September in Review: It could be different this time.


.By Rob Edel, CFA

Highlights This Month

Read the monthly commentary in pdf format

 

Nicola Wealth Management Portfolio

Returns for the NWM Core Portfolio Fund were down 0.3% in the month of September.  The NWM Core Portfolio Fund is managed using similar weights as our model portfolio is comprised entirely of NWM Pooled Funds and Limited Partnerships.  Actual client returns will vary depending on specific client situations and asset mixes.

Rising interest rates have been good news for the NWM Bond Fund. It is seeing higher yields, now at 3.2%, while also generating positive returns along the path to these higher yields. In September, the NWM Bond Fund returned +0.2% versus -1.0% for the FTSE TMX Canadian Universe Bond Index. Year-to-date, the NWM Bond Fund is +1.7% versus +0.4% for the Index. We expect the NWM Bond Fund to continue performing consistently while protecting against rising interest rates.

NWM High Yield Bond Fund returned -0.1% in September, and is +3.5% year-to-date. All of the component funds had positive monthly performance, but the two U.S. funds Apollo Credit Strategies and Oaktree Global High Yield had negative returns of -0.5% and -0.6% respectively when translating back into Canadian dollar terms. The NWM High Yield Bond Fund remains defensively positioned within high yield, with lower duration and yield than the broader high yield market.

The NWM Global Bond Fund was down -0.2% for the month.  The NWM Global Bond Fund benefited from an emerging markets bounce back (close to 2% for the JPM EM Bond Index) but gains were offset by strength in the Canadian dollar vs USD$ (+1%).  NWM Global Bond Fund had ~53% in USD$ exposure.  In local currency terms, both the PIMCO Monthly Income & Manulife Strategic Income Fund was slightly positive from tightening credit spreads in the U.S. High yield and Investment grade bonds space.

The Mortgage Pools continued to deliver consistent returns, with the NWM Primary Mortgage Fund and the NWM Balanced Mortgage Fund returning +0.3% and +0.4% respectively last month. Current yields, which are what they 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 4.4% for the NWM Primary Mortgage Fund and 5.5% for the NWM Balanced Mortgage Fund.  The NWM Primary Mortgage Fund had 6.1% cash at month end, while the NWM Balanced Mortgage Fund had 12.9%.

The NWM Preferred Share Fund returned -0.4% for the month while the BMO Laddered Preferred Share Index ETF returned -0.5%.  Three new issues came to market after a prolonged quiet period as TD, Brookfield Infrastructure, and Bank of Montreal all had new issues totaling over a $1 billion of new supply. All three issues were well received by both the retail and institutional investors with preferred share mandates; however, the demand from fixed income investors that had come to preferred shares to pick up yield for their bond portfolios has noticeably declined for the past few new issues.

Canadian Equities were weak in September with the S&P/TSX 60 Index down -0.9%. The NWM Canadian Equity Income Fund was -1.3%. Consumer Staple and Industrials were positive contributing sectors. This was offset by our positioning in Health Care and Consumer Discretionary. We were called away on Vermilion Energy. There were no new additions.  Top contributors to performance were Cargojet, Aritzia and Teck Resources. Detractors were Interfor, Dollarama and Sleep Country.  We are covered on 5% of the portfolio currently. The yield estimate is 4%.

The NWM Canadian Tactical High Income Fund returned -1.1% in the month slightly behind the S&P/TSX 60 Index’s -0.9% return.  The main reason for relative underperformance was due to being stock selection (i.e. Transcontinental & Sleep Country).  Option volatility dropped in mid-September, but surged back to where it started by month-end.  Dollarama is the only new name added during the month; we also bought more IGM Financial and sold more KP Tissue (~40bps remaining).

The NWM Global Equity Fund returned -1.1% in September, vs -0.5% for the MSCI ACWI (all CAD).  Performance for the NWM Global Equity Fund was relatively weaker versus the index mainly due to a) style: global small cap underperformed, and we have exposure there through Lazard Global Small Cap; and b) manager performance: Valueinvest’s positions in defensive Food companies such as Conagra and General Mills hurt as the stocks reacted negatively to quarterly earnings releases.  Performance of our managers in descending order: BMO Asian Growth and Income Fund: +0.3%, NWM EAFE Quant -0.2%, Edgepoint: -0.6%, C Worldwide: -0.9%, Valueinvest: -1.6%, Lazard: -2.8%.

