Market participants had to swerve and maneuver as President Trump’s protectionist trade threats studded the road during the quarter stealing the limelight from other historic events such as the meeting of the United States and North Korea for the first time since the Korean War. Elsewhere, NAFTA renegotiation talks broke down and the threat of a collapse looms larger now that a more populist government has formed in Mexico. An agreement may not be reached until the autumn, but a resolution would be very positive. Both Canada and the EU have tried curb-hopping these chicanes asking for tariff exemptions, but this has been met with a lukewarm response.
Meanwhile, the US black flagged China’s trade surplus and imposed several sets of trade tariffs. Although the US imports significantly more goods from China, China is in a unique position to shut out imports of US-produced shale gas which could cripple that industry. Furthermore, China could choose to devalue their currency and sell their holdings of US Treasury bonds – both of which could have severe consequences for global trade and interest rates.
Some may describe President Trump’s trade tactics as shenanigans; the impact has been to throw curves into the road and slow down the momentum of the market and potentially the global economy. Ultimately, tariffs are a form of tax and inflation. However, daily volatility aside, the stock market shrugged off potential fallout as technology and small cap stocks led the way to a positive quarter. Corporate earnings and revenues are still strong and growing while credit markets remain healthy albeit with some cracks starting to show.
Emerging Market equities were unable to draft off a still-strong US economy as they were caught up in a myriad of concerns about a potential crisis developing. Bond yields rose with the US 10-year Treasury note surpassing 3% for the first time in almost 5 years amid these Asian contagion fears. We felt these concerns were overblown and they ultimately dissipated by quarter-end; bonds are now trading in a stable range.
Global economies continue to be supported by the US, in pole position, with an expanding GDP, positive but not too-hot inflation and robust capital investment spending. The Fed raised interest rates by 0.25% this quarter, which brings the total to 0.50% year-to-date.
The Bank of Canada is also expected to raise rates by 0.25% in July, but they may be on hold given the short-shifting they will have to do if a NAFTA settlement isn’t reached soon. Furthermore, the housing market has slowed due to the previous mortgage rule changes. It is only a matter of time until Marijuana becomes fully legal as the bill passed the third reading in the Senate. Most noteworthy, however, is the nationalization of the Trans Mountain Pipeline which appears to have been required to get it built; is this now how business needs to get done in Canada? We hope not.
Lack of pipeline access also affected US shale producers who are getting squeezed. The fallout: they now have a price differential for their product vs. Brent crude. Oil prices were higher than our expected range due to various supply constraints including the US red lighting of Iran and subsequent imposition of sanctions as well as the sharp drop in Libyan supply.
We executed some trades in our bond portfolio to reduce credit risk and improve quality. We remain underweight in bonds and have a short duration. Our fully invested position in preferred shares was maintained as they are a good bond complement. We rebalanced our equity portfolios by again reducing global equities and left the proceeds in cash. Our Canadian equities continued to lag the TSX composite but still chalked up a 4.8% quarterly return. Our overweight emerging markets exposure was a drag on both absolute and relative performance.
Volatility is back! January started off very positive, however the combination of a strong US payroll report, surging bond yields and trade wars (both real and threatened) triggered a dramatic market sell-off and subsequent weekly reversals.