It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

A SHINDER-TREMBLAY NEWSLETTERA Wealthy Insight

Volume 3

April 2019

Hello esteemed clients and prospective clients. “A Wealthy Insight” is a newsletter produced quarterly by the Shinder-Tremblay team to help our clients better understand investment theory and strategies, market movements, leading economic indicators and even world and local macroeconomic topics that can affect your investments. We also produce a weekly blog, bi-annual case studies, bi-annual white papers and videos to help enrich your investment experience with us.

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

CONTENTS:The Markets TodayHas the FED sided with the markets, or did the economy decelerate faster than anticipated?

Canada’s Federal Budget

Padis Portfolios

Small Business StrategyThe Shareholder Agreement

Product SpotlightThe Quebec Immigrant Investor Program

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inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

The Markets Today

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

ShinderTremblay.caVolume 3 | April, 2019

HAS THE FED SIDED WITH THE MARKETS, OR DID THE ECONOMY DECELERATE FASTER THAN ANTICIPATED?

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

Source: Bloomberg

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Market expectation of what the Fed is likely to do vis-à-vis rate hikes?

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

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inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

Source: Bloomberg

Source: Bloomberg, NFIB

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

Cost of Labour Issues

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

Source: Bloomberg

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

Source: Factset

Source: Bloomberg

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Source: Bloomberg

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Source: Bloomberg

Source: The International Monetary Fund

Consumer Current Situation Minus Expectations Index

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-riskbusiness environment, equity markets wouldbe up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because thisprice-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in ouropinion it will continue drifting lower until at least some of the closely followed leadingeconomic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst thecrowd is policy uncertainty. On the monetarypolicy front, for example, the US has turnedwhat those in geopolitics would call “dovish”,striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if youlook at the below table with data about the current expectations of what the Fed will do,you can take notice of the “cut prob” (cut probability) column. It seems that the marketbelieves that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believesit can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a differentmeasure than the one you are probably familiar with—the Consumer Price Index(CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talkinghere about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it alsotends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition,the most recent small business surveyfrom the National Federation of IndependentBusiness (NFIB) shows that the two most important problems affecting small businessesare labor quality and labor cost, with the latter being at the highest level it has been inthe past 20 years. And this will only get worsewith Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed thinktwice about their proposed rate hikes, but it also decided to forestall them. Fastforward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the paceof their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and thesecond objective is to help the US reach full employment. The latter seems to have takena step back over the past few decades whilethe Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much,but this complete shift in policy suggests that it is indeed the case. The Fed has varioustools with which it can pursue its “three” objectives, which include raising or loweringrates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currentlypicking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basicallystated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated thatit will not raise rates at all this year. Germany,which has been the Eurozone’s (EZ) economicengine over the past decade, has dramaticallyslowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks,the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offeringfunding to commercial banks under attractiveconditions in order, among other things, to spur private sector borrowing and investing.The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasingthat the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps beforeultimately crashing and burning?

We are a bit perplexed, to say the least, as towhy investors seem to be so complacentwhile the economy is still slowing down. Thiscomplacency is reflected, for example, in thewidely published CBOE (Chicago Board of Exchange) volatility index, the VIX. FromOctober to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter,it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development,depending upon how big the increase isof course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings,another uncertainty facing investors pertainsto economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high.But over the past year or so, the two indicatorshave been moving in opposite directions. Whatwill give? Will the PMI catch up to stocks andmove up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It isan indicator that we regularly pay attention to. The inverted yield curve on three-monthto ten-year treasuries in the US is also invertedin Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, forexample the relationship between two-year and ten-year t-bonds, the business yield curvelooks at the yield spread between the FederalReserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can seefrom the graph below, this curve is accurateand it leads the famous treasury yield curveby about six months. According to the latter,we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, whichnow happen to be positive, less theirperceptions of the future, which happento be negative. Notice, from this chartbelow, that when future expectations are so bleak, they tend to change the perceptionof the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be servicedon an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall outof our chairs. He mentioned a few different interesting facts. One fact that stood out to usis that the BBB-rated bond market was 2.5 times larger than the high-yield market. In andof itself, this is not a huge deal, but if you looka little closer to see that 45% of those BBB-rated securities would immediately be ratedas junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rateddownwards, their value drops, and their yields goes up, which is not a good thingwhen their issuers need to refinance. The silverlining here is that the number of companiesreducing their debt is rising, so maybe this can explain why rating agencies are keepingtheir ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that therewill be no further indictments and that therewas no collusion with Russia from the Trumpadministration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how longand how deep the Mueller investigation was.The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount ofstock they buy back if certain criteria are not met. From the Democratic camp,Senators Schumer and Sanders’s proposalwould prevent companies from repurchasingshares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments madeby corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individualsthan on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of theseparation of a married or common-law couple, it will still be possible to participatein the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferredlife annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock optionsfor employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Laudercontributed to 1.08% of the first quarter return, while the human resources companyPaychex and the electrical and HVACproduct company Johnson Controlscontributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively.

