by Mawer Investment Management, via The Art of Boring Blog
Monetary policy “normalization” returned as a major theme this quarter. As indicators for the global economy continued to show signs of strength, central bankers in many major economies—e.g., U.S., Canada, China and Europe—have signaled that the end of a very loose monetary era is nigh. Markets may be facing an important inflection point.
For Canadian investors, this monetary environment has landed close to home, with not one but two rate increases in the past three months. Canada has been leading the pack among those countries that are tightening their monetary policies, resulting in the Canadian dollar strengthening appreciably versus a basket of major currencies (see table). For example, the Canadian Dollar (CAD) reached a high of 82 cents to the USD in this period. One consequence to this surge has been to investments held in foreign currencies—i.e., a higher CAD has muted what would have otherwise been strong returns. As ever, we view the increase in the CAD as a temporary headwind— sometimes currency works for you, sometimes against you—and the long-term case for investing globally remains compelling.
Overall, world equity markets performed strongly, with the MSCI ACWI Index gaining 4.4% in local currencies (1.3% in CAD). In Canada, the S&P/TSX Index was helped by recovering commodity prices and a strong domestic economy and rose 3.7%. Meanwhile, rising rates in Canada and globally contributed to negative returns in fixed income. The FTSE TMX Canada Bond Universe Index fell 1.8% and the Citi World Government Bond Index dipped 2.0% (CAD). Together, this meant that Balanced returns were marginally negative for the quarter; the Mawer Balanced Fund (Series A) fell -0.3%, but remained positive for the year at +5.6%.
Big picture issues and observations:
- Central Bank expectations
The Bank of Canada doubled the overnight rate to 1.00% via two moves during the quarter. Elsewhere, the bias has been to raise rates and remove quantitative measures gradually. How quickly central banks tighten will depend on supportive data points, especially measures of growth, labour market employment, and inflation. The path forward may not be linear; for instance, if inflation fails to pick up more meaningfully, central banks may be forced to slow down.
- Promises to policy
Investors have appeared concerned with U.S. tax reform, Brexit, and NAFTA negotiations. So far, NAFTA appears to be progressing toward a revision more than a repeal; in the UK, Brexit negotiations remain a long-term process with much to be determined, although the probability of a “hard” Brexit is high; and in the U.S., President Trump continues to face headwinds in implementing his policy agenda. U.S. tax reform is the legislative piece investors seem to care most about, yet markets remain skeptical about Trump’s ability to see it passed this year.
- Global growth
Global growth figures have been promising in recent quarters. According to JP Morgan, Q2 global real GDP growth came in at 3.8% which is the strongest quarter since mid-2010. Q3 will likely come in slightly lower but still a very healthy rate. Supporting this thesis is the latest round of purchasing manager index (PMI) data with most countries firmly in expansionary territory and the U.S coming in particularly strong.
- Political results