July 2018


Politics was front and center on the financial stage this past spring.  Internationally, two of Italy’s more populist minded political parties formed a coalition to govern that country in mid-May.  Given their somewhat extreme political views and policy platforms, investors worried that this new government may soon lead Italy into the kind of financial difficulties that Greece had to endure in 2015, and as well, may promote the idea of leaving the European Union, a la Brexit in 2016.  Markets were rattled as investors have not forgotten the turmoil, however short lived, those previous events had upon global financial markets.  Closer to home, Canada as of June is no longer exempt from tariffs on steel and aluminum products shipped to the US.  Canada has since imposed tariffs at the same dollar value upon a host of items imported from the US.  With initial fears of a bigger trade war in the making, the markets were again rattled.  Investors calmed down a bit upon reflection that this mini trade war might just be tactics and gamesmanship of the ongoing renegotiation of the North American Free Trade Agreement (NAFTA).  Finally, right here at home, the Canadian government likely averted a potential constitutional showdown when it decided that it was easier to settle an acrimonious dispute between BC and Alberta, over the Trans Mountain Pipeline expansion, by buying the pipeline instead of settling the dispute by exercising its constitutional authority.  The market’s reaction was muted as investors were mostly unimpressed.  After some of the dust has settled, all the major markets came through the quarter with gains.  The Dow Jones Industrials Average gained 0.7%, the S&P/TSX Composite Index jumped 6.8% and the Canadian Bond Index edged up 0.5%.  


It looks to us that less trade and more tariffs between North America’s two neighboring countries may be in the offing.  In addition to tariffs on Canadian steel and aluminum, the US has recently indicated that it is exploring the idea of imposing a tariff on Canadian automobiles.  The mulled figure for that tariff is 25%.  If it was to come to pass, then this tariff would surely cripple Ontario’s economy and throw Canada’s into a mild recession.  We see a 35% probability of this unfortunate eventuality.  Let’s hope that this threat is nothing more than just the US exercising its leverage in their ongoing renegotiation of NAFTA.  The most recent word out of Washington is that mid-November would be the earliest for a resolution of the NAFTA talks.  Outside of the impending trade related uncertainties, North American economic conditions are strong and meeting every expectation.  Especially true is in the US where its citizens are enjoying their recently enacted tax cuts.  Economies are running at nearly full capacity, unemployment rates are at extreme lows, consumers are happy to spend and spend, and businesses are busy reinvesting their tax savings.  The only fly in the ointment is that there is tad too much consumer debt in the system and that the inflation rate is slightly above target.  For now, we believe that all of the above economic conditions will persist for the balance of this year.   



The US Federal Reserve lived up to its words and investors’ expectations by raising its benchmark interest rate by 25 basis points in June.  However, it wants investors to revise their expectations going forward.  In a released statement, the Fed signaled that it will likely hike interest rates twice more before yearend, rather than just once more as it had guided earlier.  The Fed cited solid economic growth, an above target inflation rate and an extremely low unemployment rate as reasons for wanting to raise its interest rates more aggressively.  Market reaction to the Fed’s new guidance was mixed.  Prices on short term maturity bonds fell while those of long term maturity bonds held steady.  Because of this shift in market sentiment, yields on short term bonds are now nearly equal to those of long term bonds.  This market behavior is known as a flattening in the yield curve, which can be interpreted as investors having confidence in the Fed’s plan to grow their economy in the long term without fuelling inflation.  Indeed, if successful, such an outcome would be nothing short of ideal.  For now, we are very pleased to see that the yield on 5-year maturity Government of Canada bonds has risen sharply, because this will soon translate into higher dividend rates on our rate reset preferred shares.

Income Trusts

Real estate income trusts (REIT’s) have of late out-performed both stocks and bonds.  Investors seem to have again caught on to the fact that REIT’s possess great defensive characteristics as well as strong upside potential.  One area of growth that is gaining momentum is the development of mixed-use properties, which is where residential units are integrated into the REIT’s existing commercial properties.  Indeed, right here in the greater Vancouver area, Crombie REIT is about to close some of its Safeways stores and chances are high that those properties will be redeveloped into mixed-use ones.  We are very excited by the long-term potential in this type of redevelopment, but for now, we will curb our enthusiasm.  Clearly, we need to be mindful that while Vancouver and Toronto may be ripe for residential redevelopment, other cities in Canada may not experience the same explosive demand and valuation in their residential real estate as Vancouver and Toronto have had.  We will not get carried away by the prospects of mixed-use redevelopment when assessing a REIT for our portfolios.  We will weigh all valuation parameters appropriately in our investment process.   


Canadian stocks put in an excellent performance over the second quarter.  It looks like the market correction that consumed the first half of this year is now behind us.  After a “W” shaped decline and recovery, the S&P/TSX Index is now slightly above the level where it was at over the first days of the year.  Equity prices, at the moment, more closely reflect the strong corporate fundamentals achieved, such as the solid earning reports and dividend increase announcements made over the recent months.  One industry that stood out in the second quarter was the oil industry.  Not only did crude oil prices gain nearly 25% over the past 6 months, the industry also seemed to have gained some rare support from our federal government.  The Canadian government bought the Trans Mountain Pipeline to ensure that additional throughput capacity by its expansion is achieved within the next couple of years.  This pipeline expansion will be a definite positive for Canada’s oil industry for years to come.  Until closer to yearend, we will maintain our current portfolio weighting of equities.