First Quarter 2019 Market Commentary
What a difference three months make
After a near bear market in the final three months of 2018, we have experienced a sharp reversal in global equities during the first quarter of 2019. The stage seems to be set for this year’s rally, with hints to a resolution in the U.S. and Chinese trade dispute, early signs of Chinese stimulus taking hold, and an optimistic shift by the U.S. Federal Reserve and other central banks. We often cite that equity markets move up or down for many reasons and that market valuations tend to return to fundamentals over the long term. This quarter was no exception. While long-term investors held fast, those who were influenced by the fluctuations and sold late last year have not participated in the rally.
The S&P/TSX was able to look past weak housing, consumer data and political noise, rising 12.4 percent during the first three months of the year. The Canadian stock market was driven higher by energy prices and generally positive market sentiment. Oil, as measured by West Texas Intermediate (WTI), rose nearly 30 percent, supporting the commodity-heavy S&P/TSX. All ten sectors were positive in Canada with a widespread rally.
The United States
Despite issues ranging from slowing global growth and the political climate, the S&P500 had its best quarter since September 2009, seemingly influenced by optimism around trade talks and the Federal Reserve’s move towards freezing interest rates increases. The S&P 500, Dow Jones and Nasdaq were up 13.1, 11.2 and 16.5 percent respectively. One reason for the recovery is the expectation that a U.S.-China trade agreement will stabilize the global economy which would help boost corporate earnings.
In overseas markets, international equities rose 9.0 percent in U.S. dollars, as measured by the MSCI EAFE index (Europe, Asia & Far East). Overseas markets were driven higher on expectations that Chinese government stimulus would support the underlying economy and those economies that rely on China. For example, nearly a quarter of European exports are to China. We are beginning to see early signs of green shoots from China’s investments and that has supported equity markets globally.
Central bank policy
In 2018 we saw central banks increasing interest rates based on global economic strength. The narrative has flipped in 2019, where central banks are pausing interest rates hikes due to muted global economic growth. In 2018, the Bank of Canada increased its interest rate to 1.75 percent in the form of three rate increases of 25 basis points each, while the U.S. Federal Reserve raised its overnight rate four times from 1.25 percent to 2.25 percent. Capital markets do not predict that either Central Bank will raise interest rates this year; in fact, the odds are that they may cut them.
2019 Federal budget
The Liberal government delivered its fourth federal budget on March 19. The budget had no new personal or corporate tax rate changes. The focus was mainly on home buying, retraining, and retirement–geared towards millennials, people adjusting to working in the new economy, and seniors respectively. Other than closing perceived tax loopholes, very little was directed at small business owners, professionals or high-income earners.
- Registered plan funds will be able to be used to purchase an Advanced Life Deferred Annuity (ALDA). The current rules do not allow people to use registered funds to purchase a deferred annuity. Instead when individuals turn 71, they’re expected to start taking income from these funds. Starting in 2020, and subject to certain limits, individuals will be able to purchase an ALDA from certain registered plans such as an RRSP or RRIF. An ALDA is a life annuity with payments that can be deferred up to the end of the year in which the annuitant reaches age 85. The value of the ALDA will not be included as part of the annual minimum RRIF withdrawal calculations.
- The Home Buyers Plan (HBP) withdrawal limit will increase from $25,000 to $35,000. As a result, a couple could potentially withdraw up to $70,000 from their RRSPs to buy their first home. Also, individuals who experience a breakdown of their marriage or common-law partnership may now be able to qualify for the HBP even if they don’t meet the first-time home buyer requirement.
- Registered Disability Savings Plans (RDSPs) are tax-assisted savings for disabled people who qualify for the disability tax credit (DTC). RDSPs give the disabled person and their family a vehicle for saving for their financial security. If a beneficiary of an RDSP stops being eligible for the DTC, the RDSP has to be closed and grants and bonds received from the government must be repaid. It’s proposed that this will no longer be the case, if the beneficiary stops qualifying for the DTC. The budget also proposes to exempt RDSPs, just like RRSPs, from seizure by creditors in bankruptcy, except for contributions made in the 12 months before the filing.
- A new Canada Training Credit is applicable starting in 2019. This refundable tax credit will help cover up to half of eligible tuition and fees associated with training. Eligible workers between 25 and 64 with a net income between $10,000 and $147,667 in 2019 (indexed annually) will accumulate $250 per year in a notional account up to a lifetime maximum of $5,000.
- The budget proposes a $200,000 annual cap on employee stock options grants - based on the fair market value of the underlying shares - that may receive tax-preferred tax treatment for employees of large, long-established, mature firms. The cap will not apply to start ups and emerging businesses. This change will not apply to stock options granted before the future legislative proposals. More details are promised before the summer of 2019.
- Individual Pension Plans (IPPs) are now prohibited from providing retirement benefits for past years of employment that were pensionable service under a former employer’s defined benefit (DB) plan. An asset transfer from a former employer’s DB plan to an IPP that relates to prohibited service will not be a qualifying transfer and will result in an income inclusion for the member. This measure applies to pensionable service credited under an IPP on or after March 19, 2019.
The last quarter of 2018 was the worst quarter for stocks in seven years. Alternatively, the first quarter of 2019 was the best quarter for stocks in 10 years. We’re not suggesting that a recession or a bear market are imminent, however, we do need to be respectful of the length of the current economic cycle and where we are within it. Therefore, we believe that a balanced asset allocation and a defensive approach throughout the year may serve investors well.