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Anthony Sabti

2016 Market Review & Key Themes for 2017

2016 was the year of surprises.  There were a number of unexpected political outcomes throughout the year, namely the “Brexit” vote, Donald Trump winning the U.S. presidential election and OPEC members reaching a deal to reduce oil production.

But perhaps the biggest surprise was stock markets themselves.  After the worst 10-day start in history and a January that saw 93% of investors lose money, both Canadian and U.S. markets finished the year with healthy double digit returns.  The Canadian index, represented by the TSX finished up 17.62%. The Dow Jones Industrial Index (DOW) in the U.S. set new highs and almost reached the 20,000 point mark.  It finished the year up 13.42%.  The Global Index, represented by the MSCI world, finished the year up 5.41%

What happened in 2016 serves as a reminder to investors to ignore the “noise”, take a long-term approach, and remember the importance of investing in a high quality and diversified portfolio.

Key Themes for 2017

We expect two key themes to emerge in 2017:  Improved U.S. Growth and Bond/Equity Divergence.

Economic indicators in the U.S. strengthened in the second half of 2016, confirmed by a Gross Domestic Product (GDP) number of 3.5% and a projected 2.0% pace in the 4th quarter, which comfortably exceeds the ceiling for U.S. economic growth.  The Republican administration’s planned policies are also expected to accelerate economic growth in the U.S.  Overall there is renewed faith in the longevity of the U.S. recovery.

The second key theme for 2017 is likely to be a continued divergence between equity and bond returns. For thirty years equity and bond returns have been positively correlated in that falling interest rates have benefitted equities and bonds. That has changed since the U.S. election on November 8th. Since the election, U.S. equities have rallied sharply in anticipation of stronger economic growth and its causal linkage to stronger corporate earnings while U.S. bond returns have been very soft. Bond returns have been weak because investors fear that fiscal stimulus will cause inflation to move upward.

Equity Outlook

As mentioned above, the Republican administration’s planned fiscal stimulus is expected to accelerate economic growth in the U.S.  Stronger economic growth and higher inflation should be beneficial for revenue growth, and proposed corporate tax cuts would provide a meaningful boost to corporate earnings. Because of all these possible measures, we continue to be biased towards U.S. equities.

Several Canadian companies should benefit from the strengthening of the U.S. economy in 2017. However, with weak commodity prices and Canadian economic growth and inflation expected to remain modest, Canadian equities are likely to underperform their U.S. counterparts in 2017.

Equities in some European countries are attractively valued but because of persistently low growth, inflation, high unemployment, and growing uncertainty about the future of the euro, we recommend an underweight position in international and emerging market equities.

Fixed-Income Outlook

During the first part of 2016, bond prices increased due to weak economic growth and inflation. However, as central banks’ monetary policies appeared to have peaked and it seemed that governments would have to begin implementing their own fiscal stimulus, bond prices decreased in the second half of the year.

While domestic and global government bonds can offer stability and diversification benefits, overall returns are expected to be low. Thus, most bond managers are underweight government bonds.  They may simply decide to hold cash instead and maintain a neutral weighting in investment grade bonds based on the slightly higher yields they offer over governments.

The consensus is that the Bank of Canada will hold its key interest rate steady for some time to come and that the U.S. Federal Reserve Board will modestly increase the federal funds rate over 2017.  This will likely keep short-term rates low, but U.S. fiscal stimulus may push longer yields modestly higher.

This will help keep the Canadian dollar remain low for an extended period.  The U.S. dollar is expected to drive higher due to higher growth and inflation in the U.S.

Conclusion

Although 2016’s surprises created volatility and uncertainty in the capital markets, they also created opportunities for experienced investors, and will continue to do so in the coming year.

We continue to recommend a diversified portfolio that is tailored to your individual investment objectives to take advantage of opportunities as they arise, while protecting your investments from further volatility.

On behalf of the entire You First team, we would like to wish you and your family all the best for the year ahead, and to remind you that my team and I are just an e-mail or phone call away should you wish to discuss your investment portfolio in greater detail.

