I wanted to provide a summary of some of the market themes that we have been managing around so far this year. Context is always very important to have as an investor. It helps you assess the ongoing landscape of risks and opportunities and refresh your positioning as needed.
So far in 2017 opportunity has been fairly mute for investments offered strictly in Canada. As I write this the TSX Composite for Canadian stocks is down -0.70% for the year. Within the sub-indexes the best performer has been the Consumer Discretionary group at +10% and worst performer (not surprisingly) being Energy down -18%. US and Global Markets have been better- roughly performing between 5%-6% when you adjust back into Canadian dollars. The technology group has been the clear leader with Nasdaq returning 12% YTD in Canadian dollar terms.
In order to post a positive return so far this year you have needed good stock selection within Canada and/or the ownership of some US and Global stocks within your portfolio. Bonds have not been meaningful contributors either to return especially with both the US and Canada on a path of higher interest rates.
Unfortunately the Canadian/US dollar exchange has muted some of these gains so far this year in percentage terms. The Canadian Dollar today buys you $0.80 US. The exchange rate began the year at $0.74 US and got as low as $0.72 in May. Since then the Canadian dollar has essentially strengthened over 10% versus the US dollar. It has not just been a case of Canadian dollar strength because the US dollar has been weaker at the same time- reflecting some risks in the US growth agenda and the Republican governments ability to pass tax reform and other promises they made. There are a few other factors contributing to this which I’m happy to talk about in person. Its seems unlikely however that the exchange rate will stay here. Both RBC Capital Markets and RBC Global Asset management have published 12 month targets placing the Canadian dollar somewhere between $0.69 and $0.75 US. This would be better for the Canadian economy in fostering better conditions for manufacturing and trade and also provide a lift to the investments we own in US dollars. So if you need to buy US dollars for any purpose such as travel, now is not a bad time to do so.
The opportunity set and positioning of investments between Canadian and US equities is best done in tandem I believe. It should not be a choice of one over the other. Currently Canadian Markets (TSX) are more reasonable valued at nearly 16X earnings versus the US market (S&P 500) at nearly 18.5X (see Chart 1 below). Canadian Markets are also trending to the lower extremity of what returns they have historically provided in 10 year rolling periods. As of June 30th 2017 the TSX posted a 10 year average of 4% versus a longer dated average of about 8% (Chart 2).
The US markets, however, provide much better depth of industry and companies with real leverage to global growth. Earnings Growth from US Companies have also been strong which should rightly command higher multiples (Chart 3).
There is also the Ying versus Yang effect: While weaker oil prices are not a positive for the Canadian Economy (roughly 20% of the Index), cheap oil for the US is a positive as consumers pay less at the pump and more for other things. 70% of US GDP is determined by consumer spending and cheaper oil acts as stimulus and is one of the contributing factors to solid consumer sentiment (Chart 4). This bodes well for continued strength from US stocks. If Geo-political risks or other factors push the price of oil higher, it could abate this sentiment in the US somewhat and yet provide a nice lift to energy companies in Canada.
Anyways, I just thought I’d provide some commentary on some of the moving parts so far in 2017. Should you know anyone who would benefit from this type of insight please feel free to forward along as I am always happy to share my views and help where I can. I continue to adapt portfolios as required to ensure the proper positioning to finish out the second half of 2017.
Chart 1: Canadian (in blue) versus US Stock (in beige) Index Valuation comparison
Chart 2: 10 Year Rolling Rates of Return for the Canadian TSX Stock Index dating back to 1966
Chart 3: US Stock Market Earnings per Share Growth:
Chart 4: US Consumer Sentiment (in Blue) and US Stock Performance: