Tricia Leadbeater’s Market Updates

Q2 2016 Review: Brexit, Trump, and Don’t Fight the Fed

We’ve had exceptionally exciting markets over the last year, with volatility being the major theme up until a month ago. Over the last calendar year, the TSX is flat, but not without first losing 20% in value from August 2015 to January 2016. 2016 came in with a whimper, stock markets generally reeling from the first and very modest interest rate hike by the Federal Reserve in 8 years, along with extreme weakness in commodity prices. The TSX and the S&P 500 gave up 10% in the first 13 trading days of 2016, prompting some analysts and pundits to forecast that a 2008-style market crash was around the corner. But then, the exact opposite happened. The US dollar continued to fall from multi-year peaks against it trading partners, which is a stimulus for international S&P 500 listed companies, emerging markets and other trading partners with the US, like Canada. The price of oil, gold, copper, among other commodities, bottomed. The Federal Reserve, in their March and April meetings assured the markets that they would back away from tightening monetary policy or raising interest rates for the near term, which encouraged risk taking investors. The markets continued to rock through spring, tracking commodities prices upwards.

If one was forearmed with the knowledge that in the first ½ of 2016 Donald Trump would transition from one of the most parodied figures in America, to a likely candidate for US president; the UK would vote to separate and isolate itself from the nearly 40 year economic union with the EU; there would be several more horrifying terrorist attacks on civilians in France, Germany, Belgium; an attempted military coup in Turkey; and social pressures would continue to rise from the still increasing waves of refugees out of Syria, Afghanistan and Northern Africa to Europe, it would be unlikely that anyone would predict North American markets would reach multi-year highs.



The surprise outcome of the “Brexit” vote is a powerful indicator of how strong a grip that populism and protectionism has in contemporary politics, and therefore future public policy. Brexit was driven by the same factors that seem to be propelling parts of Europe to swing very sharply to nationalist/ right wing parties, and Donald Trump’s rise to Republican candidacy in the US: entrenched unemployment among blue collar and middle class workers; a belief that immigration is a part of the unemployment problem; high geopolitical tension driven by increasing incidents of unpredictable and violent terrorist attacks; a sense that the gap between the rich and the middle class is widening; an implicit understanding that Quantitative Easing has functioned essentially as welfare for the equity owning and banking classes, while the working middle class stagnated. Near zero interest rates on savings for nearly a decade are steadily destroying the value of retirement assets saved by middle class pensioners.

The current concern in markets is whether a broad dampening of trade and demand will be an outcome of Eurozone instability. Uncertainty is negative for markets – corporations and investors tend to stay on the sidelines without clear visibility on growth and future policy. They have shied away from European markets post Brexit, which are still down 12% year to date. A slowdown in European demand does impact the US economy, as Europe is its largest trading partner, followed closely by China. The move in the oil price post-Brexit has reflected this uncertainty of economic activity, moving down 10% in the two weeks following the vote. It remains early days yet on whether this fear is overdone.

For now, investors have reacted post Brexit by piling into US Treasuries and US and Canadian stocks. Interestingly, for the first time in six years, the TSX is outperforming the US market, driven by our now devalued currency and weighting to commodity oriented companies. The TSX has been a consistent underperformer, and very volatile since 2011, when commodity prices peaked out. Other winning sectors have been defensive, yield-oriented plays like telecomm and utility stocks. The S&P 500 Utilities sector is now trading at 19.5 trailing earnings, a 30% premium to its long term average. In the US, Utilities in 2016 have replaced the “FANG” stocks of 2015, with 20% + returns year to date (“FANG” stocks, Facebook, Amazon, Netflix, Google, are the 4 stocks that performed so disproportionate to the rest of the stock market in 2015, that if manager didn’t own them they couldn’t beat their benchmark averages).

The market today: can the bull market continue?

Given all the troubles mentioned above, why are stocks trading near all-time highs? Why do we think they could continue to get support from here, even after the rally we have had through July?

Equity valuations are not cheap by traditional metrics. The post-Brexit rally has pushed US indexes back to all-time highs. One could think that further gains from here may be unlikely, when we consider the low rate of corporate earnings growth that most companies are facing on the S&P 500, relative to earnings multiples of 20x earnings (long term around 15.5x). However, if the interest rate stays at all-time lows, higher than normal price-to-earnings multiples could be sustained for some time. Stocks could continue to move to higher

Investors could keep buying stocks for several reasons:

Dividend yields versus Treasury yields. Dividend yields on high credit quality mega-cap US companies are far more attractive than the 10 year Treasury, with the possibility of capital growth too. And the same ratio holds in Canada, with the 10 year Canada bond yielding 1.1% while the TSX has a yield of 2.9%. This is a complete inversion of the usual relationship. Historically, this inversion started happening only after the financial crisis of 2008, after which governments started pushing interest rates towards zero and even below.



