Tricia Leadbeater’s Market Updates

Fourth Quarter Review

After a terrible start to 2016, and despite many forecasts for gloom to come, investors were happily surprised and rewarded by the end of the year. Several key factors, that were a surprise to most market watchers given indications in January, triggered the turnaround. Remember, the TSX dropped 11% in the first three weeks of January 2016:

  • Interest rates did not go up as expected: The Federal Reserve decided in March to back away from their plan to raise rates in 2016, allowing investors to jump back into equities, particularly bond-proxy high dividend paying stocks like utilities and telecomms. Canadian interest rates continued to move down. The Fed raised rates only once, and not until December.

  • The USD weakened: the USD backed off its upward trajectory, which improves the bottom line of multi-national US companies, and eases the debt payment burden for emerging market borrowers. This helped calm markets globally. The loonie gained 3% against the USD over 2016, finishing at 74.4 cents (still well below its 5 year average of 87 cents). Note the dollar rose again to new highs in the last month of 2016, following the interest rate hike in the US and Donald Trump’s election win. For now, the promises of adding growth and lowering tax rates have kept the US markets strong, but emerging markets bonds and equities have seen outflows of funds.

  • Commodity prices improved: China’s economy did not have the crash that many feared, and since there was a sustained drop in base metal investment and development since 2012, lower inventories finally balanced markets. China introduced production curbs in April on coal, after which coal prices doubled (controls in China have since relaxed). Iron ore also nearly doubled in 2016. After major miner Glencore cut zinc production in half in 2015, in 2016 zinc prices rose nearly 60%. Agricultural commodities were the exception following bumper crops in wheat and corn. Canada’s stock market was a key beneficiary of the base metals price improvements. Commodity price strength was probably the root cause of the 3% gain in the Canadian dollar, given we are otherwise in a low growth, low interest rate and deficit and debt driven environment.

  • Oil prices improved enough to save much of the North American sector from insolvency: At the end of 2016, OPEC decided that US shale oil production had backed off sufficiently that they too could pull back on production and preserve market share. Oil prices ended the year around $53 USD after dropping to $26 in January. This helped bond and equity markets as a substantial amount of high-yield debt outstanding is connected to oil and gas producers and service companies, a large component of weakness in earnings growth in Canada and the US was attributable to the drop in oil prices.

Broad commodity index returns, last 6 years

Financial Times, December 22, 2016

The dramatic turn in commodity prices was a key factor in the turnaround in Canada’s banking, oil and gas, and base metals sectors in 2016.

Key markets performed as follows, price only, in local currencies, 2016:

  • S&P 500: 9.54%

    • More than half of that return generated since Donald Trump was elected in November.

  • TSX: 17.5%

    • The 2 year annualized price-only return is 2.2%, since the TSX was down 11% in 2015. The 3 year annualized average on the TSX is 3.9%.

    • Commodity producers and financials were the key drivers of performance. This was the first year since 2010 that Canada outperformed the US markets.

  • Europe (Eurostoxx): 0.7%

  • England:  14%

    • Yet the British pound dropped over 20% since June against the USD.

  • EAFE (Europe, Australasia, Far East): -1.9%

    • Our global equity funds reflected lower returns in 2016 versus 2015 because of weaker global markets.

Financial Times

Fixed income in Canada marginally positive, total returns of 1.67% on the TMX Universe and 2.47% on the TMX Canada Long Term Bond Index.

  • Canadian bonds dramatically underperformed equities in the last quarter of 2016: The FTSE TMX Canada Universe Bond index down by -3.44% in Q4; the FTSE TMX Canada Long Term overall Bond Index down -7.54% in Q4.

  • Since the US election, over $41 billion was pulled out of bond funds, the largest redemption since the “taper tantrum” of 2013. 10 year treasuries shot up from 1.8% to 2.4% following the US election, which led to a broad sell off in bonds, as investors expect Trump’s policies to lead to higher growth and inflation, and therefore better investment opportunities elsewhere.

  • Our bond funds that are strategic and opportunitist fared well over this period, with some even rising in value by year end.

3 year chart TSX (blue) versus S&P 500 (red line)

As you can see from the chart above, stock market indexes, while up, have been challenging for the last three years. For Canadian investors who bought in summer of 2014 or spring of 2015 – their portfolios are just back onside if they held steadily through periods like the 23% drop the TSX had between May of 2015 and January 2016.

The 3 year TSX annualized price return has been 3.9%; while the S&P 500 has been 6.6% (in USD terms). Much of the 2016 upward move in equity markets took place in the last 6 weeks of the year following three critical events: the US election, the Federal Reserve raising rates, and OPEC signalling they would reduce production in order to support a higher oil price.

Fixed Income review:

3 Year performance (price only) ishares Canadian Universe Bond Index as measured by the ishares exhange traded fund XBB:


We could be seeing a real change in the outlook for bonds, for the first time in 10 years. Most investors are not used to the idea that bonds do not necessarily provide a near risk free return. While coupon payments can stay steady, longer maturity bonds have huge price swings when interest rates change. With the prolonged period of zero interest rates, we saw a huge volatility swings in bond markets as rates rose. This volatility and repricing of longer term bonds will likely continue through the year as the Federal Reserve is expected to put through three more .25% interest rate hikes in 2017.

To demonstrate how senstive long term bonds are to a small change in interest rates, the ishares 10+ Year Credit Bond fund ETF CLY is below:


Since this index yields about 4%, if could take several years to earn back your capital losses if interest rates do continue to climb. The investment grade bond index dropped 5.7% just in November following the Trump election win. Yields dramatically changed in bond markets following the election, then adjusted back somewhat in the latter weeks of December.

