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Market Update for September 2017 – Rising Interest Rates

By Isaac Schweigert | October 26, 2017

Despite its historical reputation, September was a good month for stocks.  Bonds didn’t fare as well as interest rates continued to rise.

 

September 2017 Market Performance

All index returns are total return (includes reinvestment of dividends) and are in Canadian Dollars unless noted.

 

*Absolute change in yield, not the return from holding the security.

 

The S&P/TSX Composite was up +3.1% in September, its best month in over a year, and is up +4.4% so far in 2017.  In the US, the S&P500 hit several new record highs during the month and finished the month up +2.1%. European stocks were up +2.6% in September, driven primarily by the strong performance from German stocks.  Emerging markets posted their 9th consecutive positive month, up +0.3% in local currency.

With interest rates rising during the month, the major bond indexes posted negative performance. The broad index of Canadian bonds, FTSE TMX Universe Bond Index was down -1.3% in September, but is still up +0.5% for 2017.  The FTSE TMX Short Term Bond Index was down -0.5%, and is down -0.2% for 2017.  High grade US bonds were also negative, while the high yield indexes were positive.  Emerging market bonds, when measured in Canadian dollars were down -0.2%, but are still up +1.6% for 2017.

Oil posted its best monthly performance in over a year in September, and was up +9.4%.  Gold was down -2.8%.   The broad Bloomberg Commodity Index was down -0.2% for September and is down -3.5% for 2017.

The Canadian dollar gained strength following the Bank of Canada’s moved to raise interest rates +0.25%. Against the US dollar the Canadian dollar rose +0.4%, and is up +7.1% in 2017.  In September the Canadian dollar gained +1.0% against the Euro, but has lost -4.0% in 2017.

 

Commentary

In case you missed it, although I don’t know how you could have unless you were stranded in the wilderness, interest rates are on the rise after the Bank of Canada hiked interest rates for the second time this year.  Within hours the major Canadian banks hiked their prime lending rates by 0.25%, triggering a flood of articles that Canadians are going to struggle with their debt loads.  This second interest rate hike of the year wasn’t unexpected, but most expected the rate increase to come later in the year.

What does rising interest rates mean for you?  Credit products that are linked to the prime rate saw their interest rate increase by 0.25%.  That means if you have a variable rate mortgage, a line of credit, or certain credit cards, your cost of borrowing went up.

If you have a fixed-rate mortgage like the majority of Canadians, you have nothing to worry about right now.  When it comes to renew your mortgage your borrowing cost and payment amounts may be higher.  If you have a variable rate mortgage with fixed payments, your borrowing cost went up and the length (amortization) of your mortgage got longer.  But if your variable rate mortgage doesn’t have fixed payments, then your payments just got bigger.

 

What do rising interest rates mean for your investments?

 

For savings accounts and GICs, interest rates have finally started going up.  So squirreling away money for a rainy day will feel less like a waste of time.

Bonds, especially long term bonds have seen their prices decline (bond prices and interest rates are inversely related).  Short-term bonds have also lost ground. Since the interest received (coupon) on most bonds is fixed, previously issued bonds with lower coupon payments are less attractive so their price declines.

 

With interest rates on the rise should you make any changes to your investments?

 

It depends.

Take a look at the term to maturity and the duration of your bond mutual funds and ETFs.  Duration is the measure of the sensitivity of a bond to changes in interest rates.  Bonds and bond funds with higher durations have greater sensitivity to rising interest rates, and will have larger losses than those with low durations.  I would be wary of adding to bond investments that have durations greater than 3-4 years right now.

If you own a bond ETF like the Vanguard Canadian Aggregate Bond Index ETF (VAB) or the iShares Core Canadian Universe Bond Index ETF (XBB), it is probably time to switch to their short-term counterparts.  At ModernAdvisor we’ve been using the Vanguard Canadian Short-Term Bond Index ETF (VSB) to give clients Canadian bond exposure since we launched.

When interest rates were on their way down, many investors looked for alternatives to low yields that were available on low risk products, choosing preferred shares, and high yield bonds instead.

Most Canadian preferred shares are rate-reset preferreds, which means as interest rates went down, the dividend rates on those also went down.  Now that interest rates are on the rise, preferred share dividend rates will slowly start to rise as well. High yield bonds don’t typically have much sensitivity to changes in interest rates as their credit risk tends to dominate their risk profile, but in the rush for yield  many investors seemingly ignored the credit risk and may have more risk in their portfolio than they realize.  High yield bond yields are at multi-year lows, making it a good time to consider reducing your exposure.

Overall, rising interest rates should be good for most types of investments, helping to offset the rising cost of any debt you may have.

 

September Economic Indicator Recap

Below are the current readings on the major economic indicators: central bank interest rates, inflation, GDP and unemployment.

Below are the current readings on a few other often followed economic indicators: retail sales and housing market metrics.

A Closer Look at the Canadian Economy

Canada’s unemployment rate ticked down 0.1% to +6.2% in August, as a net 22,200 new jobs were added. 110,400 of those were part time jobs, the largest monthly increase since 2010.  Unfortunately, 88,100 full time jobs were lost, the largest monthly decline in full time jobs since 2010.

Housing prices across Canada rose +0.6% in August.  The top performing markets were: Vancouver (+2.4%), Victoria (+1.8%), Ottawa (+1.4%), Winnipeg (+1.3%) and Edmonton (+0.8%).  Toronto was down -0.4%.

New housing starts rose +0.5% in August, while the value of building permits issued declined -3.5% in July.

The inflation rate was up +0.1% in August, or +1.4% on an annual basis.  Core inflation which excludes more variable items such as gasoline, natural gas, fruit & vegetables and mortgage interest has been stuck at +0.9% for the last 4 months, the lowest level since the 1980s.

Retail sales were up +0.4% in July.  Gains at new car dealers and grocery stores drove the increase in retail sales.  Compared to a year ago, retail sales were up a healthy +7.8%.

Canada’s GDP was flat in July.  Gains in the services sector were offset by declines in mining, oil & gas, and manufacturing.

At their September 6 meeting the Bank of Canada raised their benchmark interest rate 0.25% to 1.0%, citing expected strong future economic growth.  The next meeting of the BOC is on October 25, when the interest rate is expected to remain unchanged.

 

 

*Sources: MSCI, FTSE, Morningstar Direct, Trading Economics


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Isaac Schweigert

Isaac Schweigert

Isaac is a CFA charterholder and is Portfolio Manager and Chief Compliance Officer at ModernAdvisor. He has over 11 years of investment industry experience, including asset allocation, portfolio management, due diligence, compliance and reporting.