The NWM U.S. Tactical High Income Fund’s performance was +0.3% during the month; whereas, the S&P 500 posted a +0.6% return.  The NWN U.S. Tactical High Income Fund’s underperformance was mostly due to being underweight top performing sectors, but was offset by strong security selection (Dave&Busters and L Brands). Two new names were added to the NWM U.S. Tactical High Income Fund this month, Texas Instruments and TJX Companies.  We made a significant change in the composition of the float to reduce credit risk exposure.  In the month of September we sold all of the Manulife Strategic Bond Fund ($25MM) and trimmed PIMCO Monthly Income by $35MM.  We have been purchasing short dated U.S. Treasuries with yields between 2.11% to 2.61%.   The float now yields 2.81% vs 3.14% (August).

The NWM Real Estate Fund was -0.3% for the month of September vs. the iShares (XRE) -0.5%. Publicly traded REITs were weaker due to the rising 10 year bond yields.  The Canadian 10 year yields moved from 2.26% up to 2.43% as of the end of the month. Yields are now 2.57%. If yields continue to march higher, the publicly traded REITs will likely continue to be weak. With the North American real estate cycle getting long in the tooth, we think that the timing is right to diversify the NWM Real Estate Fund globally. At the end of September, we received a capital call for the Invesco Core Europe Fund (8% weight pro forma). We sold Artis REIT and H&R REIT to help fund the purchase. As a result, we have decreased our exposure to the publicly traded REITs down to 25%. Our weighting to LPs will be closer to 75%.

We report our internal hard asset real estate Limited Partnerships in this report with a one month lag.  As of September 30th, August performance for SPIRE Real Estate Limited Partnership was -0.1%, SPIRE U.S. Limited Partnership +1.2% (in US$’s), and SPIRE Value Add Limited Partnership +1.2%.

The NWM Alternative Strategies Fund returned approximately -0.2% in September (these are estimates and can’t be confirmed until later in the month).  Currency detracted 0.6% from returns as the Canadian dollar strengthened on a new trade deal between Canada, the U.S., and Mexico. In local currency terms, Winton returned -0.3%, Millennium 1.0%, Apollo Offshore Credit Strategies Fund Ltd 0.4%, Verition International Multi-Strategy Fund Ltd 0.3%, RPIA Debt Opportunities 0.6%, and Polar Multi-Strategy Fund 0.3% for the month. With another solid month, Millennium is up almost 7% for the year as spikes in volatility have benefitted its equity long short based strategies, primarily World Quant and their statistical arbitrage trades in the U.S.

The NWM Precious Metals Fund returned -2.2% as precious metals stocks were volatile during the month trying to find a base from the large sell off last month but eventually finishing on a down-note.  Gold bullion declined -1.9% in Canadian dollar terms for the month despite the Canadian dollar strengthening.

September in Review

September marked the 10 year anniversary of the closure of investment banking giant, Lehman Brothers, which filed for bankruptcy September 15th, 2008.  Lehman’s demise was one of the seminal events of the financial crisis and preceded the start of a global market decline in which nearly $10 trillion in market capitalization was lost.  Good times!   As we look back over the past 10 years, we can see U.S. investors have done pretty well.

In equities, only India has had a better performing stock market, while U.S. fixed income investors have benefitted from falling yields and a strong currency.  Only the Swiss franc, Thai baht, and Singapore dollar have appreciated against the U.S. dollar over the past 10 years.  Canada hasn’t done quite as well, with the S&P/TSX 60 Index up just over 75% over the past 10 years compared to the S&P 500’s rise in excess of 200%.  Though not as extreme, stocks last month followed a similar pattern, with the S&P/TSX 60 Index down 0.9% versus a 0.6% gain in the S&P 500.  The Canadian dollar was a little stronger, however, rising 1.0%, meaning U.S. equity returns translated back into Canadian dollars were actually down 0.4%.  Not to turn the knife even more for Canadian equity investors, but following the same math, U.S. have gained nearly 270% over the past 10 years translated back into Canadian dollars, or a CAGR (compound annual growth rate) of almost 14% a year.

