The first quarter of 2016 delivered modest gains for Canadian investors, but the results conceal wild swings in both the fundamental economic outlook and financial markets.
Expectations for the Canadian economy deteriorated to start the year as oil prices plummeted to USD $26/barrel amid growing fears of a U.S. recession. However, those concerns were mollified as Canadian data did not show deterioration early in the quarter, oil prices stabilized and U.S. recession fears diminished. Of particular note is the improvement in non-energy exports and retail sales. Employment and business investment spending remain weak given the nearly 30% lower oil price from year ago levels.
The Bank of Canada (BoC) opted to leave interest rates unchanged during the first quarter, and we think it is likely to remain on hold unless economic weakness and an energy price swoon return. The Federal budget released in late March provides modest fiscal stimulus to the Canadian economy during the balance of the year. And more modest expectations for Federal Reserve rate hikes during 2016 also give the BoC room to leave rates steady. The turn higher in the Loonie already reflects this more stable monetary policy environment, and a lift in energy prices may be susceptible to a move lower if the Fed raises rates sooner than anticipated, or if oil swoons.
With the exception of the very front end of the yield curve, Canadian government bond yields declined, as did spreads on investment grade corporate bonds. 10-year Canadian government bond yields had declined to as low as 0.90% during mid-February, when recession fears hit an apex but ended the quarter at just over 1.2%. As a result, Canadian bonds delivered broadly positive, albeit low single-digit, returns. We anticipate low Canadian interest rates, anchored by still low global inflation and broadly accommodative monetary policy.
Canadian stocks also had a topsy-turvy first quarter, but ended up being one of the top-performing developed equity markets given the outsized exposure to firming commodity prices. The materials sector, which makes up roughly 11% of the S&P/TSX Composite Index, vastly outpaced the overall Canadian equity market with a gain of 20% during Q1. The Canadian gold mining companies, which account for a bit over 5% of the index, delivered a nearly 40% total return during the same time period. Solid performance among Canadian banks and energy companies also lent support during the quarter. While Canadian stocks appear modestly cheap and offer a compelling dividend yield, the market’s higher sensitivity to natural resource prices implies there may be heightened volatility ahead.
Read more about the global themes we’re focusing on in Q2 in the full BlackRock Global Investment Outlook.