Strong September boosts returns

IOn the Contrary nvestors set to receive their third-quarter statements have the month of September to thank for helping to boost their yearto-date returns.

The S&P TSX was running flat until the beginning of September, but a 10-per-cent rally in oil stocks over the past 30 days helped turn the S&P TSX positive with a modest 3.5-percent gain for the year on a total return basis.

Canadian bonds as represented by the FTSE TMX Universe Bond Index lost 1.6 per cent in the month resulting in a near zero return this year after accounting for the income received. Therefore, a Canadian balanced portfolio with a 60/40 split is up only 2.2 per cent.

For those with more globally diversified portfolios, the rallying Canadian dollar has taken a big chunk out of the outperformance to date. In Canadian dollar terms, the S&P 500 has gained only 4.1 per cent this year while the MSCI World index is up 6.3 per cent. A global balanced portfolio, also with a 60/40 split, is up only 3.8 per cent this year.

We think these low returns will come as a bit of a shock to most Canadian investors who have been reading about the new market highs being set especially outside of our borders. That said, given our outlook for the Canadian economy, we think more moderate returns could become the norm.

Specifically, we remain worried about the effect a high Canadian dollar is having. While our federal finance minister says there is nothing to be worried about, early indications of its potential impact showed up in the July GDP print. The Bank of Canada is also a wild card as evidenced by its recent decision to raise interest rates twice on a GDP print that contained a lot of one-time items and one that was based on a low base point at the depths of the oil price shock.

We also remain very concerned about the impact of the proposed tax hike on small business as the short consultation period comes to a close. These tax hikes are the most pervasive in 50 years and are being implemented on a sector that is the backbone of the Canadian economy.

All of this could spell trouble for the Canadian dollar, which is up 8.7 per cent this year. This would be good news for Canadian oil producers who are paid in U.S. dollars while their expenses are in Canadian dollars. There is also a bit of momentum in the sector on an improved oil price backstopped by the Saudis who are gearing up for their Aramco IPO. In addition, despite the strong showing for the month, the capped energy index still remains down approximately 14 per cent this year so there is still room for incremental upside on the recovery.

Canadian bonds have also sold off on the sudden hawkish stance by the Bank of Canada. Should the economy soften, so will our central bank, which could result in a recovery in bond prices. Interestingly, a recent report by Bloomberg highlights that Canada's two-year sovereign bonds are now yielding the same rate the 50-year bonds were back in July, 2016.

Finally, this may also be a good time to look abroad taking advantage of our higher Canadian dollar while it lasts — especially for those lacking international diversification.

The U.S. economy for example isn't facing the same kinds of monetary and fiscal policy risks as ours with an added bonus should their proposed tax cuts come to fruition. Additionally, the Federal Reserve is about to embark on the unwinding of its balance sheet which could raise U.S. interest rates and along with it the U.S. dollar.