Quarterly Commentary - Holdun

Up, Up and Away… For Now

The value of international diversification was on display from a U.S. perspective in the first quarter as foreign stocks and bonds topped the performance list for the major asset classes.

Uncertainty over President Trump’s economic and foreign policies and geo-political risk from Brexit and elections in the EU lead to safe haven demand for gold and silver bullion in the first quarter with gains of 8% and 14% respectively.

Canada & U.S.
Canada’s benchmark stock index eked out a gain of 2.4% in the first quarter, ranking it a dismal 21st among the world’s developed markets. By contrast, the S&P 500 rose 6.1%. The obvious culprit for the underperformance is oil. The price of West Texas Intermediate crude fell over 10% from its January high dragging the energy index down over 6%. With energy companies accounting for 21% of the index, the decline in those shares dwarfs any impact from the so called Trump rally that has driven US stocks. The top three sectors in Canada represent roughly 68% of the index (Financials, Materials and Energy) and contributed a net +0.8% to the quarterly return. We are also mindful that the two largest sectors in Canada’s TSX – financials (33%) and energy (21%) – are facing potentially damaging headwinds. Banks face growing consumer unrest about questionable sales incentives and cross selling. They also face what many are referring to as bubble conditions in housing in both Vancouver and Toronto. Energy companies are coming out of a quarter that saw energy prices slashed by 6% and are forced to revisit cash flow and working capital budgets. As bank borrowing determination season starts in April, we could be in for a few surprises.

As we entered 2017, Italy’s banks were estimated to be stuck with ~ €356 billion of bad loans – a third of the Eurozone’s total. In early February, Italy’s largest lender UniCredit sold shares to raise €13bn, as it needed to rebuild its capital reserves after suffering a loss estimated at €11.8 billion in 2016. Subsequently in late March, Deutsche Bank came to markets with an €8bn capital raise and another strategic overhaul. This was believed to boost Deutsche’s core capital ratio, which stood at 11.9% at the end of last year, to about 14% on a pro forma basis.

It appears then that European banks may be on the mend and this has been reflected in the fact that European stocks hit their highest level in 15 months recently. However, tensions in the political landscape will likely continue to trigger volatility in the banking sector. On the currency
front, the euro rallied on the bank recapitalization news as well as the comment by the ECB’ President Draghi that …”the risk spectrum is shifting.” An exit from QE by the ECB would be a sign that sustainable growth may be at hand. Chinese politics will also figure prominently in 2017, in the form of the 19th National Congress of the Communist Party, due in the Fall. This event is expected to result in a further consolidation of power for President Xi Jinxing. But we have concerns beyond the realm of Chinese domestic politics.

We do worry about an economic slowdown in China and the reliability of its economic data. China lowered its 2017 GDP growth target to 6.5% during the recent National People’s Congress, down from a target of between 6.5% and 7% in 2016. To rein in debt, China lowered its total social financing growth target to 12% in 2017 from 13% last year. Total social financing is the broadest measure of credit recognized by the People’s Bank of China. In addition, China’s fixed asset investment growth was lowered to 9%, down from 10.5% in 2016. Much of China’s “shadow financing” is channeled to infrastructure spending by local governments.