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Q2 2019: The importance of diversification

Richard Morin

Update :
Update :
July 18, 2019

After a remarkable rebound in the first quarter of 2019 - following the correction the markets experienced in the last quarter of 2018 - the balanced portfolio continued to deliver excellent performance in the second quarter.

Canadian bonds - up 2.51% - and Canadian and developed country equities accounted for the portfolio's strong performance. Canadian and U.S. stock markets were at record levels at the end of the quarter. REITs declined slightly, after rising nearly 16% in the first quarter.

Asset classes Returns in $C
2nd quarter YTD
Bonds[1] 2,51% 6,52%
- Canadian women[2] 2,59% 16,24%
- Americans[3] 2,22% 13,74%
- International (EAEE)[4] 1,60% 9,41%
- Emerging markets[5] -1,77% 5,28%
Real estate investments (REITs)[6]. -0,57% 15,23%

The last 3 quarters illustrate very well the importance of maintaining a healthy diversification and not paying attention to the rhetoric of those who claim to be able to predict financial market trends.

Canadian equities: techs lead the way

Canadian equities returned 2.59% in the second quarter. The excellent performance of the technology sector (+14.2%, mainly due to the 43% increase in Shopify) more than offset the decline in the energy sector, where oil companies had a poor quarter after a strong start to the year. The entire oil exploration and production industry was down, including Encana at -30% for the quarter.

The significant drop in the price of cannabis stocks did not have a significant impact given their low weight in the stock market index.

Like the U.S. stock market, the Canadian stock market is within a few points of its record high.

U.S. equities: we like interest rate cuts

The U.S. Federal Reserve is about to fulfill Donald Trump's wishes and lower the rate at which it lends to commercial banks (the Fed Funds Rate) in order to stimulate the economy. Like Mr. Trump, the stock market likes rate cuts and therefore reacted positively, rising 4.30%. Given the appreciation of our currency, the return was 2.22% for Archer clients.

Technology stocks are particularly sensitive to interest rate changes and therefore outperformed over the quarter and year-to-date, as they have in Canada. U.S. energy stocks also had a negative return.

After 10 years of uninterrupted economic growth and rising stock markets, signs of a slowdown in trade and the global economy lead many to conclude that the risks of a correction, or even a bear market, are relatively high. Another concern is that central banks have little ammunition to fight a potential recession since interest rates are already at historically low levels. While potential recessions and market corrections are inevitable, their timing is unpredictable. The only way to protect yourself is to maintain an asset allocation that suits your investment profile and objectives, as well as healthy diversification. In the meantime, we continue to reap the rewards.

International equities: the European economy slows down, and then?

International equities in developed countries generated a return of 3.68% (1.60% in CAD) in the second quarter. Most of the performance came from Europe: companies in France, Switzerland, the Netherlands, Germany and Sweden were up 5% to 9% for the quarter. This shows once again that there is little correlation in the short or medium term between a region's economic outlook (the European economy is showing signs of slowing down) and stock market performance. It is therefore futile to actively manage the geographic allocation of the portfolio.

Emerging markets: China's fault

The 0.43% performance of emerging markets was insufficient to offset the appreciation of the Canadian dollar; the decline was 1.77% for the quarter in C$.

China and, to a lesser extent, Korea pulled the index down. Otherwise, the other heavyweights Brazil, South Africa, Russia and Thailand are all up between 7% and 16%. That's why our investments are spread across all emerging markets.

Prospects for lower rates in the U.S. and Europe and a possible easing of trade tensions are good news for emerging markets.

Bonds: a bull market that never ends

For more than 15 years now, people have been predicting the imminent end of the bond bull market. Remember that interest rates on government bonds - particularly in Canada and the United States - have been falling almost constantly since the early 1980s, reflecting the decline in inflation. Those who have been able to maintain a portfolio of long-dated bonds have benefited from the steady rise in their price (which fluctuates inversely with rates). The last quarter was no exception, with the bond portfolio returning 2.51% (6.52% year-to-date).

Those who believe that rates - currently 1.5% on Canadian 10-year bonds - cannot get much lower need only look to Germany, where 10-year bonds are trading at -0.33%. Why accept a negative current yield on a bond? Because it offers some protection against a possible economic downturn and deflation; it is an insurance policy.

With this in mind, Archer continues to maintain an average maturity of nearly 10 years in its bond portfolio. By adding a reasonable proportion of corporate bonds (about 30%), we obtain a yield to maturity of nearly 2.9%. The Germans should invest in Canada!

Real estate investment trusts (REITs): slight decline

After a strong start in the first quarter, REITs experienced a 0.57% decline in the second quarter. REITs are very sensitive to changes in interest rates and have benefited from an improved rate outlook since the beginning of the year.

1] FTSE TMX Canada UniverseXM Bond Index

2] S&P/TSX Capped Composite Index

3] S&P 500 Index

4] MSCI EAFE Index

5] MSCI Emerging Markets Investable Market Index

6] FTSE Canada All Cap Real Estate Capped 25% Index