First Quarter Review and Outlook

Our clients have done well this quarter. The ongoing strength of the US dollar was the main story of the first quarter. The US Dollar gained 9.3% versus the Canadian Dollar and 12.7% against the Euro. Condor's clients benefited from the stronger US Dollar as the majority of equities held by our clients are in US stocks. Diverging policies from central bankers with respect to interest rates was the primary reason for the rising US dollar. The US Fed Reserve Bank is signaling that they are poised to begin an interest rate tightening cycle due to better economic data. Europe is entering a period of lower rates as the European Central Bank is starting a quantitative easing program. Here in Canada, The Bank of Canada cut interest rates due to slackening economic growth. All things being equal, higher interest rates and a stronger economy tend to attract investments resulting in higher exchange rates.

Although our clients saw their portfolio values increase, stocks were relatively flat for the quarter, not withstanding their trading with increasing volatility. The S&P 500 increased fractionally (+0.4%), while the Canadian market (S&P / TSX) was up 1.8% reversing some of the decline from the previous six months. The Canadian bond market returned 4.2% as it benefited from the surprise interest rate cut by the Bank of Canada.

US economic growth was positive during the first quarter, but was not as robust as the prior three quarters. Economic activity was impacted by the West Coast port strike and unusually cold weather. This will translate into earnings growth being a little slower than previously forecast. Companies with big international exposure will also see earnings impacted by a stronger dollar which will hurt both sales and margins.

Lower energy prices detracted from the aggregate S&P 500 earnings number, as energy companies realized lower revenues and profits. On the other hand, companies with significant energy input costs have yet to see the benefit of lower commodity prices. Companies that are net energy users, typically hedge oil and gas costs six to twelve months out. These companies will benefit from lower energy prices in the second half of the year as the hedges roll off. We recently saw the first example of this when Carnival Cruise Lines reported better than expected earnings, primarily related to lower energy costs. For 2015, this will result in the S&P 500 earnings recovering some of the earnings lost from the energy producing companies.

Equity markets remain fairly valued, being neither cheap nor expensive. Markets that are fairly valued, with average economic growth (2.0% - 3.5%) should see stock prices increase close to the long term average of 7 - 8%. S&P 500 returns were flat during the quarter, but this follows positive returns in every quarter of 2014. The S&P 500 appears to be consolidating last year's gain resulting in a churning type of market. The volatility in the first quarter is probably a good indication of what to expect for the remainder of the year.

With the Fed on the cusp of its first interest rate hike in many years, we would expect that stock volatility will increase. While there has been significant analysis of when the Fed will institute the first rate hike, there has been little discussion as to the type or timeline for subsequent rate hikes. We believe that interest rate hikes will be at a measured pace (0.25% per rate hike) and continue at a slow and gradual pace. We anticipate the Fed's future action will be data dependent. If the economy continues to experience strong growth, rates will continue to increase. If growth lags, rate increases will be put on hold. We do not believe that rate hikes will cause major problems for the economy or the financial markets as interest rates are currently near zero. A cumulative rate increase of 1.0% will still leave interest rates below what is considered to be neutral and will remain economically stimulative.

The Bank of Canada lowered the overnight lending rate in January by 0.25% due to a sluggish economic outlook related to lower oil prices. The rate cut took everyone (including us) by surprise, resulting in strong bond returns in the first quarter. Our current thoughts are that the Bank of Canada is unlikely to change interest rates in the short-term. With the current low level of interest rates, bond returns will remain in the low single digit range.

US dollar strength should persist, albeit not to the same degree as the last four months. US GDP growth is stronger than Canadian GDP growth and this situation should continue through the remainder of 2015. The US economy is benefiting from accelerating job growth, stronger US auto production and increased housing activity. Canada on the other hand is facing economic challenges from a combination of layoffs associated with lower oil prices and a peaking housing market. This potentially leads to higher interest rates in the US with the Bank of Canada having more of a neutral bias on rates.

Depressed oil prices are also impacting the Canadian dollar US dollar exchange rate. Lower oil prices result in less (US $) revenues for energy companies. As Canadian energy producers convert less US dollar revenues into Canadian dollars (to cover their costs), there is less demand for Canadian dollars. The Canadian dollar has been viewed by some financial investors, as a “petro currency” resulting in the dollar moving in tandem with oil prices. Persistent oil price weakness has translated into persistent Canadian dollar weakness. If the price of oil rebounds significantly, there would be a reversal of the recent Canadian dollar weakness. Our ability to predict oil production is limited due to the uncertainly of global conflicts and of OPEC oil quotas.

We continue to believe that stocks are the most attractive asset class, although we expect stock volatility to be higher and stock returns to be lower as compared to the last few years. While stock price variability will increase, we currently do not envision a stock market decline of greater than 10% as economic growth is still positive and stock valuations are not expensive. Bonds will continue to yield positive returns, but in a low interest rate environment, returns are unlikely to be as robust as equities.