Market Surprises of 2017Jan 5, 2018

Looking back at 2017, we saw a strong year for global equities, with the MSCI All Country World Index up 18% in Canadian-dollar terms. Equity gains were supported by synchronised economic growth, firmer corporate profits as well as low volatility which kept valuations high. This was broadly expected and a good back-drop for risky assets, but there were also a number of market surprises in 2017 that most investors didn’t anticipate.

Canada’s stock market underperformance

When the global economy improves, commodity prices rise, and US interest rates are moving up, Canada’s equity market tends to outperform given its relatively high exposure to the commodity-related and financials sectors. While the Canadian dollar performed well, Canada’s stock market was a global laggard. This was perhaps surprising in a year when the price of oil (West Texas Intermediate) closed near $60, 15% higher. What surprised most investors was the poor performance of Western Canada Select crude oil which significantly underperformed the WTI crude benchmark. WCS now stands at a $27 discount to WTI, reflecting a negative perception of heavy, dirty Canadian oil and increasing light US shale supply production. 

Canadian interest rates

As oil prices collapsed in 2015, the Bank of Canada (BOC) was forced to cut rates to address the strained Canadian economy. By 2017, GDP growth was accelerating and unemployment was falling, making the BOC more comfortable with removing the 2015 emergency level rate cuts, resulting in 25 basis-point (bp) hikes in both July and September. The timing took markets by surprise and the Canadian dollar rallied almost 14%, while yields on Canadian government bonds rose by 60 bps.

Flattening yield curves in the US

South of the border, one of the bigger surprises was the incessant flattening of the 2-year and 10-year yield curves on US Treasuries. As the US Federal Reserve (Fed) raised rates and reconfirmed their forward guidance for additional hikes, the 2-year US Treasury yield rose from 1.21% to 1.89%. What was surprising was that the 10-year US Treasury yield fell from 2.45% to 2.41%, resulting in a flattening of the curve by just over 70 bps. Underwhelming inflation data, the continued easy monetary policy by various central banks and the general reach for yield all supported the long end of the curve, much to the markets surprise.

China’s economy/market resiliency

Coming into to 2017 many investors felt like China would experience a hard landing as its economy attempted economic reform in an attempt to wean itself off addiction to debt and fixed asset investments. China’s economy grew 6.8% in 2017, similar to 2016’s performance. The country also took steps towards economic reform with crackdowns on shadow lending, improving asset quality at the banks. China also attempted genuine supply-side reform in heavy industry sectors. Consumption of goods and services led tech companies like Alibaba and Tencent to benefit tremendously, leading China to one of the best equity market performances of the year.

What’s in store for 2018?

Watch for our 2018 outlook piece in the upcoming weeks where we will look ahead at some of our key themes and risks for the year ahead.

Stephen Lingard’s comments, opinions and analyses are for informational purposes only and should not be considered individual investment advice or recommendations to invest in any security or to adopt any investment strategy. Because market and economic conditions are subject to rapid change, comments, opinions and analyses are rendered as of the date of the posting and may change without notice. The material is not intended as a complete analysis of every material fact regarding any country, region, market, industry, investment or strategy.