Knowledge Centre

Q1 2019


Stock markets have been on a wild ride the past six months, having gone from record highs, to being on the cusp of a bear market, to being back within striking distance of their recent peaks. This has left many investors feeling discombobulated and even fearful of what will happen next in this 10 year old bull market. And while investors appear to be on firmer footing, they still have many issues to deal with.

With five interest rate hikes since 2017, Canada is one of a handful of nations to have made sustained increases, however future hikes are now essentially on hold. In fact, the Bank of Canada’s next move may be a rate cut. The recent slump in oil prices and production cuts could cause Canada’s growth to slow sharply and there are several signs that the business cycle is close to its peak as well. As long as inflation isn’t a threat, the Bank of Canada will likely put growth first. Canada is very reliant on consumption and housing for growth, so additional pressure from higher interest rates is definitely counterproductive.

The U.S. Federal Reserve last hiked its target interest rate in December, but hinted that it was approaching a neutral point. In reality, they probably will not hike interest rates anytime soon as domestic and external headwinds grow. The U.S. economy has ultra-low unemployment rates and core inflation has been subdued; so, the risk of a contraction this year is limited, even if recent data hints at some weakness. Investors shouldn’t read too much into the recessionary signal coming from the U.S. Treasury market. While a true inversion of the yield curve has been a highly reliable recession warning signal, typically preceding a downturn by more than a year; the current conditions seem to discount this possibility, for now.

The European economy has shifted down a gear with a broad based slowdown in growth. With core inflation remaining well below the target, interest rate policies should stay unchanged for the foreseeable future. The U.K. economy and currency will likely hold up better than is widely expected in most Brexit outcomes. Japanese policy will remain very accommodating as the government is attempting to mitigate the pain of an upcoming sales tax hike, which has become increasingly necessary.

Emerging markets in Asia are experiencing the weakest growth in a decade. With inflation set to decline, most regional tightening cycles are likely to end, so countries like Malaysia and the Philippines will most likely start to cut interest rates. India’s growth has peaked in this cycle, but should remain strong ahead of the general election. China has signaled a $100 billion plus stimulus package after its weakest growth in a decade; while the increasingly probable resolution of the U.S. / China trade dispute would provide a significant catalyst for expansion.

What a difference a quarter makes! After central banks backed off, the markets recovered and then some. The Canadian and U.S. equity markets are close to levels when the sell-off began, climbing almost 20% from pre-Christmas lows. Canadian stocks were amongst the world’s best performing stocks surging 13.3% in the quarter. U.S. stocks notched their biggest quarterly gains in nearly a decade, climbing 11.6% (all figures in Canadian dollar terms). International stocks collectively rose 8.1%; paced by Europe’s 8.0% gains, Emerging Markets’ 7.9% increase and the Asian 5.1% gain. Investors piled into bonds forcing bond yields to plummet and generate a 3.9% return in the quarter; the best return for bonds in 4 years.

In 2018, the sky was falling. Investors were searching for shelter, cringing over fears of a global economic slowdown, rising interest rates, plummeting commodity prices and a trade war between the world’s two largest economies. This produced one of the worst Decembers since the Great Depression. While global economic growth remains a huge concern, there has been a steady stream of little positives that could turn the tide. The question now is whether optimism is justified.


The Canadian economy has been slowing on the backdrop of softening in housing and consumer spending. Renewed fears of a recession re-emerged for the first time in a decade as Canada’s yield curve inverted just like the one south of the border. However, these fears appear to be premature as various cycle indicators point to positive global growth albeit below the trend of previous years. Overall global markets shrugged off the negative economic sentiment as most of them, along with their various sectors, wrapped up the quarter on a positive note after a dismal 2018. The Canadian market in particular posted its best start to a year since 1980 and finished the quarter with 13.3% total return making it one of the top performing global markets.

The strong reversal of the S&P / TSX index in the first quarter (from its stiff correction in the previous quarter) was broad based with many sectors posting double digit returns. The rebound seems to indicate that investors had over-discounted a near term full recession which is traditionally a rare occurrence. Financials managed to end the quarter with over a 9% return. However that performance came in contrast to the bearish calls on Canadian banks—the so called “Big Short”. The banks continue to be exposed to a rising debt service ratio and some analysts believe this could lead to credit defaults. Also the Bank of Canada’s dovish tone and the sudden inversion of the yield curve during the quarter have not been in the Big Six Banks’ favour.

