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April 2018 Market Commentary & Fund Spotlight

Following a rocky first quarter to start 2018, the much-anticipated earnings season commenced in April. At the start of 2018, analysts had adjusted expected US earnings growth to 12% to account for the impact of the US tax cuts announced in December. During Q1, the expected earnings growth rate increased to 18%. Approximately 80% of reporting companies beat consensus earnings forecasts, versus the historical average of 64%i. Normally this would push equity prices higher, however by the end of the month the S&P 500 had only gained 38 basis points in domestic terms and only two basis points in Canadian dollars.

A statement from Caterpillar (CAT) management during their earnings conference call, that their first-quarter would likely be the high-water mark for the yearii, sparked a market wide sell-off despite solid earnings reports from most reporting companies. Caterpillar is widely considered the bellwether of global economic activity. Their statements when coupled with the possibility for international trade conflict significantly dampened investor sentiment in April.

Surprisingly strong numbers from the likes of Boeing, Intel, Microsoft, and Facebook, who beat both top and bottom lines while increasing guidance for 2018, found resistance from investors. With tax cuts adding 8% to the quarterly earnings growth rate for the next three to four quarters, investors were left wondering what would propel earnings thereafter. Investors remain unconvinced that markets will extend an already long-in-tooth bull market.

April 2018 Fund Spotlight

This month, we would also like to highlight one of the fund strategies in the Smart Money Portfolios, the short-duration mortgage-lending strategy. In a rising rate environment, one might question why we would have a position in a mortgage fund, when at some point, the rising rates would be expected to impact housing starts and construction activity.

The mortgage strategy in our portfolios is focused on three specific growth areas of the US: Texas, Florida and Arizona. The Texas strategy is focused mainly on single-family residential lot development while in Florida, the focus is on multi-family lot development due to the limited land available in the high-demand area of the Miami corridor. Once a developer purchases the land and is granted all the permits required for the development, the mortgage fund provides first lien lending for infrastructure development, which involves preparing the lots for model homes to be built by approved builders. As the lots are sold, the loans are paid in full.

Based on recent US migration studies, we expect housing demand in these areas will continue for several years. Economists Arthur Laffer and Stephen Moore recently penned an op-ed in the Wall Street Journal entitled “So long, California. Sayonara, New York”iii. They spoke about the migration trend over the past decade of more than 3.5 million people who left high-tax states like California, New York, and others in the Northeast, for low-tax states such as Texas, Florida and Arizona. They expect that the recently introduced $10,000 cap on the deduction for state and local taxes could accelerate the mass migration to lower-taxed states. In their estimation, they expect roughly 800,000 people will migrate in the next two to three years.

Having been on the ground in both Texas and Florida, the Smart Money team has witnessed the activity not only in housing starts but also in commercial and industrial development. We will closely monitor the rising rate environment in the US and state migration trends to ensure this fund’s continued suitability in our Smart Money Portfolios.

1 http://www.trpropresearch.com/pdf/This_Week_In_Earnings.pdf/
2 http://s7d2.scene7.com/is/content/Caterpillar/CM20180426-29530-10397
3 https://www.wsj.com/articles/so-long-california-sayonara-new-york-1524611900
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