Most capital markets around the world registered impressive gains early in the second quarter before moderating in June, reflecting steady global economic growth and supportive business conditions. Unfortunately for Canadian investors, two Bank of Canada rate increases negatively impacted global returns, as the Canadian dollar appreciated relative to global currencies.
This has resulted in global stock market indices like the S&P 500 or Dow Jones Industrial Average (DJIA) having vastly different returns in U.S. dollars compared to Canadian dollars. As of September 1, the S&P 500 Index, a broad measure of U.S. large-cap equity performance, is up 10.6% for the year in U.S. dollar terms; however, when adjusting for the appreciation of the Canadian dollar relative to the U.S. dollar, the S&P 500 is up only 2%.
The same goes for the MSCI World, a global index that represents large and mid-cap equity performance across 23 developed market countries. It is up 12.3% year-to-date in local currency terms, but only 3.5% in Canadian dollars.
For a simple example, imagine taking $1,000 Canadian and converting it to U.S. dollars (USD) when the exchange rate is at 75 cents, resulting in $750 USD. Let’s say the $750 USD is invested in an equity, which then increases by 10% to $825. The $825 U.S. is converted back to Canadian dollars when the exchange rate is at 82 cents (the inverse of which would be 1.22 Canadian). The $825 thus becomes $1,006 Canadian. The 10% made on the equity is effectively erased by the increase in value of the Canadian currency. This is exactly what is happening with global equity funds right now, unless the managers have taken measures to hedge against currency movement.
The Canadian equity market noticeably lagged many other developed market indexes, despite strong economic output and employment data. The S&P/TSX Composite Index is down 0.6% for the year, based on softening oil prices, weaker financial shares and investor sentiment that was dampened by trade-related issues with the U.S.
Global fixed-income markets, meanwhile, prepared for the gradual end of ultra-low interest rates. As anticipated, the U.S. Federal Reserve Board raised its overnight lending rate by 25 basis-points in mid-June, the second such increase in 2017. The Bank of Canada has also raised rates twice, on July 12th and September 6th. An interest rate increase usually leads to declines in bond prices. The FTSE TMX Canadian Bond Index is up only 1.5% for the year.
What does this mean for you?
With a long-term perspective at mind: with higher interest rates, you can purchase fixed-income investments at a higher yield, and earn a higher return. With the Canadian dollar rally, you can buy global assets at cheaper prices. Any pullback in the Canadian dollar will boost Global equity returns.
Where do we go from here? Key points to remember:
Global economy is still very strong, and the Canadian economy is expected to moderate
- Central banks around the world, including the Bank of Canada, are moving from emergency levels to neutral levels. There could be two more interest rate increases in the next year
- Despite the increases, long term interest rates are still expected to remain “lower for longer“
- Corporate health in equities remains very healthy and earnings growth is robust.
Market Table (as of September 1st, 2017)
|TSX Composite (Canada)||15,192||Down 0.6%||Down 0.6%|
|S&P 500 (U.S.)||2,477||Up 10.6%||Up 2.0%|
|Dow Jones (U.S.)||21,988||Up 11.3%||Up 2.6%|
|DAX (Germany)||12,143||Up 6.0%||Up 10.3%|
|FTSE (U.K)||7,439||Up 4.1%||Up 0.9%|
|MSCI EAFE (Europe & Asia)||1,938||Up 15.1%||Up 6.1%|
|MSCI World||1,966||Up 12.3%||Up 3.5%|
|MSCI Emerging||1,091||Up 26.6%||Up 16.7%|
|FTSE Canadian Universe Bond||1,027||Up 1.5%||Up 1.5%|