Canada

From a sector contribution perspective, industrials, technology, and financial serviceswere the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy,healthcare, and cash (large overweight) witha combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connectionscontributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary.We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramaticbursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chasethis rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

Source: United States Census Bureau

Source: St-Louis FRED, Congressional Budget Office (CBO)

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

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inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

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inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

Source: Morningstar Direct, as of April 3rd, 2019

Source: Bloomberg

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

ShinderTremblay.ca

“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

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inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

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Volume 3 | April, 2019

It’s definitely been a wild ride. Who would have thought that, in such a high-risk business environment, equity markets would be up double digits just three months after experiencing the worst December since the 1930s? And who could have predicted that this would occur with standard economic indicators hardly budging?

This sharp rise of the S&P 500, from trough to peak of more than 21% (dip on December 24 to peak on March 29)—though quite surprising—was pleasantly welcomed by investors. We owe a big thank you to the Federal Reserve (Fed) for this renewed interest in risky assets, because this price-to-earnings (PE) ratio expansion was driven not by better economic figures but by lower perceived risk.

However, the global slowdown that started in 2018 and accelerated towards the end of 2018 is still in a downward trend, and in our opinion it will continue drifting lower until at least some of the closely followed leading economic indicators start turning around. Investors today are faced with plenty of uncertainties, and standing out amongst the crowd is policy uncertainty. On the monetary policy front, for example, the US has turned what those in geopolitics would call “dovish”, striking a rather accommodative tone. It feels like it’s been forever, but it was only last December that the Fed was still

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“wealth effect.” If financial asset values rise or at least stop decreasing, investors feel better about the future and are more inclined to put money into the markets and into the economy.

Getting back to the Fed’s first objective, if you look at the below table with data about the current expectations of what the Fed will do, you can take notice of the “cut prob” (cut probability) column. It seems that the market believes that the Fed is actually going to cut rates in the near future, a move above and beyond slowing rate increases down or keeping rates where they are.

The Fed said that it will tolerate higher short-term inflation and focus instead on longer-term inflation level because it believes it can get the latter under control, one indicator is showing that inflation is starting to gain some momentum. It is important to understand here that the Fed uses a different measure than the one you are probably familiar with—the Consumer Price Index (CPI). Its preferred measure is known as the Personal Consumption Expenditures (PCE) metric, which does what its name implies, but which excludes food and energy. The latest PCE reading suggests that at 1.8%

inflation has slipped. But lately, a newer measure has been used to gauge inflation, which should be closely watched. I’m talking here about the New York Fed Underlying Inflation Gauge (UIG). As you can see from the graph below, not only does it correlate well with other inflation measures, but it also tends to lead by approximately 16 months.

With oil prices having rebounded by more than 50% in the last quarter, we should expect higher inflation pressure. In addition, the most recent small business survey from the National Federation of Independent Business (NFIB) shows that the two most important problems affecting small businesses are labor quality and labor cost, with the latter being at the highest level it has been in the past 20 years. And this will only get worse with Congress looking to pass a new bill raising the minimum wage. While this last point was not discussed much either in the media or among investors, we think that it is important and that is being overlooked.

On the flip side, we are also seeing some numbers that indicate that inflation is not likely to flare up. Take, for example, those having to do with productivity. Productivity can be defined as the rate of output per

comfortable with its “hawkish” tone and its decision to raise interest rates. But then the market collapsed, and it seems like Fed officials panicked. Not only did the Fed think twice about their proposed rate hikes, but it also decided to forestall them. Fast forward to March 20, and the Federal Open Market Committee voted to refrain from raising rates in 2019 and to reduce the pace of their balance sheet reduction measures.

For some, this about-face made it look as if the Fed just added a third objective to their agenda. As economists and historians well know, the first objective of the institution is achieve price stability (inflation) and the second objective is to help the US reach full employment. The latter seems to have taken a step back over the past few decades while the Fed was busy fighting inflation. Now, it seems that the Fed is in the business, as it were, of achieving equity market stability. Of course, it has never officially said as much, but this complete shift in policy suggests that it is indeed the case. The Fed has various tools with which it can pursue its “three” objectives, which include raising or lowering rates, adjusting reserve requirements, and using its balance sheet to buy and sell securities in the open market.