Enough about the past!  What are the next 10 years going to bring us?  Or perhaps lowering our expectations a little bit, how about the next 10 months perhaps?  To help answer this question, we attended the Bank Credit Analyst Annual Conference last month. BCA is a leading provider of independent global investment research and probably one of the best global macro research shops in the world. Determining the timing and severity of the next recession was one of our key missions in attending, however trade wars, debt levels, inflation, and politics are some of the other many issues we also strive to keep on top of.  Using our notes from the conference, as well as our normal monthly research, we review these issues and the events last month that influenced them.  We’ve also added some graphics to break things up a bit, though none of this material is from the BCA conference.

 

Consumer confidence in the U.S. hit its highest level in 18 years.

First, let’s set the scene and take a quick look at the state of the U.S. economy.  Based on the general sentiment at the conference and from data we have seen during the month, we conclude the U.S. economy is in fine form.  With the ISM Manufacturing index well into expansionary territory, the services sector hitting post-recession highs, and the unemployment rate plummeting to 3.8%, the lowest since 1969, it’s no wonder consumer confidence hit its highest level in 18 years.  It’s also no wonder the Atlanta Fed is pegging third quarter GDP to expand 4.1%, following up on the second quarter’s strong 4.2% growth.

A strong economy is usually good for corporate earnings, and this has largely been the case so far in 2018.  First and second quarter corporate earnings reports from S&P 500 companies grew 25% and have consistently been revised higher by forecasters as the year has progressed.  This is a bullish sign as the typical pattern for earnings estimates is for forecasters to start the year on an optimistic note, only to have to revise estimates lower as the year progresses. Leading into the third quarter, however, more companies have been issuing negative earnings guidance. S&P 500 companies are still expected to report respectable earnings growth of 19%, but some investors are starting to feel less optimistic on the outlook for the market and are questioning whether a bear market is almost here.

 

The slope of the yield curve tells all.

Probably the best indicator of recession and a bear market is the slope of the yield curve.  When short term interest rates (typically identified as two year U.S. Treasuries) start yielding more than long term interest rates (10 year U.S. treasuries) a recession has historically followed.  It might take 12 to 18 months, but an inverted yield curve has historically been an almost perfect predictor of a recession.

To comment on the current state of the yield curve, who better than former Federal Reserve Chairwomen and keynote speaker at the BCA Conference, Janet Yellen.  Yellen believes the Fed will continue to gradually raise interest rates and isn’t concerned about the yield curve potentially inverting, even stating “it could be different this time”.  We are continuously reminded that these are the most dangerous words in finance (it’s never “different this time”), the diminutive former central banker shared with the audience her opinion that the predictive power of an inverted yield results from the fact that inversion is caused by higher short rates, which subsequently restrict lending and economic growth.  Short rates today, however, aren’t restrictive, and even if they were, Yellen believes the economy isn’t as sensitive to interest rates as it was given the diminished role of the housing market in today’s economy.

Yes, higher interest rates might positively impact the U.S. dollar and adversely influence equity valuations, but the economy, not so much. Not yet, anyways.  High inflation has also historically been a required prerequisite for an inverted yield curve to predict a recession, and low wage growth appears to be holding inflation in check.  For what it’s worth, a recent WSJ survey found most economists believe a recession is either very or somewhat likely to occur if the yield curve were to invert. Yellen has always been considered a bit of a dove when it comes to monetary policy, meaning she errs on the side of leaving rates lower for longer.  As for the Fed’s traditional 2% inflation target, when asked about whether she believes the Federal Reserve should consider increasing it, something some economists, including Yellen herself, have suggested in the past, Yellen wasn’t convinced this was necessary.  She did point out, however, the 2% target was an average, so it should be expected inflation would rise above 2% for periods of time in order to average 2%.  Her math would appear reasonable to us.

Janet Yellen’s comments were timely given the Federal Reserve decided to increase short term rates in late September by another 25 basis points to a range of 2.0% to 2.25%, their third such increase this year and the eighth since Yellen herself kicked off the current tightening cycle in late 2015.  In addition, the Fed signaled its plans to raise rates one more time this year and three in 2019.  This is not only higher than what the market is expecting, but would increase rates above what the Federal Reserve has previously determined the neutral rate (the rate which neither spurs nor slows growth) to be.  This is significant because it infers monetary policy would start to become restrictive near the end of next year.

