Challenges in the quarter
This past quarter exemplifies what investors should consider regarding their portfolios. We’ve seen tensions increase in the North Korean peninsula and the Middle East, and continued drama from the United States. You would be forgiven if you believed the increase in drama had negatively impacted global equity markets. Equity markets can move up or down for any and all reasons on a daily basis. However, over the long term, market valuations tend to return to their fundamentals—and the fundamentals over the past two quarters have justified markets moving higher.
Starting in Canada, oil prices declined throughout the quarter by nearly nine per cent to US$46 per barrel. Concerns about the business operations of Canada’s largest subprime lender, Home Capital Group, and its impact on Canadian banks, helped the S&P/TSX Composite Index fall 2.4 per cent through the quarter. Oil is likely to average in the high US$40 range for the rest of the year as the U.S. is expected to produce 10 million barrels of oil a day by next year. This will replace 80 per cent of OPEC’s production cuts discussed in November 2016.
The United States
U.S. corporations are reporting better year-over-year sales and earnings results. Employment continues to improve with a falling unemployment rate, recently at 4.3 per cent, which implies wage growth in the second half of 2017. Higher wage growth coupled with the lowest gasoline prices we’ve seen in 2017 means U.S. consumption is in a strong fundamental position. Since U.S. consumption accounts for three quarters of U.S. economic output, the U.S. economy is on the right track. As a result, prospects for equities should be good for the rest of the year. The benchmark S&P 500 Index gained 2.6 per cent in the second quarter in U.S. dollar terms or 0.2% per cent in Canadian dollar terms, reflecting improved company results.
In overseas markets, international equities rose 2.6 per cent in Canadian dollar terms as measured by the MSCI EAFE Index. Brexit considerations aside, the European economic outlook has improved. Asia is showing improvement in its regional economies and stock markets—suggesting the growth we see is truly global in nature.
Central Bank Policy
The U.S. Federal Reserve continued to tighten its interest rate policy, raising its benchmark interest rate to 1.25 per cent in June. This marks the second rate increase this year and the fourth in two years since the Great Recession, which confirms the strength in the U.S. economy. The U.S. Federal Reserve is expected to continue to raise its benchmark rate another one or two times this year. It appears the Bank of Canada is preparing to hike its benchmark interest rate supported by a strengthening Canadian economy. While it’s expected rates will increase very gradually, it’s a significant change since Canada has not seen a rate increase since September 2010.
We continue to believe the U.S., Canadian and international economic environment will improve over what it was a year ago but it bears repeating that a positive economic environment doesn’t necessarily mean better returns. While we may be confident equity markets will deliver another year of positive returns, market volatility is likely to remain through much of 2017, driven mainly by headline news and politics. We continue to advise a balanced approach to asset allocation matched to your individual goals.
As always, if you have any questions about the markets or your investments, please feel free to contact us.