Broadly speaking, bonds fell in value across many countries and many term-to-maturities, including everything from low-risk government bonds to the highest risk corporate bonds. The decline was very widespread. What was behind that increase in interest rates and decline in bonds is the rising cost of fuel from the Iran war and the phenomenal level of spending by Artificial Intelligence (AI) companies trying to build enough data centres to serve their needs. Rising gasoline and diesel prices began to weave their way directly into the costs of many businesses such as airlines, trucking, and package delivery companies.<\/p>\n\n\n\n Fig. 1: Bonds-Med. term Cdn Gov\u2019t-purple, Cdn Corp-green, High Yield-red, Long Term US-yellow – 2 years \u2013 TradingView<\/p>\n\n\n\n During the quarter the new chairman of the US Federal Reserve, Kevin Warsh, reported that he does not believe inflation is coming down to 2% fast enough and so the Fed raised short-term interest rates to slow down the economy. Meanwhile, for long term bonds, the market is still very worried that the Federal Reserve is not moving far enough fast enough to cool off inflation so long term bond rates rose too, in anticipation that higher inflation will remain a factor for the long term. Recall that since the interest coupon of a bond is a fixed dollar amount, the way the market increases the overall yield that the bond will return is by dropping the open market purchase price below the eventual $1000 redemption price. Total overall yield of a bond consists of coupons paid plus the price rise from the bond purchase price to the $1000 redemption price paid back at maturity.<\/p>\n\n\n\n In some countries, central bankers are following the Fed\u2019s lead of raising short term rates but not the Bank of Canada (yet). Canada\u2019s top central banker, Tiff Macklem, is concerned that the Canada-US trade war is dampening Canada\u2019s economy and so the BoC has decided to pause on raising short term rates for now. Still, even though overnight rates have not been increased in Canada, long term rates have risen here too.<\/p>\n\n\n\n Broadly speaking, this quarter the rising bond yields have been the strongest headwind our investment portfolios have faced overall. I believe the increased interest rates will do little to tackle war-induced inflation and the AI spending craze. Since boosting rates does not impact the fuel shortage directly or throw much cold water on AI, a rate increase will force other debt-dependent parts of the economy, like car sales and home sales, to endure excruciating pain to bring the overall inflation \u201caverage\u201d down to 2% while inflation in certain sectors stays high. This explains why we have seen the stock prices of home builders and building supply companies sell off dramatically as the higher rates really hurt their sectors of the economy. We do not (yet) own the shares of any companies in this space.<\/p>\n\n\n\n I expect this interest rate trend will turn around, especially with respect to the Iran war. In the US there is a lot of voter disillusionment with the Republican party over the war in Iran. I believe the Trump administration is under extreme and urgent pressure to find some sort of resolution to the war. For that reason, I think some solution will be found that brings inflation back down imminently. When that happens, interest rates should fall and bond returns will rise strongly.<\/p>\n\n\n\n Currencies<\/u><\/strong><\/p>\n\n\n\n Recently, US interest rates have risen faster than the interest rates of many other countries. Often when that happens the US Dollar strengthens against other currencies as investors move their money from other countries to the USA. For Canadians, the strengthening of the USD (and thus weakening of the CAD) had a second driver: the Canada-US trade war has dampened investor enthusiasm in Canada, thus keeping Canadian interest rates lower.<\/p>\n\n\n\n That effect counteracted the usual impact of the high oil prices we recently experienced, which typically drive the CAD higher. Not this time around. Other factors like the trade war had far more dominant impacts on the CAD this time. If those other factors abate, the CAD should restrengthen.<\/p>\n\n\n\n Meanwhile, right now the Canadian government led by Mark Carney is trying to coax foreign investors to channel their capital into Canadian projects. If Team Carney has any meaningful success, that capital inflow could push the CAD higher but the timeline for those capital flows is far down the road. The sorts of projects he is talking about typically take at least a couple years of designing and permitting before there is ever any material capital spending.<\/p>\n\n\n\n Fig. 2: US Dollar Index-green and USD vs CAD-purple \u2013 2 years \u2013 TradingView<\/p>\n\n\n\n During this quarter, the currency effect has been a tailwind to our investments thanks to the USD exposure we get by owning US securities. We must always keep in mind that l our target equity returns are much larger than the currency movements, regardless of whether the stock is in CAD or USD. For that reason, we need to make sure the tail is not wagging the dog. First and foremost, we look for good companies to invest in wherever they may be located. We don\u2019t usually prioritize geographies for the currency effect. Currently we see a number of potential opportunities on both sides of the border and so it is my belief that in the fall quarter our currency exposure will not likely change dramatically.<\/p>\n\n\n\n Stock Markets<\/u><\/strong><\/p>\n\n\n\n Lack of broad-based participation was the highlight of this summer\u2019s equity market. We usually use the TSX index and the S&P500 index as indicators of the overall behaviour of the Canadian and US stock market, respectively. The TSX represents roughly 100 companies and the S&P500 just shy of 500 companies. Although the indexes overall held up somewhat this summer, that masks the true behaviour of what was going on under the covers. This time the difference was extreme. The indexes held up because a handful of big tech companies held them up while many companies floundered. It reached the extreme level where in the month of September over half the companies in the TSX declined and in the S&P500 index 78% of companies declined even though that very small collection of high-flying semiconductor stocks held the overall index average. When only a very few companies are keeping the index up we say that breadth is weak, the economy is definitely not firing on all cylinders and there is a chance the market is facing exhaustion.<\/p>\n\n\n\n What does this mean for our investment strategy on a go-forward basis? One group of stocks that should do well is a group we already own: utilities. The likes of Hydro One have been benefitting from the growing trend towards electrification and off fossil fuels. We already have meaningful exposure to utilities. The trend towards electricity is further accelerated by the high costs of gasoline, steering car-buyers towards hybrid and electric vehicles. For example, recently brands like Hyundai have gained market share in the US versus their American competitors because they offer more hybrid models and focus less on the pickup truck market than the American brands do. Those sorts of trends work to the favour of utilities.<\/p>\n\n\n\n In recent times consumer staples and healthcare have largely been out of favour and housing-related stocks have gotten really clobbered! Those are all areas of emerging investment opportunity that I believe will move out of sync with the AI-driven tech trend.<\/p>\n\n\n\n Fig. 3: Stocks: US-red, Can-purple, Jpn-green, UK-yellow, Germany-green \u2013 2 yrs \u2013 Trading View<\/p>\n\n\n\n With the Iran war continuing, Federal Reserve interest rates rising, and a US election on the horizon there is certainly plenty afoot to buffet the investment markets. These gyrations will likely create opportunity to buy low. We look forward to the opportunities that may show up.<\/p>\n\n\n\n Respectfully submitted,<\/p>\n\n\n\n Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.<\/p>\n","protected":false},"excerpt":{"rendered":" In the third quarter the Iran war still garnered a lot of attention but two other news players joined in as dominant themes: the Canada-US trade war and the return to rising interest rates plaguing the bond market. 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