Perhaps even more of a concern to the market, current Chairman Reserve Jerome Powell, dropped the word “accommodative” from the Fed’s post meeting statement describing current monetary policy, leading some forecasters to believe Powell’s Fed (as opposed to Yellen’s Fed) would be more hawkish in raising rates.  In reality, it is more likely  pragmatic that Powell is merely conceding the fact the neutral rate is exceedingly hard to determine and thus it is somewhat disingenuous to be precise when describing monetary policy as accommodative, neutral, or restrictive.  It’s more art than a science.  On the other hand, Powell does appear to be determined to continue raising rates.

A strong economy and a potentially less “accommodative” Fed is likely to test the resolve of fixed income investors at some point, and that point appeared to arrive in early October with 10 year U.S. Treasury yields spiking above 3.2%.  Not all interest rate increases are bad, however.  If rates are rising because the economy is strong, that’s good.  If rates are moving higher because inflation and inflationary expectations are rising, that’s bad.  We think the move higher in rates in early October was a case of the former.  Ten and thirty year breakeven rates are stable around the 2% level, thus indicating inflationary expectations are not a concern.  Longer term U.S. bond prices have likely been buoyed by demand from U.S. companies taking advantage of tax breaks and topping up their pension plans. While one might have expected German or Japanese yield hungry investors to have stepped in given spreads,  U.S. and German 30 year bonds  recently hit their highest level since 2014.However, on a currency hedged basis U.S. bond yields are not very attractive to either German or Japanese investors.  On a positive note, the move higher in 10 year U.S. treasury yields has helped steepen the yield curve, thus giving the Fed more room to increase rates without fear of inverting the yield curve.

The key will be how quickly the Fed increases short term rates, and inflation will play a large role in determining how aggressive Chairman Powell and his colleagues at the Fed can be tightening monetary policy.  Inflationary expectations are stable right now, but wage growth is gaining traction and companies are starting to raise prices.  Inflation was a hot topic at the conference, and for good reason.  One presenter believed output gap (the difference between potential and actual economic output), which recently closed in the U.S., doesn’t influence as much anymore and global factors now play a bigger role.

Oil prices and tariffs are potential factors that could push inflation higher, while a stronger U.S. dollar will have the opposite effect.  Janet Yellen detailed some possible explanations for why wage growth has been so low despite the strong labour market, including issues like secular stagnation and the aging population.  Yellen also cited low productivity growth, the lack of bargaining power by workers, and less competition in the U.S. economy as other potential causes.  It’s probably a good thing inflation didn’t spike higher during Yellen’s watch at the Fed because it was our impression that Yellen didn’t really have a good handle on what causes inflation, or more specifically, why inflation has been so low.  The next Chairman is unlikely to be so lucky and the Fed is going to have to remember what it’s like to manage growth and inflation at the same time.

Chairman Powell would like to see short rates move higher if for no  reason other than it will give the Fed more room to cut rates in the next recession.  During her presentation, Janet Yellen lamented how Fed has only one tool available to help the economy in a recession, namely monetary policy.  She acknowledged zero interest rates and quantitative easing inflated asset prices, but what was the Fed supposed to do.  Though she didn’t specifically state it, Yellen was inferring fiscal policy was needed in order to share the load, but political dysfunction prevented it from being used, meaning the Republicans and Democrats couldn’t agree on a spending package that would get Congress’ approval.

 

The ultimate end game for America’s debt problem will result in choosing between several unpalatable options.

Now with Trumps’ tax cuts, we finally get fiscal policy at a time the economy doesn’t really need it.  Yellen stated she didn’t know what the sustainable level of government debt was for the U.S., but she is surprised Congress hasn’t already dealt with the issue, despite knowing for the past 25 years it is a problem.  While not every recession is the same, Yellen appeared unsure about what would happen in the next downturn given both monetary and fiscal policy options appear limited.  The ultimate endgame for America’s (and the world’s for that matter) debt problem was a subject that came up in a number of presentations.  Yellen inferred a financial crisis will likely be needed in order to force politicians into choosing between several unpalatable options (cut retirement healthcare and retirement benefits or raise taxes).

