Mid-Year Market Update

July 04, 2017 | Rita Li


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Mid-Year Market Update

 

In June the U.S. S&P 500 performed well on the back of stronger corporate earnings and positive economic release. While the Canadian S&P/TSX was in a slight negative territory, we anticipate stronger domestic economic growth for the 2H of 2017 and that may very well translate into stronger stock performance.

 

Interest Rate Outlook

The fixed income and currency markets were jolted by Bank of Canada officials’ hawkish comments. As a result, RBC Economics has adjusted its interest rate forecast and now calling for two rate hikes in 2017 and two in 2018.

 

 

The Business Outlook Survey indicator, which summarizes the full results of Bank of Canada quarterly consultation with businesses across Canada, continued to improve and is now at its highest level since 2011. This suggests broad-based improvement in business sentiment and aligns with recent comments by Bank of Canada officials.

 

BOS indicator and BoC’s average estimate of the output gap

A natural concern in a rising interest rate environment is its impact on the Canadian housing market as well as Canadian’s ability to service household debt. RBC Economics estimates Canadian household debt now exceeds C$2 trillion, with 65% of it in mortgages. Low rates have kept the interest burden in check. If rates were to rise 1% over the next twelve months, households, in aggregate, would have to allocate an additional 2 cents of every $1 income to service debt.

 

Digging beyond the household debt headlines…

The majority of mortgages in Canada are fixed rate, which suggests that households will be exposed to higher interest rates gradually as they refinance at different times. The interest payments for consumer credit accounts for ~30% of household debt and are equal to the total interest paid on mortgages. (Exhibit 1) Consumer credit debt tends to be tied to variable rates, so the ramp-up increasingly leaves households exposed to higher interest rates.

 

Exhibit 1: Interest Paid on Household Debt                                    Exhibit 2: Owners’ equity as a % of real estate

       

 

We also take a closer look at the current home owners’ equity as a % of appraised real estate value (Exhibit 2). We take a step further by incorporating home equity lines of credit for a more realistic reflection than statistic Canada’s official measure. While a 1% rate increase over the next twelve month will not cause a significant shock to household’s ability to service debt, the current Canadian household debt is tremendous and will likely limit Bank of Canada’s ability to raise interest rate too fast.

 

 

 

 

 

Rita Li, CFA, MBA, CFP

Rita is a seasoned investment professional with experience working with different asset classes at top investment firms in Canada and abroad.  Rita is a Chartered Financial Analyst CFA® and Certified Financial Planner CFP®. She works with a multi-disciplined team to provide comprehensive wealth management services to High Net Worth families.