By Rob Edel, CFA
Highlights This Month
- Lack of action from Trump’s administration slows U.S. markets.
- Healthcare and tax reform top the wish list.
- Trump needs a win to raise confidence.
- Long term projections remain unwavering.
- Management is using optimistic vocabulary, but for how long?
- Political action in Europe appears to lift the economy, slightly.
- Greece and Italy continue to lean on the ECB, for the time being.
- Trump, the U.S. economy, and Europe: the long and the short of it.
The NWM Portfolio
Returns for the NWM Core Portfolio Fund increased 0.9% for the month of March. The Fund is managed using similar weights as our model portfolio and is comprised entirely of NWM Pooled Funds and Limited Partnerships. Actual client returns will vary depending on specific client situations and asset mixes.
Canadian and U.S. yields were virtually unchanged from last month. The NWM Bond Fund was up 0.4%, mainly due to higher coupon interest.
The NWM High Yield Bond Fund was -0.4% in March and has returned +1.6% year-to-date. The broad high yield bond market weakened by -1.6% leading into the Fed rate hike mid-month, but then bounced back to end March with a slightly negative return.
In March, the NWM High Yield Bond Fund made a manager change, switching out of the Monegy High Yield Bond Fund after the Bank of Montreal announced the closing of its Monegy High Yield Investment Team. We have reallocated to our other high yield component funds—Oaktree Global High Yield, PH&N High Yield, Picton Mahoney Income Opportunities and our internal actively managed high yield bond investments. The NWM High Yield Bond Fund remains conservatively constructed, and the reallocation makes the Fund more opportunistic and nimble going forward. The Fund currently earns a 4.5% yield with its defensive portfolio, while standing ready to capitalize on any dislocations in the high yield market.
Favorable foreign exchange positioning and lower global bond yields helped the NWM Global Bond Fund record a 1.9% return in March.
The NWM mortgage pools continued to deliver consistent returns, with the NWM Primary Mortgage Fund returning 0.3% and the NWM Balanced Mortgage Fund +0.4% in March. Current yields, which are what the funds would return if all mortgages presently in the fund were held to maturity and all interest and principal were repaid and in no way is a predictor of future performance, are 4.3% for NWM Primary Mortgage Fund and 5.2% for NWM Balanced Mortgage Fund. NWM Primary Mortgage Fund ended the month with cash of $12.6 million, or 7.6%. NWM Balanced Mortgage Fund ended the month with $75.3 million in cash, or 15.4%.
The NWM Preferred Share Fund outperformed the overall rate reset market, returning 2.2% last month. March mainly reflected a continuation of last month’s trade, with investors directing flows into preferred share ETF’s.
The Fed’s rate hike of 25 bps also produced volatility in the marketplace as returns were up sharply mid-month before correcting during the third week and finally recovering by month-end. The 5-year Government of Canada bonds were unchanged month to month but rate resets were still up 1.9%. We anticipate new issuance to pick up in the coming months which may create some softness in the marketplace.
Canadian equities were stronger in March, with S&P/TSX up 1.0% (total return, including dividends). The NWM Canadian Equity Income Fund matched the S&P/TSX’s 1.3% with a strong contribution from our consumer-discretionary positions being offset by our lack of holdings in the utilities and telecom sectors.
The NWM Canadian Tactical High Income Fund gained 1.5%, with the fund’s low net equity exposure (current delta adjusted exposure 33%) being more than offset by positive float returns and income from option premiums. In the NWM Canadian Equity Income Fund, we initiated a new position in Spin Master and Quebecor and sold our positions in Constellation Software and restaurant brands. In the NWM Canadian Tactical High Income Fund, a new short position was written on Winpak, while Milestone REIT was sold.
Foreign equities were stronger in February with the NWM Global Equity Fund up 1.9% compared to a 1.3% increase in the MSCI All World Index and a 0.3% rise in the S&P 500 (all in Canadian dollar terms). Of our external managers, all had positive returns last month, with Pier 21 Carnegie +3.0%, BMO Asia Growth & Income +2.5%, Pier 21 Value Invest +2.3%, Lazard Global +1.8%, and Edgepoint +0.4%. Our new internal EAFE Quantitative investments returned +3.5%. The NWM U.S. Equity Income Fund declined 0.2% in U.S. dollar terms and the NWM U.S. Tactical High Income Fund increased 0.1% versus a 0.1% increase in the S&P 500 (all in U.S. dollar terms). In the NWM U.S. Equity Income Fund, we established a new position in Raytheon. As for the NWM U.S. Tactical High Income Fund, no new positions were added or sold.
Real estate was stronger up in March with the NWM Real Estate Fund up 0.2% versus the iShares REIT Index +0.3%.
