Fickel s Focus First quarter investment commentary David Fickel, CFA Vice-President & Portfolio Manager 416-966-0612 david.fickel@rbc.com Miro Czyzewski Associate Advisor 416-960-7881 miro.czyzewski@rbc.com Jaana Sauso Administrative Assistant 416-960-7880 jaana.sauso@rbc.com Global Markets Surge in Q1, 2017 Q1 marked the strongest quarterly equity performance in more than three years. Improving economic data dominated global market action as hopes for immediate U.S. tax reform and infrastructure investment faded. Fixed-income investments provided modest returns as bond yields declined slightly despite improving economic trends and rising expectations for Federal Reserve rate hikes. The S&P/TSX Canadian Preferred Share Index was a standout among income investments returning a stunning 7.51%, bringing the twelve month return to 21.87%. Portfolio performance exceeded benchmark returns for accounts on board for the full quarter and migrated to their appropriate models. Please contact us to further discuss the performance of your portfolio(s). Nathan Fickel Administrative Assistant 416-960-6816 nathan.fickel@rbc.com 45 St. Clair Ave. W., Suite 1101 Toronto, ON M4V 1K6 Fax: 416-960-8440 www.rbcds.com/david.fickel Economic Overview 2017 will be the first synchronized global recovery since 2009 with GDP set to breach 3%. Inflation is picking up and labour markets are strengthening. Increasing government spending will enhance growth in many regions. Global manufacturing indices are rising and economic indicators are coming in ahead of forecast. The need for extremely low interest rates is diminishing. U.S. growth is being led by employment and wage gains. Unemployment fell to 4.5% in March and hourly earnings climbed 2.7%, the fastest rate in 7 years. These trends support continued growth in the important housing sector which is benefitting from high affordability and record low home ownership (see top two charts on next page). A buoyant housing market bodes well for clients positions in Costco, Home Depot, and West Fraser.
Eurozone momentum ended 2016 on an uptrend with Q4 GDP rising 1.7%. Bank lending to households has grown at its fastest rate in 6 years. Businesses are hiring at the quickest pace since the financial crisis adding 429,000 jobs over the past 3 months. The Purchasing Managers Index (PMI), a gauge for manufacturing, reached a post-recession high in March and is consistent with GDP growth of 3.0%. Equities have historically been up 1, 3, and 6 months following PMI readings at this level. Eurozone growth is converging with US growth (see third chart). Canada s economy is recovering. Broadening activity could see Q1 GDP reach 4%. 19,400 jobs were added in March and housing starts surged to a 10-year high. The $150 billion infrastructure stimulus package will boost activity while the weak Canadian dollar is helping exports. Equity Commentary The average equity weight in fully-invested balanced portfolios is 50.9%, below the Balanced Benchmark weight of 55%. Equity weightings declined during Q1 as partial profits were taken following significant gains. Fully invested balanced portfolios are underweight Canadian stocks (average 25.1% versus 30% Balanced Benchmark). Weightings were reduced in Canadian bank shares following significant appreciation which took valuations to the upper end of historical ranges (see bottom chart). Eurozone and US real GDP growth Magna International was sold in view of peaking auto sales, deteriorating used car prices, and rising delinquencies in the subprime auto loan market. West Fraser Timber was trimmed after an approximate 50% gain and ahead of the softwood lumber tariff announcement. Longer term, the S&P/TSX is poised to benefit from President Trump s initiatives. The prospect of pro-growth policies has led to a rise in interest rates and a steeper yield curve. This is positive for Banks & Life Insurance companies. More liberal energy policies will benefit the oil and gas sector, and increased infrastructure spending will lead to higher demand for materials. The S&P/TSX has higher weightings in these sectors compared to other developed markets (see chart at top of next page).
