For the second consecutive quarter, we find ourselves saying “What a difference three months makes!” Largely due to a more dovish stance by North American central banks, all asset types – stocks, government bonds, corporate bonds - soared in 2019’s first quarter. What was the economic backdrop to this broad-based rally?
The European economy showed little change. Though Germany’s growth slowed in the second half of 2018, its labour market remained strong into the new year. In contrast, Italy’s economy continued to contract. In response to the modest growth in the Euro area as a whole, the European Central Bank kept its target interest rate at zero.
The UK’s path to Brexit is no clearer now than it was three months ago, as the March 29 deadline came, went, and was extended. Despite the high political drama, the UK economy didn’t skip a beat in late 2018 and appears to be growing at a healthy rate so far in 2019. The Bank of England kept its target interest rate at 0.75%, the same level since last August.
The Canadian economy slowed to only a 0.4% annualized growth rate in the last quarter of 2018. Job growth also slowed somewhat as the year came to a close but rebounded in January, and early indications are that it remained strong in February and March. The 12-month figures also highlight the ongoing saga of the Canadian economy’s “two solitudes”, namely an Alberta economy that continued to tread water due to the energy sector’s travails, while the rest of the country experienced record levels of job creation.
As in Canada, the American economy also slowed slightly in the last quarter of 2018, but its 2.1% annualized pace remained quite healthy. US job growth so far in 2019 has been robust, and initial unemployment insurance applications remained just slightly above the record lows they reached in mid-2018.
Despite what appeared to be good economic growth in the first quarter, both the Canadian and US central banks made no change to their target short-term interest rates. Indeed, both communicated several times through the quarter that they will proceed even more cautiously than previously thought. The central banks’ increased caution was likely prompted by the steep decline in stock and corporate bond prices in late 2018, along with the slight slowdown in both economies concurrent with financial market decline.
As shown in the first chart, stock prices rose sharply across the globe in the first quarter. Corporate bond prices also joined the celebration. Government bond prices – which moved opposite to stocks and corporate bonds in late 2018 and rose as the latter two fell – were equally buoyant in this year’s first quarter, and the Universe index of Canadian bonds experienced a return of nearly 4%. However, low interest rates contain the seeds of their own future limitations: after the last five months’ strong rally, the Canadian federal government 10-year bond now yields barely 1.60%.
Due to significant price increases across all the major asset classes, all the Compass portfolio returns were positive in the quarter, and ranged from about 4% for the most conservative to about 10% for the most aggressive portfolio.
Looking Forward – and Backward
The likely cause of the first quarter’s financial euphoria was North American central banks’ decision to “ease up” significantly on the pace of their interest rate increases; however, it was a given that interest rate increases would decelerate as they began to approach the central banks’ neutral level. The goal of the last two year’s increases was never to slow the economy and squelch inflation, because inflation was (and remains) well under control.
Rather, as stated numerous times by the central banks, the goal was to gradually remove the excess monetary stimulus enacted after the 2008 financial crisis and recession (i.e. to wean the economy off ultra-low interest rates). Because a meaningful amount of that stimulus has now been removed, it’s no surprise that central banks will proceed more cautiously until they see how the prior interest rate increases are digested.
However, the view that the central banks’ greater caution will translate into target interest rate reductions is likely misplaced, for several reasons. First, the North American economy isn’t sputtering, let alone collapsing. Secondly, the broad level of interest rates for corporate borrowers wasn’t restrictive even before this quarter’s rally, and is even less so now. If the North American economy tips into recession, we have little doubt the central banks will lower their target interest rates. But we also have little doubt that if the economy continues to grow at a healthy pace, the central banks will increase their target rates, albeit at a slower pace than during the past two years.
The virtue of patience in the pursuit of long-term investment success can never be overstated. Merely three months ago, many were rubbing their wrists with worry over the stock market drop. Our exact words in this space at that time were “don’t let the inevitable short-term gyrations distract you from your long-term journey to investment success.”
We take no credit whatsoever for predicting the quick reversal of fortune in this year’s first 90 days. We do, however, take full credit for noting that short-term gyrations are part and parcel of financial markets, that they are best ignored, and that patience and time are your allies when running the investment marathon.
Chief Investment Officer
ATB Investment Management Inc.
This report has been prepared by ATB Investment Management Inc. (“ATBIM”) which manages the Compass Portfolio and ATBIS Pools. ATBSI is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF). ATBIM, ATB Securities Inc. (“ATBSI”), and ATB Insurance Advisors Inc. are wholly owned subsidiaries of ATB Financial and operate under the trade name ATB Wealth.
The mutual fund performance data provided assumes re-investment of distributions only and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that may reduce returns. Unit values of mutual funds will fluctuate and past performance may not be repeated. Mutual Funds are not insured by the Canada Deposit Insurance Corporation, nor guaranteed by ATBIM, ATBSI, ATB Financial, the province of Alberta, any other government or any government agency. Commissions, trailing commissions, management fees, and expenses may all be associated with mutual fund investments. Read the fund offering documents provided before investing. The Compass Portfolio and ATBIS Pools includes investments in other mutual funds. Information on these mutual funds, including the prospectus, is available on the internet at www.sedar.com.
Opinions, estimates, and projections contained herein are subject to change without notice and ATBIM does not undertake to provide updated information should a change occur. This information has been compiled or arrived at from sources believed reliable but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. ATB Financial, ATBIM and ATBSI do not accept any liability whatsoever for any losses arising from the use of this report or its contents.
This report is not, and should not be construed as, an offer to sell or a solicitation of an offer to buy any investment. This report may not be reproduced in whole or in part; referred to in any manner whatsoever; nor may the information, opinions, and conclusions contained herein be referred to without the prior written consent of ATBIM.