When it comes to the third objective, we agree that financial stability is important because it creates what we like to call the

unit of input. Productivity in the US is currently picking up and is almost at its cyclical high. This recent increase is helping to keep unit labor costs down, even if wage growth is currently somewhere north of 3%.

THE EU IS DOVISHThe European Central Bank (ECB) has basically stated that the growth outlook has slowed. Their projections for 2019 and 2020 are down

to a mere 1.1% and 1.6%, respectively. Due to these lower projections, it has stated that it will not raise rates at all this year. Germany, which has been the Eurozone’s (EZ) economic engine over the past decade, has dramatically slowed. The latest GDP growth rate was down to 0.6% on annual basis from a 2.8% growth in 2018. Additionally, in order to create more lending from commercial banks, the ECB has reinstated a new round of TLTROs (targeted long-term refinancing

operations). While quite a mouthful, the TLTRO is all about the central bank offering funding to commercial banks under attractive conditions in order, among other things, to spur private sector borrowing and investing. The more these financial institutions lend out with these funds, the better —the lower —the interest rates under the TLTRO loans to those institutions will be.

CHINAStimulus is working its way through the system. After having made cuts to interest rates and taxes, the government is now increasing infrastructure spending and lowering its banks’ reserve requirements.The recent steps taken by the Chinese government are essential for global growth and especially for the growth of the surrounding countries. It will be hard for the Asia-Pacific region to do well if China can’t reverse its slowdown. Although Europe is far from China geographically speaking, its exports to China have slowed as per the latest Purchasing Managers Index (PMI) reading. All these measures are slowly being felt through the outperfor-mance of the Shanghai Equity Index year-to-date (YTD) returns, but they have yet to be seen in another leading economic indicator, the PMI Survey. We continue to

monitor these indicators to see how the China and the Asia-Pacific region will be affected by the stimulus and whether the slowdown will in fact slow down.

CANADA: NEUTRALThe Bank of Canada (BoC) decided to leave the key interest rate at 1.75%. The decision was mainly due to a softer economic figure, slower growth from the oil patch, and less consumer spending. The odds are increasing that the BoC’s next interest decision will probably be a rate cut.

COMPLACENCY?Are we headed for a soft landing, or are we driving over a series of speed bumps before ultimately crashing and burning?

We are a bit perplexed, to say the least, as to why investors seem to be so complacent while the economy is still slowing down. This complacency is reflected, for example, in the widely published CBOE (Chicago Board of Exchange) volatility index, the VIX. From October to the early days of January, the VIX went from 11.61 to 36.07 and back down to below 20. As of the writing of this newsletter, it is at 13.44.

LOWER EARNINGSA second uncertainty facing investors has to do with corporate earnings, which are currently projecting a slowdown in the economy. Due to last year’s tax cuts in the US, corporations have seen their earnings grow; profit margins are at their highest

level in 20 years. But this growth will fade. Expectations have been lowered every week since the beginning of the year to maybe a point where they are too low. The consensus, as per FactSet, is currently looking at a paltry 2.8% growth in earnings. If, in fact, real earnings per share (EPS) growth winds up being stronger than the lowered expectations have made us

anticipate, then investors will undoubtedly welcome this result as a positive development, depending upon how big the increase is of course.

LEADING ECONOMIC INDICATORSIn addition to policy and corporate earnings, another uncertainty facing investors pertains to economic indicators, which now appear to be softening. There is no shortage of indicators, so we’ve decided for clarity’s sake to go over just a select few. That’s all we will need to paint our picture, which will explain why in the last quarter, a lower-risk environment has actually pushed the market higher.

Purchasing Managers Index (PMI)

On the global PMI front, the reading has decreased ten times since the last uptick. Some countries/regions, notable among them are Japan and the Eurozone, are even in a sub-50 zone, which is considered to be contraction territory. The US is not there yet,

but if the trend continues it sure is going to get there. Over the years, the correlation between the PMI and earnings is fairly high. But over the past year or so, the two indicators have been moving in opposite directions. What will give? Will the PMI catch up to stocks and move up, or will the market retest its lows?

