3/31/2019 12:00 AM < Back
Sub-Advisor Commentary Q1 2019 - Markets
Canso Investment Counsel – Fixed Income
Contributed by Canso Investment Counsel
Signs of a slowdown in economic growth combined with pressure from President Trump caused the U.S. Federal Reserve to abruptly end their policy of increasing interest rates. Equity and bond markets rallied sharply on the news. Equity markets reversed much of their fourth quarter selloff and yields dropped across the yield curve. The magnitude of the equity rally was puzzling, given that the decline in yields was so large it seemed to indicate a severe economic slowdown could be imminent. If true, this would normally be expected to be very negative for corporate profits and stock prices.

Falling interest rates were positive for bond returns in the quarter. The Universe Index returned 3.9% in that period. Yields fell slightly more for mid term bonds than short or long maturities, but the shift was largely parallel and duration was rewarded. Longer duration Provincial bonds reflected this and were the strongest performers. Credit spreads tightened in an environment that rewarded risk and Corporate bonds outperformed with shorter duration AAA/AA bonds underperforming A and BBB issues.
QV Investors Inc
Contributed by QV Investors Inc.
What a difference a few months makes. Following an extremely volatile end to 2018, with global stock markets plunging, all major equity markets advanced in the first quarter of the year. The catalyst for this market reversal was a dramatic 180-degree turn in the outlook of the Federal Reserve. Shifting away from the current tightening cycle, Chairman Powell signalled there would be no further rate hikes in 2019, providing a huge psychological boost to investors.

While the U.S. continues to post healthy economic data, the global economy is showing signs of weakness. Growth in China’s industrial output recently fell to a 17-year low alongside a rise in the jobless rate. With 2019 growth on track to land near 30-year lows, the Chinese government has increased assistance for the economy. Premier Li Keqiang announced hundreds of billions of dollars in additional tax cuts and infrastructure spending. In Europe, the central bank slashed its growth forecast for 2019 to just over 1%, an anemic rate of growth. ECB President Mario Draghi reiterated that interest rates are likely to remain at these record low levels at least until the end of the year, and also announced a fresh set of loans to European banks aimed at boosting the economy.

Where to from here? While there is certainly no shortage of global economic concerns, when it comes to the stock market, the effects from returning to more accommodative monetary policy cannot be underestimated. The last three months prove just that. The weak economic data alongside continued uncertainty about trade wars and geopolitical concerns didn’t disappear, yet markets generally surged ahead. By returning to neutral or potentially accommodative monetary policy, the central banks of the world are further prolonging this equity cycle.

The recent reversal by the Fed is reminiscent of other attempts in stock market history to stabilize markets. In the late 1990’s, as the tech bubble was inflating, then Fed Chairman Alan Greenspan wasted no time easing policy when a little-known hedge fund called Long-Term Capital Management collapsed and sent the stock markets into free fall. This year, the recent plunge in markets due to growing global economic woes was enough to force Fed Chairman Powell to take soothing action. While these measures can provide a powerful short-term solution for investors, they can also create longer-term imbalances.

The fears that appeared at the end of last year have subsided for now, but we don’t think investors should be increasing their exposure to risk assets. To be clear, while the near-term threat of higher rates has diminished for the time being, the greater concern is that the world is so overwhelmed by debt that the global economy can’t afford higher rates. We are in year 10 of this cycle, and the level of debt and monetary stimulus already worked into global economies remains at or near unprecedented levels. There isn’t a lot of dry powder for future stimulus. Consumers, businesses and governments are dependent on borrowing, with little savings for rainy days.

The world’s bond markets are flashing warning signs with yields collapsing and major economies like Germany once again finding themselves with negative 10-year government bond rates. The inability of economic powerhouses like Europe or Japan to find their footing and show sustainable growth after prolonged and aggressive monetary policy is worrisome. But who knows - if China and the U.S. come to terms on trade, it may help all these interconnected economies.

Challenges within the Canadian economy are also growing. Like in many other global markets, real estate in Canada is slowing. This has been a major driver of the wealth effect for many Canadians over the last few decades, contributing to high levels of consumption. Also, significant levels of debt are tied to the value of real estate, as is the soundness of our banking system. A continued slowdown will impact the growth of our domestic economy. We expect the Canadian central bank will be prepared to act if challenges persist in this respect. Again, though, it would be to treat the symptoms (by easing consumers excessive debt payments) rather than addressing the real issue of absolutely high debt levels.

We anticipate heightened volatility for the remainder of the year as the struggles of the global economy draw focus from short-term monetary moves. In general, our portfolios remain well diversified and conservatively positioned, with historically attractive valuations that are better than the market. With uncertainty comes opportunity. We are finding pockets of good value in companies that have been beaten down by negative sentiment or ignored by the market. We will continue to invest in these businesses as many of them are leaders in their industries with track records of resilience. We can’t be afraid of market cycles but rather will aim to use them to our advantage.

Mawer Investment Management Ltd. 
Contributed by Mawer Investment Management Ltd.
What a difference a quarter can make! Not a typical statement from us at Mawer given we are long-term investors, but after the steep decline in global equities at the end of 4Q18, stock markets, led by the U.S. and Canada, snapped back in the first three months of 2019. Global equities, as measured by the MSCI All-Country World Index, gained a substantial 9.7% CAD and Canadian bonds (as measured by the FTSE Canada Universe Bond Index) rose 3.9% while global sovereign bonds (as measured by the FTSE World Government Bond Index) were basically flat, falling -0.5% CAD.

While equity market returns were significantly different quarter to quarter, the issues remained quite similar— central bank actions, China-U.S. trade relations, decelerating economic growth, and Brexit banter were all in the mix during the past six months. Reaction to these issues, however, have been quite different, primarily because of perceived or realized shifts. Foremost among them is the U.S. Federal Reserve hitting the pause button on raising interest rates and shrinking its balance sheet. Its latest policy statement shows a removal of any planned interest rate increases for 2019 and only one more in 2020. The Bank of Canada and other major central banks around the world followed suit, shifting to more accommodative policies which could ultimately lead to an environment of lower rates for longer.

China-U.S. trade relations appeared to be a major risk during the fourth quarter with each country upping the ante in potential tariffs. But a movement toward more dialogue between the world’s two largest economies somewhat alleviated investor concerns by providing hope of a constructive outcome. This may prove a hot button for markets going forward as no resolution or agreement has been reached and political positioning in the next U.S. presidential election cycle begins to accelerate. So, while there is potential for China-U.S. trade relations to take a turn for the better, there is likely to be just as much potential for it to head down the tariff path again.

With Brexit, the ultimate policy shift could see the voting populace head back for another referendum and vote to remain in the EU. As political wrangling kicks the proverbial can down the road, the outcome is very uncertain. The most disruptive outcome would likely see the U.K. leave the EU without any deal, ushering in an era of uncertainty sure to confuse and frustrate management teams of companies in the region.

While global economic activity is showing some signs of slowing, we don’t view conditions as indicative of recession—slowing yes, but not negative growth. The companies we own and the management teams that run them are continuing to seek areas of growth and ways to strengthen their businesses in the current economic environment.

Equity markets have reacted positively to lower rates for quite some time and our concern is that investors become complacent, or even reliant on central banks to step in whenever financial asset values decline substantially. This is not an underlying assumption of our investment philosophy and process—albeit it does present a challenge for determining what fair value is to pay for those investments that meet our criteria.

 
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