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Balancing Risk and Reward in the 2nd Half

Balancing Risk and Reward in the 2nd Half

When you're ahead in at halftime, it takes talented coaching to stay strong for the second half.  We got an amazing and unusual ride during the first half of 2019, as both equities and bonds performed well.   After a negative finish to 2018, many stock markets were up by 10% or more in the first half of 2019, while many balanced portfolios were up by 4-6%.  Now that we are reaching new highs, the question is how we can balance risk and reward in an uncertain environment.    

In early April, the S&P/TSX reached a record high of 16,672 points, with stocks in energy, materials, and consumer staples rallied.  In the US, the S&P500 surged this spring, as the Federal Reserve signaled an openness to interest rate cuts to boost the economy in the face of uncertainty.   

The first half was not a strait line up...  market watchers would have noticed the stock market was negative 2-3% in May, mainly based on market reaction to the breakdown in US-China trade talks, the US threat to impose tariff's on goods from Mexico, and the continuing problems with Brexit and the resignation of UK PM Theresa May.   In late May, as investors flocked from stocks to bonds on concerns about US trade tensions, the yield curve inverted the most in twelve years.  The yield curve is a graph showing short and long term interest rates, and when the long-term products pay less than short-term products, the yield curve is inverted.   An inverted yield curve predicts an economic downturn.

Weaker-than-expected payroll data, trade deficits and other soft numbers in the U.S. have fuelled concern of a broader slowdown and boosted calls for the Federal Reserve cut interest-rates to stimulate the economy.  U.S. central banker Jerome Powell announced in July that U.S. interest rate cuts were on the way.    

In contrast, on the Canadian side of the border, there are very few calls for a rate cut, and chances are there may be no rate cuts in Canada in 2019.   From a fundamental perspective, stocks should move as an indicator of economic growth.  In Canada, we have three positive signs.

1. Unemployment is Low:  Canada’s unemployment rate is at its lowest point in over 40 years, and recent data shows Canada is on a path to economic growth after stalling late in 2018.   If economic activity improves or trade tensions with the US are resolved, equity prices will be strengthened.

2. Interest Rates Not Declining:  On July 10th,  the Bank of Canada announced its interest rate remains unchanged, balancing domestic economic improvements with an expanding global slowdown caused by trade tensions.  The Bank of Canada announced that Canada’s robust growth in early 2019 was due to temporary factors, such as the recovery from weather-related weakness and a boost in oil production.   If it felt it needed to stimulate the economy, it would lower interest rates to encourage borrowing and spending, as it did in 2018.    

3. Canadian Dollar is Up:  Positive economic data has boosted the Loonie recently to US76.50 cents, up from 73UScents in May.  If US rates are lowered and Canada's remain flat, the interest rate differential could attract new capital to Canada, boosting the Canadian dollar.   Usually the Canadian dollar moves on three factors: attractiveness of Canada as an investment destination, Canadian export surplus, and Canadian interest rates vs. US rates. 

Many of the conditions that have supported market growth in recent years such as low interest rates, measured economic growth and expanding corporate earnings are expected to continue and we don’t expect a recession this year.  Typically, a recession with slower growth and lower sales and revenues means lower stock prices. Early indicators of a recession are things like declining interest rates, lower manufacturers purchasing, lower capacity utilization, lower housing starts, lower hiring and employment.  We have not seen these signs in Canada this year, and have positioned client portfolios to participate in the growing economy. 

However, we expect the economy to grow more slowly, and stock prices could weaken from current market highs, in particular markets would weaken with any further tension in tariffs or trade wars, and with the uncertainty of oil prices and our fall election.  In other words, after a strong first half, the second half of 2019 could become volatile.  In this environment, it is prudent to be cautious, in particular with accounts that have a shorter investment time horizon.   We believe a professionally managed, diversified portfolio that is suited to your time horizon and risk tolerance remains the best strategy to help you achieve your financial goals.  Please contact your Investment Advisor to let us know of any changes in your personal or financial situation, so that we can ensure your portfolio is balanced for the risk and rewards that suit your needs and goals.  

Elaine Kelly MBA CFP FCSI

Senior Investment Advisor, Manulife Securities Incorporated