Weekly Market Update (July 4 – 7, 2017)

July 10, 2017

Canadian stocks were lower but U.S. stocks finished flat on the week as positive data from the June’s jobs report couldn’t overcome geopolitical and monetary-policy jitters and lower oil prices. Last week had a little something for everyone when it came to influential economic data. Two of the most powerful forces for the markets over the past few years – jobs and central banks – were in the spotlight, while global politics also continued to fill the headlines. These events, along with corporate earnings growth, will likely drive the stock market returns for the foreseeable future. Though there may be noisy headlines, you should focus on your long-term financial goals and the things you can control. None of us can control the headlines, but you can control how you react to them. We think it’s better to follow time-tested investment principles, such as owning a well-diversified portfolio that contains quality investments, to help you reach your long-term financial goals.

Reviewing the Blueprints for the Market

If we think of the economy as a house, last week’s events provided additional insights into the various stages of construction. In our consumer-driven economy, the labour market is the foundation upon which the house of GDP growth is built. Central bank policy can be viewed as the elements of the environment that contribute to the size of the house and the speed of construction. And we’d consider recent geopolitical events and factors to represent the uncertainties that can potentially delay or disrupt the building process. Here are a few perspectives on that blueprint:

  • Strong job growth reinforces a positive view for the economy – Canada’s economy added 45,000 jobs last month, more than four times consensus expectations. This added to a string of strong hiring gains in recent months that has brought total job growth to 351,000 over the past year. This is a welcome sign given the subdued, choppy hiring trends experienced in recent years. The majority of the hiring in June was part-time, but 27,000 jobs were added in the professional, scientific and technical services area, offering support to the quality of new jobs. The domestic unemployment rate remains above 6%, so there is still sufficient slack in the labour market, which showed up the ongoing weak wage growth (up just 1% in June). With 7 straight months of domestic job gains (averaging 33,000 per month), the trend is encouraging; however, we don’t believe the Canadian economy has fully turned the corner as imbalances in the economy are likely to drive more subdued GDP growth over the balance of the year. In the U.S., 222,000 new jobs were added in June, bringing the 2017 monthly average to 180,000 – an indication that the footing remains solid. The unemployment rate ticked up from a 16-year low to 4.4%, but did so due to individuals returning to the labour force (by the improved prospects of finding a job), another indication of healthier employment conditions. The June data confirm a firm base of job growth, but the next phase for the labour market will, in our view, need to include faster wage growth as a means to supporting and spurring rising consumer spending. June’s report showed wages are rising at a 2.5% rate, a level that, while improved from the 2010-2015 average of 2.0%, is still below the level necessary to drive GDP growth to that desired 3% level. U.S. job openings have risen to a new high above six million, and labour turnover (job switching) has increased, suggesting employers may need to begin raising wages to attract and retain workers.
  • The U.S. Fed continues its plan to let off of the accelerator – Six years of a 0% interest rate policy and several installments of bond-purchase programs (referred to as “Quantitative Easing”) set favourable conditions for a bigger “economic house” (improving GDP growth). With nearly 4% unemployment and sustainable albeit modest U.S. GDP growth, the Fed will continue to pursue a strategy to withdraw that stimulus over time. Put simply, the house is now more capable of standing on its own without as much monetary policy bracing. The Fed has raised short-term rates three times since the end of 2015 and will likely continue to raise the overnight rate in a gradual fashion. Last week, minutes from the recent Fed meeting began to outline the next phase of withdrawing stimulus – winding down its balance sheet. This entails reducing the amount of assets (bonds) it has purchased over the years. We don’t anticipate a hasty approach to reducing its more than $4 trillion balance sheet, but we think this will be the next step in taking down the economic braces that have been in place for many years. There is growing anticipation that the Bank of Canada (BoC) will also soon pivot toward tighter policy with a rate hike on July 12. Improved economic growth so far this year (as reflected in job growth) makes a case less interest rate stimulus from the BoC, though we’d advocate a cautious approach as we don’t believe the domestic economy has shifted to a sustainably higher plateau of growth. Nevertheless, as central banks ease off the accelerator and as growth continues, this should allow longer-term interest rates to rise gradually. At the same time, stimulus has helped reduce stock market volatility in recent years as investors found comfort in the safety net of monetary policy. Moving forward, particularly as the Fed pulls back, we think stock market reactions to shocks or disappointing data may be more volatile than we’ve experienced in recent years.
  • Geopolitical uncertainties heightened amid the G20 meeting – Just as weather and other variables can delay construction, elevated political uncertainties have the potential to disrupt the current environment. Rising tensions surrounding North Korea and the intense focus on global policy challenges amid the G20 meeting in Hamburg, Germany weighed on investor sentiment. Geopolitical uncertainties along with the potential for delays and adjustments to President Trump’s U.S. pro-growth agenda raise the risk of disappointments or knee-jerk reactions in the market. Importantly, however, history shows that political and headlines reactions in the market are often temporary. While these current risks should not be dismissed, against the backdrop of an expanding economy and rising corporate earnings, we’d view dips as a buying opportunity. In other words, we don’t think the house will face structural damage despite a more charged political environment.

The home base that has fostered the 50% gain for the stock market over the past five years has been a growing economy, rising corporate earnings, and a favourable interest rate environment. We believe all of those trends will remain in place, but surrounding conditions are likely to swing as we progress, raising the importance and value of proper asset-class diversification, proactive rebalancing and appropriate expectations. In our view, that’s the blueprint for staying on track.

The Stock & Bond Market

TSX 15,027 -1.0% -1.7%
S&P 500 Index 2,425 0.1% 8.3%
MSCI EAFE* 1,874 -0.5% 11.3%
10-yr GoC Yield 1.88% 0.12% 0.16%
Oil ($/bbl) $44.32 -3.7% -17.5%
Canadian US $0.78 0.7% 4.4%

The Week Ahead

On Wednesday, the Bank of Canada is expected to raise short-term interest rates for the first time in seven years in response to better economic growth in the first half of the year. The Canadian dollar, along with short and long-term bond yields, have recently increased as the central bank communicated that it is ready to begin the process of normalizing interest rates.

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