Investment Commentary

Investment Commentary February 2017 The Mighty Dollar

DXY INDEX AND HOUSEHOLD NET WORTH

DXY INDEX AND HOUSEHOLD NET WORTH Source: Bloomberg Chart 1 | USD Index andAND Household Net Worth DXY INDEX HOUSEHOLD NET WORTH Source: Bloomberg

95

DXY Index DXY Index

Household Net Worth

90 to question the outlook for the greenback, not least because 90

DXY Index

a strong U.S. dollar has been one of 85 the more popular macro 85

trades since the election. Given85the80 critical nature of the USD in 80 terms of inflation and potential 80interest rate hikes, not to mention 75 75

the knock-on effects to commodity prices and emerging markets, 75 70

investors need to be well informed Mar-2012 70on this topic.

Mar-2015 Sep-2013 Federal Reserve US Household & NPO DXY Index Mar-2015 Sep-2013 Federal Reserve US Household & Sep-2013 NPO DXY Index Mar-2015 Federal Reserve US Household & NPO DXY Index

Household Worth Household NetNet Worth

85K

80K

75K

70K

65K

70 Mar-2012 Mar-2012

60K

Why is the President so concerned with a strong dollar when policy for the last several decades favored exactly that? The

90K

100

85K 85K

95 95

95

80K 80K

90 90

90

75K 75K

85

70K 70K

80

65K 65K

75

60K 60K MAR 2012 SEP 2013 MAR 2012 SEP 2013 MAR 2012 SEPHousehold 2013 Federal Reserve US & NPO Federal Reserve US Household & NPO Federal Reserve US Household & NPO

capita are also up materially, +65%, +23% and +47%, respectively, over the same period (Chart 1). In other words, a strong dollar in-

U.S. Trade-Weighted Dollar (DXY) Index U.S. Trade-Weighted Dollar (DXY) Index

Manufacturing as % GDP and-of itself is not a barrier to higher income and earnings. Manufacturing as % GDP Manufacturing as % GDP

Mainly, President Trump seems concerned with rebuilding the domestic manufacturing base, which now represents only 11.7% of GDP (Chart 2), and restoring the competitiveness of U.S. labour, which is consistent with the campaign promise that won him the

Sep-2013 Sep-2013 p-2013

rustSep-2010 belt and in Sep-2007 turn the Presidency. Other side benefits of making Sep-2010 Sep-2007 Sep-2010

Sep-2007

the USD a political discussion point could include providing a “stick” for discussions with China as well as justification for taxing imports (more on this later), which in turn could fund reduced corporate taxes. Notwithstanding potential positives of a weaker USD, the country’s strong economic trends and the market’s positive technical setup both argue for further dollar gains. The U.S.

2017 GDP forecasts 2017 GDP forecasts economy world (Chart 3) and 2017 GDP forecastscontinues to lead the developed 2.30% 2.30% all signs point to the Federal1.90% Reserve leading on interest rate 2.30% 1.90%

1.90%support dollar strength. Ironically, hikes, both of which1.50% should 1.50% 1.30% 1.50% 1.30% 1.20% 1.30% 1.20% 1.20% 1.20% 1.20% 1.10% 1.20% 1.10% 0.80% 1.10% 0.80% 1.00% 1.50% 0.80% 1.00% 1.50% 1.00% 1.50%

however, top Congressional priorities could be the most

significant potential driver of a major bull run in the U.S. Dollar. A repatriation tax break on more than $2 trillion of overseas cash would create short-term demand for dollars, as would increased 2.00% 2.50%

0.50% 0.50%

0.50%

2.00% 2.50% infrastructure spending that lifted economic growth. Yet with all 2.00% 2.50%

these moving parts, we believe it is the border tax that could be the real wildcard in the deck.

