Sometimes A Picture Is Worth A Thousand Words

For a Canadian investor, this has been a very frustrating year. How is that possible? Wasn’t the Dow Jones hitting all-time records recently?

Let’s take a look at the three most common places Canadians might invest. The green line is XBB which is a proxy for the Canadian Core Universe Bond Index. The blue line is the Canadian S&P/TSX stock index. The red line is the US S&P 500 stock index – in Canadian dollars.

Source: SIA Charts

The Canadian bond index is up about 1% year-to-date (YTD). The Canadian S&P/TSX stock index is down about 2% YTD. The US S&P 500 stock index, in Canadian dollars, is up about 1% YTD. All figures are as of August 18, 2017.

Based on these returns a simple “balanced portfolio” that is 60% Bonds/20% Canadian Stocks/20% US Stocks would be flat YTD. A “balanced growth portfolio” that is 40% Bonds/30% Canadian Stocks/30% US Stocks would also be flat YTD. Even a “growth portfolio” that had no bonds would be flat YTD.

Note that the US markets have done reasonably well this year, but the Canadian dollar has jumped from about 73 cents to 80 cents since the Bank of Canada raised interest rates unexpectedly in June – which is about a 10% increase. For a Canadian investor, this means all US investments actually dropped in value by about 10% in Canadian dollar terms through that same period. That is the main reason for the red line dropping since June.

US markets have actually done well over the last three years, but the Canadian bond index has only averaged about 1% per year and the Canadian S&P/TSX stock index is negative over the last three years. It is tough to have strong performance in a portfolio when two out of three key components are flat or negative. And for most people, 100% exposure to US stocks – i.e. investments held in a different currency – is too aggressive.

So why bother to invest?

While anything is possible in the short term, stock markets should outperform bonds or GICs over a period of 3-5 years – especially when interest rates are this low. Some years it will be US markets that lead, some years it will be Canadian.

What is the outlook for markets?

In the short term, markets trade on sentiment. Over the long term they trade on fundamentals. We don’t know if we are in the summer doldrums. We don’t know if markets are concerned with the bluster of Trump’s tweets, sabre-rattling with North Korea, Russian intervention or something else. What we do know is that, despite the black headlines, the fundamental backdrop for the markets seems to be improving.

  • S&P 500 earnings for Q2 (second quarter) of 2017 exceeded analysts’ expectations following a stellar Q1. This is the first time the index has posted back-to-back double-digit growth in earnings per share since Q4 of 2011.
  • The growth in both earnings and sales were well above average. Every sector experienced positive growth this quarter.
  • Improving global economic prospects and accelerating earnings momentum continue to underpin this bull market.
  • Globally, investors remain grossly under-invested in equities and are sitting on a mountain of cash. As investors recognize the improving fundamentals of specific companies, some of that cash will likely be redeployed into equities.

Our portfolios have come a long way over the last four years. We are not happy to be treading water in the short term. Our goal is to outperform the indices while providing greater downside protection than a buy and hold approach. We believe we have the right investments in place to achieve this over the next 3-5 years, but based on these improving fundamentals we sure would appreciate an upwards move in the markets themselves.

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