There is mounting evidence of global sub-trend growth in the upcoming months. The U.S. economy, though still leading the world, has seen some revised GDP growth expectations to the downside. Europe, amid Brexit uncertainties, is struggling with sluggish growth while China’s reputation as an economy with double digit GDP growth seems like a thing of the past. As for the Canadian economy, it is facing many headwinds including fading consumer spending and a cooling housing market. But the state of the global economy appears in contrast with one morphing into a possible recession. The pullback was concentrated in manufacturing while the service sector, the largest in most economies, remains strong. There is also growing optimism that a no deal Brexit is off the table; and a possible trade agreement between the U.S. and China should help avert the fading global momentum.

Canada has seen encouraging signs that should rule out any speculation of near term recession, such as improving energy prices and a strong labour market with unemployment at a multi-decades low. The picture looks much better than the one of an economy on the brink of collapse as was painted just a few months ago.


The Canadian FTSE TMX Universe Bond Index gained 3.9% in the first quarter of 2019, following a gain of only 1.4% for all of 2018. Bonds have rallied as expectations for future central bank interest rate hikes have fallen dramatically. Over the course of 2018 the Bank of Canada raised rates in July and again in October bringing the Canadian interest rate benchmark to 1.75%. In the U.S., the Federal Reserve increased its benchmark interest rate in December 2018 to the target range of 2.25% to 2.5%. That increase was the ninth rate rise since the U.S. began raising rates in December of 2015.

On March 6th the Bank of Canada announced that it would be keeping its overnight rate unchanged at 1.75%, as was widely expected. The central bank has taken on a dovish tone as the Canadian economy lost momentum in the latter half of 2018. Weakness was seen across the board but driven in large part by oil sector curtailments. The Bank noted that “the slowdown in the fourth quarter was sharper and more broadly based” than it had expected and that “it appears that the economy will be weaker in the first half of 2019 than the Bank projected in January”. On the inflation front, the forecast has been downgraded as the bank now expects inflation to stay below its 2% target this year, reflecting energy price impacts and a softer economic backdrop. Overall it appears that the economy may require more stimulus than was previously thought as the note concludes that “the outlook continues to warrant a policy interest rate that is below its neutral range”.

Canada briefly joined the U.S. in the inverted yield curve club late in the quarter. The yield on Canada’s 10 year bond dipped to 1.6% on the final trading day of the quarter, which was 6 basis points lower than the rate on the 3 month Treasury bill. That hadn’t happened since the start of the financial crisis in 2007. On March 22nd Germany’s worst manufacturing survey in seven years saw investors switching to bonds. For the first time in three years yields on German 10 year government debt fell below zero, meaning that investors were willing to pay to hold it. And later that day in the U.S. the yield on the 10 year Treasury bond fell beneath that on the 3 month Treasury bill. The inverted yield curve in the U.S. suggests that the Federal Reserve’s interest rate rise in December will be its last for now.

A yield curve inversion has preceded a number of recessions in the U.S. but that does not mean a recession is imminent as the in a position of relative strength. Unemployment is low, consumers are flush with cash and underlying inflation is close to the Fed’s 2% target. In Canada not everyone agrees that the inversion of the yield curve precedes a recession. Canada’s curve has historically been flatter than other G10 countries due to factors including a large number of insurers and pension funds that demand long-term bonds. The flattening of the yield curve does mean that the Bank of Canada will be constrained from raising rates and may even incur a rate cut if it worsens. With little good news to be seen on the economic front, central bank Governor Stephen Poloz will likely keep rates on hold during his final year as head of Canada’s central bank.


The Standard & Poor’s 500 index rose 13.6% in U.S. dollars over the first quarter of 2019 and in Canadian dollar terms the index was up 11.6%. The loonie finished the first quarter with a 2.0% gain after losing almost 9% over the course of 2018. The U.S. stock market came roaring back in the first three months of the year as the S&P 500 index scored its biggest first quarter gain since 1998. The primary catalysts behind the first quarter’s strong performance were the U.S. central bank’s January about-face as it abandoned plans to hike interest rates and optimism over a U.S. / China trade deal. Other factors included stock prices which were due for a bounce back after the fourth quarter rout, oil prices also rebounded, fourth quarter earnings were better than expected and China took steps to stimulate its economy.

