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Review first quarter 2017

Quarterly review

Richard Morin

Update :
Update :
September 11, 2017

All asset classes generated positive returns in the first quarter.

The balanced portfolio is up almost 3% since the beginning of the year.

Asset classFirst quarter 2017 return (C$)
- Canadian2,0%
- American women4,6%
- International7,1%
- Emerging markets13,0
Real Estate Investment Trusts (REITs)3,5%

The actions

Emerging market equities rose nearly 13% (in C$ terms), offering by far the best performance year-to-date, buoyed by an improving global economic outlook and rising prices for the commodities they produce.

U.S. and international equities also performed very well, up 4.6% and 7.1% respectively. The "measured" reaction of the markets to President Trump's recent setbacks seems to indicate that the good performance of equities since the fall of 2016 is mainly explained by improving economic indicators in the United States, Europe, China. Expectations related to the impact of potential infrastructure spending and tax cuts (which may well not materialize) may have played a less important role than initially thought. That said, the risks of a correction are there.

After an excellent performance in 2016 (+21.1%) Canadian equities are up 2% in the first quarter, slowed by the decline in oil prices of about 10% in the first quarter of 2017.


After the 3.5% decline experienced in the last quarter of 2016 in the wake of Donald Trump's election and its anticipated impact on inflation, bonds offered a positive 1.2% return in the first quarter of 2017. Most of the upside has come since mid-March, as it became apparent that Donal Trump's agenda was not going to pass muster. The forward yield on 10-year Government of Canada bonds (which fluctuates inversely with their price) rose from 1.71% at the beginning of the year to 1.62% as of March 31.

Real Estate Investment Trusts (REITs)

REITs made a good contribution to the portfolio in the first quarter with a total return of 3.5%. They have been an excellent diversification tool for Canadian investors for the past 3 years and their distribution yield is 4.75% as of March 31.

The perspectives

Archer's investment strategy is not based on short- or medium-term forecasts since no one can predict market movements. Instead, our approach is based on a strategic allocation of the portfolio among different asset classes - government and corporate bonds, Canadian and foreign equities, REITs - to ensure a healthy diversification. In addition, the use of low-cost exchange-traded funds ensures that we capture the returns of each of these asset classes.

While no predictions are made in the short or medium term, assumptions must be made about the long-term returns of the various asset classes. These assumptions are crucial for the development of the investor's financial plan and the construction of his portfolio.

Of all the asset classes, bonds have the least random return assumptions. For example, we know that the expected return for the next 10 years on a bond maturing in 10 years is...its yield to maturity; a known fact. Applying this logic to the universe of Canadian bonds (government and corporate), we arrive at an expected return for the next 10 years of approximately 2.0%.

On the equity side, it is much less easy to make assumptions, even over the long term. However, some factors make us cautious. In particular, stocks (S&P 500) are currently trading at a multiple of nearly 29x the average earnings of the last 10 years (CAPE ratio, "cyclically adjusted price to earnings"), a level that is clearly higher than the historical average of about 17x. If stocks are "expensive", it is largely due to the low interest rates that are pushing investors in search of returns toward riskier asset classes. When interest rates rise, however, we may see the opposite movement from stocks to bonds, which bodes less well for equity returns.

So, what return should we expect over the next 10 years? Probably less than the long-term average of 9% (before fees) for Canadian stocks. When the CAPE ratio is between 20 and 45, as it is now, the median annual return for the next 10 years is 5.9% (S&P 500). The following table, taken from the blog site A Wealth of Common Sense , shows the range of historical data for the S&P 500 by starting level of the CAPE ratio.

CAPE ratio and subsequent 10-year annual return
5 à 1010 à 1515 à 2020 à 45

This data justifies a certain caution in the choice of return assumptions for the next 10 years when developing a financial plan for investors who are retired or who plan to retire in the next few years. For a portfolio invested 60% in stocks and 40% in bonds, a benign scenario would result in a return of just under 5%. An optimistic scenario would result in a return of about 8%, while the pessimistic scenario would result in a zero return.

In an environment of lower expected returns, it is also very important to have the discipline to stay within the strategic asset allocation you have agreed upon with your financial advisor, despite the ups and downs of the markets, and to avoid the high fees associated with active management. Exchange-traded funds are the perfect tool to do this.