Global equities had stellar gains in the first quarter with the TSX up 13%, S&P 500 (US stocks) 11% and MSCI EAFE (International stocks) 8% in Canadian dollar terms. Confidence in economic growth increased despite weakness in some data. The improvement was largely due to changes in central bank policy. The U.S. Federal Reserve and our Bank of Canada both put the brakes on rate increases for this year. The People’s Bank of China lowered rates and in Europe, the central bank announced rate increases would be delayed until 2020. Accommodative monetary policy is positive for stocks because it supports economic growth and as a result, corporate earnings. Also, dividends are more attractive due to low interest rates.
Trade policy in the U.S. will continue to influence the performance of equities. As we have written before, tariffs tend to be negative for the economy. The uncertainty caused by the trade negotiations between China and the U.S. over the past year has weighed on growth in many countries. Businesses are reluctant to invest when the rules of the game are unknown. This past quarter, the U.S. did not increase tariffs on China due to progress on the trade talks. Reaching a trade deal in the not too distant future should be positive for stocks. The longer the negotiations drag on, the more damage will be inflicted on the economy.
In terms of fiscal policy (taxation and spending), governments in the big 3 economies as well as Canada have been opening their wallets. The U.S. lowered taxes dramatically last year and is now running a deficit of close to $1 billion for 2019. China has cut taxes and increased infrastructure spending. Europe has been reluctant to increase government spending however, an agreement was finally reached with Italy to run a deficit. The March Canadian federal budget contained numerous new spending initiatives typical of a pre-election budget. Increased government spending will boost economic growth and indirectly help the stock market.
Policy changes can have huge effects on the global economy and capital markets with this quarter being a prime example. They can also be very influential at the sector level. We thought it would be of interest to review some of the policies that have affected the Energy sector. Changing policies for getting pipelines approved has resulted in the cancellation of two major Canadian projects: Energy East and Northern Gateway. Energy East would have converted parts of the existing underutilized TransCanada gas pipeline to transport oil from Alberta to the Maritimes. Currently, east coast oil is purchased from foreign producers. The Northern Gateway pipeline was proposed to run from Alberta to the B.C. coast where the oil would be exported to Asia. These projects were shelved due to environmental and indigenous issues.
There have been numerous delays for proposed pipelines including Trans Mountain, Enbridge’s Line 3 and TransCanada’s Keystone XL. Line 3 is the only project that has obtained final approval and is under construction. Lack of a consistent process for pipeline approvals has hurt Canadian energy stocks.
The need for pipelines to reach the coast of Canada has increased. This is because of the revolution in technology that has occurred with extracting oil – “fracking” . The U.S., our largest and only energy customer, is now one of the top three oil producers in the world. It recently approved oil exports due to additional supply.
Mr. Trump’s foreign policy involving sanctions on Iran and most recently Venezuela, has also had an impact on the Energy sector. Last year when Iranian sanctions were announced, Trump encouraged Saudi Arabia to increase production to offset the loss from Iran. This strategy was not enough to keep oil from rising to over $70 per barrel. In the fall, the U.S. offered six month exemptions from the sanctions to eight countries including China, Japan and India. Suddenly, the oil market was facing a surplus. These changes in U.S. foreign policy contributed to the volatility in oil prices during 2018.
Within weeks the U.S. will announce whether the exemptions will be renewed, reduced or ended. If the White House does not renew at least a portion of the exemptions, oil prices will likely rise. Higher oil prices would dampen economic activity and hurt some non- energy sectors of the stock market.
Where do we go from here? We would not be surprised to see some consolidation take place with potential for a modest pullback in the near term. For the second half of 2019, we expect markets will reach our targets—17,000 for the TSX and 3,000 for the S&P 500— barring negative policy changes. This represents upside from quarter end levels of about 7% including dividends.