Key factors that will influence markets and drive investment decisions in 2017:

US corporate earnings growth and their debt loads:

  • As of writing, investors believe that Trumpism will generally be positive for equities. Trump promises lower corporate taxes, lower personal taxes, and an amnesty to encourage corporations to bring back the billions of earnings sitting offshore. All this, if enacted, may promote corporate investment, dividend hikes, growth in after-tax earnings, and share buybacks. Trump also promises large spends on infrastructure, further putting workers back into the workforce, and perhaps starting a virtuous cycle of consumption. All these factors may encourage investment in US equities.

  • The US markets are now trading at 19x earnings. So without a boost to corporate earnings from here it is difficult for prices to increase from these levels – but Trump’s policies may in fact help boost earnings from here.

  • Corporate debt issuance has surpassed 2007 levels, and over-leveraging traditionally slows down growth in companies and can make them riskier investments for bond and equity owners. However the maturity dates are generally very far out so corporate America may have some cushion. Issuers went to market with 20, 30 and 40 year bonds in the last several years. Much of this debt has been issued to buyback shares, fund higher dividends and support large M&A deals. With higher borrowing rates, these types of activities could slow down. Corporate debt outstanding will leave investors in the shorter term exposed to interest rate shocks, but borrowers have locked in extremely low cost of capital. For example, the 30 year bond that Microsoft sold in August to fund its LinkedIn purchase fell to 92.30 cents on the dollar in December, from 100 in August (Financial Times, December 4, 2016). With a coupon of 3.7%, it would take several years to make your capital back if the bond price didn’t improve.

Financial Times

Commodity price forecasts, especially oil:

  • Canadian stock market returns and the value of the Canadian dollar are correlated with the price of oil. There are a lot of risks in forecasting the oil price over the year ahead. Even if Saudi Arabia and Russia stay committed to production cuts, it is unlikely that supplies from the US (many shale oil producers are profitable above $50 WTI), Iran and Iraq won’t make up that difference. Nigeria and Libya are also trying to lift their production levels, and are not a part of that output agreement.

  • Trump is potentially going to loosen regulatory constraints on drilling this year. This is also bad for Canada’s industry as we are going in the opposite direction of tightening regulatory frameworks and continue to impose restrictions market access owing to pipeline constraints.

  • For now, investment in the oil industry is predicated on the WTI price staying within a band of $50-$55, allowing that price shocks on either side are possible. Many Canadian oil companies are already trading at valuations that are implying much higher future oil prices, meaning that there is room for disappointment for investors in this sector again. The future oil price depends on supply factors that are difficult to predict with accuracy right now.

US dollar strength:

  • A strong USD can make it difficult for emerging markets; borrowing costs on their debt goes up.

  • If the dollar gets too heated, this presents risk to US corporate earnings as over 50% of the earnings on the S&P 500 come from outside the USA – this could negatively impact earnings and the stock market.

  • Canadian investors may want to consider having exposure to the USD for diversification due to a generally weak Canadian dollar.

Trumpism, the rise of populist politics and public policy present risks to growth:

  • Whether Trump follows through on protectionist tariffs and policies will impact corporate earnings globally. Policies of the new administration will become clearer in coming months.

  • But it is possible that Trump’s exapnsionary fiscal policies are more effective than the Federal reserve’s attempts to stimulate the economy- restoring the US to full employment and create aggregate demand.

  • Elections will take place in France, Germany and the Netherlands this year. Italy also faces political turmoil with its extremely stressed banking system.

  • There is some reason to worry whether the EU holds together through elections this year and as Britain attempts to negotiate an advantageous exit starting in March.

Inflation and the Federal Reserve’s plan to raise interest rates:

  • The Fed appears to be on a monetary tightening policy. The current expectation is that the Fed will have 3 more rate hikes in 2017. This is highly dependent on GDP growth expectations being met, with an eye to the health of the global economy.

  • Interest rate sensitive equities may be considered only if they also have real growth opportunities in their business. Companies with excessive leverage need to be approached with caution. Insurance, Banks, and Energy tend to do well in rising interest rate environments. Banks may get an additional boost from Trump’s promises to relax regulation on the banking sector. Cyclicals, like Chemicals, Railroads and Energy traditionally benefit. We also think disruptive technology companies will continue to be a focus for growth.

  • There is a risk as highly leveraged companies could start to default if rates rise faster than expected, which could cause volatility in bond and equity markets.

  • We advocate lowering duration in bond portfolios – in general looking for durations under 3 or 4 years for safety. The investment universe should expand to opportunities outside Canada. Managers like Manulife’s Strategic and PIMCO’s Monthly Income funds have exposure to Australian sovereigns and US non-agency mortgage backed debt, by example. This year is likely to be challenging for bonds, but higher/ normalized interest rates may be better for bond investors in future years. I look for active managers with long experience in different interest rate envrionments and who performed well in the dramatic bond environment of the last two months: RP Investment Advisors; Manulife; PIMCO, Canso are some of the top performers.

Please feel free to contact me with your comments.


Tricia Leadbeater
Director, Wealth Management


The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author's judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. The comments contained herein are general in nature and are not intended to be, nor should be construed to be, legal or tax advice to any particular individual. Accordingly, individuals should consult their own legal or tax advisors for advice with respect to the tax consequences to them, having regard to their own particular circumstances..Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.