Chalten Investment Review – Q2 2017

Welcome to the Chalten Investment Review for Q2 2017.   Last quarter we touted the merits of holding a passive, globally diversified portfolio of stocks and bonds versus the potential perils and pitfalls of trying to time market swings.  Trying to beat the market is a loser’s game and as Charles Ellis so rightly pointed out in 1975, the only winning move in a loser’s game is not to play! 

Now of course taking a passive approach doesn’t mean things will go your way all of the time.  Indeed the only way to achieve market returns over the long term is to stay disciplined and ride through market ups and downs.  This quarter a lot of the roller coaster ride was driven by currency movement.  The Canadian dollar slid against the USD in April but reversed course in May and then June delivered the strongest monthly appreciation of the CAD versus the USD that we’ve seen since we started writing this review 2 years ago.  So while global diversification is the right thing to do over the long run, sometimes we wish we had just stayed home – June was one of those months! 

Over time we should expect net returns to currency to be zero but currency returns can be volatile along the way.  For the equity side of our allocation, that volatility can be beneficial to the overall risk of our portfolio but for the bond side, currency volatility can sometimes overwhelm what we’re trying to achieve in terms of safety.  For this reason we advocate hedging currency exposure on the bond side of the allocation.  To use June as an example, in CAD terms the Barclays US Aggregate Bond Index was down 4% over the month.  Most of this move was related to currency as the CAD was up nearly 4% against the USD over the period.  A hedged US bond exposure would have delivered more stable performance.  In many ways, investing this June was like Vancouver weather – difficult to predict in advance but in retrospect it would have been better to stay local.   Rain is great for the garden but not for getting from A to B when we want to stay dry.  Think of the currency hedge like carrying an umbrella for your bonds. 

Since our last review we wrote about why beating the market is so difficult – (see “It’s a tough job…somebody has to do it, just not necessarily you!”) Outperforming stocks are rare, it’s impossible to identify in advance the very few (if any) professional stock pickers that can outperform and for those few that do, it’s difficult to attribute their success to luck or skill.  However while most individual investors (amateur and professional) get it wrong, the beauty is that collectively they do a great job of allocating capital and discovering efficient market prices – the result is a market than can be accessed in a very liquid, diversified and low cost way.  The efficiency of the market means that you can put your money at risk and be confident that over the long run sensible risk taking should be rewarded with commensurate investment returns.  So rather than speculating, the key to success over the long run is investing in a sensible way that is appropriate for your risk profile and tuned to your financial goals.


Q2 Market Review

In local currency terms, global equity markets were broadly up during the 2nd quarter of 2017.  Canadian markets were the exception again, delivering negative performance for domestic investors.  Furthermore, as discussed above, the strength of the CAD relative to the USD and other currencies meant that global equity performance in CAD terms was not as strong this quarter.  As we write this Q2 review it looks as though the Bank of Canada is set to raise its benchmark rate for the first time in 7 years, apparently confident that the economy is heating up despite still low oil prices and remaining uncertainty over US trade conditions.  In the US, there is still uncertainty about the prospects for the current government to push through major legislative measures although this didn’t seem to impact the US stock market as again we saw major market indices hit record highs in USD terms.  Stock markets outside of North America continued to move up even in CAD terms so at least while the CAD strength didn’t help international holdings, stock market performance certainly made diversification outside of North America worthwhile. 

  • The total return on the Canadian stock market was -1.6% for Q2 2017 and, like in Q1, the weakest among Canadian, US and International equity markets.
  • In the US, the total net return of the S&P500 in Canadian dollar terms was 0.4% for Q2.
  • The total net return for the S&P Global ex-US BMI Index of stocks outside of the US (in Canadian dollar terms) remained solid again this quarter at 3.3% despite the strong CAD.
  • The Canadian dollar gained just under 2.5% against the US dollar during the quarter.
  • Total return for Canadian bonds was 1.0% this quarter, ahead of US and Global bond returns in CAD terms. As we continue to watch global interest rates and central bank activity with interest, we remember that the purpose of bonds is to act as an uncorrelated shock absorber when equity markets turn down rather than as a return enhancer in their own right. To repeat what we said last quarter, it is also important to remember that just because central banks might be raising short term interest rates, it doesn’t necessarily follow that bond returns will be negative.  The shape of the yield curve and other factors can also impact bond returns.    


Financial Planning topics of interest

After so many years of low interest rates, the mortgage lenders are happy for any excuse to raise their prime lending rates and when the Bank of Canada raises its benchmark rate, lenders will follow suit almost immediately.  If you have a variable rate mortgage, are looking to renew a mortgage or have a floating line of credit then it might be a good time to review the impact of higher interest rates on your monthly budget. According to a variety of sources we Canadians are as indebted as we’ve ever been. 

Earlier in the quarter we saw one of Canada’s largest independent mortgage companies struggling for survival as savers pulled their money out in fear of a good old fashioned bank run.  While that situation seems to have stabilized it’s a good reminder that the Canadian Deposit Insurance Corporation (CDIC) will only insure deposits up to $100,000.  If you’re thinking of storing your emergency fund or cash reserve at one of these smaller independent institutions that need to offer higher GIC or account savings rates to attract savers, just be sure to keep balances under the $100,000 insured limit.


In closing we’ll remind you again that diversification often means you’ll hate something in your portfolio – as of late that thing seems to be a strong Canadian dollar!  But in the long run, returns to currency should even out and on the risky (equity) side of the portfolio we’re OK with currency exposure.   On the safety (bond) side of the portfolio, we’d like our ballast to do its job so we’re happy to pay a little extra to neutralize the currency risk.

And while a stronger Canadian dollar does hurt our foreign stock returns in the near term, it also makes those trips across the border a little less painful so we won’t bemoan it too much!