Daniel Straus, Head of ETF Research & Strategy, National Bank Financial
FOCUS: Exchange-traded funds
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MARKET OUTLOOK

2017 has been an exciting year for ETFs. On the macro side, we’ve had record low volatility and positive sentiment for virtually all asset classes and regions under the sun. When investors move en masse into a theme, region, asset class, or strategy, ETFs become the vehicle of choice.

Global equity: Our economists and strategists have commented that earnings growth, rather than P/E expansion, is what’s driving the global equity rally. World trade volume hit a new record in the third quarter of 2017. Though we’ve seen positive contributions from emerging market Asia, Latin America, and Japan, it’s important to keep portfolios diversified.

Canadian equity: The S&P/TSX is doing well into Q4, led by financials and the tailwind they might be receiving from a rising rate outlook. Producer prices are making a comeback. And while there might be the occasional reason to temper our optimism (a rising debt-to-disposable income ratio comes to mind), our strategists aren’t particularly alarmed, claiming there’s still room to expect modest earnings growth.

U.S. equity: With every month tacked on to the U.S.’s current booming economic cycle (now 118 months in duration), alarm grows, raising the question: is a recession overdue? Our strategists feel that length alone is too crude a basis for turning bearish, and they look instead to output gap and the continuing steepness of the yield curve to recommend allocation to what is still the bedrock foundation of the global equity markets.

Fixed income: Though the long-awaited rising rate environment may finally be at hand, a flattening yield curve has propped up the returns from the benchmark aggregate bond ETFs that form the core of our model portfolios. That said, our strategists still see increasing odds of inflation acceleration, meaning that a few rate hikes are still on the table for the coming year. ETF investors should look to short-term, investment grade ETFs to manage duration down to levels in line with risk tolerances.

TOP PICKS

ISHARES S&P/TSX 60 INDEX ETF (XIU.TO)
MER of 0.18 per cent. This is Canada’s oldest, largest, and most liquid ETF, with assets of $12 billion and average daily volume of seven million shares. We’re choosing to highlight XIU over slightly cheaper and even more diversified ETFs for Canadian equity, because our strategists are favouring Canada’s banking sector at the moment. Because of its large-cap focus, XIU has 31 per cent in banks, whereas the broader composite is 23 per cent in banks.

BMO EQUAL WEIGHT OIL & GAS ETF (ZEO.TO)
MER of 0.61 per cent. Increasing oil/gas demand spurred by global economic growth bodes well for energy stocks. Our tactical allocation to this ETF is part of a shorter-term call, and it’s also a candidate for several tax loss switches.

POWERSHARES FTSE RAFI U.S. FUNDAMENTAL INDEX ETF (PXS.TO)
MER of 0.57 per cent. This is an example of the kind of ETF we use in our model portfolios as the “satellite” position around a pure, passive, cap-weighted benchmark index ETF. RAFI’s “fundamental” methodology injects a bias to slightly cheaper companies into a broad basket that still strongly resembles the benchmark. In other words, a slight tilt to U.S. value, with exposure to the U.S. dollar.

PAST PICKS: JUNE 29, 2017

HORIZONS ACTIVE FLOATING RATE BOND ETF (HFR.TO)

• Then: $10.07
• Now: $10.08
• Return: 0.09%
• Total return: 0.79%

BMO S&P/TSX CAPPED COMPOSITE INDEX ETF (ZCN.TO)

• Then: $20.50
• Now: $21.75
• Return: 6.09%
• Total return: 6.84%

ISHARES MSCI EUROPE IMI INDEX ETF CAD-HEDGED (XEH.TO)

• Then: $23.79
• Now: $24.75
• Return: 4.03%
• Total return: 4.03%

TOTAL RETURN AVERAGE: 3.88%

WEBSITE: www.nbc.ca