Second Quarter Commentary

Accelerating US corporate earnings growth lifted US stock prices while the Canadian stock market declined. Stock gains should continue in the US and resume in Canada. The corporate profit outlook remains encouraging and there are no signs of a recession.

The yield curve (a graph of bond yields plotted against their time till maturity) is typically relied upon to provide signals of an impending recession. A normal yield curve (where short-term interest rates are lower than long term interest rates) is a sign that the economy is still growing. An inverted yield curve (short term rates higher than long term rates) typically signals the onset of a recession. Short term interest rates are currently lower than long term rates (albeit a little flatter than normal) signalling that we are not on the cusp of a recession.

Excesses in the economy (i.e. inventories) can also lead an economy into a recession but there are no obvious economic excesses. The fed dot plots (a prediction of future interest rates by the open Market committee members) are showing a steady, yet measured pace of interest rate hikes. If members of the Open Market Committee have recession concerns, they would not be forecasting a gradual increase in interest rates.

Global PMI's (Purchasing manager Indexes) are currently in the low 50's. Anything above 50% indicates an expanding manufacturing sector. Global economic data suggests that the global economy is experiencing synchronized GDP growth. The International Monetary Fund (IMF) recently raised its forecast for global growth from 3.3% to 3.5% for 2017. They also see a slight acceleration in growth in 2018 to 3.6%. While these growth rates are less than they were before the financial crisis, most regions are contributing to this growth. As 40% of S&P 500 revenues and revenues and profits are linked to overseas economies, global growth will provide a boast to US corporate earnings. This will be most pronounced in the technology, healthcare, and industrial sectors, as they are most exposed to non-US markets. An expanding global economy is typically positive for stocks. US stock gains have benefited from both earnings growth and an expanding price / earnings multiple. Valuations can be justified based on accelerating earnings growth and future earnings projections but they are not cheap based on current earnings. Although there is no indication that the market has peaked, it will likely be more difficult to make large gains from these levels by investing in stocks. We are not predicting a market decline, but we believe it is prudent to be more cautious.

The Canadian stock market dynamics are vastly different from the US stock market. While technology, Healthcare and industrial sectors should benefit from their large foreign exposure, the Canadian market has limited exposure to these sectors. The financial sector, the largest sector in the Canadian stock market, lagged due to a moderation in interest rate expectations. With the Bank of Canada hinting at rate increases through the end of the year, the bank stocks are poised to rebound. Declining energy prices has depressed the energy sector, which is the second largest sector in Canada. Any stabilization or rebound in oil prices would provide a lift to investor sentiment and stock prices.

Although bonds ended the quarter on a sour note, they still managed to post gains for the quarter. The Bank of Canada is moving to a less accommodative stance. Rate increases will be gradual, but the direction of rates is clearly up. Rising interest rates will pressure bond prices in the near term. Longer term we believe bonds will provide investors with low single digit returns that are consistent with their coupons. We view bonds as a stable repository for portfolio assets, whilst acknowledging their potential to reducing overall portfolio returns as interest rates rise. Our client’s portfolios are positioned in shorter duration bonds, mitigating the impact of rising rates.

We continue to prefer equities over bonds but plan to trim equity positions as stocks continue their push to new heights. This is a tactical decision to boost client cash positions to opportunistically take advantage of any stock price weakness. As the Fed is beginning a tightening cycle, greater volatility is to be expected.

By providing strategic personalized portfolio diversification, over the past five years, Condor's clients have enjoyed returns that significantly outperformed the Canadian stock market. Please refer us to your colleagues or friends who may be looking for a personalized investment service. As always, we welcome your thoughts and comments.