So this is what volatility feels like. After record low volatility in 2017, the market is getting reacquainted with risk, which is not such a bad thing as complacency can be dangerous. There have been many opportunities over the last eighteen months for markets to take a breather but it seems the threat of higher rates was the domino that needed to fall. The selloff in early February was in part a reaction to a US jobs report which showed rising wages. The market rebounded but concerns re-emerged on fears of a global trade war coming out of the US.
Ultimately one of our biggest concerns surrounding the Trump presidency is the nationalist rhetoric and specifically the potential for increasing trade tensions. As often has been the case, the bluster has failed to live up to reality, and most countries, Canada included, were spared US import tariffs. It also appears that cooler heads are likely to prevail between the world’s two largest economies as China seems willing to make concessions, long overdue in terms of fair trade and tariffs. From a Canadian perspective, it would seem that NAFTA negotiations are headed in the right direction and worst case scenarios are less likely than feared.
While trade wars are never good, rising wages can be a good thing for the economy and frankly they have been rising for some time now. Economies remain in a good place with global employment continuing to improve. Europe has seen consistent improvement over the last five years and the US economy continues to drive forward. Canadian unemployment is at the lowest level in twenty years and wage growth in 2017 was the strongest in in 4 years.
Despite this good news, investor fears are now focused on rising rates. Normalizing rates is healthy as the extremely low rates used as monetary stimulus appear to have done their job. Government stimulus in the form of infrastructure spending and for the US, tax cuts, is likely to drive further growth. We believe central banks raising rates is prudent to keep inflation in check and barring a big jump higher in rates (not expected), the markets should be able to absorb this new reality.
Canadian markets disappointed in the first quarter. Concern about NAFTA, consumer debt and our inability to get pipelines built were the main culprits. We think the weakness has been overdone given the economic backdrop, a better outlook for NAFTA and a softer Canadian dollar which can act as a stimulus for export growth. Valuations in Canada are now at reasonable levels for the most part and we are constructive on domestic opportunities going forward.
In the US, technology stocks continue to outperform by a wide margin as it was the only sector to outperform the index average in the first quarter. This lack of breadth gives us pause and is concentrated in a few particular stocks. We have talked at length on the danger of momentum and we continue to view this as a risk going forward. While we see value in some of these stocks, we continue to avoid the riskiest as the herd mentality is exacerbated by ETFs and algorithmic trading.
Going forward we will remain selective and focused on companies which have defensive attributes in terms of their business models and balance sheets. We do not pretend to know where the next “presidential tweet” or geopolitical event could lead and will not try to time the market. We remain disciplined in our approach to manage risk and our client’s hard earned capital by focusing on underlying fundamentals and ensuring we are paying a fair price (valuation) for those companies.