May started out nicely for equity investors as markets rallied higher on stronger corporate earnings and rising oil prices. Over the course of the month, the volatility that we had seen in February, March, and April seemed to settle down, with markets taking on a calmer tone. A calmer tone, that is, until the final few days of the month, as political uncertainty in Italy and Spain caught investors’ attention.
The main attraction was the inability of the Italians to form a government, which created worry and speculation that Italy may take a cue from the U.K. and leave the European Union with its own version of Brexit.
The yield on the Italian 2-year bond went from being negative in the early part of the month to trading as high as 2.75% on May 29. Such a violent move in rates sparked concern of a contagion that could spread across Europe, as bond markets around the world sold off heavily, and investors plowed into the safe haven of U.S. Treasuries.
This bout of high anxiety also saw a short selloff in the equity markets, but with strong gains earlier in the month, most equity markets finished in positive territory. Fortunately, in the first few days of June, calmer heads have prevailed, and sanity has returned to the markets.
Another headline was the escalation of President Trump’s trade war with the announcement that Canada, Mexico, and the European Union would no longer be exempted from tariffs on steel and aluminum. Canada, Mexico, and the EU acted swiftly, announcing retaliatory tariffs on a mixed bag of goods.
So far, equity markets have largely yawned at the tit-for-tat tariff wars, hoping a solution can be worked out.
For the month, the S&P/TSX Composite Index gained 3.1%, with healthcare and technology leading the way. The S&P 500 Composite Index rose by 2.4% in U.S. dollar terms, but thanks to a rise in the U.S. dollar, the return for unhedged Canadian investors was 3.6%. European and Asian markets ended mostly down on the back of increasing turmoil in the region. Canadian bonds were mostly higher over the month, with government bonds outpacing corporates.
In this environment, the portfolios each finished higher. The Conservative Portfolio rose by 0.3%, the Balanced Portfolio gained 0.9%, and the all equity Growth Portfolio was higher by 1.5%. The portfolios again trailed their benchmarks, with the defensively positioned Fidelity Canadian Large Cap Fund and the Mackenzie Ivy Foreign Equity Fund weighing on relative performance. These funds continue to position for a more volatile market environment.
For a detailed review of the portfolios’ performance and risk reward metrics, you can download our standard monthly portfolio report here. Additional detail can be found in these reports generated by Morningstar. A summary report can be downloaded here, while the more detailed report can be downloaded here.
The U.S. Federal Reserve hiked its federal funds rate on June 13 by 25 basis points, and the Bank of Canada is likely to follow suit in coming months. Economic data continues to be strong, and concerns over inflation pressures are on the rise. This may create a further headwind for bonds.
Despite the recent underperformance, I continue to believe the portfolios are well positioned. The fixed income holdings remain positioned for a rising rate environment and the equity holdings remain largely positioned for a more volatile environment. My portfolio construction process is focused on managing risks, and will tend to lag in a rising market, particularly as we approach a market top. However, when markets sell off, they are expected to hold up better than their peers.