Third Quarter 2017

The North American economies have experienced a steady recovery and expansion since the “great recession” of 2008-2009. In recent years, most major economies have joined in, providing a current landscape of synchronous global economic growth, a phenomenon not seen in over a decade.

With a lengthy period of recovery behind them, and positive outlooks ahead, central banks around the world are cautiously edging up interest rates. As the record low rates of the past eight years were in response to the financial crisis and the resultant recession, central banks are now trying to restore a semblance of normality to financial markets.

The U.S. Federal Reserve raised interest rates in December 2015, December 2016, and twice so far in 2017. Their indicated overnight rate is now 1.25% to1.50%. It is expected that the “Fed” will raise rates one more time before year-end and follow with further increases in 2018.

The Bank of Canada raised interest rates twice in 2017, reversing the two rate cuts of 2015. The Canadian overnight rate is now 1.0%. The Bank of Canada increased rates against the backdrop of a Canadian economy that has delivered surprisingly strong economic growth, without the benefit of higher oil prices.

Under normal circumstances, interest rates are increased as a result of central banks restricting the money supply in order to fight inflation. That is not the case with this current cycle. Inflation is barely noticeable in any of the developed world, despite strengthening economies and falling unemployment. U.S. unemployment is currently at 4.2%, effectively approaching full employment.

Without any threat of inflation, why are banks easing rates back up? The answer is twofold. First, it returns the economic landscape to a more classically “normal” interest rate environment. The concept that money should be “free” is not sustainable in the long run. This is especially true in parts of Europe, where interest rates have actually been negative. Second, higher rates provide central banks with the ability to lower rates sometime in the future in order to stimulate flagging economies.

A shifting interest rate environment affects all financial markets, be they for credit or equity, as well as foreign exchange rates. In our view, increasing interest rates and a return to a more stable economic environment are positive for equity markets. While the recent recovery of the Canadian dollar may dampen the performance of our U.S based equities (as measured in the Canadian dollar) in the short run, we do not view this as a risk longer term. When we invest outside of Canada, we do so in order to invest in superior companies at attractive values and in industry sectors that are not well developed domestically.

Having said that, we do not expect the Canadian dollar to rise much further compared to its U.S. counterpart, unless there is a surprising surge in global oil prices. Therefore, our strategy will continue to favor our current exposure to Canadian and U.S. equities while maintaining a short term horizon for fixed income investments.




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