Happy Easter! We hope you and your family had a wonderful long weekend and are enjoying a great Spring.
Considering the year began with such uncertainty, stock and bond markets performed exceptionally well in the first quarter. People overestimated the magnitude of market volatility that would ensue from an Obama to Trump transition of power and markets shrugged off the political drama and took stocks higher.
Challenges in the quarter
This past quarter exemplifies what we as investors should consider with regard to our portfolios. There are many sentimental reasons to worry about the stock market, including recent examples like Brexit, Grexit, the Fiscal Cliff, the Debt Ceiling, the election, and the budget. Markets can be swayed over the short term by daily headlines. Stock markets can move up or down for various reasons on a daily basis. However, over the long term, market valuations tend to return to their fundamentals—and the fundamentals over the past two quarters have justified markets moving higher.
Starting in Canada, oil prices seem to have stabilized through the first quarter to nearly US$50 per barrel, bringing less volatility for Canadian stocks. The S&P/TSX Composite Index gained 2.4 per cent factoring in dividends through the quarter. Oil prices are expected to remain near their current level, which has multiple implications. First, stable oil prices are positive for the Canadian energy sector and Canadian stocks overall. Secondly, as oil prices remain a strong influence on the Canadian dollar, stable prices should translate into a stable dollar with an average exchange rate near its current US$0.75.
The United States
South of the border, the Trump administration added a new element to conversation–and not just for talk shows! Putting politics aside, companies are reporting better year-over-year results on sales and earnings. Unemployment continues to fall. Economic growth continues to improve. In short, the U.S. economy is on the right track, and with it comes prospects for stocks through the remainder of the year. The benchmark S&P 500 Index gained 6.1 per cent in the first quarter including dividends, in U.S. dollar terms, or 5.3 per cent, in Canadian dollar terms, reflecting improvements in company results.
Overseas markets showed healthy gains with international stocks up 6.6 per cent in Canadian dollar terms as measured by the MSCI EAFE Index. Brexit considerations aside, the European economic outlook has improved, akin to that of the United States. On the other side of the world, Asia is showing improvement in its regional economies and stock markets—suggesting the growth we see is truly global in nature.
Central Bank Policy
This quarter marked the third time in two years the U.S. Federal Reserve raised its benchmark interest rate. The Bank of Canada hasn’t followed suit as the Canadian economy hasn’t performed as strongly as the U.S. economy. The U.S. Federal Reserve is expected to continue to raise its benchmark rate another two or three times this year. The U.S. environment is meeting the conditions of low unemployment and stable inflation, allowing the Fed to act.
We continue to feel the U.S., Canadian and international economic environment will improve this year. However, it bears repeating a positive economic environment doesn’t necessarily mean better returns. While we may be optimistic stock markets will deliver another year of positive returns, market volatility is likely to remain through much of 2017—driven mainly by headline news and politics. We continue to advise a balanced approach to asset allocation matched to your individual goals.
Investment Shock Absorbers
Ever ridden in a car with worn-out shock absorbers? Every bump is jarring, every corner stomach-churning, and every red light an excuse to assume the brace position. Having an undiversified portfolio can trigger similar reactions.
You can drive a car with a broken suspension system, but it will be an extremely uncomfortable ride and the vehicle will be much harder to control, particularly in difficult conditions. Throw in the risk of a breakdown or running off the road altogether and there’s a real chance you may not reach your destination.
In the world of investment, a similarly bumpy and unpredictable ride can await those with concentrated and undiversified portfolios or those who constantly tinker with their allocation. Of course, everyone feels in control when the surface is straight and smooth, but it’s harder to stay on the road during sudden turns and ups and downs. For this reason, our approach is one of diversification – spreading your portfolio across different securities, sectors, and countries. This also means identifying the right mix of investments (e.g. stocks, bonds, real estate) aligning with your risk tolerance.
Using this approach, your returns from year to year may not match the hottest market, but neither are they likely to match the worst. More importantly, this is a ride you are likelier to stick with (and enjoy). Here’s an example: among developed markets, Denmark was number one in US dollar terms in 2015 with a return of more than 23%. But a big bet on that country the following year would have backfired, as Denmark slid to the bottom of the table with a drop of nearly 16%. It’s true the US stock market (by far the world’s biggest) has been a strong performer in recent years. A decade before, in 2004 and 2006, it was the second worst-performing developed market in the world.
Predicting which part of a market will do best over a given period is tough. US small cap stocks were among the top performers in 2016 with a return of more than 21%. A year before, their results looked relatively disappointing with a loss of more than 4%. International small cap stocks had their turn in the sun in 2015, topping the performance tables with a return of just below 6%. But the year before that, they were the second worst with a loss of 5%.
If you’ve ever taken a long road trip, you’ll know conditions along the way can change quickly and unpredictably, which is why you need a vehicle ready for the worst roads as well as the best. While diversification can never completely eliminate the impact of bumps along your particular investment road, it does help reduce the potential impact any singular investment can have on your journey. With sufficient diversification, the jarring effects of performance extremes level out. That, in turn, helps you stay in your chosen lane and on the road to reaching your financial goals.
If you’d like to discuss this topic in greater detail or have any questions, please reach out to a member of your Arbutus Financial Team.