Early in the year there was increasing expectation for the economy to show signs of a slowdown but the gross domestic product (GDP) cooled by less than expected as business investment picked up. At the end of February the Commerce Department reported a 2.6% annualized gain in GDP from October to December of 2018 compared with the 2.2% median estimate. It followed a 3.4% advance in the prior three months. That number suggests growth could be stronger for longer as the Federal Reserve takes a patient approach to interest rates.

While financial conditions have improved recently there are some signs of weakness in the domestic economy. December retail sales surprised on the downside with a 1.2% drop but much of that was attributed to a plunge in gasoline prices as gasoline station sales fell by 5.1%. It is possible that the swings were due to seasonal adjustment problems but there was no hiding that there was a definite tailing off of momentum at the end of 2018 as weakness was subsequently seen in industrial production and durable orders. These numbers do not mean the economy is falling into recession however because consumers are being supported by strong payroll gains and falling energy prices which has freed up around $40 billion for consumers to spend on other goods and services.

There are many reasons why the U.S. equity market underwent a setback lately but the health of the U.S. economy isn’t one of them. The U.S. economy looks to be doing just fine and should strengthen this year thanks to the brisk fiscal tailwind. The concern for investors is not that the U.S. economy will slow this year but that it will grow too fast thanks to the fiscal expansion. At this stage it appears that this correction may well turn out to be just another dip in the long running bull market.


The global business cycle is likely to face increased uncertainty and elevated volatility as monetary conditions become more uncertain. Growth rates around the world are mixed as corporate expenditures have declined. On the other hand, consumers seem healthy as strong job markets and rising wages have led to decent spending rates. Fortunately, the world’s leading economies appear to have become more stable as economic downturns have become less severe and have occurred less frequently than in the past.

Europe as a whole is essentially at an economic standstill. Italy has officially slipped into recession (it’s third since 2008) and its massive level of government’s debt coupled with any prolonged economic slump could significantly add to the risk of default which would have global repercussions. Consumer confidence in Germany is falling rapidly. Across Europe, divergent and declining economic momentum and increasing political risks are leading to decreasing corporate earnings growth. As a result, the European Central Bank pushed out the timing of its first post-crisis rate hike until 2020 as a global trade war and Brexit uncertainty take their toll on a fragile Eurozone.

In Japan, the outlook is uncertain. The downturn in manufacturing and a general lack of inflation has led to a very weak stock market environment. Wage growth remains strong, but this has not led to increased spending or improved retail sales activity. The level of negative sentiment is so high that a turnaround could come very quickly if the right catalyst occurs. For example, a resolution to the U.S. / China trade spat would be very positive for the Japanese market. Given that much of Japan’s corporate sector is cash rich, any evidence of a better than expected outcome is going to be very bullish indeed.

At the same time, China’s economy is slowing in part because of the trade war with America. While China’s growth is decelerating, the magnitude of this decline is relatively insignificant. China’s policymakers face a difficult challenge in attempting to stop the country’s slowdown but they do not want to over stimulate after a decade long credit boom that left private sector debt at worrisome levels. Unfortunately, China’s current easing measures appear insufficient to sustain any reacceleration. On a positive note, China and the U.S. now appear very close to a lasting trade agreement. This will prove to be extremely bullish for the markets as companies will be able to carry on with their investment plans.

The U-turn by the U.S. Federal Reserve in January, shelving plans for future rate increases in favour of a wait and see attitude, set the stage for the first quarter’s huge equity market rally. International stock markets as whole delivered double-digit gains in the quarter, surging 10.1% (all returns in U.S. dollar terms). This was led by a 17.7% return in China and an 11.9% gain from the U.K. as it overcame the Brexit quagmire to lead Europe’s overall return of 11.0%. Trailing behind were Germany’s with only a 7.0% gain and Japan which managed to generate just a 6.9% return. Emerging markets achieved a robust 10.0% gain.

The further maturity of the global business cycle is likely to increase uncertainty. As the cycle matures, tighter labour conditions tend to put upward pressure on wages and generate headwinds for corporate profit margins. Global growth will remain in expansion mode, but the outlook is deteriorating and has passed its peak. Looking forward, the world will continue to muddle through especially if all major economies once again prioritize supportive monetary policies.

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