As in 2Q15, global economic developments were mixed but, once again, generally disappointing:
- The forecast for global real GDP growth in 2015 fell further in 3Q. Eight of the twelve large economies that I track saw downward revisions in their 2015 growth forecast. The US growth forecast edged up in 3Q after upward revisions to 2Q growth. However, real GDP growth forecasts for 2015 were revised down for the Eurozone, Japan, Canada, Australia, China, Korea, Brazil and Russia in 3Q15.
- Signs of weaker global growth, and particularly weaker Chinese growth, contributed to a fall back in crude oil prices following a modest recovery in 2Q15.
- Forecasts of 2015 inflation fell in nine out of the twelve countries in 3Q15 as oil prices fell back and deflation worries increased.
- China, Canada and Russia cut their policy rates in 3Q15, while Brazil was again forced to hike its policy rate in response to rising inflation and a weakening currency.
- Bond yields fell virtually everywhere in 3Q15, after rising virtually everywhere in 2Q15.
- China's equity market continued its' sharp correction that began in the final weeks of 2Q, falling by over xx% from its highs. The PBoC devalued the CNY sending shock waves through global markets.
- Emerging market turbulence, especially in China, combined with confusion over Fed policy added to worries about corporate earnings and triggered corrections in major global equity markets.
Despite below target inflation, the Fed continued to stress the need for "policy normalization". The window appeared to be open for a rate hike in September after growth rebounded in 2Q and employment gains remained strong through August. However, the Fed passed on the opportunity, apparently concerned that in light of China's growth slowdown and emerging market financial outflows, a Fed rate hike might further destabilize global financial markets. In the event, the non-action by the Fed appeared to exacerbate concerns of global growth slowdown, and sent equity markets into a further tailspin.
The Bank of Canada followed up on a January rate cut with a second 25 basis point easing in July, as it became increasingly apparent that the economy had suffered a second consecutive modest contraction in 2Q. The Canadian dollar, which had firmed versus the USD in 2Q on moderately higher crude oil prices, came under renewed downward pressure in 3Q as China's growth slowed and oil prices fell back.
Global Market ETFs: Performance for 3Q15In 3Q15, with global growth and inflation expectations weakening, crude oil prices falling, and the USD appreciating by 6.6% against the CAD, the best global ETF returns for Canadian investors were in US government and investment grade corporate bonds. The worst returns were in commodities and Emerging Market equities. The chart below shows 3Q15 and year-to-date returns in CAD terms, including reinvested dividends, for the ETFs tracked in this blog.
In CAD terms, 11 of 19 ETFs posted losses, while 8 posted gains. In local currency terms, only 3 of the 19 RTFs posted gains.
The best returns, in CAD terms, were in US Long Teasury Bonds (TLH) +10.6%; US Investment Grade bonds (LQD) +7.8%; non-US Developed Market bonds (BWX) +6.7%; and US Inflation-linked bonds (TIP) +5.6%.
The worst losses were in the commodity ETF (GSG), which returned -13.8% in CAD, and the Emerging Market equity ETF (EEM), which returned -11.8%.
All of the Canadian ETFs that we track posted losses in 3Q15, but Canadian bond ETFs outperformed Canadian equity ETFs. The Long Bond ETF (XLB) returned -0.3%; the Real Return bond (XRB) -0.6%; the Corporate bond (XCB) -0.8%; while Canadian equities (XIU) returned -6.8%.
Global ETF Portfolio PerformanceIn 3Q15, the global ETF portfolios tracked in this blog posted mixed returns in CAD terms, when USD currency exposure was left unhedged.
The traditional Canadian 60% Equity/40% Bond ETF Portfolio lost 2.3% in CAD when USD exposure was left unhedged, but lost 5.2% if the USD exposure was hedged. A less volatile portfolio for cautious investors, the 45/25/30, comprised of 45% global equities, 25% government and corporate bonds and 30% cash, lost 1.1% if unhedged, but lost 4.1% if USD hedged.
Risk balanced portfolios outperformed in 3Q15 if USD exposure was left unhedged. A Levered Global Risk Balanced (RB) Portfolio, which uses leverage to balance the expected risk contribution from the Global Market ETFs, gained 1.6% in CAD terms if USD-unhedged, but lost 5.0% if USD-hedged. An Unlevered Global Risk Balanced (RB) Portfolio, which has less exposure to government bonds, ILBs and commodities but more exposure to corporate credit, gained 0.1% if USD-unhedged, but lost 4.6% if USD-hedged.
Despite their 3Q15 losses, all of the global ETF portfolios retained gains for the year-to-date in CAD terms if USD exposure was left unhedged. Year-to-date returns ranged from a high of 9.3% for the Levered Risk Balanced Portfolio to a low of 3.5% for the conservative 45/25/30 portfolio. If the portfolios were USD hedged, they all posted year-to-date losses, ranging from -3.0% for the 60/40 portfolio to -4.9% for the Levered Global Risk Balanced Portfolio. Interestingly, the Levered Global Risk Balanced Portfolio is the best year-to-date performer if USD unhedged, but the worst performer if USD hedged.
Recent Performance in PerspectiveThe mixed 3Q15 performance of the USD unhedged global ETF portfolios was driven by two factors: the fall in bond yields as global, and particularly Chinese growth, continued to slow; and the sharp weakening of the CAD versus USD as the Canadian economy contracted for two consecutive quarters, the Bank of Canada delivered another rate cut, and price of crude oil and other commodities fell.
Fed and BoC policy continue to tilt in opposite directions. US real GDP growth, while disappointing, is still expected to reach 2.5% in 2015, double that expected in Canada. However, weak September readings for the ISM manufacturing PMI and US nonfarm payrolls, suggest that the US economy is losing momentum again. While Canada's economic data has firmed so far in 3Q, the RBC manufacturing PMI showed a sharp contraction in September as the negative effects of lower crude oil prices continued to weigh on economic activity. While some Fed officials have resumed signalling a rate hike before year end, a US tightening this year is clearly in doubt. The BoC seems much more likely to cut rates again than to raise them over the next six months.
Three months ago, I said "As we enter 3Q15 in a continuing uncertain environment, characterized by sluggish global growth and divergent central bank policies, and with rich valuations for US equities, remaining well diversified with an ample cash position continues to be a prudent strategy." As 4Q15 begins, that still seems to be the scenario that is playing out.
The more conservative 45/25/30 portfolio (which I have favoured) was less volatile and incurred smaller losses in 3Q15 than the more aggressive 60/40 portfolio. The Risk Balanced portfolios outperformed because of their larger positions in government, corporate bonds and inflation-linked bonds. As we enter 4Q15, the environment remains uncertain, characterized by weak and divergent global growth and central bank policies. US equity valuations have become less stretched but are still expensive. Global recession risks are rising, not falling as expected by the consensus. Remaining well diversified with substantial US dollar exposure and an ample cash position continues to be a prudent strategy.