 

Anthony Sabti

Corporate Class Switching Deadline Extended – Will Take Effect January 1, 2017

In March, the 2016 Federal Budget announced that the tax-deferred switching advantage of corporate class funds would be ending this year. Originally, the budget called for the regulation change to take effect on October 1, 2016; however, the regulation change will now take effect on January 1, 2017.

Until this year, an investor was able to use this fund structure in a non-registered account and switch from one corporate class fund to another – within the same fund company – on a tax-deferred basis.  For example, an investor could switch from ABC Canadian Equity Fund Corp. Class to ABC Global Equity Fund Corp. Class without incurring a capital gain. With a regular fund structure, the investor would normally pay capital gains taxes on the profit incurred on the fund being sold.

While this is unfortunate news, corporate class funds will continue to offer the advantage of tax-efficient distributions.  These funds will restructure any income distribution (including interest income) in the form of capital gains or dividends, and are taxed at a lower rate than interest income.

Since the announcement was made, we have reviewed and will continue to review all non-registered portfolios at client meetings for any changes we would like to make before the rule change takes place. If you have a non-registered account with us and would like to see if we should act on your portfolio before the end of the year, please do not hesitate to contact us.

Anthony Sabti

Post-Brexit Vote Analysis

 

The Results

Britain voted 51.9% to 48.1% in favor of leaving the EU, of which it has been a member since 1973.  The voter turnout was 72.2%.

Scotland and Northern Ireland voted strongly favour of remaining as part of the EU (62% and 55.8% respectively). England and Wales voted to leave by a relatively narrow margin. Voter turnout in these four nations was strongest in England (73%), followed by Wales at 71.7%; both Scotland and Northern Ireland saw voter turnout below 70%, lower than the 84.6% during the 2014 Scottish referendum.

The BBC link below breaks down the results with various maps and charts:

http://www.bbc.com/news/uk-politics-36616028

The Immediate Aftermath

The GBPUSD, which had traded higher before the vote (over $1.50) plunged a record 10% as the outcome of the referendum became clear. The currency touched a three-decade low of $1.3229, and is currently around $1.38.  In Canadian terms, The GDBCAD fell from around $1.90 to $1.72 and now sits at $1.77.

Rating agency S&P has already confirmed that the UK is likely to lose its final AAA credit rating.

David Cameron announced he will step down from his post by October.

Markets Today

Not surprisingly, Global financial markets sold off sharply early Friday morning. There has been a strong knee-jerk sell-off in risk assets.

The Nikkei (Japan) and Dax (Germany) were down 7.9% and 6.9% respectively.  The French CAC was down 6%.  Italian and Spanish markets posted their sharpest one-day drops ever, falling more than 12%.

London’s FTSE fell by 9% initially but has since reclaimed part of that drop to finish down 3.2%.  Some investors are speculating that the plunge in sterling could benefit Britain’s economy.  Some names in the UK financial sector fell as much as 30% before cutting losses in half later in the day.

The Toronto stock market (TSX) plunged more than 300 points within minutes of opening this morning but recovered slightly afterwards. The TSX ended down 239.5 points, or 1.69%, to 13,891.88.

The S&P 500 fell 3.6% to 2,037.35 in New York, the most since August 2015. The benchmark erased its gain for the year, which reached as much as 3.7% earlier this month. The Nasdaq Composite Index tumbled 4.1%, the most in almost five years.

The risk-off sentiment is also hitting commodity prices, driving oil down by 3.6% to $47.60 U.S. per barrel, putting further downward pressure on the Canadian dollar.

Gold prices benefited from the flight to safety, with prices rising to as high as $1,258 (U.S.) per ounce – the highest since early 2014.

What Happens Next?

As stated, Prime Minister David Cameron and head of the Remain campaign announced he will step down as leader of the Conservative party and be replaced by a leader of the Leave campaign within the next few months, before the Conservative Party Conference in early October.

The Bank of England’s contingency plans kick in – The UK will have two years to negotiate a deal with the EU.

According to European Commission President Juncker, Britain will have to negotiate withdrawal terms first, before talking about how the new relationship will work. In other words, there will be a deep dive into what other options or alternatives are available to the U.K. There is a web of issues around regulations and trade. Anti-EU parties in other countries will be watching closely, as an amicable split may fuel further efforts to exit the EU.

