Preferred shares endured a remarkably weak month, with the S&P/TSX Preferred Share Index falling -10.40%. The magnitude of the drop reflected the illiquidity currently in the preferred share market, as small scale selling led to large scale price declines. As well, the risk-off sentiment that prevailed encouraged selling of preferred shares. The weakness in the preferred share market was exacerbated by two new bank NVCC issues, from TD Bank and National Bank, which repriced existing issues lower in price and higher in yield. Interestingly, though, the TD issue was upsized to $700 million, making it the second largest issue on record. That suggests demand for preferred shares remained good, especially from bargain-hunting institutions that bought most of the TD issue. It was also positive that most of the recent bank issues (with 5.50% or higher dividend rates) and the non-bank rate reset issues with floors continued to trade above par. That suggests the deeply oversold preferred share market may be stabilizing.

Canada’s economy experienced little if any growth in the last three months of 2015, reflecting the energy sector’s importance in this country. In view of the continuing economic and financial turbulence, and even lower oil prices, Canadian growth will be modest at best in the first half of this year. Barring a rebound in oil prices, it appears Canadian economic activity will struggle to grow at greater than a 1% pace. The federal government’s promised fiscal stimulus, if significant, will have more impact on 2017 growth than in the current year. The Bank of Canada will likely remain on hold, however, both to evaluate the effectiveness of the federal stimulus package and to avoid weakening the exchange rate further. The Loonie’s 25% decline in the last year and a half should be sufficient competitive advantage for Canadian exporters, and further declines would only increase the potential for imported inflation. From a duration perspective, we are remaining close to benchmarks as bond prices appear to be in a trading range. Looking at the yield curve, we believe the shorter term yields will be relatively stable due to the Bank of Canada’s stance, but longer yields are vulnerable to rising U.S. yields.

While growth will be subpar, we do not anticipate that Canada will lapse into a serious recession. The market chaos of January, in our opinion, was an overreaction to slow economic and profit growth. For many asset classes, including corporate bonds and preferred shares, their risk premiums are at the highest levels since the financial crisis and the current situation nowhere close to the seriousness of that period. Accordingly, we believe that the risk/reward trade-off has shifted significantly in favour of accepting more not less risk.
As much as current valuations represent a buying opportunity, the key question is when to take on more risk. In market conditions such as existed in January that decision seemed akin to trying to catch the proverbial falling knife. Also, liquidity, particularly within the corporate sector, has become quite challenging. From a practical point of view, we are waiting to see some stability, with particular emphasis on market sentiment, oil prices, and new issues not repricing existing issues. At that point, it may be time to realize the opportunity and increase credit exposure.

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