BCA’s Martin Barnes summarized the potential choices as default, which can never happen since the U.S. is able to issue debt in their own currency and can always “print” more money, financial repression (which entails keeping interest rates very low and forcing institutions to buy government debt), or inflation.  Barnes believes financial repression is really just a coping mechanism, leaving inflation as the only real long term option for dealing with debt.  Barnes, however, doesn’t think the problem will come to a head in the near term, especially given the US dollar is so strong.  In fact while a number of presenters acknowledged the debt issue, no one appeared particularly concerned right now. U.S. political analyst Greg Valliere remarked on how both the Democrats and Republicans want to spend money.  There is no one trying to contain the deficit in Washington right now, something Valliere has never seen before. In fairness, however, Valliere also said he had never seen economic fundamentals as good as them as well.

America is in a privileged position when it comes to debt given the U.S. dollar is the world’s reserve currency.  Countries around the world need greenbacks, not just to trade with the U.S., but when they trade with each other.  The bulk of their foreign currency reserves are held in dollars, and in times of crisis, they flock to the safety of U.S. Treasuries, the deepest and most liquid bond market in the world.  How does one become the world’s reserve currency? There’s no official vote, but if you have the world’s largest economy and most powerful military, you’ll typically get the nod.

 

The euro-zone is not a concern, with mixed feelings around Brexit in the long term.

If an investor is worried about America’s growing debt levels, what are their alternatives?  Euros?  Maybe.  The size of the Euro-zone economy certainly makes it a worthy competitor, but without fiscal union, the future of the Euro is uncertain.  From a military perspective, Europe is a regional military power, at best.  Discussion of the Euro-zone at the conference, in fact, was notable mainly by its absence.  BCA’s Chief Political Strategist Marko Papic was one of the few to even mention Europe, and even he did so only to say it wasn’t a concern right now.

Yes, Italy is the main concern given their debt levels, stagnant economic growth, and populist government, but public support for the Euro is high in the Euro-zone, even in Italy.  Italy won’t risk leaving the Euro-zone and will eventually fall into line.  As for Brexit, conference presenters were optimistic longer term.  The big stumbling block right now is Ireland and how to maintain the open border between the Republic of Ireland and Northern Ireland and avoid erecting some kind of physical border between countries.  Presenters at the conference appeared to believe a solution could be reached.  An election or even another referendum are also possibilities. Short term, investors should expect more volatility, but longer term, the British pound might be attractive at present levels.

 

A brewing trade war continues between the U.S. and China.

Just keeping the Euro alive, however, hardly makes it a potential rival to the U.S. dollar as the World reserve currency.  But how about Chinese Yuan?  No one expressly suggested the Chinese Yuan was a candidate to become the world’s next reserve currency, but the size of the Chinese economy and growing military power increasingly put it in a position to challenge the U.S.  The brewing trade war between China and the U.S. was a major talking point at the conference, with most believing there was more behind the tariffs being levied by the U.S. than the uneven terms of trade between the two countries.  In reading Bob Woodward’s recent book, “Fear” it is evident Trump doesn’t believe trade has been positive for the U.S. economy and uses the U.S. trade deficit as a score card to make his point.  Based on this thinking, any action leading to a reduction in America’s trade deficit could solve the problem and end the threat of more tariffs.  In other words, getting China to buy more American natural gas and soybeans will let Trump declare a victory and the problem is solved.  It is becoming clear however, the problem is much deeper, and it extends well beyond Trump.  America doesn’t trust China on trade and believes Chinese trade policies to be unfair.  Tariffs are becoming more than just a negotiating tactic.  Properly applied, they can incent foreign companies to move manufacturing and technical knowledge out of China, thus reshaping global supply chains.  China might be trying to wait Trump out, hoping the next administration will be more trade friendly, but anti-China sentiment appears to be one of the few things Washington agrees on right now.  That and spending money, of course.

Even if China were to agree to the more than 100 demands the U.S. presented to China in May (China has indicated at least a fifth aren’t even open for negotiation) some believe the real goal is not just to get a better deal with China, but to slow down its growth, both economically and militarily.  Last month, there were disturbing signs not only of increased tariffs, but rising geopolitical tensions as well.  A Chinese warship nearly collided with a U.S. destroyer, the USS Wasp. in the hotly disputed South China Sea, an area to which the U.S. sent several nuclear capable U.S. B-52s escorted by Japanese fighters into last month, and China denied the US destroyer permission for a Hong Kong port visit.

