**June 24th Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer Market – Insurance Edition
- JMRD Strategy Comments – What the Team did over the past 24 hours
- Geopolitical Briefing – What comes after Brexit?
- NBFM Economics and Strategy – Monthly Economic Monitor
- NBFM Economics and Strategy – Forex Update
- NBFM Strategy Update
- Reads of the Week
- Earnings Reports
JMRD Strategy Comments – What the Team did over the past 24 hours
As we have mentioned in many of our recent communications, there is a great deal of noise in the financial markets and we felt that various events in June would drive news headlines and volatility. There was the US election, the US Federal Reserve interest rate meetings, OPEC meetings and the Brexit vote, the latter occurring yesterday. Well, the winner for the event with the most impact so far is definitely the results of the Brexit referendum with the final outcome being supportive of the United Kingdom leaving the European Union.
The lead up to the vote yesterday was interesting in that a few weeks ago, some investors were assuming they would vote to leave and then it turned to a majority thinking they would remain right up to the close of markets yesterday when we were at recent highs for many financial markets. The final vote to leave then came as quite a surprise to many investors and the impact on the financial markets Friday was that much of the recent gains were erased. The Canadian markets are still up 7% for the year with a boost from gold’s performance. The major US markets are flat except for the Nasdaq Composite, down 6%. The weak performing regions before and after the referendum have been Europe and Asia.
What did the JMRD team do over the past 24 hours as this unfolded?
We all went to bed last night looking at early voting results that were indicating a result leaning towards remaining in the EU. As the night wore on, it became a real possibility that the opposite could happen. By the time we turned on our computers this morning at 5:30 am, it was confirmed that the vote was to leave and the European markets were dramatically weaker.
We use emails and an application called “Slack” that allows us to share information and articles throughout the morning until we arrive at the office. This allows us to get all of our JMRD Portfolio Managers’ views on the events and get outside opinions that we value to see what action could or should be taken, if any.
We met informally as a group before the market open to discuss the results, the potential impact, a game plan moving forward and points to discuss with clients. At the same time, we scheduled another conference call for the Portfolio Managers for 1 pm to review the markets and confirm a game plan for the rest of the day and the weekend.
The morning was spent talking to clients and sending emails. The afternoon was spent doing the same. We are lucky in that we have a variety of very knowledgeable clients and some are overseas, including the UK. Getting various informed points of view and thoughts from actual citizens helps in these instances as well.
What was the JMRD game plan that we developed through these 24 hours and what did we do today?
The general game plan (specifically with the various JMRD Baskets) is to let the markets digest this news and get the initial re-positioning and margin calls (for large investors that borrowed to invest) out of the way. This also gives us the weekend to read more of the commentary and analysis, keeping in mind that many of these sources did not forecast this outcome. We will then develop a list of holdings that have surprised us in a negative way and a list of names that we would like to own but currently do not. We will have another Portfolio Manager meeting early next week to see if there are any obvious changes to consider.
For some clients with large cash balances or newer clients where we are gradually implementing a long term plan, we are buying large Canadian financial companies and a couple of the Baskets that are most exposed to international markets through Exchange Traded Funds (ETFs), where the pullback has been the greatest today.
What should investors, who have an investment and financial plan already in place, do? The answer is really nothing. Our 20 years in the business has taught us that these events are common, even though they may have different catalysts or origins. The Brexit outcome should lead to lower interest rates for longer and will impact global economic growth in the short to medium term but we still believe that there will be growth. This is still an environment where a thoughtfully developed investment and financial plan will provide reasonable returns for an investor with a holding period over a few years.
Geopolitical Briefing – What comes after Brexit?
The UK’s vote to exit the EU (51.9% leave vs. 48.1% remain) is a geopolitical earthquake that will have tremendous long term consequences. The note analyzes some of the more immediate aftershocks, with a particular focus on the June 26th election in Spain.
- Prime Minister David Cameron has decided to step down as Prime Minister by this fall. He is not the only politician whose career is at risk. Jeremy Corbyn, the leader of the Labour Party, has been heavily criticized for not campaigning more vigorously in favour of the EU. While the next general election isn’t scheduled until 2020, an earlier vote could be held if two-thirds of lawmakers in the House of Commons support an early general election. All of this raises uncertainty of who will be negotiating on UK’s behalf with the EU in the near term. See attachment for more information.
NBFM Economics and Strategy – Monthly Economic Monitor
- With Britain voting to exit the European Union, downside risks have increased for a global economy that was already sputtering. Related uncertainties alone will restrain economic activity particularly in Europe, while the expected USD surge due to the risk-off mood will not only weigh on the US economy and commodity prices but should also raise odds of default outside America for holders of record amounts of USD-denominated debt. Those additional headwinds won’t help China as it continues to struggle in rebalancing its economy. We have cut our forecasts for world GDP growth for both this year and next to 3.0% and 3.2% respectively.