  • Dividend increase announcements remains a stable trend to last several years. Increasing income helps to match inflation based expenses over time for savers.

  • Indicators all point to continued low interest rates from here, meanings dividend yields will remain the favored means of income: the UK is expected to lower rates in August; the EU is actively buying government and corporate debt to keep rates down; the US is hesitant to raise against the back drop of low inflation and the risk of creating a strong US dollar value. Over 50% of S&P 500 earnings come from outside the US, so a softening dollar along with low interest rates helps US corporate earnings.

  • The rule of “don’t fight the FEDS” applies – investors have piled into stocks believing more quantitative easing is coming, on a global perspective.

  • As long as rates stay low – the bond-proxy high dividend payers will remain in demand. Record low interest rates keep investors focused on dividends to satisfy investment return objectives.

  • Long bonds are becoming an ever riskier and overvalued asset class – zero and near zero-coupon bonds will be extremely volatile in price if interest rates ever move up. There is the real likelihood, near certainty, that investors buying long government and corporate issued bonds today will lose money if they sell before 10-, 20-, 30-year maturity dates. Investors for now don’t seem to care. The book on the $20 billion Microsoft issue of last week was more than 2x oversubscribed, allowing Microsoft to borrow for 30 years at 3.7%. The average retail investor in Canada may look at high quality corporate bank bonds for their fixed income allocation, but even a 5 year Bank of Nova Scotia bond today yields 1.35% annually. Equities keep getting more attractive in this context.

  • Cost of capital remains cheap, helping merger and acquisition activity, and share buyback programs, and borrowing to grow businesses, which is supportive for stocks.

  • EPS revisions to the upside continue on an upward trend in 2016: current year over year earnings growth for 2016 is 5.3% growth on large caps and 7.2% on small and mid-caps in the US (Credit Suisse research).

  • Segments of Canada could also experience EPS growth in the year ahead, with the Canadian dollar stabilizing in the mid 70 cent range (GMP Securities, consensus forecasts). Labour is comparatively less expensive, produced goods for export are relatively less expensive to years when we had a stronger dollar and higher commodity input costs; USD receipts back to Canada are more valuable. The mining and manufacturing sectors are big beneficiaries of these trends.

  • US attracts fund flows because is still the economy that is growing: structural growth likely remains 2-2.5% right now, but has slowed in the first part of 2016, in part because of the sustained downturn in energy investment, which sector is a large employer as it is in Canada (“US Business Leaders Lower Growth Forecast for American Economy,” Financial Times, 15 June 2016). Europe is at best stagnating: it had 0.3% growth for the 2nd quarter and faces risks following Brexit and a potential banking crisis around the corner, Emerging markets are risky with uncertain growth out of China, and for now even Canada is barely fending off recessionary trends.

Risks to stocks:

  • Any renewed US dollar strength will pressure earnings in the US and beyond

  • Equity and High Yield markets are sensitive to the direction of the oil price

  • Additional shocks out of Europe

  • US presidential election, may possibly affect markets

  • The market doesn’t seem to be worried about China’s economy for now, but risks to their growth affects global growth

  • Corporate cash balances are still healthy, but debt continues to rise since the financial crisis

  • Governments continue to borrow which is a drag on growth and ability to spend in the future

  • Low interest rates mean lower returns for savers, and lower ability to consume as they need to increase savings rates to meet long term retirement needs.

Investment position for 2016:

  • Cautiously bullish for the rest of the year

  • Own shorter duration (under 6 years) corporate bonds, with exposure outside Canada

  • Modest exposure to high-yield bonds for improving income generation

  • Modest position in gold and gold stocks as a hedge against market and currency volatility. With gold above $1300 an ounce, the industry has been transformed from barely surviving to thriving.

  • Dividend payers than can growth earnings and dividends, at the right valuations. This is a long term structural demand trend. Take advantage of market volatility to add to these positions.

  • US dollars as a hedge against potential Canadian currency weakness


Please feel free to contact me with your comments.


Tricia Leadbeater
Director, Wealth Management


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