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Q2 2018: protectionism and tensions

Quarterly review

Richard Morin

Update :
Update :
July 27, 2018

Against a backdrop of uncertainty and trade tensions, the global economy continues to grow at a steady pace. The Bank of Canada projects the global economy to grow by 3.75% for 2018. The cloud of protectionism still hangs heavily over our letter, but let's keep in mind that the long-term outlook remains good despite the passing storm caused by the Trump administration.

Asset classes Returns in $C
2nd quarter YTD
Bonds 0,50% 0,60%
- Canadian 6,77% 1,94%
- American women 5,37% 7,79%
- International (EAFE) 0,78% 2,13%
- Emerging markets -6,14% -2,22%
Real estate investments (REITs) 4,65% 6,05%

Canadian Equities

Canadian markets had an outstanding second quarter with a return of 6.77%. This performance was led by the energy sector, which returned 14.7% during the quarter and represented one-fifth of the index.

From an economic standpoint, the first few months of 2018 have been enviable for Canada. Its production level is now close to its potential production capacity.

The unemployment rate remains at a historically low level and labour shortages are intensifying in some sectors. Canadian wages are growing at a steady pace (3.6%) not seen since 2012, and inflation is close to its target level of 2%.

Anticipated risks:

The deterioration of trade relations with the United States is cause for concern. After the steel and aluminum sectors, and unfortunately for Canada, the Trump administration is starting to take an interest in the automotive sector, which is a key sector in Ontario.

If the tariffs are limited to steel and aluminum producers, 80 per cent of whose exports go to the United States, the impact on the Canadian economy would be manageable. The real risk is that tariffs on Canadian exports will continue to expand into new sectors.

U.S. Equities

While other regions of the world are all suffering from certain ills, the U.S. machine is currently running at full speed. Our neighbors to the south currently have an enviable positive output gap. Unemployment is at an all-time low, and households are enjoying high net worth and recent income tax cuts. Corporations are also benefiting from lower taxes, allowing them to invest and be more competitive. The U.S. is therefore very well positioned to sustain its consumption levels and continue to stimulate its economy.

The net worth of U.S. households is growing at a much faster pace than their debt levels, which has allowed the U.S. to achieve a debt-to-net worth ratio that has not been this good since 1987.

The protectionist policy of the United States, combined with a tightening of its monetary policy, benefited the U.S. dollar, which appreciated against the Canadian dollar. This benefited the performance of the Canadian investor who invested in the United States. The U.S. markets returned 3.4% (5.37% in Canadian dollars) during the last quarter.

The only cloud on the horizon for the world's leading power is the threat to "Made in USA". Millions of jobs that depend directly on the country's exports and imports are currently at risk. To some extent, the survival of these jobs is in the hands of America's trading partners. The same is true for U.S. companies whose growth depends heavily on their overseas operations.

International Equities

The Eurozone continues to show good fundamental indicators. However, it has lost momentum in the early months of 2018. With 48% of its gross domestic product based on exports, the Eurozone is being hit hard by the slowdown in international trade caused by Trump's trade approach.

On a more positive note, inflation in these countries is relatively low and below the target level of central banks. As a result, central banks will eventually have to take measures to stimulate the economy and should keep interest rates low. These measures would help limit the damage.

International equities returned 1.79% (0.78% in Canadian dollars) in the last quarter.

Emerging markets

Growth in emerging economies continues to be healthy: the first quarter of 2018 represents their largest quarterly industrial production growth since 2012. Unfortunately, the performance of equities in financial markets does not always reflect the level of health of the economy in which they operate. Indeed, during the last quarter, investors reacted strongly to the deterioration of trade relations between several of these countries and the United States, causing this asset class to decline by 6.14%.

It is important to remember that the economies of these countries are highly dependent on their exports. The new U.S. trade policies could therefore lead to a subsequent slowdown in growth in these countries.

In the current climate of uncertainty, investors tend to retreat to safe havens. There is currently an outflow of capital from emerging economies that is being reinvested in "stronger" currencies such as the US dollar. This transfer of capital has contributed to the appreciation of the US dollar. The appreciation of the U.S. dollar is a problem for emerging countries since many of these countries have incurred large amounts of U.S. dollar-denominated debt over the past decade. Any appreciation of the U.S. dollar against their respective currencies will increase their debt, thereby increasing their risk of default.


The Canadian bond market had another positive quarter with a yield of 0.50%. The policy rate remained unchanged during the quarter and the yield curve remained relatively flat. As a result, investors are less rewarded for investing in long-term Canadian bonds than they might be for buying foreign bonds.

Real Estate Investment Trusts (REITs)

The growth of the Canadian economy, combined with stable long-term interest rates and a healthy job market, allowed REITs to shine in the last quarter. This asset class ended the quarter in positive territory with a return of 4.65%.