There was a lot to digest over the past three months including NAFTA negotiations, trade tensions between the world’s two largest economies and geopolitical concerns relating to Emerging Markets. Investors were swayed by the 4 T’s – Tariffs, Trade, Turkey and Trump which provided headwinds for most global markets except for the United States. Despite the negative sentiment, the global economy remained strong which led to strong corporate profits during the period.
The Canadian stock market measured by the S&P/TSX underperformed its peers in the third quarter falling nearly 1.5 percent due to flat oil prices as measured by West Texas Intermediate (WTI) and uncertainty surrounding NAFTA negotiations. Moving forward, the path of least resistance for oil is upward with supply constraints likely from impending sanction against Iran and economic deterioration in Venezuela which should help the S&P/TSX. The recent resolution to NAFTA negotiation should increase investor confidence but confidence may be short lived as investor’s attention will focus on the impact of higher interest rates on the Canadian economy.
New rounds of tariffs between the U.S. and China did little to impact the S&P 500 which rose in the quarter by approximately seven percent in U.S. dollar terms. Investors focused on the continued strength in the underlying economy which led to strong corporate profits. The U.S. economy grew at 4.2% in the second quarter leading to strong year over year sales and earnings growth. Strong corporate profits were a result of higher business activity and favourable tax policy. The benefit from tax cuts will roll off in 2019 and given that manufacturing is showing signs of slowing, the rate of earnings growth has likely peaked for the current cycle.
Despite sales and earnings growth of approximately 5 percent, flat returns were driven by trade tariff fears, Italian political instability, Turkey and a strong U.S. dollar. International equities were down 0.8 percent in U.S. dollar terms as measured by the MSCI EAFE index. There has been some economic slowdown, but the underperformance has likely been overdone. Setting aside the potential for trade wars, Europe and Asia’s economic outlook continues to be robust and this will likely flow through to company earnings. Combined with accommodating interest rate policies, this part of the world will likely experience stronger market returns.
Central Bank Policy
In the third quarter, the U.S. Federal Reserve continued raising interest rates in one increment of 0.25 percent to 2.25 percent. The U.S. Federal Reserve is expected to continue to raise its benchmark rate one more time by the end of the year on the back of strong US economy. The Bank of Canada raised its interest rates during the third quarter by 0.25 percent to 1.50 percent. It’s expected that the Bank of Canada will raise one more time this year.
The ‘war of words’ that have been used as a negotiation tactics in trade discussions has led to an increase in volatility in stock prices globally. As we have witnessed with NAFTA negotiations, trade war rhetoric is likely to subside as cooler heads prevail. No one wins from a prolonged trade dispute. Over the long run, market returns will likely be driven by fundamentals and interest rate policy. Fundamentals continue to be strong—the likely explanation for higher interest rates. In this environment, equity markets will likely be positive but may not experience the above-average returns we’ve seen in the past couple of years due to higher interest rates, oil and wages.
As always, if you have any questions about the markets or your investments, call your Mercator wealth advisor.
Image 1: Stock exchange source: https://www.bloomberg.com/markets
Article Source: Manulife Securities Pre-Approved third Quarter Client Letter, October 2018