Stock Market Commentary - 2016 Year End

With 2016 now over it's time to reflect on what happened and what we should look for in 2017.

CANADA

This year has turned out to be a very successful year but this can be attributed to one main factor .... OIL.

In the first two months of 2016 the Canadian stock market was down by 9% largely due to the price of oil. By year end the market was up 17%.

At the beginning of the year oil was at $44 then dipped to $36 in late January then rebounded by year end to almost $54 .

This initial drop in oil price was driven by OPEC. Specifically, Saudi Arabia in its quest to grab market share with lower prices.

As Canada is a high cost oil producer it had a compounding negative effect on our oil production, staff layoffs and a serious reduction in oil related capital expenditures.

Alberta was devastated. Add to that the massive forest fires in Fort McMurray and things were terrible.

Since March there has been a steady increase in oil prices and a corresponding increase in the stock market.

When oil went down, the value of oil stocks went down.

Bank stocks dropped in value because of the fear of oil loan exposure and the possibility of personal mortgage loans exposure of laid off workers.

As oil prices increased the pressure for loan loss provisions at the banks declined, giving them additional upside as the year wound up.

PETRO-CURRENCY

Canada's dollar is essentially a 'petro-currency'. It is one of the single biggest factors in establishing how our dollar reacts in foreign exchange rates.

Anyone who travelled can recall when we were at dollar for dollar parity with the US.

Why was that? It was driven by a high oil price which at the time was in the $100 range.

Our dollar's value is dependent on other countries wanting to buy what we have.

This demand requires them to buy Canadian dollars to pay for Canadian dollar goods and materials.

The more they want to buy and the higher the value of what we offer (oil, autos, manufactured goods, agricultural products) will determine our comparative exchange rate.

Essentially we want and really need a higher oil price.

Regardless of your environmental bent, it is unfair to Alberta and Saskatchewan to not give them an outlet for their Oil and Natural Gas resources.

You should also remember we are the largest international supplier of oil to the US.

Under the New Presidency of Donald Trump he is prepared to open up oil and gas production on US soil to renewed shale fracking and offshore oil drilling.

Although the primary purpose is to make the US more self sufficient it is really trying to reduce their demand for OPEC oil.

As a result, the XL Pipeline that was stalled under Barrack Obama will likely be reopened. This should be good news for Alberta, assuming it happens.

BREXIT

In June UK citizens voted to leave the Eurozone. This has huge consequences for the UK and to lesser, yet still significant, extent on Europe.

The Pound Sterling dropped in value giving rise to an increase in London Stock Market. The fundamental premise here was having a lower Pound meant exports would be higher.

The realities are many. Why would the Politicians allow the general population to vote on such a significant issue? The general public has voted with their emotions and not financial logic. I find it interesting, if not confusing, that the politicians never asked the citizens to vote to get in to the European Union.

In my view the vote came down to two things: 1. Immigration control and 2. Lost jobs in the outlying more rural areas.

These areas have seen greater reductions in jobs due to lower fishing and lower manufacturing and wanted to return to the old days when things were apparently better. This attitude is running fairly deeply in Europe and the US.

Global realities have impacted Britain just like they have Canada and the US where jobs go overseas to low cost, low wage countries.

Basically this vote broke down into urban versus rural differences. Scotland, not surprisingly, wants to stay in the EU.

The next two to three years will see lots of press on the issues surrounding UK's departure. This inevitably will bring varying degrees of market turmoil.

EUROPE

The European Union is the largest economic unit in the world, collectively accounting for more GDP (Gross Domestic Product) than the US.

On a single country basis the US is still number one. But one of the main reasons the EU was created was to establish itself as a viable economic option to the US.

With the Greece situation in a stagnant mode, the EU now must turn its attention to Italy where they are going through some tumultuous times. Their banking system is in a state of turmoil and just recently the Government had to bail out one of its biggest banks. This entire situation needs to be monitored closely as there is no quick and easy fix.

Italy is the third largest economy in the EU which uses the EURO (excludes the UK who still uses the Pound Sterling) and consequently will totally overshadow anything we've seen before in Europe. Greece with its 11 million population will pale when compared to Italy's 61 Milion.

Germany continues to be the financial backbone of the EU. Its focus on high end, value added products sets it apart from the China's traditional lower cost model.

With the Populous Movement (similar to the US) growing in Europe and with four significant elections happening this year in Germany, France, Italy and the Netherlands, there will be uncertainty. It is hard to know what or even how that will impact the markets.

US

The US economy is more diverse but has still reaped market benefits from the increasing cost of Oil but to a much lesser extent than Canada.

Let's review what has caused the US market to jump.

  • Prior to the election in November the US S&P 500 market was up a meager 2.7%.

  • Since the election it has jumped almost 7% for total YTD return of almost 9+%..

Let's review why this happened.

  • Essentially there has been no formal change in any law or regulation to warrant this change, so what then?

  • The President Elect has simply stated what his plans are. Remember these are tentative so we'll need to see if any become reality.

  • He is planning to open up Oil and Gas production with few or likely no restrictions on Environmental issues. Generally this is good for business so the speculative stock prices rise.

He is planning to MAKE AMERICA GREAT AGAIN. What does this mean?

He is talking about bringing jobs back to the US.

Let's look at this.

  • The US unemployment rate is the lowest it has been in 9 years at 4.6% (Nov. 2016). It is close to what is called Full Employment.

  • There is always some level of unemployment in a country and this level hovers around 4%.

  • One of the main reasons cited for unemployment never being zero is, although there may be jobs available but people do not have the right skill set to match the jobs requirements or the location of the jobs is not where the people are.

  • He wants to bring back Jobs to the US but someone needs to ask who is going to fill those jobs?

  • Yet, he wants to deport illegal Mexicans by the Millions.

Something in this equation doesn't add up.

  • He wants to lower taxes. But really who is this lower tax strategy going to benefit. With multiple billionaires in his inner circle, I can only guess.

  • The strategy of making the rich richer does not lead to increased GDP as they save or invest.

  • Sharing the wealth to the Middle class creates more demand for goods and services and this should be the goal. Quite simply people in the middle class are more likely to buy goods and services and this is what generates GDP.

He has already criticized a Union in the Central US for seeking a fair share of wage increases instead of seeing those jobs leave for low wage countries.

Does this sound consistent with the earlier statement. I don't think so.

Infrastructure spending is another proposal. In concept this is good. It will be paid for by increasing deficits caused by higher spending and lower taxes.

When does this get repaid. Maybe the next President will be stuck with that problem.

The US market has been driven upward in the last two months more by speculation than by fundamentals. How long will that last and what will the fallout be if these speculations fall flat?

On a reflective note, it seems the Obama Administration has worked hard for the past 8 years to clean up a huge financial mess left by the previous Republican government.

Here we go again with loosening Bank controls, wide open environmental disregard and lowering taxes. All of this at a time when unemployment is at its lowest.

INTEREST RATES

Interest rates are set by a country's central bank. In Canada it is the Bank of Canada. In the US it is the Federal Reserve.

The setting of interest rates is done for two fundamental reasons: 1. to stimulate or de-stimulate the economy and 2. to control inflation.

The low interest rates we have seen in the past 8 years have provided the stimulus for the economies of the world after the devastation caused by the 2008 financial crises.

This has led to low mortgage rates, increased home construction and a better economy.

The major concern being expressed by the Bank of Canada, Economists and the Government all centers around the impact to homeowners when their mortgage renews at higher rates.

An increase of 1% on a $300,000 mortgage adds an annual cost of $3,000 per year or $250 per month. If there is no wiggle room in their personal budgets then rate increases can have serious consequences.

The actions proposed by the President elect have already had a negative effect on rates as they have begun to rise before he has even taken office.

What is the fallout from higher interest rates?

  1. Mortgage defaults

  2. Lower returns on your existing bond portfolio as capital losses arise and partially offset interest income.

2017 OUTLOOK

  • 2016 was a very rewarding year in the Canadian and, lately, in the US markets.

  • Optimism and Caution are the words of the day.

  • A well Diversified approach is the best one to follow when there is uncertainty where the real gains will come from.

  • The New US President may have an upswing effect on the markets but without a clearly defined direction it is difficult to know if the current upswing is a lasting one.

  • The US economy is the largest one in the world and we still need to be investing there.

  • Currency swings with the low Canadian dollar will add a complicating factor, particularly if it rises against the US dollar.

DIVERSIFICATION is still the key

  • A Diversified approach with excellent investment managers is the best way to protect long term gains.

  • Virtually all of our clients have this kind of approach even with different investor profiles.

  • The world will always have its uncertainties but a well developed investment strategy will provide long term comfort and steady results.

I hope you have found this comments of interest. If you have any question please let us know.

Wishing everyone continued success and a Happy New Year.

#trump #marketcommentary #Oil #interestrates #Brexit #2017outlook

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