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3rd quarter 2017: the economic planet is doing well!

Richard Morin

Update :
27
January
2018
Update :
January 27, 2018

The economic world is doing quite well. Nearly a decade after the fact, the global economy is beginning to shake off the legacy of the financial crisis. Growth is accelerating around the world: in the United States and Canada, but also in Europe, Asia and emerging markets.

What does this mean for investors?

On the one hand, the increase in profits that accompanies economic growth is supporting stock prices. On the other hand, economic growth is also leading to a rise in long-term interest rates. The impact has already been felt in the bond portfolio, which is down in thethird quarter. On the other hand, bond investors can start to look forward to the day when they can invest their cash at more attractive returns.

Asset classesReturns in $C
 3 rd trimYTD
Bonds-1,84%0,48%
Equities  
- Canadian3,68%4,45%
- American women0,46%6,06%
- International (EAFE)1,79%12,59%
- Emerging markets3,61%18,51%
Real estate investments (REITs)0,05%3,82%

Canadian Equities: Resurgence

The Canadian economy is one of the best performing in the developed world in 2017 with growth of 3.5% in the second quarter. All sectors of the economy appear to be contributing to this performance, which is reflected in strong employment growth. The Bank of Canada therefore felt justified in raising its key rate twice during the quarter; it is now at 1%.

After spending the first 2 quarters of 2017 lagging other markets, Canadian stocks are up 3.68% in the third quarter and 4.45% year-to-date. The rising price of a barrel of oil - itself pumped by the global growth outlook - has helped. Oil company stocks are up 10% in September.

U.S. equities: record levels

S&P500 companies generate about 50% of their revenues and profits abroad. It is therefore not surprising that the US stock market's flagship index is reaching record levels as global economic growth finally picks up. The S&P500 is up 4.48% for the quarter and 14.24% year-to-date. However, the rise of the loonie against the USD means that in CAD terms, the increase is only 0.46% for the quarter and 6.06% for the year to date.

International equities: up in spite of the pitfalls

Despite Brexit, the relative timidity of Macron's reforms in France, and the entry of the far right into the German parliament, the European economy continues to gain momentum inQ2 2017. Even Italy is contributing with its best performance since 2010. The European Central Bank, however, feels it is too early to tighten monetary policy.

Even Japan - the world'sthird largest economy despite struggling to emerge from its nearly three-decade-long slump - grew by 4% in the second quarter, topping Canada.

It is in this growth environment that international equities returned 4.84% inQ3 (1.79% in $C).

Emerging markets: all growing

Emerging markets equities are the best performing asset class in our portfolios: +3.61% over the quarter and +18.51% since the beginning of 2017 in $C.

For the first time since 2009, all of the so-called "emerging economies" experienced positive growth in the second quarter. This growth is reflected not only in stock prices but also in currencies, which increases our return in C$.

However, we must remain cautious with emerging market equities: they are sensitive to the tightening of U.S. monetary policy, which is currently a risk. For this reason, we limit the weight of emerging market equities in our balanced growth portfolios to 8%.

Bonds: beware of sorcerers' apprentices

The good economic news that has been accumulating since the summer has had the desired effect on long-term interest rates and, in turn, on bonds. From a low of 1.41% in early June, the Canadian 10-year bond rate rose to 2.13% by the end of September. Bond prices followed the opposite path (this is purely mathematical): their return during the quarter was -1.84%. For the year to date, however, the return remains positive at +0.48%.

With interest rates starting to rise, it is timely to remember that bonds play 3 roles in your portfolio: generating income, diversifying the portfolio and acting as an insurance policy in the event of an economic downturn. They are not expected to be the best performing part of your portfolio right now, but you will be very happy to hold them when the inevitable and unpredictable economic downturn comes.

On the other hand, there has been no shortage of fund managers over the past 2-3 years telling you that rising rates will have a negative impact on your bond portfolio (true) and therefore you should trust them to manage it to protect you from that decline (false). In fact, Canadian bond fund managers have generated returns of 1.54% per year for the past 3 years (as of August 31, 2017) while the bond index funds used by Archer have made 2.71%. These sorcerers' apprentices have therefore "destroyed" approximately 1.2% of their clients' capital annually. So much for protection!

Real estate investment trusts (REITs): good diversification

The threat to retail REITs (whose tenants are threatened by the Amazon's of this world) from online commerce (led by Amazon) was offset by growth in other sectors. So for a second quarter, the performance of REITs was about zero, but they held their year-to-date gains at +3.82%. So far in 2017, this asset class has had little correlation with stocks and bonds and is therefore fulfilling its diversification mission very well.