S&P/TSX performance is highly correlated to changes in the price of oil which has doubled from its 2016 low. Over the past 20 years, oil prices have risen 10% on nine occasions and, on these occasions, the S&P/TSX has outperformed the S&P 500 by an average of 14% (see second chart). The S&P/TSX forward P/E of 17.5x is slightly above the long-term average of 16.1x (see third chart). A stock market correction would be viewed as an opportunity to add equity exposure. Fully invested portfolios are underweight U.S. stocks (average 13.8% versus 20% Balanced Benchmark). High valuations led to partial profit taking in Q1. Stocks sold include Prudential Financial and Wells Fargo. The proceeds were added to European financials which offer better return potential. Time Warner was sold ahead of its purchase by AT&T. Clients are well represented in U.S. healthcare (although we trimmed Abbott Laboratories and Medtronic after double digit price gains). Generally speaking, healthcare valuations are reasonable and demographics favourable. The S&P TSX/TSX has a heavy weighting to good Trump The S&P/TSX has consistently outperformed in 10%+ oil years weighting to good Trump The TSX is above its long-term Forward P/E average The S&P 500 is expensive. J.P. Morgan estimates the trailing and forward 12 month P/E s at 20.6x and 18.6x respectively; this is well above their historical averages of 16.8x and 15.2x (see bottom charts). Clients are overweight International Stocks (12.0% versus 5% Balanced Benchmark). Eurozone equities trade at a reasonable P/E of about 15x forward earnings, a substantial discount to the S&P 500 (see top left chart on next page). Eurozone economic data is improving and EPS growth is faster than U.S. growth (see top right chart on next page). S&P 500 Trailing 12-Month P/E S&P 500 Forward 12-Month P/E
Forward P/E: U.S. vs EAFE Eurozone and US quarterly EPS growth Fixed Income The average fixed-income weight in fully invested balance portfolios is 26.4%. This compares to 40% for the balanced benchmark. Global inflation surprises on the upside Global bonds are expensive as yields do not compensate investors for inflation. Real bond yields (interest rate minus inflation) are at historically low levels despite inflation across the globe beating analysts forecasts (see chart). The majority of fixed income is in preferred shares. The S&P/TSX Preferred Share Index (TR), a proxy for client preferred share holdings, gained 7.51% during Q1. This compares to the Broad Bond Composite Index return of 1.2%. Clients hold 3 types of preferred shares: fixed rate resets, floating, and perpetuals. This strategy accomplishes several objectives- stable income via perpetuals, and interest rate protection through rate reset and floating shares. Performance Overweight preferred shares and equities (for most of the quarter), good stock selection, and underweight bonds contributed to positive returns. Many preferred shares did well. Notable gainers (in $CDN) include Enbridge fixed resets (ENB.PR.U, +7.5%, ENB.PF.U, +7.0%), BCE floating rates (BCE.PR.S, +12.2%, BCE.PR.Y, +12.2%), and TransCanada floating rate (TRP.PR.F, +25.9%). Clients Canadian equities performed in line with the benchmark S&P/TSX return of 2.4%. Strong performers include West Fraser (+15.9%), Canadian National Railway (+8.63%), Canadian Utilities (+7.7%) and Royal Bank (+6.6%). Suncor (-7.0%), Agrium (-6.0%, although we sold some at higher levels), and Freehold Royalties (-4.9%) were laggards. U.S. equities handily beat the S&P 500 return of 5.0% during Q1 (in $Cdn). Many stocks that were weak in Q4, did well in Q1. Healthcare stocks, Abbott Labs (+13.7%), Medtronic (+ 12.6%), Johnson & Johnson (+8.5%), and Merck (+7.4%) fall into this camp.
Technology stocks rebounded with strong performances from Facebook (+22.7%) and Google (+11.4%). Consumer stocks, Home Depot (+9.8%) and Costco (+ 6.2%), fared well. International investments lagged the EAFE Q1 Index return of 5.4% (in $Cdn). Financials were smartly higher with Allianz (+11.4%), Banco Santander (+8.1%), and ING (+6.3%) leading the way. However, energy stocks languished with meagre gains from Total (+1.6%) and ENI (+0.4%). Announcements We would like to formally announce that Nathan Fickel has joined our team. Nathan recently graduated from the DeGroote School of Business at McMaster University having spent his last semester at Wollongong University in Australia. Nathan has completed the Canadian Securities Course and is enrolled in Level 2 of the Chartered Financial Analyst Program (CFA). He will be assisting in all aspects of our business. Wealth services for our valued clients A number of our clients have recently taken advantage of RBC Wealth Management s services including: In-depth Financial Planning Will & Estate consultation help you structure the succession of your estate in an efficient and tax effective manner Insurance assessment Estate planning specialists assess the need and suitability of tax-exempt insurance Strategic tax minimization Inhouse tax specialists review the effectiveness of particular strategies Business owner planning help you explore succession, tax, retirement and estate planning issues you face as a business owner These services are complimentary for our valued clients. If you would like to take advantage of any of the wealth management services, please call Jaana at 416-960-7880 to schedule an appointment. This information is not investment advice and should be used only in conjunction with a discussion with your Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. Insurance products are offered through RBC Wealth Management Financial Services Inc. ( RBC WMFS ), a subsidiary of Inc. When providing life insurance products in all provinces except Quebec, Investment Advisors are acting as Insurance Representatives of RBC WMFS. In Quebec, Investment Advisors are acting as Financial Security Advisors of RBC WMFS. RBC DS WMFS is licensed as a financial services firm in the province of Quebec. Registered trademarks of Royal Bank of Canada. Used under license. 2017 RBC Dominion Securities Inc. All rights reserved.