DR.CHENJIAZI ZHONG

On Oil: Prices Jump to Three-Week High on Talk of Extending Production Cuts

Oil prices jumped to a three-week high on May 15. U.S. crude futures rose to $48.85 a barrel on the New York Mercantile Exchange and Brent rose to $51.82 a barrel on ICE Futures Europe. The move capped a four-day streak of gains for oil prices, lifting both benchmarks to their highest levels since late April. In a joint statement, Saudi Energy Minister Khalid al-Falih and Russian Energy Minister Alexander Novak said a pact by the Organization of the Petroleum Exporting Countries and external producers, including Russia, to cut output by some 1.8 million barrels a day should be extended to the end of March 2018.

On U.S. Dollar: The U.S. Dollar remains soft with both EUR and GBP rallying

The USD has been a soft undertone as it struggled to rekindle the sort of form that saw it rally broadly, and strongly, in the immediate aftermath of the US presidential election in 2016. The Trump administration’s early policy setbacks, which investors fear will slow the broader drive for tax reform, deregulation and fiscal stimulus, account for some of the USD’s underwhelming performance in April. Geopolitical concerns, such as Asia, and political developments in Europe have also undercut the USD more recently. Finally, the U.S. economy appears to have stumbled out of the starting blocks this year again, which weakened the market’s confidence in the Federal Reserve’s ability to tighten monetary policy over the balance of the year.

On U.S. Markets: Stocks and Bond Appear to Be Telling Different Stories about the U.S. Economy

Stock and bond markets appear to be telling different stories about the U.S. economy, with stock prices climbing and bonds holding relatively steady. While strength from Technology remains notable, performance is not at a historical extreme. While the Nasdaq 100 has certainly been a standout performer, it has been significantly more stretched before.

Yields remain near 2.30%, the bond proxies and defensive groups continue to underperform. In addition to geopolitical risks in Syria and North Korea, several other factors continue to argue for a low-yield environment that is broadly range bound, including that inflation fears are contained, U.S. and Chinese economic data are showing signs of weakness, and the European Central Bank and Bank of Japan remain accommodative.

Bank of Canada on Hold, Assessing Uncertainties in Nation’s Economy

The April Bank of Canada (BOC) monetary policy statement was mildly hawkish: It acknowledged the recent stronger growth and better-than-expected economic data, yet revised down the forecast for the potential GDP growth rate. U.S. policy, especially trade, is by far the greatest source of uncertainty to Canada’s outlook. Any movement toward U.S. protectionism would have a major negative impact on the Canadian economy. Recognizing this risk, the BOC mentions U.S. trade policy often in the latest Monetary Policy Report.

The reliance on U.S. policy highlights one of the weak points in the Canadian economy: its persistently underwhelming exports, especially in non-commodity sectors. A key question for policymakers is whether this weakness is structural or cyclical. The BOC needs more time and data to make that assessment.

The housing market is clearly a concern for the BOC. Its 2017 forecast revised down housing’s contribution to GDP growth, demonstrating caution on the Toronto housing market as its boom continued in the first quarter of this year. The surge in home prices presents real risks to the macro economy, and residential investment and consumption as a percentage of GDP is very high by historical standards. As people “consume” a lot of housing and go deeper into debt doing so, they effectively borrow that consumption from the future. This means we can’t rely on Canadian consumers to be the main drivers of real GDP growth the way they have in the past – a vulnerability the BOC has consciously incorporated in its growth forecast.

A Couple Thoughts

With equities delivering strong returns since the post-crisis bottom in 2009, simple exposure to equity beta, or the market’s return, has been enough for many investors to achieve their return targets. While in the coming years, with equity returns likely to be significantly lower compared to recent levels.

A recent study by Morningstar revealed that only 14% of U.S. large cap managers outperformed their passive counterparts over 10 years, and only about 30% of managers outperformed in the perceived less efficient areas of small cap, international and emerging markets. Low returns, scarcity of alpha and the tendency to chase performance. With all of these challenges, how does an equity investor achieve higher returns going forward?

Part of the answer lies in portfolio structuring: that is, reallocating away from traditional passive and active strategies and toward structural or systematic approaches that may offer more reliable sources of returns. To be sure, investing in nontraditional equity strategies requires education and the ability to navigate an evolving landscape. But the potential rewards – achieving higher returns in an environment where beta alone may no longer be enough could be meaningful. Rethinking traditional approaches and moving toward strategies that benefit from systematic and structural sources of returns may help investors to achieve the excess returns they seek.