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Anthony Sabti

2017 Market Recap – A Tale of Two S&P 500s

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)

Market Level YTD YTD C$
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%
Anthony Sabti

Big Changes Coming for Incorporated Professionals

On July 18, 2017, Federal Finance Minister Bill Morneau released a consultation paper on proposed private corporation tax measures. These measures are designed to close tax advantages used by Canadians who use private corporations for income sprinkling, accumulating passive investment income and converting income into capital gains.

Most of the proposed changes are anticipated to be implemented on a go forward basis, effective for 2018. Many businesses will need to review their corporate and compensation structures and consider planning for changes to be in effect for 2018.

Which practices is the government focusing on?

1. Income-Splitting Using Private Corporations

Perceived Benefit: Shifting income that would otherwise be realized by a high-income individual to family members (usually a spouse) who are subject to lower personal tax rates (e.g., via dividends or multiplication of the lifetime capital gains exemption (LCGE)).

Proposed Measure: Extend the existing “tax on split income” rules that previously applied to minors (“kiddie tax”) to certain adult individuals. The change would effectively impose a tax at the top personal rate on dividends paid to any related individual who provide no labor or capital contributions to the business.

Reasonable payments made to related parties who do help in the business would not be affected by this change.

In addition, a related individual would no longer qualify for the LCGE in respect of capital gains that are realized, or that accrue, before the taxation year in which the individual attains the age of 18 years. Also, there will be restrictions on using the LCGE for gains accruing through family trusts.

2. Holding a Passive Investment Portfolio Inside a Private Corporation

Perceived Benefit: Corporate income tax rates, which are generally much lower than personal rates, may facilitate the accumulation of earnings that can be invested in a passive portfolio, providing the owner with a significant tax deferral advantage.

Proposed Measure: The government is considering changes such that investments held within corporations are taxed at the same effective rate as investments held directly. According to the government, the tax advantage conferred on private corporations – the lower rate of tax –was never intended to be used to realize higher personal savings.

What are the Next Steps?

No decision, consultation only: Until October 2, 2017, the government will accept submissions and comments from Canadians. Those interested in having their say should submit their comments to email hidden; JavaScript is required

Anthony Sabti

Bank of Canada Raises Overnight Rate to 1.00%

As we discussed last Friday in our Weekly Update, the Bank of Canada followed up on expectations by raising its overnight rate by 25 basis-points to 1.00%. Analysts had forecast a rate hike in either October or December, but recent Q2 GDP growth data exceeded expectation, leading some to predict a rate hike this week. This is the second such rate increase of 25bps, following up on the July 12th increase. Before the July increase, the overnight rate had been at 0.50%.

Inflation is below the 2% target, but there was a slight uptick during Q2. In the face of continued and robust consumer spending, solid employment figures and income growth, the Bank of Canada acted to raise the rate as a means of stemming further inflation.

Recent rate levels have been at historic lows, so these recent rate increases were, in a way, inevitable; still, they are the first such increases in 7 years. The Bank of Canada is confident that the economy is strong enough to weather these increases.

As one might expect, the markets have reacted by driving the Loonie up over 1 cent vs the Greenback to 81.81 cents USD, a 1.29% increase (as of 2:33pm EST).

Sources: Globe Advisor, Bank of Canada

Anthony Sabti

Bank of Canada Raises Overnight Rate to 0.75%

Yesterday, the Bank of Canada (BoC) met market expectations by raising the target overnight interest rate by 25 basis points to 0.75%. Although investors were broadly expecting an increase, it is notable as it marks the first rate hike in about seven years.
 
The BoC’s assessment is that growth in Canada has broadened across industries and regions. The Central Bank believes the growth is sustainable and upgraded its growth forecasts for 2017 from 2.6% to 2.8%. Overall, the announcement was viewed as being relatively “hawkish” (being in favour of higher rates) and strongly hints at further increases in the near future.
 
Canadian government bond yields and the loonie rose after the hike on speculation that the BoC will raise rates again later this year. Since May, the CAD has rallied 8% against the USD.
 
The BoC is no doubt aware of the delicate act it has to perform. Raising rates increases the risk prospects of a growing competitive wedge between Canadian and the U.S and an overextended housing market. Major banks have already increased their prime rate, and anyone with a variable mortgage will now have higher lending costs. Those with fixed-rate mortgages will likely have higher lending costs at renewal.
 
The action taken by the BoC is part of a coordinated tightening effort among major central banks. Given where we are now, the trend globally will be to slowly increase rates over time. This will in turn lead to higher bond yields. In the short-term, managers are likely to adapt a cautious approach in their portfolios.
Anthony Sabti

Weekly Update – July 7, 2017

Look on every exit as being an entrance somewhere else.” – Tom Stoppard

The Next Chapter of You First Financial & Benefits Consultants

Today marks the end of my first week as owner of You First. Odette & Terry’s presence will be missed, but their values and principles will continue to guide the company’s future. We will continue to provide timely service and professional, sensible advice. We are here to help you meet your financial planning objectives. Most importantly, know that we ALWAYS have your best interests in mind when we consider any question or situation you may have.

I look forward to meeting with you in the weeks and months to come. In the meantime, enjoy your long-awaited summer!

Anticipation of Rate Hike, Oil Price Declines pull Toronto Stock Exchange to 7 ½ Month Low

The Toronto Stock Exchange’s S&P/TSX composite index dropped 50.84 points to finish the week at 15,027.16. However, during the Friday trading session, the TSX dropped for a time as low as 14,916.94, its lowest point since November.

Expectations of Bank of Canada rate hike, as well as encouraging June jobs numbers, pushed the Loonie up to 77.6 cents (U.S.). Rate hike anticipation has also led a few of the larger banks – Royal Bank of Canada among them – to increase their mortgage rate offering.

Oil prices dropped by 2.5% drop in oil prices today alone, on news of OPEC exports reaching their highest levels in 2017. The constant “will they or won’t they” questions surrounding potential OPEC production cuts again veered to the “they won’t” camp, as analysts raised doubts about OPEC’s efforts on the matter. Brent futures dropped by $1.36 (U.S.) to close the week at $46.28 per barrel, while West Texas Intermediate dropped by $1.28 (U.S.) per barrel to finish at $43.78.

In the United States, Wall Street reacted positively to strong U.S. jobs data, as the S&P 500, the Dow Jones Industrial Average (DJIA) and the NASDAQ all posted strong increases. Analysts project a 51.5% chance of a December rate hike by the U.S. Federal Reserve; however, policymakers have differing opinions on inflation, which dropped further below the Fed’s 2% target. This differing opinion has cast doubts on future rate hikes.

Sources: Globe Advisor

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.