The NWM Alternative Strategies Fund was up 0.4% in March (these are estimates and can’t be confirmed until later in the month) with Winton +0.2%, Citadel +0.7%, and Millenium +1.0%. Brevan Howard was down 1.1%. We are in the process of redeeming from this fund. Of our other alternative managers, RP Debt Opportunities and RBC Multi-Strategy Trust were both +0.2%, while Polar North Pole Multi-Strategy was flat. Precious metals stocks were weaker last month with the NWM Precious Metals Fund -2.4% while gold bullion went up 0.3%.
March In Review
The streak is over. After going 109 trading days without a drop of 1% or more, the S&P 500 fell 1.2% on March 21st for its biggest loss of the year. The S&P 500 was still up 0.1% for the month, however, and 6.1% higher for the first quarter in total. The S&P/TSX fared better, gaining 1.0% in March, but has gained only 2.4% year to date. Although the winning streak for the S&P 500 may be over, trading remains unusually quiet with volatility at record lows despite growing uncertainty around global economic policy, especially in the U.S.
While the S&P 500 ended March 10% higher than it was before the November 8th U.S. election, many of the trading strategies designed to profit from Trump’s policies have started to fade. U.S. stock performance versus Eurozone and emerging market exchanges have narrowed, small stocks and the stocks of companies with high tax rates have come under pressure; while the shares of healthcare companies and the Mexican peso have gained ground.
It was expected that Trump’s “America First” policies and his intention to lower U.S. taxes would lift the fortunes of smaller domestically-oriented companies burdened with high U.S. corporate tax rates. The repeal and replacement of Obamacare was thought to be a risk to hospitals and managed care companies. Tough talk on trade was putting pressure on Mexico along with the companies looking to invest there. The fact these tides have started to change likely means investors are less confident Trump’s policies will be implemented.
It was always debatable how successful Trump was going to be in getting a consensus on any issue from a Republican congress that doesn’t appear to agree on anything, but healthcare was always going to be particularly tough.
On March 24th, Trump and House Speaker Paul Ryan admitted defeat and pulled their plan for replacing Obamacare before it could even be put to a vote in the House of Representatives. The Senate never even had a chance to turn it down or come up with their own plan. It’s debatable how passionate Trump ever was in reforming Obamacare. During the election, he promised the ACA would be repealed on day one, but he never went into any details with what he planned to replace it with, only that it would be terrific. In failing to keep his promise, Trump missed an opportunity to bolster his slumping approval rating and brought into doubt his ability to pass any of his other economic policies, especially corporate tax reform. Healthcare was always going to be hard, but by failing to pass a new plan has made tax reform even harder.
The major problem with tax reform is that without revenue offsets, lowering corporate tax rates will increase the budget deficit, which some Republican congressmen are firmly opposed to.
The House’s plan to repeal and replace Obamacare would have resulted in $1 trillion in savings over 10 years, which would have helped pay for the planned corporate tax cuts. Without the savings from the ACA, more revenue will need to be generated from closing loopholes or adding new taxes, like the controversial Border Adjustment Tax.
Despite the stock price decline of many high tax rate companies, most analysts still believe a tax cut is in the cards. However, it could be on a less grandiose scale than previously hoped and will likely take longer to work through. A straight tax cut that expires in 10 years might be an easier target and the cut is likely to be smaller, meaning the resulting base corporate rate is likely to come in closer to 28% versus Trump’s campaign boasting of 15%. An easy win would be some kind of tax amnesty enabling companies holding cash overseas to repatriate it without incurring an onerous tax bill. Trump needs some wins as his political capital and overall popularity is running dangerously low.
Despite the soft market returns in March, most observers still appear to be giving President Trump and the Republican-led Congress the benefit of the doubt. There were signs that economic growth had turned the corner before the election, but consumer confidence and business sentiment has spiked even higher since the election with the economy’s “animal spirits” taking over.
For economic growth to be sustainable and finally reach takeoff speed, however, business confidence needs to be turned into business investment and spending, which has been largely absent during the slow growth 8-year economic recovery. Strong soft-data indicators, which are mainly based on surveys, need to turn into hard data results, like GDP growth. Trump’s credibility might have taken a hit in Washington, but if corporate America also loses faith, the market gains since the November 8th election could be at risk as the prospects for the economy moves back to pre-election levels.
The bond market has already started to react. Most analysts expected the yield curve to steepen this year with longer term yields moving higher in expectation of stronger economic growth. Instead, yields on 10-year treasury notes have slipped as investors have begun to shift assets back into bonds.
At the same time, the Federal Reserve’s move to increase rates in mid-March for the second time in three months has resulted in 2-year yields moving higher. While the Fed is not likely to tighten too quickly, they do seem keen to raise rates a couple more times this year, meaning the yield curve could flatten even more.
