Why investors should keep an eye on oil in the second half

Energy is especially important as other sectors disappoint, Martin Pelletier writes.

So far, 2018 is looking to be a year in which global markets take a breather, but there are some important themes that could get them moving again. Unfortunately the direction they take depends on the outcomes from these themes.

Overall, the majority of global equity and bond markets posted fairly flat returns in the second quarter in their native currencies. That said, thanks to an impressive 16-per-cent rally in energy stocks, the TSX posted a strong 6.8-per-cent gain, more than offsetting its first-quarter loss and leaving the return this year at a modest 1.9 per cent.

We think energy is something worth keeping a very close eye on heading into the second half of the year. In particular, oil prices are up more than 23 per cent this year while Canadian energy stocks are up only 6.8 per cent, meaning there could be some room left in the energy trade.

When it comes to getting the TSX back in the game, energy is especially important given that other sectors have been disappointing of late. Financials gained 1.8 per cent in the quarter but are still down 3.2 per cent this year.

Utilities — hit by what we think are overly aggressive views on interest rates — continued to sell off losing 0.7 per cent in the quarter for an overall decline of 6.6 per cent this year.

Holding other currencies, such as the U.S. dollar, really helped Canadian investor portfolios in the second quarter, as the loonie has been extremely volatile this year despite strong gains in oil prices.

In our view, a real-estate market that appears to be rolling over, concerns over NAFTA negotiations and uncertainty over the Bank of Canada’s interest rate policy all contributed to the loonie losing 2.7 per cent against the U.S. dollar in the second quarter. That makes the decline to date in 2018 a whopping 5.1 per cent.

Those holding U.S. equities got a significant boost from this currency adjustment, which also mitigated losses in interna- tional markets outside of North America.

The S&P 500 posted a 3.4 per cent gain in the second quarter and is up 3.2 per cent this year. However in Canadian dollar terms it gained 6.3 per cent in Q2 and is up 8.7 per cent this year. This is something to keep in mind heading into the remainder of the year especially if oil prices remain robust and the Bank of Canada follows the hawkish calls by the majority of bank economists. Additionally, it appears to be a very crowded trade within the U.S. equity market with 10 stocks out of 500 contributing 100 per cent of the S&P’s gains this year. More so, only two of these are financials with the remaining eight all being technology related.

Overseas, markets outside of North America have been affected by concerns over a potential trade war with the United States. In Canadian dollar terms, the MSCI EAFE index lost 1.2 per cent and is flat at 0.4 per cent this year, while the MSCI emerging markets lost 2.2 per cent and is up 3.3 per cent this year.

Until some comfort is provided around these trade threats it wouldn’t surprise us to see these markets remain in a holding pattern, albeit valuations are becoming rather enticing. Actually, we find it quite amazing how quickly the tone has turned, with some who not so long ago were calling for a large global reflation trade now shifting toward a recessionary outlook.

Finally, bond markets, as represented by the FTSE TMX Universe Bond index recovered a bit last quarter for a modest 0.6 per cent return this year. Therefore, we calculate that a Canadian balanced portfolio would be up only 1.4 per cent this year while global balanced portfolios are up only 2.4 per cent.

Financial Post Martin Pelletier, CFA is a Portfolio Manager and OCIO at TriVest Wealth Counsel Ltd, a Calgarybased private client and institutional investment firm specializing in discretionary risk-managed portfolios as well as investment audit and oversight services.