Further increasing tension, Bloomberg Businessweek released an article in early October detailing alleged Chinese efforts in implanting tiny spy chips on computer motherboards destined for servers belonging to American government and corporate customers while Trump accused the Chinese of trying to influence the mid-term elections by putting a number of negative ads in a Des Moines newspaper. In response, Vice President Mike Pence delivered a speech addressing some of China’s transgression and vowed the U.S. “will not stand down.”  Pence claims the Chinese want Trump out because he has been tough on China, a statement sure to appeal to Trump’s rust belt base and infuriate Chinese leaders. Two birds with one stone, well done, Mr. Vice President.  Rumor has it,Pence delivered the speech in place of Trump himself so as to not damage the special friendship Trump has developed with Chinese President Xi.

 

European and Asian stocks struggle to keep up in the midst of the trade war threats.

U.S. stocks have performed well so far in 2018, but European and most Asian stock exchanges have struggled to keep up, Japanese equities being the lone exception.  According to Strategas’ Dan Clifton, market action of U.S. small cap versus emerging market equities is a good gauge for determining how worried investors are about trade.

America small cap stocks tend to be more domestically orientated so investors tend to favor them when trade becomes a concern.  The reverse is true for emerging market equities.  The fact U.S. small cap equities have outperformed emerging market stocks confirm the statistics showing net capital flows coming out of emerging markets, and China in particular.  At the conference, there was more than one discussion regarding China, emerging markets and whether the correction had run its course.

While the verdict wasn’t unanimous, most believed it was still too early to get back into the emerging market.  BCA believes the strength of the Chinese economy, and not the strong U.S. dollar and the threat of a trade war, is the real culprit behind the decline in emerging market stocks given most emerging market economies rely on trade with China. China has been trying to reduce its economies reliance on investment and corporate debt, and while presenters at the conference couldn’t agree on whether debt growth in China was weak or strong, even the presenter arguing credit growth and the economic growth was stronger than the official data indicates, conceded that the manufacturing sector was under pressure, and has been even before U.S. tariffs were applied.  Trade wars will only make things worse.

 

Higher oil prices make things worse for emerging market economies.

During the conference, BCA articulated their high conviction call, forecasting Brent crude would top $100 a barrel by the first quarter of next year.  BCA pointed out the strong historical relationship between oil price shocks and recessions, further confirming the “house” view (meaning BCA’s forecast) calling for a U.S. recession in late 2020.  BCA actually feels oil could go even higher based on the supply demand dynamics, but demand destruction and potential supply releases from the U.S. strategic reserve should keep oil from surging as high as $200 a barrel.  Falling Iranian supply due to greater than expected U.S. sanctions compliance, along with the continued decline of production from Venezuela, Libya and Nigeria are the main factors behind the rise in oil prices.

While spare capacity from Saudi Arabia, and perhaps Russia, might be able to make up some of the shortfall, there are growing doubts around the global spare capacity of crude production.  Even increased production from U.S. shale oil will be challenged in the short term given the lack of pipeline capacity needed to bring this oil to market. Higher oil prices could help the energy heavy Canadian stock market, though like U.S. shale oil, Canadian producers also suffer from a lack of infrastructure needed to bring their product to market.

Former Canadian Prime Minister Stephen Harper commented at the conference how the world shakes their head at Canada and its inability to get its resources to market.  Decisions like the Trans Mountain Pipeline make it harder for foreign capital to find its way to Canada.

NAFTA is a political rather than economic issue.

Harper also had some pragmatic views on NAFTA.  While it’s a moot point now given Canada and the U.S. have agreed on a trade deal, Harper believed Canada would have no choice but to eventually agree to a deal.  From his perspective, it was a political rather than an economic issue.  Canada’s dependence on much of the bigger U.S. economy means Trump and the Americans can treat Canada unfairly if they choose.  Recognizing this, it was always Harper’s strategy to have a good relationship with American Presidents.  According to Harper, Prime Minster Trudeau’s challenge  explains how Canada was forced to make concessions while not getting back anything in return.  One sensed a lack of sympathy from the former Prime Minster on the subject.

In fairness, the final NAFTA result for Trudeau was better than feared as a Chapter 19 dispute resolution was maintained, a major ‘must–have’ for the Canadian negotiators.  A NAFTA deal is good because it removes uncertainty around Canada’s trade and investment relationship with the U.S.  Harper worries, however, higher government debt, and especially higher consumer debt, put Canada in a weaker position than before the last recession, and higher taxes and increased regulation put us in a weaker competitive position, especially given U.S. tax reform enacted earlier in the year and Trump’s business friendly deregulation policy.

