North American equity markets showed resilience to significant geo-political tensions and natural disasters in September. On one hand, the North Korean threat to the world escalated significantly with the latest nuclear test, while on the other hand hurricanes Harvey and Irma caused devastation in various parts of the US and the Caribbean.
*Equity Indices - FTSE Global Indices in CAD, Bonds - Barclays Global Aggregate Canadian Float Adjusted Bond Index
The Canadian equity markets performed positively on the back of the strong Q2 GDP number and corporate results. This, coupled with inflationary expectations, gave Bank of Canada sufficient fuel to increase short term interest rates by 0.25% points, which caused the Canadian dollar to appreciate to CAD 1.2065/USD. However, Governor Stephen Poloz later moderated their expectations of continued strength in economic growth, which somewhat weakened the Canadian dollar by end of the month.
The US economic numbers and corporate earnings continued to show strength driven by consumer spending, manufacturing growth, and low unemployment numbers. This helped the markets to weather the impact of the destruction caused by the hurricanes, which was expected to have little lasting impact, post-factum.
At its recent meeting, the Federal Reserve Open Market Committee decided to start reducing its balance sheet in October. This was widely expected, but an interesting point to note was that a majority of the members think the Fed will be increasing rates by at least 0.25% points later this year despite inflationary expectations remaining below the target 2%. Any such increase in rates could strengthen the US dollar to make up some of the ground it lost vs. other global currencies earlier in the year.
Strong equity markets; now what?
With markets trading at their highs, there is a general concern of a pullback. However, it’s important to remember that although valuations may seem high, they need to be considered within the context of interest rates, which continue to remain closer to historic lows despite the increases we’ve seen this year from both the US Fed and the Bank of Canada. With strong economic numbers driving strong corporate results in most major markets, we should expect to see the strength in the equity markets continue. The US tax reform bill proposed recently – if approved – could also be another positive driver for the markets in the long term, considering the lower tax rates on corporate profits and individual income.
Pullbacks are normal, especially in conditions where markets have performed strongly since 2009, a relatively long period of time. Geopolitical concerns such as the current crisis in the Korean peninsula is another significant overhang on the markets. If the tension escalates further resulting in unfortunate military action, that could trigger a significant pull back and increased volatility. However, as history suggests, these types of events may have a short-term impact on the markets; however, in the long term, the strength of the global economy and the resulting corporate profits will be the primary drivers for strong markets.
So what should I do?
Staying on the sidelines due to the current geopolitical concerns or markets seemingly at their highs, in our opinion, is a bigger risk than staying invested. These are times when a well-diversified portfolio helps in riding through volatile periods. If your goals are long-term, then the best bet would be to stay focused on those goals and ensure you are doing everything you can to maximize your savings, rather than trying to time the markets. As the wise investors commonly say, “be the market; don’t try to beat it”.