Market Commentary – Canadian Dollar – Market Impact

24 July, 2017

Since May 3rd, 2017, there has been a reversal in the long-term deterioration in the value of the Canadian dollar relative to the U.S. dollar.  Since bottoming at just under $0.72 USD on that date, the Canadian dollar has gained over 9.3% to bring it

Since May 3rd, 2017, there has been a reversal in the long-term deterioration in the value of the Canadian dollar relative to the U.S. dollar.  Since bottoming at just under $0.72 USD on that date, the Canadian dollar has gained over 9.3% to bring its value back up to just under $0.79 USD. (source: www.stockcharts.com)

As you know, the Canadian stock market is quite limited in size, representing just 3% of the world’s capital markets (source: https://www.vanguardcanada.ca/documents/learn-about-international-investing.pdf).  Our economy is also very concentrated in relatively few industries, with nearly half of it based on the resource sector and another one-third based on the financial services sector (source: https://web.tmxmoney.com/index_sector.php?qm_symbol=^TSX).

For this reason, over time, it has been our policy to diversify our clients’ portfolios internationally to improve access to better investment opportunities, most notably in the United States.

This policy of international diversification generally results in portfolios that have significant exposure to U.S. stocks and bonds, since the U.S. is the largest capital market in the world.  Throughout most of the last 5 years, this strategy has been very rewarding for our clients as the Canadian stock market has performed relatively poorly against both the U.S. stock market and many other developed markets.  Furthermore, the exposure to the U.S. dollar during this time frame has resulted in excess returns to our clients above and beyond that of the underlying markets they were exposed to.

Due to the risks associated with currency movements though, IPC’s portfolio service has integrated a dynamic currency-hedging policy as a risk-mitigation tool.  When appropriate, the IPC portfolio services team will use financial tools to reduce or increase exposure to the U.S. dollar.  To date, the strategy has allowed our clients to capture the gains associated with weakness in the Canadian dollar, and mitigate the potential losses associate with strength in our currency.

Since November of 2016, the U.S. dollar exposure has been limited to 50% (source: Counsel Portfolio Services). As a result, the negative impact caused by the recent strength in the Canadian dollar has been limited to just half of the total currency appreciation, or just 4.65%.  The impact on your specific portfolio will be determined by your relative exposure to the U.S. dollar.

In an environment of reduced stock market volatility over the last several years, with quarterly statements demonstrating an extended period of continuous gains, this recent set-back can be unnerving.  Steadily rising markets and reduced volatility tend to breed investor complacency with respect to the risk associated with investing.  This recent decline in values is a reminder that markets DO indeed fluctuate downward sometimes and it is a normal part of the investment process to expect both up AND down movements in your portfolio value, as it gradually trends upward over the longer-term.

There is no reason to panic or to believe that this is the beginning of some reversal in the fortunes of your investment portfolio.

The current macro-economic environment is generally supportive of the global stock market, and technical analysis indicates that the global stock markets are in a primary uptrend.  Technical analysis also suggests that the Canadian dollar’s recent move is approaching an end.  Furthermore, it indicates that the Canadian stock market continues to experience a correction that has shaved 3.6% (source: stockcharts.com) from it high in mid-February of this year, and has left it barely above break even from the start of the year.

As such, we continue to employ the strategy of global diversification and dynamic currency hedging to help smooth the volatility associated with this strategy.

I reiterate that price volatility is a normal part of investing and there is no need to worry about the recent decline in the value of your portfolio.

After a ‘pause that refreshes’ and with renewed strength in U.S. corporate earnings, we expect market gains to accrue in the second half of 2017.

I encourage you to be patient and optimistic.

Sincerely,

John Soutsos

P.S. The media’s over-zealous, and heavily-biased, coverage of the Trump Presidency is nothing more than a distraction. I encourage you to avoid wasting time speculating on how any of this can impact the capital markets. Over the long-term, corporate earnings are more important than any other economic factor and at present, they appear to be improving very nicely.