Stephen Harper also had some comments on populism and how it resulted in President Trump’s election victory nearly two years ago.  Harper believes the middle class hasn’t done well with globalization, a fact Hilary Clinton and the Democrats missed, but Trump capitalized on.  The focus on trade and China is an extension of this strategy.  In 2008, the rich (Wall Street, with the exception of Lehman Brothers) were bailed out, but main street was not.  Harper believes governments need to promote policies that are good for the people, though he was short on specifics.

If Trump is not the solution, voters will go to the next solution, perhaps a left leaning populist like Bernie Sanders.  The middle class (or what’s left of them) aren’t interested in liberal democracy, they want higher paying jobs.  As for what might happen in the upcoming U.S. mid-term elections, political analyst Greg Valliere’s view was more or less consensus, Democrats take the House and Republicans keep the Senate.

 

The mid-term elections are not currently a concern for the markets.

Like BCA’s Marko Papic, however, Valliere didn’t think the November mid-term elections were much of a threat to the markets, the concern being the Democrats could roll back Trump’s tax cuts.  Even if there is a blue wave and Democrats take both the House and Senate, Trump would still have veto power and he didn’t think odds of Democrats gaining the 60 Senate seats needed to overcome a Presidential veto were very high.  Historically the S&P 500 has had mixed results leading up to the mid-term elections but performed fairly well the 12 months after particularly if Congress is split between Republicans and Democrats.  Gridlock is good.

As for Valliere, he balanced his consensus view on the upcoming mid-term elections with a more non-consensus view for the 2020 Presidential election, believing the odds of a Trump victory is greater than most believe.  Valliere thinks Trump is a lock for the Republican nomination if he chooses to run and the Democrats are still very unorganized and lack a platform other than being anti-Trump.  They also need fresh blood given the current leadership is old.  Still lots of time, but Valliere pointed out Las Vegas punters have Trump as the overwhelming favorite.

The real question for Valliere is whether Trump chooses to run again.  Valliere mentioned health as a potential obstacle, and certainly the stress of being President can take a toll.  Trump seems to be battling everyone, China, Canada, NATO, the UN, the Democrats, and even his own Administration.  It reminds us the cult movie classic Fight Club, staring Brad Pitt and Edward Norton.  The big difference is during the movie, it was stressed that the first (and second) rule of fight club was you do not talk about fight club.  With Trump’s fight club, it’s the only thing people are talking about!  Sure, sign us up, and the world, for another four years.  Thanks America.

We are probably going to hear a lot about the U.S. midterm elections over the next couple of months, but we agree with the presenters at the BCA conference, it’s not really a concern for the markets right now.  Same with Europe.  Brexit and Italy have the potential to evolve into something more serious, but not in the next year or so.

We worry about debt levels and believe conference presenters maybe underestimate the potential for markets to start forcing U.S. lawmakers to address entitlement spending issues, but it’s very hard to handicap when this will be and is unlikely to happen before the next recession.  We also worry about timing the next recession, but agree with most at the conference that markets have another year or two of strong growth.  Inflation and the potential for an inverted yield curve will help us keep track of where we are in the business cycle, and for the time being, they are not flashing red.  The one area we are becoming increasingly concerned with is the potential of a longer and more disruptive trade war between the U.S. and China.

Presentations at the BCA conference and events during the past month have bolstered our belief that there is no quick solution and we could be on the verge of a new cold war.  The question remains, however, how much of a chilling effect will this have on the global economy and markets?

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. Regarding the SPIRE Limited Partnerships: SPIRE Limited Partnership returns are net of LP expenses. Distributions are not guaranteed and may vary in amount and frequency over time. 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. Please speak to your NWM advisor for advice based on your unique circumstances. NWM is registered as a Portfolio Manager, Exempt Market Dealer and Investment Fund Manager with the required provincial securities’ commissions. This is not a sales solicitation. These investments are generally intended for tax residents of Canada who are accredited investors. Some residency restrictions apply. Please read the relevant documentation for additional details and important disclosure information, including terms of redemption and limited liquidity. All values sourced through Bloomberg.