Transcript - Economic and Market Outlook: Q1 2018

May 30, 2016



Craig: Looking back in the first quarter of 2018, equity market volatility made a significant comeback. We saw the VIX gaining nine points, and the TSX Composite losing about four and a half per cent. Fortunately, MD equity portfolios have performed in line with our expectations, and for the most part have held up extremely well, not declining as much as the broad market.

Going forward, we don't think this is the end of the bull market in equities, but expect more volatility in the weeks and months to come. Looking at market returns for the quarter, we saw the Canadian stock market fall about four and a half per cent. While south of the border, the U.S. market was only off by about 0.76 per cent. And looking internationally, returns were down around 4 per cent.

The good news is the Canadian dollar was quite strong in the quarter, which meant for Canadian investors we've generally seen positive returns through foreign equity markets. In contrast, the Canadian bond market was essentially flat delivering a return of about 0.1 per cent.

And while we ended the quarter in positive territory for Canadian investors through foreign equity markets, it wasn't all up. In fact, January was very strong, followed by a couple of months of extreme volatility in markets. And, in fact, from the peak around January 26, we are still in negative territory for many of the equity markets.

The cause of the increased volatility we've seen in the first quarter is as a result of a number of different things. The good news is, in December, the U.S. announced significant tax cuts. That changed the forward expectations for earnings for a number of U.S. companies. As a result, fears of inflation started to come into the market and we saw interest rates move up. Further to that, the U.S. Federal Reserve increased interest rates by 25 basis points and has signalled at least two more rate hikes this year in an effort to cool off the red-hot economy. It was no surprise but China retaliated against Trump's proposed tariffs. There are now fears of potential global trade, although that seems to be abating as we speak.

There are many reasons for the increased volatility we've seen in the first quarter. The good news is that the U.S. tax cuts announced in December have been very positive for U.S. companies with many of them expecting to raise their earnings per share over the course of the next year. Of course, this has increased the expectation that inflation may come into the markets too soon and that subsequently meant interest rates started to move up.

On top of that, investment technology darling Facebook was embroiled in a data breach scandal connected to Cambridge Analytica. And, Chinese company Tencent announced very strong profits, but weaker than expected revenue suggesting lower margins in the future. For example, over the quarter, the majority of our Canadian funds and pools outperformed as markets fell with the MD Dividend Growth Fund and the MDPIM Dividend Pool providing very strong protection.

In the first quarter, U.S. growth continued to do very well which is a bit surprising given the way markets were reacting. So over the past year, the MD American Growth Fund is outperformed both its benchmark and passive ETFs.

In our international funds, one-year returns continue to be very strong everywhere. With international and global funds showing strong returns against their benchmarks. Within fixed income, we have positioned our funds from moderately higher rates, with yields for short-term bonds expected to rise at a faster pace than the long-term bonds. In addition, in order to enhance the capital preservation of our fixed income funds, we've increased the credit quality, we've added more exposure to defensive industries and we’ve shortened up our duration.

So with that backdrop, it should be no surprise it was a very diverse quarter with the leaders in some sectors being very strong and others, unfortunately, very weak. Some companies having phenomenal returns and some, well, quite frankly, disappointing.

How are we positioned?

Craig: In my recent review of 2017, I suggested it was time to get prepared for increased volatility. This was as a result of moving away from an overly accommodative monetary policy, we'd seen heightened political tensions, yet economic indicators suggested that we are much near towards the end of a business cycle than at the beginning.

As part of our plan, we aim to build meaningful downside protection into our investment funds. That typically means we’ll not fully participate in strong bull markets, but we should fare better when a downturn comes. We've seen strong evidence of this strategy playing out just as we expected, in the downturn over the last few months.

Our funds are generally exhibiting less risk than the market, we've got lower beta and lower volatility, and we've got strategies that have typically performed well in market pullbacks. As a result, I'm confident we'll perform well through the full market cycle and add value through a prolonged downturn if it were to come.

Inflation and waiting for the bear

Craig: Looking forward, we believe the recent correction in equity markets does not signal a bear market. In fact, our indicators point to a continuous expansion with the low probability of recession in the U.S. over the next 12 months. The correction followed about 15 straight months of positive returns for the S&P500, including one of the best Januarys on record. In fact, drawdowns like we've just seen are not uncommon. The last major drawdowns we've seen were in August of 2015 and again in January of 2016 on fears of China's growth. And finally, earnings globally continue to trend positively and the sentiment on earnings is particularly strong due to the recent tax cuts in the U.S.


Craig: I've been working in the financial services industry for 30 years and I have been through four major market declines. The crash of '87, the Asian crisis, the IT bubble and the great financial crisis. I started at MD in 1999 and we've navigated the two worst market events since the Great Depression.

I have confidence in our strategy and we have the resolve to stick to our plan and our process because it's worked. Clients who heeded our advice and stayed the course emerged wealthier than before the market corrections.

We will continue to actively monitor the market situation and make incremental adjustments and take advantage of whatever opportunities that present themselves. Rest assured that you'll be best served by sticking to your strategic asset allocation and staying invested in your portfolio.

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