1st quarter 2018: anything but relaxing

So far 2018 has been anything but restful. While the global economy has good fundamentals, the lifting of protectionism south of the border has brought a lot of uncertainty and volatility to the markets. The depreciation of the Canadian dollar against the other major currencies allowed the Canadian investor with a well-diversified portfolio to minimize the damage. Only the Canadian stock market ended the first quarter in negative territory.

Canadian Equities

After a start to the year that mirrored the last months of 2017, the US market experienced a brief correction in February. During the same month, market volatility, which was at an all-time low when we wrote our last letter, exploded, leading to the closure of several funds using structured products. This is exactly why we have always refused to invest in ETFs using leveraged structured products. History shows that it is simply not worth the risk.

The Canadian market had a difficult start to the year with a performance of -4.52%. Only the technology sector did well in Canada with a return of close to 10% over this period. Unfortunately, the importance of this sector is negligible in the Canadian index. Consequently, its impact on the performance of the index is minor.

The renegotiation of NAFTA and the rise of protectionism among U.S. politicians have put pressure on the Canadian market, given the importance of exports to the U.S. to our economy. The outcome of this negotiation could set the tone for the rest of the year.

U.S. Equities

U.S. equities, supported by the Trump administration's tax reform, had an exceptional start to the year recording a performance of 5.72% in January. We have to go back to 1997 to observe such a performance of the index at the beginning of the year.

The cloud on which the U.S. market was soaring quickly dissipated afterwards to close the quarter with a small decline of -0.76% (+2.30% in C$). Two things are worth mentioning about the decline in the world's largest economy.

First, the release of the employment report in early February showed strong annual wage growth (2.90%). The market reacted negatively to this information, seeing it as an increased risk of inflation.

Second, Donald Trump's protectionist streak and the subsequent tariff escalation between China and the U.S. certainly played a role in the underperformance of U.S. equities in the first quarter.

The thesis is that U.S. trading partners affected by the tariffs will respond in kind to the Americans. Since just over 40% of the sales of major U.S. companies are made abroad, their stock market performance has been affected.

International Equities

The European economy is building on the momentum of 2017 and continuing to strengthen. The unemployment rate is decreasing and domestic consumption is increasing. The European economy is also enjoying a relatively low inflation rate which is allowing the European Central Bank to not raise rates, thus allowing their economy to be stimulated.

Despite all the odds in their favor, international equities, which started the year strong, ended the first quarter with a return of -1.70% (1.34% in C$). This performance is also partly explained by the shadows of US protectionism.

Emerging markets

The situation in emerging markets is still enviable. Indeed, these economies benefit from an abundance of foreign capital, giving them access to low interest rates that stimulate their growth.

Supported by the performance of Brazil, Russia, Malaysia and Thailand, emerging markets had another exceptional quarter with a return of 4.19% in C$.

Bonds

For the second consecutive quarter the Canadian bond market finished in positive territory. With a 0.09% return for the quarter, the Canadian bond universe certainly confused investors. This return is reasonable considering that we are currently in a bullish rate environment where we would normally expect to see bonds pull back.

The trend mentioned in our previous letter continues. While 10-year Government of Canada bond rates are not rising or are rising slightly, short-term rates are rising much faster. So we are seeing a flattening of the yield curve.

Real Estate Investment Trusts (REITs)

The new policy of tightening regulations on home ownership came into effect in January and put pressure on the Canadian real estate sector. However, the slight increase in long-term interest rates allowed REITs to end the quarter in positive territory, with a respectable return of 1.34%.