Yield curve

A lot has been written on the yield curve. It is an indicator that we regularly pay attention to. The inverted yield curve on three-month to ten-year treasuries in the US is also inverted in Canada and South Korea, and countries that are relying more on global growth are also headed in the same direction, reflecting a higher likelihood of a global slowdown. But recently, a new type of yield curve has caught our eye. This new yield curve is called the “business yield curve.” Instead of looking at the differential in rates between both short- and long-term US treasuries, for example the relationship between two-year and ten-year t-bonds, the business yield curve looks at the yield spread between the Federal Reserve’s prime rate and Moody’s ten year

Investment Grade Bond Index. As you can see from the graph below, this curve is accurate and it leads the famous treasury yield curve by about six months. According to the latter, we are slowly heading into a recession.

US Conference Board Consumer Expectations Less the Current Situation

An unofficial but noteworthy indicator is the US Conference Board Consumer

Expectations Less the Current Situation (graph above). This instrument measures current consumer expectations, which now happen to be positive, less their perceptions of the future, which happen to be negative. Notice, from this chart below, that when future expectations are so bleak, they tend to change the perception of the current situation, which can in turn lead to a recession. We are not there yet, but it’s worth paying attention to the

chart because consumer spending represents just over two-thirds of all US economic activity.

Furthermore, the International Monetary Fund (IMF) and most investment banks have been lowering their projections for GDP growth. The IMF and most investment banks have been lowering their projections for GDP growth (graph on page 8).

TRADE

US–China trade war

In addition to policy, earnings, and indicators as markers of uncertainty we have trade. In particular, we have the so-called “trade war” that President Trump began with China by increasing tariffs on a whole swathe of US products. China has retaliated measure for measure. The fact is, however, that both leaders, Donald Trump and Xi Jinping cannot afford a long, drawn out series of negotiations, and for different reasons.

Trump needs a strong stock market because it is his yardstick. It is how he measures how great a job he is doing as the president. At the moment, we think that the present rally in the market fully reflects the two parties soon coming to an agreement, and that if there is no deal or a bad deal (especially for the US) investors may get spooked. The Chinese, on the other hand, are more patient and have a longer-term view, but officials are well aware that their economy is slowing and are putting in place numerous measures (lowering rates, cutting taxes, lowering capital ratios, etc.) in order to restart economic growth. A trade war will likely eat into any progress made by these growth initiatives. Also, by setting growth targets China is forcing itself to deliver on these targets.

US trade officials are looking for the following issues to be dealt with: (a) structural reforms on intellectual property (they don’t want US firms to be forced to transfer their patented

technologies); (b) currency manipulations (restrictions on adjusting the Yuan to compete with the dollar); (c) lowering the trade gap (China needs to buy more US goods); and (d) opening the Chinese market to US firms.

China has conceded on a few things so far. It has agreed to buy more soybeans, to suspend additional tariffs on US vehicles, and to open their financial markets to US firms. If this is a sign of things to come, there is a reason to be hopeful.

United States-Mexico-Canada Agreement (USMCA)

While it was signed by the three countries last year, the proposed free trade deal and successor to NAFTA will have to be ratified by Congress before it can be considered official. President Trump might run into opposition now that the House of Representatives has flipped to a Democratic majority. The two main reasons why Democrats might push back on the deal are (a) that they see this deal as being no different than NAFTA; and (b) that they are not interested in giving Trump a political win.

THE DEBT PROBLEMWhen President Trump was running for the top office, one of his campaign promises was to eliminate the national debt and the trade deficit in eight years. Well, after two years it certainly looks like he will miss the mark on both. In 2018 alone, the trade gap has widened by over $87.8 billion (graph below), bringing the deficit to a whopping 4.4% of GDP. Total US federal debt has gone from 55% of GDP in the mid-2000s to around 105% of GDP. And what’s incredible about this statistic is that the US economy has being growing at a decent clip.

The Fed was instrumental in kick-starting the economy and maintaining its growth over the last decade, but its success in this regard has come at a cost: an ever-increasing

mountain of debt. This debt must be serviced on an ongoing basis. The Congressional Budget Office (CBO) is projecting, on the graph below, that as a percentage of GDP the interest cost alone will rise from approximately 1.25% of GDP at present, to close to 3% in the next five years. To put things in context, last year’s GDP growth was 2.9% and if one were to take interest

payment into consideration, you would be looking at only 1.65%. With a shifting demographic landscape, where older people are spending less and where a younger generation is finding itself with less buying power, the likelihood that the economy will grow at the same pace as it did over the last twenty years seems low. In a low-growth environment with rising

debt levels and higher debt-servicing costs, the government will feel a great deal of pressure: will we see 0% growth, or, worse still, negative growth?

