Big Picture By Bill Curry
Italy Crisis Subsides, Trade Tensions Mount
A political impasse in Italy and the possibility of fresh elections put markets on edge Monday, with Italian bonds and stocks selling off sharply, renewing fears among investors in one of Europe’s largest economies. The Dow on Tuesday dropped nearly 400 points, the euro declined precipitously and U.S. Treasury yields posted their largest daily decline in nearly two years as investors around the globe flocked to safer assets like German and U.S. government bonds. By Wednesday, global markets, along with Italian bonds and the euro, rebounded over hopes that an election could be averted. The Dow and S&P also rallied, largely recouping Tuesday’s losses; and U.S. bank stocks, which had been punished Tuesday, regained ground as a sense of calm returned.
However, mounting trade tensions took centre stage later in the week as the Trump Administration followed through on threats to impose tariffs on steel and aluminum imports from the European Union, Canada and Mexico. Reports Thursday indicate that the three will see tariffs of 25% on imported steel and 10% on imported aluminum, to take effect as of midnight Thursday.
U.S. Commerce Secretary Wilbur Ross cited lack of progress in NAFTA negotiations as a key reason to eliminate Canada’s exemptions from worldwide tariffs announced earlier in the year. Canada, the EU and Mexico have vowed to respond with tariffs of their own. Meanwhile, the U.S. has also lashed out against China, with plans to target some $50 billion worth of Chinese goods that will be subject to a 25% tariff in mid-June. In early trading Thursday, the Dow dropped more than 200 points as investors weighed the unwelcome effects that tariffs are likely to bring, including market uncertainty, weaker earnings for affected companies and higher prices for U.S. consumers.
Turning back to Canada, the central bank on Wednesday left its benchmark rate at 1.25% but signalled that higher borrowing costs are on the way, with many analysts expecting further tightening in July.
A Volatile Week It was a volatile period for U.S. markets, which were closed Monday for Memorial Day; while the TSX edged slightly lower. For the four days covered in this report, the Dow lost 337 points to close at 24,416, the S&P 500 shed 16 points to end at 2,705 and the Nasdaq climbed 8 points to settle at 7,442. The TSX dropped 14 points over the period to close at 16,061.
Heightened emerging market risks and recent European risk flare-up underscore importance of diversification. The beginning of July coincides with the onset of the ‘dog days of summer’. The expression was used by the ancient Romans to describe hot and humid days associated with heat radiating from the Dog Star, which appeared to rise and set alongside the sun during July.
The past week’s political developments in Italy and Spain temporarily raised the spectre (once again) of the Eurozone being fractured by populism. However, we believe the risk of this outcome is low, difficult to time and best managed through diversification. We continue to believe that equities will outperform fixed income securities as central bank policy changes in developed markets are commensurate with moderate and gradual increases in inflation. The recent volatility in emerging markets, such as Argentina and Turkey, reinforces our comfort in obtaining international exposure through well-capitalized multinationals that are domiciled in advanced economies.
Heightened political risk and policy uncertainty will likely effect an increase in volatility, which underscores the importance of maintaining exposure to fixed income securities or alternative investments to mitigate risk. Medium to longerdated sovereign interest rates in Canada and the U.S. are expected to increase less than short-term interest rates, which are much more strongly influenced by central bank policy decisions. Accordingly, we believe that fixed income investors will need to tactically manage duration and credit risk as the business cycle progresses.
Our bias toward shorter duration fixed income portfolios will likely change when issuers begin experiencing difficulty servicing their debt obligations. In the interim, default rates are low, debt maturities have been extended and, as evidenced by the strong growth in corporate profits during 1Q18, profitability remains buoyant.
This publication has been prepared by ScotiaMcLeod, a division of Scotia Capital Inc. (SCI). This publication is intended as a general source of information and should not be considered as personal investment or tax advice. We are not tax advisors and we recommend that individuals consult with their professional tax advisor before taking any action based upon the information found in this publication. Opinions, estimates, and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither SCI nor its affiliates accepts liability whatsoever for any loss arising from any use of this publication or its contents. This publication is not, and is not to be construed as, an offer to sell or solicitation of an offer to buy any securities and/or commodity futures contracts. SCI, its affiliates and/or their respective officers, directors, or employees may from time to time acquire, hold, or sell securities and/or commodities and/or commodity futures contracts mentioned herein as principal or agent. SCI and/or its affiliates may have acted as financial advisor and/or underwriter for certain of the corporations mentioned herein and may have received and may receive remuneration for same. All insurance products are sold through Scotia Wealth Insurance Services Inc., the insurance subsidiary of Scotia Capital Inc., a member of the Scotiabank Group. When discussing life insurance products, ScotiaMcLeod advisors are acting as Insurance Advisors (Financial Security Advisors in Quebec) representing Scotia Wealth Insurance Services Inc. This publication and all the information, opinions, and conclusions contained in it are protected by copyright. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions contained in it be referred to without in each case the prior express consent of SCI.
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