Equity Market Commentary: Strong Outperformance in Third Quarter

October 12, 2017

Equities came back to life in September, closing out a strong third quarter. The S&P/TSX Composite Total Return Index returned 3.7% in the quarter and is now up 4.4% year-to-date while the S&P 500 Total Return Index returned 0.5% in Q3 and is now up 5.9% year-to-date in Canadian dollars. Higher interest rates, oil prices and surprisingly strong economic growth were the drivers of a strong quarter in Canada.

UNDERPERFORMANCE IN CANADIAN MARKETS DESPITE STRONG ECONOMY

Canadian banks and energy shares represent over 40% of the index weighting on the TSX and were the top performers of the quarter. The abrupt change in positioning in Canadian interest rates spurred forward a robust 4.5% annualized GDP growth rate in Q2. The Bank of Canada sprang into action with two surprise interest rate increases over the summer, sparking a 12.0% rally in the Canadian dollar from its mid-May lows. Increasing interest rates can be a concern for banks, causing potential credit losses from people defaulting on loans and mortgages; however, they can also be a tremendous positive, increasing the spread between borrowing and lending rates. The best case scenario for the banks going forward is a continued strong economy with gradually rising interest rates – exactly what we are currently seeing.

The fundamentals for oil continued to improve over the summer as production additions in the United States remained muted while demand was exceedingly strong. This led to the largest seasonal drawdown on record of US crude oil inventories and a 23.8% rally in crude oil prices from the lows in mid-June. While we are not wildly optimistic on either the Canadian economy or oil prices over the near to medium-term, we think the conditions for both remain solid, justifying a catch up in the Canadian banks, energy producers and pipelines, all of which have not performed inline with fundamentals so far this year.

Read full Q3-2017 Quarterly Review.

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