Markets Slide into Second Half of 2017

August 8, 2017

Canadian equities were essentially flat; however, there was significant performance dispersion among sectors.

  • Foreign capital markets remained resilient (in local-currency terms) amid geopolitical disquiet, as global stock-market volatility fell to historic lows.
  • Domestic equities were nearly flat, while fixed-income struggled following the Bank of Canada interest-rate hike.
  • We expect moderate global economic growth to persist, with rising inflation that leads to commodity-price gains; we also anticipate a stable or slightly weaker U.S. dollar, which would help emerging markets.

Economic Backdrop

Foreign capital markets remained resilient in the face of geopolitical disquiet.

The second half of 2017 began with Congressional Republicans in the U.S. failing to agree on terms to reform the country’s healthcare system, rendering the effort all-but-dead for the foreseeable future as the party turned its focus to tax reform. Top-level White House staff turnover generated many headlines as July progressed, with President Donald Trump installing a new chief of staff at the end of the month. U.S. sanctions against several belligerent states received a bevy of responses: the expulsion of hundreds of American diplomats from Russia, increasingly aggressive test-missile launches by North Korea, and a vow by Iran to press ahead with its ballistic missile defense program. Venezuelan President Nicolas Maduro was a personal recipient of sanctions and was labelled a dictator by the top U.S. national security official following a contested constitutional vote and the arrest of opposition leaders. Overseas, Brexit negotiating stances firmed, with the U.K. committed to ending free movement of European Union (EU) citizens within its borders once the divorce has been finalized—setting up an impasse that could delay progress toward addressing ongoing trade relations. The financial settlement figure remained a sticking point, while the Irish border also became a focus.

Foreign capital markets remained resilient (in local-currency terms) in the face of geopolitical disquiet; domestic markets struggled and the relentless strength of the loonie hurt performance for Canadian investors. U.S. equities rallied, as did British, Chinese and Japanese stocks, while Europe was down a bit; stock-market volatility fell to historic lows around the globe. The U.S. dollar continued a practically uninterrupted slide that began in the New Year, finishing the month near the bottom end of its range since early 2015 against a trade-weighted basket of foreign currencies; the euro strengthened against both the U.S. dollar and sterling. The U.S. Treasury yield curve continued to flatten as short-term rates rose, while long-term rates were mixed. West Texas Intermediate crude-oil prices rallied late in the month, closing at just over US$50 per barrel as U.S. inventories plummeted and major exporting countries vowed more production cuts.

The Bank of Canada (BoC) was seemingly committed to a stimulative low-interest rate environment, but a rate hike on July 12 abruptly changed sentiment from dovish to hawkish. Despite noting significant uncertainties for Canada’s economic outlook, Governor Poloz has left the distinct possibility of more hike(s) before year end on the table. Elsewhere, the U.S. Federal Open Market Committee (FOMC) made no changes in late July, indicating that it would begin reducing its balance sheet relatively soon. The Bank of England’s Monetary Policy Committee enjoyed a summer vacation in July. The European Central Bank (ECB) announced no changes following its mid-July meeting, and President Mario Draghi refrained from providing insight on future asset-purchase tapering decisions. The Bank of Japan (BOJ) altered its outlook—but not its policy—during the month, increasing economic-growth projections for the next few years and pushing back the expected date of reaching its target inflation level. The People’s Bank of China issued its annual Financial Stability Report in early July, asserting that the asset management industry would require more supervision given its rapid expansion.

According to Statistics Canada, the rate of inflation, as measured by the change in the Consumer Price Index (CPI), continued to slow, increasing just 1.0% for the twelve months ending June—despite the BOC’s assertion that its 2.0% inflation target may be attainable this year; month-over-month CPI was unchanged. Producer prices were relatively weak as well: the Industrial Product Price Index (IPPI) was up 3.3% for the year through June, but down 1.0% for the month. Meanwhile, the more volatile Raw Materials Price Index (RMPI) rose 2.2% for the year ending June, but slipped 3.7% in the month. In what has become a recent trend, inflation weakness has been due primarily to lower energy prices, especially for crude oil. Although job creation was tepid in July with only 11,000 new jobs added to the economy, the unemployment rate hit 6.3%—a level not seen since October 2008—as fewer people searched for work.

U.S. manufacturing surveys revealed healthy conditions in July, while services growth picked up somewhat. Personal incomes were unchanged in June, falling short of growth expectations. Core personal consumption expenditures (the FOMC’s preferred inflation measure) were 1.5% higher year over year, below the FOMC’s target 2% inflation level. British manufacturing accelerated more than anticipated in July, reversing a recent trend toward softer growth. The claimant count jobless rate held at 2.3% in June, while broader unemployment fell to 4.5% for the March-to-May period. Average year-over-year earnings growth slowed to 1.8% during the three months ending in May. The economy grew at a 0.3% pace during the second quarter, as anticipated, a modest improvement from the prior quarter. Eurozone manufacturing growth eased in July to still-healthy levels after a nine-month acceleration trend, while the services sector continued to expand. The labour market sustained its recovery in June, with the unemployment rate shrinking to a nine-year low of 9.1% from 9.3% in May. Economic growth increased to 0.6% in the second quarter, the best showing in more than two years and seventeenth straight quarter of growth.

Market Impact (in Canadian dollar terms)

Domestic fixed-income markets were rattled in July by the BOC’s decision to raise rates. Real-return bonds were by far the worst performers as the rate hike was expected to keep a lid on inflation. Government bonds, particularly those with shorter maturities, also performed quite poorly. Corporate bonds outperformed most other sectors, but were still negative for the month, while residential mortgages notched modest gains. U.S. high-yield bonds were notably positive on a currency-hedged basis.

Canadian equities were essentially flat; however, there was significant performance dispersion among sectors. Energy, materials and telecommunications posted gains, while healthcare, industrials and the consumers sectors declined. Foreign equities were generally positive in their local currencies, but Canadian investors saw losses as the loonie strengthened sharply during July. U.S. equities generally fared worse than other regions, while emerging-market equities were a notable exception to the losses suffered elsewhere.

Index Data

  • The S&P/TSX Composite Index was down 0.06%.
  • The FTSE TMX Canada Universe Overall Bond Index returned -1.90%.
  • The S&P 500 Index, which measures U.S. equities, slid 1.73%.
  • The MSCI ACWI Index, used to gauge global equity performance, returned -1.02%.
  • The BofA Merrill Lynch U.S. High Yield Constrained Index, representing U.S. high-yield bond markets, returned 1.05% (currency hedged) and -2.59% (unhedged).
  • The Chicago Board Options Exchange Volatility Index, a measure of implied volatility in the S&P 500 Index also known as the “fear index” or VIX, decreased in the month from 11.18 to 10.26.
  • WTI Cushing crude oil prices, a key indicator of movements in the oil market, increased from US$46.04 a barrel at the end of June to US$50.17 on the last day of July.
  • The loonie strengthened notably from C$1.30 to C$1.25 per U.S. dollar. The U.S. dollar weakened relative to the world’s other major currencies as well, ending July at $1.32 against sterling, $1.18 versus the euro and at 110.5 yen.

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