yield, or a bond in which the investor has to pay the issuer of the bond interest in order to receive their principal back at maturity. This figure continues to grow each month and begs the question of whether the U.S. Federal Reserve will follow suit and lower its overnight rate to zero or even below zero in the event of a recession.

Elections and other looming events

Canadians are set to go to the polls sometime in October this year, and the outcome is too close to call at this point. Provincially, there are now six Conservative provincial premiers (Alberta, Saskatchewan, Manitoba, Ontario, New Brunswick and the Northwest Territories) which should help with the grassroots operations of the federal Conservatives. As always, the battleground will be in Quebec and Ontario, which together account for 59% of all seats in Parliament.

The United Kingdom continues to weigh the consequences of a “hard Brexit” with no agreement with the European Union. The final vote on the successor to Prime Minister Theresa May is expected this week with former Secretary of State Boris Johnson leading so far in the run-off to assume the Prime Ministerial duties. The Brexit deadline is now October 31 of this year.

The U.S. Democratic leadership debates have begun last month, with the convention planned for July 13-16, 2020, about a year away. There are 27 candidates currently running for the nomination. Former Vice President Joe Biden is leading the polls at this point.

Besides persuading the U.S. Federal Reserve to lower interest rates, getting a trade deal done with China will be one of the significant accomplishments for President Trump and one that he will use as an election issue. Trump is keen to work out a favourable trade agreement with the U.K. in the event that a hard Brexit occurs.

Energy markets

With the wind-up of the Calgary Stampede last night, the mood in the oil patch remains pessimistic. Spending budgets continue to be lower in 2019 than 2018, and massively lower than in 2014. As expected, the Trans Mountain pipeline expansion has become a 2019 election issue, as the approval was granted in June, but construction remains on hold, pending final permits. The new Alberta Conservative government is trying various approaches to getting both the oil and gas industries off of the mat. Lower corporate tax rates, rebates for municipal taxes for natural gas leases, reduction of the of oil curtailment program, elimination of the carbon tax – these are some of the measures the Kenney government has introduced since its April 17 election win. 

With no new pipelines expected before the end of 2020, the stop-gap solution remains transporting crude by rail, which continues to grow steadily, both in Canada and in the U.S.   Crude oil has improved fairly well since the end of 2018 (to the US$60 range per barrel, from US$45 per barrel), but was fairly volatile in the second quarter with a range of US$51 in mid-June to US$66 in late April. The discount between U.S. West Texas Intermediate and Western Canadian Select remains at about US$10 per barrel.

Equity markets

It seems implausible today that the benchmark S&P 500 index is 29% higher today than it was on Christmas Eve 2018, while the TSX is 20% higher over the same interval. The longer term is even more telling, as the S&P 500 has nearly doubled its value since mid-2007, while the TSX is up only 20% in comparison. The strength of the U.S. economy relative to most global economies remains intact, however, the valuations for the markets are at elevated levels based on a number of factors. The lower interest rates are pushed, the greater the incentive will be to invest in equities. Also, investment-grade companies continue to take advantage of the record low corporate bond environment to issue debt and use the proceeds to re-purchase their equity, which drives up earnings on a per share basis. It is interesting to note that since December 1, 2018 (just before market sell-off), gold bullion is up by 15% while the S&P 500 is up by 9.5%.

Gold and currencies

One of the beneficiaries of the recent “Powell pivot” (180-degree turnaround in policy expectations) has been gold bullion.  In U.S.-dollar terms, gold has risen 10 % so far this year, but still remains about U$ 500 below its all-time high of U$ 1917 set in the summer of 2011 (Greek Crisis in full bloom).  Gold in Canadian dollar terms is actually equal today to what it was in 2011, as the Canadian dollar was trading at a premium to the US dollar then, compared to U$ 0.76 today. With the consensus view that interest rates will lower in the next year or two, gold has a good opportunity to improve its valuation from today.

The Canadian dollar has been fairly range bound over the last 4 years (trading between 72 cents and 83 cents to the US dollar). The issue remains that the US continues to have higher interest rates than Canada, and our dollar today is actually weaker to the levels seen in March 2009 in the midst of the Great Financial Crisis.

Concluding remarks 

With several of major issues still to be resolved (U.S. – China trade deal, Brexit conclusion, fear of U.S. slowdown) we should expect the markets to reflect this through added swings of volatility. The focus must remain on quality businesses, with strong balance sheets and management.  In addition, businesses that withstand economic slowdown better (utilities, consumer staples, communication services) should be stressed.

Set out below is a table of the performance of various sectors of the market in the 2nd quarter of 2019 and for the year-to-date results / three-year rolling periods:

Investment Index 

Q2 2019 Return

 2019 YTD Return

3-Year Compound Return

S&P/ TSX Composite Index

   2.6 %

 16.2 %

8.4 %

S&P 500 (Cdn Dollars)

   2.3 %

 13.8 %

14.7 %

Short Term Comp Bond Index

  0.9 %

 2.7 %

1.5 %

US$ / C$

 -1.9 %

-4.0  %

 0.4 %

Gold Bullion (C$)

 7.2 %

5.9 %

  2.3 %

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