BY: MARK NOBLE, SENIOR VICE-PRESIDENT, ETF STRATEGY, HORIZONS ETFS
August 4, 2017
Canadian investment advisors seem neither bullish nor bearish on most of the asset classes surveyed in the Q3 2017 Advisor Sentiment Survey that Horizons ETFs conducts each quarter.
The Q3 Survey asked Canadian investment advisors for their expectations of returns – bullish, bearish or neutral – on 15 distinct asset classes for the upcoming quarter (“Q3 2017”).
Sentiment on Canadian equities amongst Canadian investment advisors remains mixed. On the S&P/TSX 60™ Index, only 40% of advisors are bullish on the Canadian blue-chip equity index for Q3 2017, while 33% are neutral and 27% are bearish.
Sentiment on the key Canadian equity subsectors of financial and energy stocks was very different however. Canadian Financial stocks, as represented by the S&P/TSX Capped Financials Index, saw one of the biggest sentiment increases of the quarter, as 54% of advisors offered a bullish outlook on financial stocks versus 37% last quarter. On Energy equities, as represented by the S&P/TSX Capped Energy Index, only 40% of advisors were bullish versus 47% last quarter.
This sentiment doesn’t quite tee-up with what we’ve seen in terms of Canadian equity inflows, which have been extraordinarily strong during the second quarter of 2017. It saw nearly $2 billion going into Canadian equity ETFs1.
Part of this discrepancy may lie in a longer-term investment movement, based on the fact that economic growth in Canada has far exceeded expectations in 2017. In fact, many of the major banks in Canada, and our largest fixed income partner, Fiera Capital, all expect the Canadian equity market to generate positive returns over the next 12 months.
Canada is relatively attractive on a fundamental valuation basis versus the U.S. equity market. The chart below demonstrates traditional price-to-earnings metrics and the more value-biased CAPE/Schiller P/E ratio. Both show Canada being favorable versus U.S. equities.
Source: StarCapital, as at June 30, 2017
The relative valuations of Financials versus Energy stocks also bears this out if we look at the Canadian sectors vis-à-vis other key global equity benchmarks.
Source: Bloomberg, as at June 30, 2017.
Not surprisingly, the relative value of non-North American equities has also drawn higher advisor sentiment and inflows. After Canadian equities, the international equity ETF category was the top asset-gatherer for equity flows in Q2, accounting for about $1.46 billion in inflows1.
The asset class with the most amount of bullish sentiment was Emerging Market equities, as represented by the MSCI Emerging Markets Index. Bullish sentiment on Emerging Markets increased from 53% last quarter to 60%. The MSCI Emerging Markets Index was up 5.74% last quarter.
Concerns about risk in the Emerging Markets have largely been replaced with optimism about the economic growth, particularly in China, which is a key driver of Emerging Market returns. Even emerging market ETFs, a generally quiet asset class in the Canadian marketplace, saw relatively strong inflows of $332 million during the second quarter of 20171.
Sentiment on U.S. equities turned mildly positive this quarter versus last, with 53% of Canadian advisors bullish on the S&P 500 Index and 50% bullish on the NASDAQ-100 Index. The S&P 500 generated positive returns last quarter, delivering a 2.57% return. The NASDAQ-100 was also positive on the quarter delivering a 3.88% return. However, the NASDAQ-100 did see a steep sell-off in the month of June, where it lost more than 2%, but not enough to offset its quarterly gains.
Valuations on U.S. equities, particularly the tech-focused stocks in the NASDAQ-100, are expensive by almost every valuation metric. The swing to bullish sentiment is likely the result of the fact that we saw a dip in June in NASDAQ-100 valuations, so many advisors may be looking to that as an entry point to buy into some of the leading tech stocks that have led market returns over the last year.
Thus far, the flows tell a different story. Flows into U.S. equities were positive, but nowhere near the torrid pace seen in 2016, with only roughly $640 million going into U.S. equities1.
On U.S. bonds, 52% of advisors were bearish on the S&P U.S. Treasury Bond 7-10 Year Index (total return), while only 16% were bullish. Despite fears about rising interest rates, this asset class is up about 1.40% over the last quarter. In Canada, however, the Bank of Canada (“BoC”) did in fact raise rates in mid-July, which should favour the Canadian dollar. However, sentiment remains mixed on the direction of the Canadian dollar for Q3, which rallied strongly during the second quarter in anticipation of rate increases. Only about 37% of advisors were bullish on the loonie; whereas 32% were neutral and 31% were bearish.
Broad Canadian fixed income ETFs continue to be amongst the largest asset-gathering classes in the Canadian Fixed Income environment. In fact, the proportion of fixed income ETF assets in Canada remain amongst the largest in the world. Approximately 30% of the Canadian ETF market is invested in fixed income ETFs. This compares to an average of 17% globally and about 16% in the United States2.
The majority of fixed income ETF flows over the last year have gone into Canadian broad investment-grade bond index ETFs. Approximately $2.2 billion has gone into this category year-to-date according to National Bank. Much of this money is explicitly or implicitly benchmarked to the FTSE TMX Canada Universe Bond Index™, which has a duration of about 7.5 years. As a general rule, bonds decline 1% for every 1% rise in interest rates. This means that for each 0.25% rise in interest rates from the BoC, we can roughly anticipate that this benchmark would lose about 1.9% per interest rate move, all other things being equal.
We’ve witnessed an even steeper sell-off going into this month, after the BoC announced its first interest rate increase in seven years. This would be shaken-off and not a big loss, but consider that these ETFs only yield about 3% – you’re losing more than half the ETF’s yield on each interest rate move. Our fixed income partner, Fiera Capital, believes that there’s likely two more interest rate rises on the way for Canada over the next 12 months. Another interest rate rise could potentially result in a negative total return in a fixed income portfolio for 2017.
The asset class with the biggest upside movement in bullish sentiment in the Q3 Survey was Volatility, as measured by the S&P 500 VIX Short-Term Futures Index. Volatility continues to hit near-generational lows, and lost nearly 19% last quarter. A strong majority, 59%, of Canadian advisors expect volatility to bounce back next quarter.
Historically, Volatility does tend to be higher during the third quarter if you apply a seasonal perspective to investing. This is a key tenant of the investment strategy that underpins the Horizons Seasonal Rotation ETF (HAC). (HAC takes a defensive position during the summer months due to historically higher volatility.) This low Volatility likely has professional investors concerned that the market is not adequately pricing-in risk at the current juncture.
A new asset class was added to the survey, which was the North American Medical Marijuana Index, which is tracked by the Horizons Marijuana Life Sciences Index ETF (HMMJ). On this asset class, sentiment was mixed, with 42% of advisors bearish, 34% bullish and 24% neutral.
It’s probably too early to read sentiment on this sector, which is a highly news-driven space. Many of the large medical marijuana stock producers have had very large returns over the last couple of years, but have seen a significant decline since the announcement in April that the Federal government plans to legalize the recreational use of marijuana in 2018.
1 Source: Investor Economics.
2 Source: ETFGI.com.
The views/opinions expressed herein may not necessarily be the views of AlphaPro Management Inc. and Horizons ETFs Management (Canada) Inc. All comments, opinions and views expressed are of a general nature and should not be considered as advice to purchase or to sell mentioned securities. Before making any investment decision, please consult your investment advisor or advisors.