MANUFACTURING Chart 2 | U.S. Manufacturing as %GDPAS % GDP MANUFACTURING AS % GDP Source: Bloomberg MANUFACTURING AS % GDP Source: Bloomberg Source: Bloomberg

source: Bloomberg 13.1% 13.1% 13.1% 12.9% 12.9% 12.9% 12.7% 12.7% 12.7% 12.5% 12.5% 12.5% 12.3% 12.3% 12.3% 12.1% 12.1% 12.1% 11.9% 11.9% 11.9% 11.7% 11.7% 11.7% 11.5% 11.5% 11.5% SEP 2004 SEP 2004 SEP 2004

SEP 2007 SEP 2007 SEP 2007

SEP 2010 SEP 2010 SEP 2010

SEP 2013 SEP 2013 SEP 2013

SEP 2016 SEP 2016 SEP 2016

Chart 3 | 2017 GDP Forecasts 2017 GDP FORCASTS

2017Source: GDP Bloomberg FORCASTS 2017 GDPSource: FORCASTS Bloomberg Source: Bloomberg

source: Bloomberg United States United States United States Canada Canada Canada Germany Germany Germany France France France United Kingdom United Kingdom United Kingdom Russia Russia Russia Japan Japan Japan Italy Italy Italy

1.50% 1.50% 1.50% 1.30% 1.30% 1.30% 1.20% 1.20% 1.20% 1.20% 1.20% 1.20% 1.10% 1.10% 1.10%

0.00% 0.00%

0.00%

0.50% 0.50%

0.50%

0.80% 0.80% 0.80% 1.00% 1.00% 1.00%

1.50% 1.50%

1.50%

1.90% 1.90% 1.90%

2.00% 2.00% 2.00%

2.30% 2.30% 2.30%

2.50% 2.50% 2.50%

This publication is not intended as an offer or solicitation for the purchase or sale of any security. The contents of this publication are based upon sources of information believed to be reliable but no warranty or representation, expressed or implied, is given as to their accuracy or completeness. All opinions and estimates contained in this report constitute Equium’s judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Equium asserts that the reader is solely liable for their interpretation and use of any information contained within this publication.

2016 Corporate Tax Rate 2016 Corporate Tax Rate 2016 Corporate Tax Rate

Equium Capital Management Inc. 36 Toronto Street, Suite 1170, Toronto, ON M5C 2C5 United States United States (416) 304-9364 | [email protected] United States France France France Australia Australia

85 85 80 80 75 75

70 MAR 2015 SEP 2016 70 70 MAR 2015 SEP 2016 MAR 2015 SEP 2016 U.S. Trade-Weighted Dollar (DXY) Index

USD is up roughly 40% from the 2008 recession low and yet household net worth, average hourly earnings and GDP per

100 100

2016 CORPORATE TAX RATE 2016 CORPORATE Source: OECD TAX RATE 2016 CORPORATE TAX RATE Source: OECD Source: OECD

DXY Index DXY Index

90K

comments, the USD abruptly rolled9595over and investors began 90

Source: Bloomberg

source: Bloomberg 90K

commenting on the U.S. Dollar, describing it as “too strong” and

DXY Index and Household Net Worth 100 Index and Household Net Worth the competitiveness of 100 U.S.100companies. Following his YDXY Index and “killing” Household Net Worth

DXY Index

In January President Trump broke with yet another tradition by

0.80% 0.50%

1.00%

1.50%

2.00%

0.00%

0.50%

0.80% 1.10% 1.00%

1.50%

2.00%

2.50%

Italy 0.00%

0.50%

0.80%1.00%

1.50%

2.00%

2.50%

0.00%

0.50%

1.00%

1.50%

2.00%

2.50%

Italy Japan

2.50%

Another Kind of Wall Hyperbole aside, the proposed border adjusted tax is structured

2016 Corporate Tax Rate

similarly to our Goods and Services Tax (GST) and the VAT 2016 Corporate Tax Rate schemes used across much of the developed world. In some

2016 Corporate Tax Rate

ways, shifting to this type of tax model would normalize many of the distortions created by the current U.S. system, which incentivizes manufacturing in foreign low-tax domiciles as well as other avoidance schemes (Chart 4). In theory, imposing a

