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September Newsletter - There's a lot going on in the World

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The three key hot button issues at the moment are North Korea, the Canadian dollar and inflation/interest rates. In this months issue we will address each one.

 

North Korea

 

This is a frightening prospect. Any country, other than our lovely allies, that have nukes is a frightening prospect. Equally as disturbing is when Trump was on the campaign trail, telling voters what they wanted to hear he repeatedly said “I want to remain unpredictable with nuclear weapons”. He has also said recently, as the POTUS, that “Japan and South Korea can buy substantially more sophisticated US military equipment”. In usual Trumpian fashion no one knows what this really means. Does this include nukes? He has not clarified, but it is consistent with his previous statement regarding his wish to remain unpredictable. These two statements appeal to his constituency who like to see his deal making abilities and bullyish predilections. 

 

On the other side of the “unpredictable” equation is Kim Jong Un. Contrary to popular belief, it seems he is actually an intelligent, deliberate person. Even if he weren’t, even the dimmest bulb in North Korea would know that the entire world has a target on them and if they were to provoke military action they would be vapourized, poste haste. Further, he is following a pattern that has already been followed by both his father, Kim Jong Il and grandfather Kim Il Sung. All three have threatened military action on the United States many times. It is only now that the POTUS, arguably the largest military might on the planet has chosen to engage with this mini dictatorship. This is why the “fake news” people have picked it up. The established pattern is A. threaten the US with military action B. amp up the dialogue so it looks real C. acquiesce on the threat in settlement for more financial aid, which is the ultimate goal.

 

In summary, if Kim Jong Un follows the already established pattern, we don’t really have much to worry about. More importantly, making any investment decisions based on the potential of a war with Korea since the risk in our view is very small.

 

The Canadian Dollar

 

Since April of this year our loonie has had a huge gain on the greenback. It has gone from $0.75 to $0.82 as of time of writing, which is about a 10% difference in value. The key driver for this is not the price of oil or any of the most common factors but instead, and in large part it is the result of a narrowing of spread between the yields on the US and Canadian 2-year bond notes. The logic is simple. As a foreign investor, if you can get at or near the same return on short term money in a stable economy with a rising dollar, why wouldn’t you? Of course, as a foreigner, if you want to buy a 2 year government of Canada Bond, you have to do it in Canadian dollars which pushes up demand. Makes sense doesn’t it?

 

As you can see below, since April, the spread between the yields on the 2 year bonds in both Canada and the US has not only narrowed but as of September 6th, the CAD 2yr yield is actually higher than the US 2 yr. See the chart from Bloomberg below.

 

Source: Bloomberg

 

Sadly, during that same period, any holdings that we had in US dollars have depreciated by a proportionate amount. The puzzle is, even though the US market has gone up substantially in US$ terms, when translated back to CAD$, it doesn’t look nearly as good because of the drop in the US$.

The positive news is that we expect that the CAD$ will move back towards the middle of its trading range of roughly $0.74 to $0.82. If that were the case then a move from $0.82 to say $0.78 it would represent a gain of almost 5% in return due to currency alone.

There are a lot of numbers here we know, but the net is positive.

 

Inflation and Interest Rates

 

This is the most interesting point. The worry for most people in a rising rate environment is that the value of their bond portfolio goes down. This has been the subject of conversation for every fixed income wholesaler and portfolio manager that we have met in the last year. The common fear is that the mean will revert to the rates that were in effect in the past. This, in our view is only partially right, and for the following reasons.

 

 

ONE

 

A reversion to the mean, means a mean within what period? What we have seen for the last two decades is a constant decline in interest rates. As time goes on and we have a longer period of low inflation and low interest rates, the mean, or long term average will go down.

 

TWO

 

There has been a steady decline in the growth rate in populations globally. Fewer families are having more that two kids. Baby boomers here in North America are getting older, or worse. Not as many people are buying strollers and minivans. All of these things lead to a decrease in demand for goods and services. Lower demand means an imbalance of supply and ultimately a stabilization in prices. Lower inflation. There seems to be a direct link between population growth and inflation. Inflation is ultimately what drives interest rates.

 

Take the worst-case example of Japan. There has been a steady decline in the age of the population and their inflation rate. Makes sense. What does that mean for us here in North America?

 

Source: Financial Times

 

The news in our opinion is all good. It seems to point to the notion of interest rates lower for longer.

Recalling the notion of a reversion to the mean of interest rates, means and/or medians are not static. They are moving targets. In this case down. The longer the population growth remains static or negative, the longer inflation and therefore interest rates remain low.

 

As side note. In our collective 30 years on the street, this is the first time we have seen this seemingly obvious correlation between population growth and inflation even mentioned. Interesting, isn’t it? I guess we learn all the time.

 

Low inflation, low interest rates and low unemployment still drive economies. No matter how hard the politicians try to disrupt them. For now, the future is still bright.

 

 

Disclaimer: This material has been prepared to provide information on the products and services offered through your Manulife Securities Incorporated (MSI) Advisor. Manulife Securities is a Trade Name used by the related companies MSI (an Investment dealer) and Manulife Securities Insurance Inc.(an insurance distributor operating as a national account agency). Manulife Securities related companies are 100% owned by The Manufactures Life Insurance Company (MLI) which in turn is 100% owned by the Manulife Financial Corporation a publically traded company. Please confirm with your Advisor which company you are dealing with for each of your products and services. Details regarding all affiliated companies of MLI are provided in the Important Client Information Brochure which can be found on the Manulife Securities website www.manulifesecurities.ca. Stocks, bonds and mutual fund products and services are offered through MSI, Manulife Securities Incorporated is a Member of the Canadian Investor Protection Fund and a Member of the Investment Industry Regulatory Organization of Canada. Banking products and services are offered by referral arrangements through our related company Manulife Bank of Canada, additional disclosure information will be provided by your Advisor upon referral.

 

 

Disclaimer: This material has been prepared to provide information on the products and services offered through your Manulife Securities Incorporated (MSI) Advisor. Manulife Securities is a Trade Name used by the related companies MSI (an Investment dealer) and Manulife Securities Insurance Inc.(an insurance distributor operating as a national account agency). Manulife Securities related companies are 100% owned by The Manufactures Life Insurance Company (MLI) which in turn is 100% owned by the Manulife Financial Corporation a publically traded company. Please confirm with your Advisor which company you are dealing with for each of your products and services. Details regarding all affiliated companies of MLI are provided in the Important Client Information Brochure which can be found on the Manulife Securities website www.manulifesecurities.ca. Stocks, bonds and mutual fund products and services are offered through MSI, Manulife Securities Incorporated is a Member of the Canadian Investor Protection Fund and a Member of the Investment Industry Regulatory Organization of Canada. Banking products and services are offered by referral arrangements through our related company Manulife Bank of Canada, additional disclosure information will be provided by your Advisor upon referral.