Lower 10-year yields indicate bond investors have doubts economic growth will accelerate much higher over the next decade, and most forecasters agree. A recent Wall Street Journal survey of economists found that while current forecasts for GDP growth over the next couple of years have increased, versus forecasts before the election; predictions for growth in 2020 are virtually unchanged.
Forecasters believe growth might increase in the short term, but the prospects for growth longer term remain unchanged, even with Donald Trump as President. The Congressional Budget Office, in fact, has pegged GDP growth at only 2% or less out as far as the year 2047. Growth in the first quarter is looking even lower, with both the Federal Reserve Bank of Atlanta and Morgan Stanley estimating only 1% GDP in Q1.
In the short term, stronger earnings could help the market move higher. First quarter earnings for S&P 500 companies are forecast to increase 9.1%, which would be the highest corporate profits have grown since the fourth quarter of 2011. Management also appeared more upbeat on fourth quarter earnings calls, with more than half using the word “optimistic” and a greater ratio of the word “better” used in calls versus “worse” or “weaker”. Again, however, enthusiasm over the potential for tax cuts, de-regulation, and infrastructure spending likely played a role in boosting the spirits of many CEOs. Unless Trump is able to follow through on his promises, this enthusiasm is likely to be short-lived.
While the political environment in the U.S. was less favorable for markets last month, it was the opposite for Europe. In Holland, center-right Prime Minister Mark Rutte comfortably defeated anti-establishment candidate Geert Wilders, while Germany’s ruling Christian Democratic Party scored a convincing win in a Saarland state election.
In France, the National Front’s Marine Le Pen performed poorly in the two televised debates leading up to first round voting in France’s presidential election, with a snap poll ranking her performance in fourth place. First round voting is scheduled for April 23rd, and while a large number of undecided voters adds some uncertainty to the outcome, most observers still assign a low probability on Euro-sceptic candidate Marine Le Pen ultimately becoming President.
Economically, Europe’s fortunes have also improved, with the Eurozone’s Purchasing Manager’s Index at its highest level in six years. With European stocks trading at a significant valuation discount to their U.S. peers, a calmer political environment and recovering economic growth could provide a very favorable environment for investors.
Of course, nothing is ever clear-cut in Europe. Last month, British Prime Minister Elizabeth May formally invoked Article 50 of the Lisbon Treaty and notified the European Union of the UK’s intention to leave the Union. What this will mean for Britain and the Eurozone will now be the subject of intense negotiation and uncertainty for the next two years.
Britain runs a trade deficit with the rest of the EU so it does have some negotiating leverage. European leaders have indicated, however, that Britain can’t expect to get a better deal outside the EU than they had inside it. It should be fun to watch. British stocks have performed well since the Brexit vote, as has the British economy in general, but the uncertainty will likely weigh on growth in the near term.
Uncertainty is a way of life for the Italian and Greek economies. Manufacturing confidence is picking up in Italy, but growth remains slow. Greece is in the process of trying to secure the next payment in their bailout program in order to make a $7.5 billion debt repayment in July, and though it is likely they will get it, the long term prognosis for Greece’s economy is still poor.
As long as the European Central Bank (ECB) was buying €80 billion a month in European government and corporate debt, investors felt safe in owning Italian debt knowing the ECB was a willing buyer. As of April, however, the ECB has pared their buying program down to €60 billion per month and JP Morgan believes the entire program could be suspended by the middle of next year. Without the support of the ECB, investors might think twice about holding riskier credits like Italy or Greece. Throw in some additional political uncertainty and the Eurozone could come under increased pressure again.
It doesn’t make sense that the ECB would keep overnight deposit rates in negative territory and buy €60 billion in securities every month if the Eurozone economy is no longer in a state of crisis. At the same time, however, their timing in removing this monetary stimulus might prove to be poor given national elections in France and Germany this year, and Italy next year.
We were always skeptical over President Trump’s policies and the impact they would have on economic growth, longer term. Without addressing the underlying imbalances in the global economy, cutting taxes and infrastructure spending will only serve to stimulate growth in the short term and eventually leave the U.S. with the same slow-growth economy, and a lot more debt. This is a problem for down the road, however.
Regardless of Trump, the U.S. economy was reflating before the election, and should continue to do so even if Trump’s pro-growth policies are stalled. Anything he manages to get passed is a bonus. The market has likely gotten a bit ahead of itself but the path higher in the short term is still intact; same for Europe. As long as calmer heads prevail, a stronger European economy should lead returns higher in the short term. Longer term the Eurozone is still dysfunctional and investors need to remain vigilant.
What did you think of March’s economic activity? Let us know in the comments below!
This material contains the current opinions of the author and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information presented here has been obtained from sources believed to be reliable, but not guaranteed. NWM Fund returns are quoted net of fund level fees and expenses but before NWM portfolio management fees. Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value.