March review and Q1 update

As of the end of day on March 31, the U.S. S&P500 returned 0.0% and the Canadian S&P/TSX composite returned 1.0%.  S&P 500 in the first quarter of 2017 returned 5.5% while Canadian S&P/TSX returned 1.7%. Oil (WTI spot/bbl.) is down 6.3% trading at $50.60USD/bbl. U.S. dollar index declined 0.6% in the month and depreciated 0.1% against the Canadian loonie. Gold and copper are both up 8.4% and 7.5% respectively in the first quarter of 2017.  

 

 

U.S. Fed raising interest rates in March

 

The Fed raised interest rates in mid-month. We believe the Fed raising rates is a positive sign for the U.S. economy and demonstrates the Fed’s growing confidence in the underlying economic strength. Interestingly enough, the Treasury yield has declined post interest rate decision. This is counterintuitive and spells discrepancies in the views on the U.S. economy. 

 

The next important data to watch is the Q1 U.S. GDP which will be released in late April. This data will give us a clearer view on the strength of the U.S. economy.

 

Despite U.S. raising interest rate, Bank of Canada Governor Stephen Poloz still strikes a cautious tone on the state of the Canadian economy. A slow recovery in the resource sector and housing market uncertainties still overshadow the Canadian economy.

 

RBC does a quarterly scorecard on key economic segments of the economy- the yield curve, manufacturing activity, housing activity as well as inflation and employment trends.  The current message is “all clear” with no sign of a recession.

 

Even though the S&P 500 has returned 5.8% in Q1, we are still positive on the U.S. equity markets, however, I recommend investors tamper their return expectations for the remainder of the year.  At the beginning of the year, we have forecasted high single digit return for the U.S. benchmark indices.

 

Opportunities in EAFE-developed economies outside U.S. & Canada

 

EAFE stands for Europe, Australasian and Far East. At the beginning of the year, I have cautioned against over diversification into geographic areas outside North America. Global PMIs have shown an impressive expansion in the Euro-area: France, Germany, Italy and Spain. The forward growth estimates (next 12-month growth) now outpace U.S. companies.

 

           

 

 

Historically, U.S. trades at a Forward P/E premium to EAFE because U.S. stock markets (measured by VIX) are less volatile than European stock markets (measured by V2X) however, the current valuation has deviated from its historical average premium and EAFE is now trading at significant discount but project higher growth.

 

Given these combined factors, and in light of the strong performance in the U.S. markets, I believe it is reasonable to tactically allocate a portion of the portfolio to EAFE for select clients.

 

A note on the credit market

 

Credit spreads have moved to their tightest levels in 18 months in Canada and compensation for assuming BBB credit risk over A has narrowed to the lowest level in nearly three years. As a result, we recommend investors move to higher grade corporate credit. Year to date, preferred shares’ returns have been the strongest in the fixed income space:

 

 

 

References:

Graph 1: MSCI Country indices; FactSet consensus estimates for Non-U.S. and Thomson Financial estimates for U.S.

Graph 2: MSCI,FactSet, and RBC Capital Markets

Graph 3: RBC Wealth Management, Bloomberg, data through 2/23/2017