Impact on North America

The most immediate impact on the North American economy will come from today’s financial market volatility in the aftermath of the vote. The Federal Reserve has been very aware of global economic risks, and a Brexit qualifies, which rules out a July rate hike. A rate increase by December remains a possibility, if markets soon calm and the near-term economic fallout is minimal.

With Fed rate hikes now delayed even further, The Bank of Canada is expected to remain on hold until at least the end of 2017.  Consequently, global bond markets will be well supported, with yields likely drifting even lower in the near term.

The long-term economic consequences will be unclear for some time due to the two-year negotiation period.  However, the U.K accounts for a modest 3% of total U.S. trade and an even lesser 2.5% of Canadian trade. Such small shares and the likely modest impact on total trade suggest the direct risk to the North American economy is minimal.

In general, significant pullbacks in global stock markets tend to present opportunities for longer-term investors, although volatility can persist for weeks or months.  Many equity funds have been positioned conservatively and have been holding higher than normal cash positions in anticipation of these results.  This is when we would expect that cash to be deployed to buy companies at depressed prices.

Longer-Term Perspective

It is important to separate the short-term and long-term effects. Over the long run, the impact on the stock market and bond market should be considerably less.  The U.K. represents less than 3% of global GDP. These are still very early days, and developments in the relationship between the U.K. and EU are expected to play out slowly over many months or years.

The exit could cause the U.K. economy to meaningfully underperform, if not tip into recession.  The UK job market will likely suffer, particularly the financial services (which accounts for 8% of British GDP).   A number of global banks could potentially relocate some of their operations out of the UK.

The Eurozone will feel the biggest brunt of slower UK growth, as it sends roughly 16% of its total goods exports to the UK.

Foreign investment may decline as access to other EU markets could become much more limited. British goods trade with the EU account for 45% of exports and over 50% of imports.  And, the EU may not let go easily; they could make this difficult in order to discourage other countries from contemplating departure.

The issue of Scotland’s independence is also likely to again come to the fore, further weakening Britain’s
position, especially since the Scots voted heavily in favour of staying in the EU.

There are likely to be some positive offsetting impacts. UK domiciled industry may seek to move or extend operations within the union as quickly as possible, boosting EU investment. Similarly, EU firms that have deep ties to the UK could relocate or expand operations into the UK, offsetting the decline in investment due to increased uncertainty.

Overall, the impact should be somewhat negative due to higher tariffs, less immigration and the slight diminishment of London as a financial hub. This means that Brexit hardly prophecies economic stagnation for the U.K., though it does unhappily shave as much as a quarter percentage point off growth annually over the coming decade. Potential savings on transfers to Brussels and greater regulatory sovereignty are attractive, but do not constitute complete offsets. But the precise effect depends enormously on what sort of subsequent relationship the U.K. negotiates with the EU.

Bottom Line for Investors

This event will indeed lead to greater political uncertainty and financial volatility.  A UK separation from the EU will take years to negotiate.  Meanwhile, companies continue to do business much as they did before and the global economy continues on its path of slow but positive growth.

Your portfolios are globally diversified and are constructed to mitigate against volatility.  In fact, we expect many fund managers to take advantage of the current stock market decline and use it as an opportunity to buy quality companies at attractive prices.

If you have any questions about your investments, please feel free to contact us anytime.

Sources: TD Economics, Financial Post, BBC, Globe & Mail

Anthony Sabti

Weekly Update – February 12, 2016

February 12, 2016 – Weekly Brief

TSX Rallies on Friday, Cutting into Earlier Losses as Oil & Financials Jump

The S&P/TSX Composite finished down again this week, but rallied on Friday with a 2.4%, 293.87 point jump, to finish trading at 12,381.24. The Friday uptick was the first positive finish for the TSX in 6 days. As one might expect, this positive finish was mainly driven by increases in the financial and energy sectors; however, all 10 of the TSXs main sectors were in the black on Friday.

Oil, which hit a 12-year low earlier in the week, rebounded strongly to finish the week only slightly down. Once again, renewed optimism over the possibility of an OPEC deal with other producers to cut supply led the to the rebound. From week to week, analyst sentiment seems to be flipping between optimistic and pessimistic on the future of an OPEC agreement. West Texas Intermediate saw future contracts rise 12%.

