Manager commentary - June 30, 2019

Trade tensions between China and the U.S. dominated the headlines during the second quarter of the year. The abrupt end of the negotiations and the (once again) bellicose tone of the U.S. administration have created a shock wave throughout the financial markets. U.S. economic data continues to compare favourably at the international level. In the first quarter of 2019, growth of gross domestic product (GDP) exceeded 3.0% on an annualized basis, and the second quarter is expected to be positive, although with growth slightly lower, at 2.0%.

The American consumer remains the global economic driving force, and impressive gains were made in the labour market in recent years. The gap between the number of available jobs and the number of unemployed workers has been positive for several years, but the gap is now at historical levels. The number of jobs created monthly, which recently averaged about 200,000 per month, has fallen in recent months to 75,000 in May. The unemployment rate is also close to historical lows. The slowdown in job creation may be the result of a decline in business leaders’ confidence in this climate of trade tensions. However, if it is actually the result of a labour shortage constraint, we can expect wage pressures to intensify in the coming quarters, which should have limited impact on the overall inflation.

The synchronized slowdown in the global economy and the consequences of the tariffs imposed to date are being felt in several sectors of the U.S. economy, including manufacturing, which has been experiencing a steady slowdown for several months. Business confidence indices have also been downgraded and a cut in the U.S. Federal Reserve’s (Fed’s) federal funds rate is recommended by Fed analysts as an “insurance policy.”

After a strong rebound in equity markets in the first quarter of the year, the second quarter saw more modest performance, 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.

The S&P 500 Index (S&P 500) had a positive quarter with a return of 2.02%. During the quarter, nine of the 11 index sectors posted a positive return, with financials and materials being the best-performing sectors. Of the three biggest S&P 500 sectors, information technology and financials posted mid-single-digit returns. However, health care, which is the second-largest sector, posted a negative return during the quarter.

In terms of relative performance over the second quarter, the Fund outperformed its benchmark. The contribution from sector allocation was overall flat this quarter, while security selection was the main driver of performance.

Security selection in the information technology sector was the main driver of performance. An overweight position in Total System Services, Inc. was extremely positive for the Fund, as it rallied approximately 32% during the quarter. The overweight position in Microsoft Corporation was also positive, with the stock posting double-digit returns. In the materials sector, not holding Altria Group, Inc. was also positive, as the stock largely underperformed the benchmark.

The market has continued to drift upward on expectation of interest rate cuts and a more positive outlook on geopolitical issues and tariffs. Nevertheless, the fund manager remains cautious and is continuing to trim stocks from the Fund that exhibit excess strength without the corresponding fundamentals to support them. In particular, holdings in the information technology sector were trimmed in order to reduce risk in the Fund. The fund manager will continue to rotate excess cash into existing holdings that are trading well under assessed valuation.

The largest risk remains U.S.-China trade relations. The fund manager is optimistic that a favourable resolution will take place, but with the complication of the Huawei Technologies Co. Ltd. overhang, almost any outcome is plausible. In addition, there is a high risk of stock market weakness if the Fed does not cut interest rates. Another area of concern is Canadian GDP growth, as it remains underwhelming.

Fund and benchmark performance, as at June 30, 20191 year3 yearSince inception (Dec. 2015)
IA Clarington U.S. Dividend Growth Registered Fund - Series A-0.4%6.0%4.1%
S&P 500 Index9.7%14.4%11.4%

 

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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 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 Fund’s invests in dividend paying stocks while the benchmark is comprised of companies which may not necessarily pay a dividend. The Fund’s market capitalization, geographic and sector exposure may differ from that of the benchmark. The Fund’s currency risk exposure may be different than that of the benchmark. The Fund may hold cash while the benchmark does not. It is not possible to invest directly in market indices. The performance comparison is for illustrative purposes only and does not imply future performance.