INVESTMENT GRADE. REALLY?A fifth area of concern is the large pool of corporate bonds that have been rated investment grade. While watching Jeffrey Gundlach of Double Line being interviewed recently, something made us almost fall out of our chairs. He mentioned a few different interesting facts. One fact that stood out to us is that the BBB-rated bond market was 2.5 times larger than the high-yield market. In and of itself, this is not a huge deal, but if you look a little closer to see that 45% of those BBB-rated securities would immediately be rated as junk (non-investment grade) based on their current leverage ratio, you have reason for concern. When bonds get re-rated downwards, their value drops, and their yields goes up, which is not a good thing when their issuers need to refinance. The silver lining here is that the number of companies reducing their debt is rising, so maybe this can explain why rating agencies are keeping their ratings as is for the time being.

MUELLER REPORTThe report, in a nutshell, concluded that there will be no further indictments and that there was no collusion with Russia from the Trump administration during the 2016 election campaign. This report does not reverse any other criminal investigations. But we doubt much evidence will be found, given how long and how deep the Mueller investigation was. The report has reduced the chances that Trump will be impeached and has raised the likelihood of his getting re-elected.

SHARE BUYBACK IN THE SPOTLIGHTDuring the first quarter, representatives from both sides of the aisle have proposed

that corporations limit the amount of stock they buy back if certain criteria are not met. From the Democratic camp, Senators Schumer and Sanders’s proposal would prevent companies from repurchasing shares unless certain criteria such as a minimum wage of $15/hour and providing better health and pension plans are met. Marco Rubio was the sole Republican that was vocal about this issue, offering up his own proposal that would change the current tax advantage of stock repurchase and at the same time give a better tax treatment on capital investments made by corporations. As you can see, the two camps are targeting buybacks, but one is doing so to the benefit of employees and the other is doing so to promote growth.

CANADA’S FEDERAL BUDGETOn March 19, federal finance minister Bill Morneau unveiled the 2019 budget. The liberals decided to focus more on individuals than on corporations, and there were no hikes or cuts in tax rates. In a nutshell, here’s what you need to know:

• Home Buyers’ PlanThe maximum RRSP withdrawal amount for the purchase of a first home has been increased from $25,000 to $35,000, which means $70,000 per couple. Important fact: In the event of the separation of a married or common-law couple, it will still be possible to participate in the home buyers’ plan.

• Deferred life annuities at an advanced ageRetirees will be able to purchase a deferred life annuity and defer pension payments until age 85, subject to certain conditions.

• Variable payment life annuityVariable payments on life annuities will be available based on the member’s age and the performance of their investments.

• Employee stock optionsAnnual limit of $200,000 for stock options for employees of large, established, and mature companies.

• Donation of cultural propertyGifts of cultural property may now be foreign property. They must no longer be of national importance alone.

• Zero-emissions vehicles (ZEVs)Possibility of a tax deduction up to a value of $55,000 plus sales taxes in the year the vehicle is put into service.

PADIS PORTFOLIOS

US

One of our top allocations, technology, contributed to 3.71% of the return followed by industrials at 2.91% and consumer defensives at 2.79%. The bottom three sectors were healthcare, cash (overweight) and consumer cyclical, which together lowered returns by 0.39%.

The beauty company Estee Lauder contributed to 1.08% of the first quarter return, while the human resources company Paychex and the electrical and HVAC product company Johnson Controls contributed positively by delivering 0.92% and 0.85% of the total return, respectively. The negative performers were the neuroscience firm Biogen, which saw negative results from their Alzheimer’s drug, the pharma giants Bristol-Myers and Walgreens-Boots, which hurt results by 0.98%, 0.248%, and 0.23%, respectively. Canada

From a sector contribution perspective, industrials, technology, and financial services were the top three positive contributors to the first quarter numbers, with a combined return of 6.77%. The detractors were energy, healthcare, and cash (large overweight) with a combined contribution of a mere 0.05% return. Now from a stock selection point of view, Shopify, Domtar, and Waste Connections contributed to 2.9% of the first quarter return, while Jamieson, Transcontinental, and Franco-Nevada reduced the return by 0.53%.

