Third Quarter Review

Global equity markets saw strong gains during the third quarter as global economic growth strengthened. All 45 countries as tracked by the OECD (Organization for Economic Cooperation and Development) are set to grow this year. This is very rare as there are usually a few countries or regions experiencing economic contraction. The Canadian bond market posted negative returns as the Bank of Canada twice raised it policy interest rate.

The two interest rate increases lifted short term rates from 0.5% to 1.0% and shifted the entire yield curve upward. As an example, the ten year government of Canada bond yield moved from 1.75% to 2.1% during the quarter. As bond prices are inversely correlated with bond yields, the rise in interest rates led to a decline in bond prices and negative bond returns.

This move was not a surprise to us at Condor and client's holdings were positioned accordingly. Client’s fixed income holdings positively contributed to overall returns during the quarter as portfolios were constructed using shorter duration bonds. Shorter term bonds were less impacted from the rate increases than longer term bonds.

While we remain cautious on bonds due to their low yields, it is unlikely that Canadian interest rates will rise in the near term. The Bank of Canada is moving to a more data dependent stance relative to inflation and has signaled that they are more guarded about future rate increases.

The US stock market gained 4.0% during the third quarter. The rally was characterized by small incremental daily gains resulting in multiple record highs with no big declines. We were a little surprised by the lack of volatility. It was the economically sensitive sectors (financials, industrials and energy) that powered the market move. Somewhat coincidentally these are among the cheapest sectors in the market. The staples and utilities sectors which are historically expensive and not economically sensitive, lagged.

Canadians investing in the United States also need to factor exchange rates when determining their US equity returns. With the recent weakness of the US dollar (-3.6%), Canadian dollar returns from US stocks were virtually zero during the quarter. We believe this year's Canadian dollar rally has run its course. The Canadian dollar has retreated from its recent highs as the Bank of Canada will proceed more cautiously with respect to future rate increases.

The Canadian stock market gained on the strength of financial, energy and commodity stocks. Financials benefited from rising interest rates while higher oil prices were the primary driver for energy stocks. A less aggressive interest rate stance from the Bank of Canada and a short term peak in oil prices will hinder future Canadian stock gains.

Our outlook remains unchanged. Bonds should at best provide coupon like returns in a world where interest rates are projected to be flat to up. Rising rates will pressure longer duration bond prices. Stocks should provide returns that are in excess of bonds, although with a higher degree of volatility. While stocks are not cheap, the global economy is experiencing synchronized growth. This bodes well for continued corporate earnings growth, which is the primary driver of stock prices.

By providing strategic portfolio diversification, Condor's client returns have significantly outperformed Canadian stock and bond markets over the last five years. As always we welcome your thoughts and comments.