The first half of 2017 is in the history books. While the TSX only rose 0.74%, broader markets did very well. In Canadian dollar terms, the S&P 500 posted a gain of 5.68% for the first six months. Japanese equities increased 6.42% while European stocks returned 12.05%. Emerging markets topped the list with a sizeable rally of 14.63%.
The questions investors should be asking now, however is what comes next. Will Canadian equities play catchup with the rest of the world? And how will rising interest rates in Canada and the U.S. affect portfolios? Before we get to that we should understand what drove those markets through the first six months of the year.
Since January investors embraced equities as global economic data has been generally been healthy. While there were headwinds, both economic and geopolitical in nature, none managed to meaningfully scare markets. As a result volatility remained low by historical standards.
Putting the financial crisis in the rear-view mirror
Having been ultra-dovish for years, many central banks are now either making hawkish noises or taking hawkish actions. The Bank of Canada just raised rates for the first time since 2010. The Federal Reserve has now hiked four times since the global financial crisis, and is expected to start easing back from other stimulus measures helped stabilize the U.S. markets. Even the European Central Bank is growing more hawkish.
These actions have implications for the fixed income portions of investors’ portfolios. In a nutshell, if central bank rate hikes are going to lead to higher long-term yields, investors will want to shorten the duration of their bond holdings.
Loonie spreads its wings
Having languished for most of the first half, the Canadian dollar dramatically came to life in May, rising from just under 73 cents in mid-May to almost 79 cents currently. Even though commodity prices remain weak, the currency has been propelled by strong Canadian economic data and the realization that the Bank of Canada was serious about hiking rates.
It’s a sunny time for most markets, but will it continue? It depends who you ask.
Asset manager BlackRock says equities are still the place to be. In its recently released outlook for the second half, it points to a sustained global economic expansion, receding fears of deflation in Europe and upward revisions to global earnings as reasons to be bullish on stocks. Canadian equities, they say, are the cheapest relative to U.S. stocks since 2004. Also relative to U.S. stocks, their outlook argues that Japanese, European and emerging market equities remain attractively priced.
As for Canada, BlackRock strikes a cheery note on low-cost energy stocks, and argues that financials could do well in the second half as rates rise. They aren’t equally bullish on all aspects of our market, however. “With rates marching higher, we think the more interest-rate sensitive sectors of the stock market, such as consumer staples and utilities could lag,” says Kurt Reiman, BlackRock’s chief investment strategist for Canada. Putting aside the equity outlook, the firm suggests investors favour shorter-term bonds over longer-dated securities given central bank tightening.
Steadyhand Investment Funds is a study in contrasts with BlackRock. On the one hand, BlackRock is a behemoth in the fund world, managing trillions of dollars worldwide. Steadyhand, led by Tom Bradley, manages a much more modest $640 million or so. The firm’s market outlook also contrasts with BlackRock. While BlackRock paints a rosy market outlook, Steadyhand is more cautious.
In his latest missive to investors, Bradley writes that there are times to be aggressive in markets and now is simply not one of them. “Our managers’ research…suggests that stocks are somewhere between fully valued and expensive,” explains Bradley in his note. In Steadyhand’s Founders Fund, equities are slightly underweighted, and bonds are also being shunned given the current low yields. The result is a hefty 19% cash weighting in the portfolio.
The equity weighting, of note, has been reduced significantly since 2016. “We’ve come down about 10 points in the last year,” says Bradley. He isn’t predicting any sort of imminent top, however, conceding that high equity prices “could go on for a couple more years.”
What’s an Investor to Do?
If you side with the optimists, you can gain exposure to Canadian and global equity markets via a number of ETFs and index funds, such as:
- iShares S&P/TSX 60 Index ETF (iShares funds are managed by BlackRock)
- BMO TSX Equal Weight Banks ETF
- Vanguard Canadian Short-Term Bond Index ETF
If you’re a little more cautious or even pessimistic about this market then you have some decisions to make. Depending how cautious you are about the outlook for markets, there are a few steps you can take. If you’re bearish on equities but think fixed income products offer value, selling some equity mutual funds in favour of a bond ETF might make sense. Alternatively, if you think both bonds and stocks aren’t attractive at the moment, raising cash and waiting for better prices might be the way to go.