Manager commentary - June 30, 2019

After a strong rebound in equity markets in the first quarter of the year, the second quarter offered more modest returns, with a return to volatility. The drastic shift in tone between China and the U.S., as well as the accumulation of negative economic surprises, overshadowed the momentum that had lasted since the holiday season.

China, with its growth of more than 6% per year, appears poised to become the world’s leading economic power (a position it is expected to officially assume by 2030) and the implications for the U.S., being the leader of the free world, are far-reaching.

At the heart of the tensions is the critical role played by telecommunications technologies, for which the Chinese firm Huawei Technologies Co. Ltd. is currently paying the price by being banned from investments in the American telecommunications network, as part of an emergency measure for U.S. national security.

U.S. economic data continues to compare favourably at the international level. Growth in gross domestic product (GDP) in the first quarter of the year exceeded 3.0% on an annualized basis, and is expected to be positive in the second quarter, although with growth slightly lower, at 2.0%.

The Canadian economy had an excellent second quarter in 2019, building upon positive economic surprises. The Economic Surprise Index published by Citigroup has been one of the most positive in the world in recent months. Canada’s strong population growth, fuelled largely by immigration, adds significant resilience to the economy in this period of heightened geopolitical risks, and also fuels the supply and demand for Canadian products and services. Given the success of new Canadians in integrating into the labour market, starting families and owning homes, the cycle of rising demand is being filled by an increase in labour supply, creating a healthy labour market.

However, major trade tensions are threatening the global economy. After all, Canada is a small open economy, accounting for just below 1.5% of the world’s GDP. A titanic battle between the world’s major economic powers, which are also Canada’s main trading partners, could, of course, have important implications for our economy.

One of the biggest surprises is the uninterrupted downward trajectory of interest rates. Several factors are behind this massive decline in interest rates, which at the end of the quarter were at their lowest levels since U.S. President Trump had been elected in 2016. This sharp decline in interest rates, even pushing 10-year yields below the level of the overnight rate, means that investors now expect the U.S. Federal Reserve (Fed) to cut its key interest rate several times over the coming quarters.

In the context of a more accommodating tone by the Fed, and if trade relations between the U.S. and China improve, the prospects for a strong stock market in the second half of the year would improve significantly. History has shown that when the main risks perceived by the market disappear (in this case, a Fed that is sensitive to market concerns and the two major global powers working together), an overweight position in equities is generally a sound strategy.

In the second quarter, the Canadian bond market, as measured by the FTSE Canada Universe Bond Index, posted a 2.5% gain (6.5% in 2019). The FTSE Canada Short Term Bond Index returned 0.9% (2.7% in 2019) and the FTSE Canada Long Term Bond Index rose 4.8% (12.1% in 2019).

The U.S. equity market, as measured by the S&P 500 Index (S&P 500), generated a total return of +4.3% in the second quarter (+2.0% in Canadian dollars). The Canadian stock market, measured by the S&P/TSX Composite Index (S&P/TSX), rose 2.6%. For 2019, the respective returns for North American equity markets were +18.5% for the S&P 500 (+13.4% in Canadian dollars) and +16.2% for the S&P/TSX.

The European market, represented by the MSCI Europe Index, posted a gain of 4.0% in the second quarter and 16.1% in 2019 (+2.6% and +11.4%, respectively, in Canadian dollars). The MSCI EAFE Index rose 2.8% during the quarter and 13.7% in 2019 (+1.4% and +9.1%, respectively, in Canadian dollars). The MSCI World Index gained 3.6% during the quarter and 16.7% in 2019 (+1.7% and +11.9%, respectively, in Canadian dollars). Emerging markets, as measured by the MSCI Emerging Markets Index, returned +0.3% for the quarter and gained 10.2% in 2019 (-1.5% and +6.0%, respectively, in Canadian dollars).

Over the second quarter, the Fund underperformed its benchmark, before fees. Within the Fund’s fixed income sleeve, top contributors to performance were its holdings in IA Clarington Bond Fund, IA Clarington Core Plus Bond Fund and IA Clarington Floating Rate Income Fund. The Fund’s holding in IA Clarington Global Bond Fund was the biggest detractor from performance.

Within the equity sleeve, the Fund’s holding in IA Clarington U.S. Dividend Growth Fund was one of the biggest contributors to performance, while investments in global equities, such as IA Clarington Global Equity Fund and IA Clarington Global Opportunities Fund, detracted from performance.

On average, the Fund maintained an overweight position in equities and the fund manager instituted hedges to manage the Fund’s equity risk. As at June 30, 2019, the Fund had an underweight position in U.S. equities as earnings revisions could turn lower for the rest of the year.

A position in gold bullion was initiated during the quarter, contributing to the Fund’s performance. The low real-rate environment, combined with the Fed’s accommodative stance, has led to a significant increase in precious metals prices.

The currency hedging strategies put in place also contributed to performance as the Canadian dollar appreciated in relation to the U.S. dollar, given the good relative fundamentals of the Canadian economy. The Fund was nearly full hedged at quarter-end.

The fund manager will be monitoring several key risk factors over the next quarter, including the potential escalation of U.S.-China trade tensions, the deceleration in global economic data that could increase the probability of a recession in 2020, a loss of confidence in the ability of central banks to stimulate economies, a disorderly resolution to Brexit and a Chinese economy slowing more than expected.

Fund and benchmark performance, as at June 30, 20191 year3 yearSince inception (April 2016)
IA Clarington Balanced Portfolio – Series B-0.9%3.6%3.7%
10% MSCI World Index, 25% S&P/TSX Composite Index, 25% S&P 500 Index and 40% FTSE Canada Universe Bond Index7.2%8.1%8.4%

 

Learn more about IA Clarington Balanced Portfolio

Source: MSCI makes no express or implied warranties or representations and shall have no liability whatsoever with respect to any MSCI data contained herein. The MSCI data may not be further redistributed or used as a basis for other indices or any securities or financial products. This report is not approved, reviewed, or produced by MSCI.

The Fund’s strategy is to invest in other investment funds. The performance data comparison presented is intended to illustrate the Fund’s historical performance as compared with historical performance of widely quoted market indices. There are various important differences that may exist between the Fund and the stated indices that may affect the performance of each. The benchmark is a blend of 10% MSCI World Index, 25% S&P/TSX Composite Index, 25% S&P 500 Index and 40% FTSE Canada Universe Bond Index. The blended benchmark presented is intended to provide a more realistic representation of the general asset classes in which the Fund invests. The MSCI World Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets. The MSCI World Index consists of 24 developed market country indices. The S&P/TSX Composite Index is the premier indicator of market activity for Canadian equity markets, with 95% coverage of Canadian-based, TSX-listed companies. The index includes common stock and income trust units and is designed to offer the representation of a broad benchmark index while maintaining the liquidity characteristics of narrower indices. The S&P 500 Index includes 500 leading companies in leading industries of the U.S. economy and is widely regarded as the best single gauge of the U.S. equities market. The FTSE Canada Universe Bond Index is comprised of Canadian investment grade bonds and has significantly different portfolio duration characteristics. The FTSE Canada Universe Bond Index consists of a broadly diversified selection of investment-grade Government of Canada, provincial, corporate and municipal bonds issued domestically in Canada. The Fund's fixed income component can invest in both investment grade and high yield bonds while the benchmark has exposure only to investment grade bonds. The Fund’s sector and geographic exposure may differ from that of the benchmark. The Fund may have different currency risk exposure than the benchmark. The Fund may hold cash while the benchmark does not. Overall, the Fund's bond and equity exposure can differ, because the Fund does not use a fixed ratio similar to the benchmark. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance.