Expect smaller gains, bigger yields for remainder of 2017

Investing in 2017 has paid off so far, with many asset classes posting strong performances.

Foreign stock markets shot up in particular, notes Desjardins says in an economics report. For example, the MSCI EAFE has posted a total return of almost 15% since the year’s start.

Foreign stock markets

International stock markets are seeing similar strong growth to that of the S&P 500, when expressed in local currencies.

However, the outperformance of the MSCI EAFE index, which is expressed in U.S. dollars, was primarily due to the decline in the U.S. dollar in recent months, notes Desjardins. The yen and the euro likewise appreciated more than 5% against the U.S. dollar.

For S&P 500 companies, reported earnings and operation earnings were up 26% and 20% respectively, compared to Q1 2016.

The performance is due to improved profitability in energy, materials, financials and information technology, says the report.

Canada’s performance

In contrast, the S&P/TSX posted a total return of only 0.4% in mid-June since the start of the year. That compares to a spectacular yearly gain of 21% in 2016, on the back of rising oil prices.

The blame for this year’s poor performance can again be attributed to the energy sector, “as profit-taking and concerns over future moves in oil prices have brought this component down by nearly 15%,” says the report. Further, energy makes up a large weighting on the Canadian index, compared to the S&P 500 (20% versus 6%, respectively).

Financials are also struggling, posting a decline of about 3% in mid-June, in part due to the difficulties facing Home Capital and signs of excess in the real estate market.

“Most of the other sectors posted significant gains,” says the report, “with the exception of healthcare, which continues to face difficulties, but without a notable impact on the total index.”

Bonds

With strong global growth and the Fed pursuing monetary tightening, the strong performance of the bond market is more difficult to explain, says the report.

In Canada, the bond market posted a 3% gain this year.

Downward pressure on bond yields can be attributed to dropping inflation expectations, as the Trump administration faces difficulty in implementing tax cuts expected to fuel inflation.

“However, maintaining 10-year bond yields at close to 2% is incompatible with further monetary firming in the United States,” says the report.

Outlook for second half

Gradual tightening by the Fed means yields should soon resume an upward trend, which would limit bond market returns.

In Canada, with many forecasters expecting monetary firming to begin in October, “the next few months could be particularly difficult for the Canadian bond market,” says the report.

Desjardins expects smaller gains for foreign stock markets for the second half of 2o17, as the U.S. dollar rebounds. However, “there is little reason to anticipate a sustained slump for stock indexes, in general, until clear signs that the end of the expansion cycle become apparent.”

In Canada, stocks should compensate for recent losses and post a total return of about 6.5% for the year. That performance will be possible because mortgage risk isn’t spreading, and oil prices could rise to US$55 per barrel.

Read the full Desjardins report.