The Loonie finished the week at 72.22 cents to the US Dollar, up 0.5% for the week. Gold has been seen all year as a safe haven, and that sentiment did not change this week; indeed, Gold increased on the week to $1238.50 per ounce, up 5.5% for the week. Gold maintained its status trend as a safe haven, as evidenced by it’s nearly 11% increase year-to-date.

In the U.S., data from Friday revealed that consumer confidence has declined in February, with stock prices and the perception of weaker global conditions being front-and-centre in consumers’ thoughts. A difficult week in the U.S. markets did nothing to bolster consumer confidence either, as all markets were down for the week.

Much of the selloff was sparked on Wednesday, as U.S. Federal Reserve Chair Janet Yellen’s Tuesday remarks to Congress indicated a potential delay in further rate hikes. Worries about a softening U.S. economy were certainly not eased by these statements, and Wednesday saw a selloff in Europe and Asia which was followed by similar such selloffs later in the day in North America.

Many banks also scared investors, as plunging rates around the world have led to fears of decreasing profitability for banks; consequently, banks in Greece, France, Italy and Germany saw their stocks decrease. Sweden Central Bank “Riksbank” also added fuel to the fire with an additional rate cut, plunging the key Swedish rate to -0.5% from -0.35%.

Falling markets continue to offer a stellar opportunity for Canadians looking to invest for the long term. By adding to their current portfolios, investors in Canada can enjoy a lowered average cost base on their overall portfolio. To be sure, low oil prices are transferring money out of the hands of oil exporters and into the hands of oil importing countries.

Inevitably, that transfer will lead to increased spending by these importing countries. Increased spending will help the economy to grow, and the ensuing market rebounds will allow today’s investments to enjoy strong growth down the line. It cannot be stressed enough how opportune the timing is of the markets declining, as the RRSP contribution deadline for the 2015 Tax Year is a little over 2 weeks away (February 29th).

Blog Links

Why A Bad Economy Can Make for a Better Lifestyle

Market Update as of February 12, 2016

North America

The TSX closed at 12381, down -383 points or -3.00% over the past week. YTD the TSX is down -4.67%.

The DOW closed at 15974, down -231 points or -1.43% over the past week. YTD the DOW is down -8.33%.

The S&P closed at 1865, down -15 points or -0.80% over the past week. YTD the S&P is down -8.76%.

The Nasdaq closed at 4338, down -251 points or -0.57% over the past week. YTD the Nasdaq is down -13.36%.

Gold closed at 1239, up 56.00 points or 5.54% over the past week. YTD gold is up 17.00%.

Oil closed at 29.08, down -1.77 points or -5.74% over the past week. YTD oil is down -21.51%.

The USD/CAD closed at 1.384803, down -0.0058 points or -0.42% over the past week. YTD the USD/CAD is up 0.08%.

Europe/Asia

The MSCI closed at 1469, down -80 points or -5.16% over the past week. YTD the MSCI is down -11.67%.

The Euro Stoxx 50 closed at 2756, down -123 points or -4.27% over the past week. YTD the Euro Stoxx 50 is down -15.67%.

The FTSE closed at 5708, down -140 points or -2.39% over the past week. YTD the FTSE is down -8.55%.

The CAC closed at 3995, down -216 points or -4.90% over the past week. YTD the CAC is down -13.85%.

DAX closed at 8968, down -512.00 points or -3.42% over the past week. YTD DAX is down -16.52%.

Nikkei closed at 14953, down -1867.00 points or -11.10% over the past week. YTD Nikkei is down -21.44%.

The Shanghai closed at 2765, up 1.0000 points or 0.04% over the past week. YTD the Shanghai is down -21.87%.

Sources: Globe Advisor, Yahoo! Finance, Dynamic Funds

Anthony Sabti

RRSP vs. Mortgage – Where Should I Put My Money?

 

Clients often ask the following question: “Should I use my excess funds to pay down my mortgage, or to contribute to my RRSP?” It’s a great question, and as with most issues in financial planning, there is no definite answer.

Paying down the mortgage is the “risk-free” option. If $1,000 is applied towards the mortgage, there is a guaranteed savings of the mortgage interest on that amount.

