Decreased fixed income; increased International equities
Current Target Positioning as of June 12, 2015
The Canadian bond market has experienced an extremely volatile year so far. The recent rise in yields has hurt bond prices, resulting in negative short term returns. For example, the FTSE TMX Canada Universe Bond Index declined by -1.5% over the past three months as at the end of May (however, it is still positive +3% year-to-date).
A main factor driving bond yields this year has been the European economic saga. Earlier in the year, European deflationary threats and the announcement of an aggressive quantitative easing program drove yields down to very low levels. Recently, however, economic data in Europe has surprised on the upside, causing German 10yr bund yields to rise by a massive 90 basis points since April, from 0.07% to 0.98% in recent days. In North America, the economic data has been somewhat mixed. However, a strong U.S. payroll report last Friday means the probability remains high that the U.S. Federal Reserve (the “Fed”) will begin hiking rates later this year. The potential of flat to modestly negative bond market performance over the near term has incrementally increased our overweight in equities.
As a result, we have tactically widened our underweight target allocation to fixed income.
The European economy appears to have responded to the European Central Bank’s aggressive growth policies. While flirting with mild deflation in the first quarter of 2015, consumer inflation rebounded back into positive territory in May. Economic growth, while still at moderate levels for the region as a whole, has shown better breadth among its member nations. The Italian economy grew for the first time in over a year, and both France and Spain contributed meaningfully to the region’s growth. European equities reacted negatively to the positive economic developments on fears that stimulus may be cut short. In our view, this provided an attractive opportunity to add to an asset class with improving fundamentals.
With both Europe and Japan, a key policy strategy is currency devaluation to promote exports. For foreigners investing in these regions, the currency impact may be negative. However, since the Canadian dollar has also fallen against its major trading partners due to declining oil prices, the currency impact to Canadian based investors has been less of an issueAs a result we have tactically increased our target allocation to international equities.