2016 CORPORATE TAX RATE Source: OECD

2016 Tax CORPORATE Chart 4 | 2016 Corporate Rate TAX RATE

France United States Australia Australia France Italy Italy Australia Canada Canada Italy Spain

an appreciation in the USD. In that case, long-term trade patterns

Spain Canada Japan

be deemed protectionist by the World Trade Organization (WTO). However rational this approach 15.00% 20.00% 25.00% 30.00% 35.00%might 40.00%be for the U.S., it does

5.00%

10.00%

5.00%

10.00%

5.00%

10.00%

25.00% 30.00%rest 35.00% not 15.00% make it20.00% benign for the of the40.00% world and especially for

Canada. JP Morgan estimates that the equilibrium move in the 15.00% 20.00% 25.00% 30.00% 35.00% 40.00% USD would be an across the board appreciation of ~25%, which

2016 CORPORATE TAX RATE Source: OECD

UnitedFrance States

symmetrical 20% import tax and 20% export rebate should lead to should not be impacted and the policy would therefore likely not

Source: OECD

source: OECD

United States

Japan Spain South Korea South Japan Korea United Kingdom United Kingdom South Korea Germany United Germany Kingdom Ireland Ireland 0.00% Germany

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Ireland

– in theory – would put the Canadian dollar below 60c. The knock

S&P/TSX FINANCIALS INDEX Source: Bloomberg S&P/TSX FINANCIALS INDEX Source: Bloomberg

on effects to the economy would be material, both positive and negative. Energy, potentially not subject to the import tax, would S&P/TSX Financials become moreIndex profitable as the relative cost base drops. On S&P/TSX Financials Index

the downside, the Canadian consumer would likely suffer from

S&P/TSX Financials higher levels Index of inflation and reduced purchasing power.

2700

Chart 5 | S&P/TSX Financials Index INDEX S&P/TSX FINANCIALS

2700 source: 2500

Bloomberg

Source: Bloomberg

2700 2500 2300 2500 2300

More Banks, Please

2100

Canadian financials, already up 12% since the U.S. election on

1900

2300 2100

Apr-1 Apr-1 Apr-1 Apr-1 Mar-1 Mar-1 Feb-1 Feb-1 Feb-1 Feb-1 Jan-1 Jan-1 Dec-1 Dec-1 Dec-1 Dec-1 NovNov- NovNovOct-1 Oct-1 Sep-1 Sep-1 Sep-1 Sep-1 AugAugJul-1 Jul-1 Jul-1 Jul-1 Jun-1 Jun-1 Jun-1 Jun-1 MayMay- Apr-1 Apr-1 Apr-1 Apr-1 Mar-1 Mar-1 Mar-1 Mar-1 Feb-1 Feb-1 Jan-1 Jan-1 Jan-1 Jan-1 Dec-1 Dec-1 NovNov- NovNovOct-1 Oct-1 Oct-1 Oct-1 Sep-1 Sep-1 AugAug- AugAugJul-1 Jul-1 Jun-1 Jun-1 Jun-1 Jun-1 MayMayMayMay- Apr-1 Apr-1 Mar-1 Mar-1 Mar-1 Mar-1 Feb-1 Feb-1 Jan-1 Jan-1 Jan-1 Jan-1 Dec-1 Dec-1 Dec-1 Dec-1 NovNov- Oct-1 Oct-1 Oct-1 Oct-1 Sep-1 Sep-1 AugAugAugAugJul-1 Jul-1 Jul-1 Jul-1 Jun-1 Jun-1 MayMay- MayMayApr-1 Apr-1 Apr-1 Apr-1 Mar-1 Mar-1 Feb-1 Feb-1 Feb-1 Feb-1 Jan-1 Jan-1 Dec-1 Dec-1 Dec-1 Dec-1 NovNov- NovNovOct-1 Oct-1 Sep-1 Sep-1 Sep-1 Sep-1 AugAugJul-1 Jul-1 Jul-1 Jul-1 Jun-1 Jun-1 Jun-1 Jun-1 MayMay- Apr-1 Apr-1 Apr-1 Apr-1 Mar-1 Mar-1 Mar-1 Mar-1 Feb-1 Feb-1 Jan-1 Jan-1