Alternatively, if $1,000 is added to a retirement portfolio, there is no “guaranteed” return. Historically, the Canadian (TSX) and U.S. markets (S&P, Dow Jones) have returned around 8% in the long-run. We project about a 6-8% rate of return for our client’s long-term growth-oriented portfolios.

Mortgage rates are very low these days, somewhere around the 2.5% mark for a five-year fixed rate. This makes the “break-even” point for an investment portfolio to beat mortgage savings fairly low. Without talking about interest compounding or taxes, if the investments return more than 2.5%, then they beat out any mortgage savings strategy.

Our favourite strategy is a hybrid one. Invest long-term money in an RRSP and use the ensuing tax savings to pay down the mortgage. When families can maximize RRSP contributions, they can create significant tax savings which can supplement retirement income plans, as well as reduce mortgage debt. The tax savings created by an RRSP contribution can free up “new money” to be used to pay down mortgage debt. This quickly increases family net worth.

As we say, every situation is unique and depends on your mortgage interest rate and the anticipated return on your investment. Please call or e-mail us and we will be happy to work through the numbers to give you the best advice for your circumstances. We’re here to help you!

Odette Morin

Fall Investment Research (written by Anthony Sabti)

investment research

Each year Odette and I complete a thorough review of the investments we use for You First clients. We cover the entire Canadian mutual fund spectrum and eventually narrow it down to a list we are comfortable recommending. There is much more to a fund then merely its rate of return. Here are some of the metrics we look at when assessing a particular investment:

Manager: Who runs the fund? How long has he/she been in the industry? What is their investment style? Are they by themselves or part of a team? Do they have a repeatable process? Do they have long-term track record of above average returns? A fund’s portfolio manager is one of the most important considerations.

Quartile rankings: Every mutual fund is placed in a category based on the assets inside the fund (ex. Balanced Fund, Global Equity Fund, Canadian Dividend Fund). This allows for a comparison of the fund within its peer list. Each fund in a category is ranked according to return and is assigned in one of four quartiles. A fund with a 1st quartile 5-year return means it has achieved returns in the top 25% of all funds in its category over the past 5 years. We look for funds that consistently achieve top 2 quartile returns.

Standard Deviation: How volatile is a fund? Standard Deviation measures the variation in a mutual fund’s returns. Here are two very basic examples:

• Over three years Fund A has returns of 8%, 10%, 6%. The basic average (I won’t go into the timing of these returns) of these three returns is 8%. The standard deviation would be 1.63%.

• Over three years Fund B has returns of 16%, 0%, 8%. The basic average (ignoring timing) of these three returns is 8%. The standard deviation would be 6.53%.

Fund A and Fund B achieved the same rate of return, but fund B was much more volatile. All other things being equal, fund A has achieved a better risk-adjusted return. We look for funds with low volatility and high risk-adjusted returns.

Fees: All mutual funds have a Management Expense Ratio (MER) which bundles in both the management firm and advisor’s compensation. For an equity fund the MER averages around 2.3% although more expensive funds can near the 3% mark. Although a lower fee won’t guarantee a higher return, there is a correlation between the two and we strive to use funds with average or below average MERs.

Concentration: A mutual fund can hold as few as 10 stocks, but there are also funds that have hundreds of holdings. We generally look for concentrated funds that hold around 20-50 companies. This is usually the sign of an active manager with conviction and studies have shown that mutual funds with concentrated portfolios tend to outperform.

Upside/Downside capture: This metric compares how a fund performs relative to its benchmark index. If Canadian Equity Fund A has a 5-year upside capture of 100% relative to Toronto Stock Exchange (TSX), it means it increased as much as the benchmark in that period. If it has an 85% 5-year downside ratio, it only decreased 85% compared to the TSX. Naturally we look for funds to capture as much of the upside with as little of the downside. This is another way of assessing risk-adjusted return. Successful managers love highlighting a good upside/downside capture ratio during their presentations.

A lot of work goes into our fall analysis.  It is essential to do an in-depth review every year but ongoing monitoring is also part of our regular work. You will be updated at your annual review meeting and contacted should any urgent changes are required during the year.