Closing arguments

We do not think that the US and Canadian economies will fall into a recession this year. The yield curve did invert and other leading economic indicators are slowing but still positive, productivity is rising, wages are rising, central banks have taken an accommodative (“dovish”) posture, credit spreads are not flashing warning signals yet, the trade war with China seems to be coming to an end, the stock market has rebounded, and, for now, consumers are feeling more positive about the current economic environment. This situation, ultimately like all situations, will be temporary. We might retest last December lows sooner than later. The lagging effect of higher rates will still be felt in the economy for the next few months, profitability margin is decreasing, corporate profits are slowing, employment seems to have peaked, over $700 billion in corporate debt is coming due and will most likely be refinanced at higher rates, and the US federal deficit and the national debt are both rising quickly: the former is already up over to 6% of GDP if you include entitlements. Investors are not pricing in the likely negative effects of tariffs or any form of restrictions on the European car industry. This is much bigger than China in terms of potential impact. Are we already in a bear market? Time will tell. But it is important to realize that even during bear markets we could experience dramatic bursts of positive news even more so when we are adding the FOMO effect (fear of missing out) and investors deciding to chase this rally, hence pushing equity markets even higher.

The shareholder agreement is therefore the contract that future partners should always conclude. It is not mandatory but is strongly recommended and will generally be adopted when each shareholder plays an important role in the company.

The "rules of the game" described therein will be known and accepted in advance by all shareholders. This predictability provided by the shareholder agreement eliminates a large number of misunderstandings that lead to financial losses, performance losses and, unfortunately, friendships. Indeed, it is when harmony prevails that it is important to base shareholder understanding on specific and solid documents.

We recommend planning for 5 important situations:

1) Voluntary withdrawal

2) Forced withdrawal

THE SHAREHOLDER AGREEMENTSmall Business Strategy

3) Disagreement

4) Death

5) Acquisition by a third party

Whether you have a shareholder agreement in hand that you wish to review, or you need information about its implementation, contact our team who will be pleased to help you.

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QUEBEC IMMIGRANT INVESTOR PROGRAMYou’re not an immigrant? It doesn’t matter. You can still benefit if you are an entrepreneur!

Through Echelon Wealth Partners, and because of its accredited status from Investissement Québec, business owners can benefit from this program if their business operates in certain sectors such as manufacturing, tourism, and aerospace. Eligible funding in the form of a non-refundable financial contribution to businesses operating under this program ranges from $40,000 to $250,000, covering up to 10% of the project’s costs. Please reach out to us if you are planning to expand your business.

QUEBEC IMMIGRANT INVESTOR PROGRAMProduct Spotlight

CASH MANAGEMENTDue to our team’s deep knowledge of financial engineering, we are able to boost the overall yield on a traditional GIC. If you want to know more, please reach out to us.

“We have to remember that while money is important, it is ultimately a tool. We should all strive to use that tool to achieve happi-ness in our lives. And while we may all have our own definition of happiness, we like to think of it as being in good health and having healthy relationships.”

— Nick Shinder

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Echelon Wealth Partners Inc. is a member of the Investment Industry Regulatory Organization of Canada and the Canadian Investor Protection Fund.This newsletter is solely the work of Nick Shinder and Thierry Tremblay for the private information of their clients. Although the author is a registered Investment Advisor with Echelon Wealth Partners Inc. (“Echelon”) this is not an o�icial publication of Echelon, and the author is not an Echelon research analyst. The views (including any recommendations) expressed in this newsletter are those of the author alone and are not necessarily those of, Echelon. Every e�ort has been made to ensure that the contents have been compiled or derived from sources believed to be reliable and contain information and opinions that are accurate and complete.Forward-looking statements are based on current expectations, estimates, forecasts and projections based on beliefs and assumptions made by author. These statements involve risks and uncertainties and are not guarantees of future performance or results and no assurance can be given that these estimates and expectations will prove to have been correct, and actual outcomes and results may di�er materially from what is expressed, implied or projected in such forward-looking statements.The opinions expressed in this report are the opinions of the authors and readers should not assume they reflect the opinions or recommendations of Echelon Wealth Partners Inc. or its a�iliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results.These estimates and expectations will prove to have been correct, and actual outcomes and results may di�er materially from what is expressed, implied or projected in such forward-looking statements.

Volume 3 | April, 2019

Nick ShinderVice President,

Portfolio Manager(514) 905 3619

nshinder@echelonpartners.com

Thierry TremblayVice President,

Portfolio Manager(514) 905 3620

ttremblay@echelonpartners.com

Caroline PaquierAdministrative Assistant

(514) 905 3617cpaquier@echelonpartners.com

Louis GazailleJunior Data Analyst

(514) 395 0290lgazaille@echelonpartners.com

Julie QuennevilleFinancial Planner

(514) 905 3619jquenneville@echelonpartners.com