rising yields and the rebound in oil (Chart 5), would benefit in Last Price

2100 1900 1700

several ways from a stronger USD. First and most explicitly,

1900 1700

the banks benefit from the translation in the value of their

1500

Apr-1 Apr-1 Mar-1 Feb-1 Feb-1 Jan-1 Dec-1 Dec-1 NovNovOct-1 Sep-1 Sep-1 AugJul-1 Jul-1 Jun-1 Jun-1 MayApr-1 Apr-1 Mar-1 Mar-1 Feb-1 Jan-1 Jan-1 Dec-1 NovNovOct-1 Oct-1 Sep-1 AugAugJul-1 Jun-1 Jun-1 MayMayApr-1 Mar-1 Mar-1 Feb-1 Jan-1 Jan-1 Dec-1 Dec-1 NovOct-1 Oct-1 Sep-1 AugAugJul-1 Jul-1 Jun-1 MayMayApr-1 Apr-1 Mar-1 Feb-1 Feb-1 Jan-1 Dec-1 Dec-1 NovNovOct-1 Sep-1 Sep-1 AugJul-1 Jul-1 Jun-1 Jun-1 MayApr-1 Apr-1 Mar-1 Mar-1 Feb-1 Jan-1

Last Price

Last Price

U.S. subsidiaries, which have become much more material contributors over the last decade. Second, a lower CAD would

1700 JAN 2012 1500 JAN 2012

JAN 2013

JAN 2014

JAN 2015

JAN 2016

JAN 2017

JAN 2013

JAN 2014

Last Price JAN 2015

JAN 2016

JAN 2017

JAN 2014

Last Price JAN 2015

JAN 2016

JAN 2017

1500 JAN 2012

JAN 2013

likely drive up inflation expectations and therefore the long end

Last Price

of the bond curve, creating a steepening effect and thus higher interest rate margins. Importantly, the extent and pace of these changes will need to be monitored for excessive moves that could undermine market sentiment, especially as it relates to the domestic housing market.

Table 1 | Investment Recommendation Snapshot

INVESTMENT RECOMMENDATION SNAPSHOT source: Equium Capital Management Inc INVESTMENT RECOMMENDATION SNAPSHOT Sector Region INVESTMENT RECOMMENDATION SNAPSHOT Sector Region

As the great Yogi Berra once said “In theory there is no difference between theory and practice. In practice there is”. With policy uncertainty elevated and the consequences of those policies Sector Region

Industrialsdifficult to judge, having a disciplined and unemotional unusually Japan Sector Region

Overweight

investment process to guide portfolio allocations is particularly

Overweight

important. Similarly fortunate for Equium Capital’s tactical, active

Underweight

strategy, the fundamentals, technicals and policy probabilities do

Underweight

not seem well aligned with current investor thinking, resulting

Underweight

US

Overweight Overweight Underweight Overweight Underweight Underweight

Overweight

Financials Industrials Technology Financials Sector Staples Technology Industrials Telecom Staples Financials Utilities Telecom Technology Utilities Staples Telecom Utilities

US Germany Japan France Region Germany Australia US France China Japan Australia United Kingdom Germany China France United Kingdom Australia China United Kingdom

in multiple compelling investment opportunities in Canada and

Industrials Sector Financials Industrials Technology Financials Technology Industrials Financials Staples Technology Telecom Staples Utilities Telecom Utilities Staples Telecom Utilities

abroad.

Adam Murl, CFA

Cameron B. Hurst

Portfolio Manager/Head of Research [email protected] (416) 304-9359

Chief Investment Officer [email protected] (416) 304-9360

Equium Capital Management Inc. 36 Toronto Street, Suite 1170, Toronto, ON M5C 2C5 (416) 304-9364 | [email protected]

US Region Japan US Germany Japan France Germany US France Japan Australia Germany China France Australia United Kingdom China United Kingdom Australia China United Kingdom