- While US growth seems to have picked up a bit after a soft Q1, things are far from rosy in the world’s largest economy. The goods sector continues to struggle under the weight of the mining slump and weak factory activity, while the services sector (a source of resilience earlier) is now losing steam. Trade remains under pressure from a strong dollar, while domestic demand is constrained by weak investment. The string of soft data, including employment creation, explains the Fed’s decision to downgrade its growth forecasts at its June meeting. With Brexit wreaking havoc and the November elections on the horizon, Fed rate hikes now seem to be off the table for this year. In light of uncertainties brought by Brexit and the expected USD surge, we have lowered our 2017 growth forecast for the US by two ticks to 1.8%.
- The poor handoff from the first quarter and the devastation caused by Alberta’s wildfires point to a contraction of Canada’s economy in the second quarter. Economic growth should bounce back in Q3 thanks to cleanup and rebuilding efforts and as oil production recovers. Overall, the wildfires may trim about a tenth of a percentage point from the country’s annual growth rate if oil production was at half capacity for a month. Uncertainties created by Brexit could potentially cause a sharper-than-expected slowdown in overall global growth and hence hurt commodity prices and Canada’s export volumes. We have accordingly lowered by our Canadian GDP growth forecasts to 1.2% this year and to 1.7% for 2017. See attachment for more information.
NBFM Economics and Strategy – Forex Update
- With Britain voting to exit the European Union, downside risks have increased for a global economy that was already sputtering. Related uncertainties alone will restrain economic activity worldwide and force the Fed to remain on the sidelines for longer. But the dollar should find support via its safe-haven properties. The world’s reserve currency indeed tends to benefit from periods of heightened uncertainties and stress in financial markets. We have adjusted our currency forecasts accordingly to reflect a stronger USD over the forecast horizon. See attachment for more information.
NBFM Strategy Update
- With Britain voting to exit the European Union, downside risks have increased for the global economy. Related uncertainties alone will restrain economic activity worldwide and force the major central banks to maintain accommodative monetary policies. As such, the threat of a Federal Reserve tightening in 2016 has disappeared. Still, the U.S. dollar should find support via its safe-haven properties.
- We see a stronger greenback as bad news for global equities as we anticipate a tightening of financial conditions. Emerging countries are particularly vulnerable because of the sizable portion of USD- denominated debt outstanding. Also, we now see downside for commodity prices in the coming weeks (WTI down to $40).
- In light of the political/economic uncertainty created by Brexit (see the attached geopolitical analysis), we are altering our asset allocation by moving to a more defensive stance. Cash is raised from 5% to 10% at the expense of equities. At the regional level, we are trimming our exposure to emerging equities, EAFE and Canada as to reflect our views on currencies. Within our Canadian sector allocation, our exposure to Energy is reduced in favour of Golds, Utilities and Telcos.
- We do not anticipate a global recession as we expect central banks to gain some traction in supporting investor confidence in the coming weeks. Still, we feel that the current environment is prone to heightened volatility and justifies a reduction of risk in the portfolio. More details to come in our upcoming Monthly Equity Monitor. See attachment for more information.
- What you need to know about changes coming to Canada Pension Plan, and Canadian wallets – (Financial Post)
Week at a Glance
The Week at a Glance will be available again next week.
Reads of the Week
- Lessons That Must Be Learned the Hard Way – (The Motley Fool)
- For Canada, Immigration is Essential for Economic Growth – (Bloomberg)
- Hot Charts – Canada: Household debt service manageable despite house price surge (See the attachment) Hot Chart – Canada Watch
Canada Watch – Just how serious is the problem of household debt in Canada? Analysts often raise alarm bells by pointing to measures such as debt-to-disposable income. But as we often caution, comparing a stock variable such as debt to a flow variable such as income has its limitations. Sure, the debt-to-disposable income ratio is high, but it largely reflects record home ownership rates and the sizable mortgages that were taken to purchase homes in a resilient housing market. A flow to flow comparison such as interest payments to disposable income is arguably more relevant in gauging how manageable the debt actually is. As it turns out, thanks to low interest rates, interest payment as a share of household disposable income is at a record low in Canada. In contrast, capital payments have increased as a share of income, contributing to household wealth accumulation. Overall debt service, i.e. payment of interest and capital, remains manageable as it accounts for 14% of disposable income. As today’s Hot Charts show, that’s below 2007 levels despite home prices surging about 50% over the last nine years. That’s not to say one should be complacent about the risks posed by household debt. A disorderly deleveraging can never be ruled out should the labour market take a dive and the housing boom turn to bust.
Monday June 27th – None
Tuesday June 28th – Nike
Wednesday June 29th – Monsanto
Thursday June 30th – None
Friday July 1st – Canadian Markets Closed for Canada Day
Have a good weekend!