SECOND QUARTER 2017 RETROSPECTIVE AND PROSPECTIVE – Polarizing Views

SECOND QUARTER 2017 RETROSPECTIVE AND PROSPECTIVE – Polarizing Views

When democratic governments create economic calamity, free markets get the blame.”- Jack Kemp

The media and President Trump continue their war of words on fake news and counter accusations of bias and polarized opinion. While Mr. Trump’s base support remains firm despite the deluge of negative press, investors are focussing more on economic fundamentals. In that regard, it is becoming more apparent that the administration’s ability to deliver on campaign promises, particularly those favourable to the investment climate, will be held up by the growing political rancour in Washington as has been evident in the debate over health care.

Global stock markets were mixed in the second quarter of 2017. The US market recorded another positive quarter, albeit half as robust as the prior quarter. European markets managed to eke out a modestly positive quarter in spite of a large decline in June following the inconclusive UK election.

Asian markets were very strong due to trade in information technology and a positive election result in South Korea. Resource heavy markets such as those of Latin America, Australia and Canada were not as fortunate and generally posted negative returns in the quarter. The Toronto Stock Exchange recorded a decline of 1.6% as Energy (-8.3%), Materials (-6.4%) and Financials (-0.9%) weighed on the market.

 

 

                     Canadian Dollar

US Dollar

 

 

Q1

Q2

Q3

Q4

YTD

Q1

Q2

Q3

Q4

YTD

 

 

 

 

 

 

 

 

 

 

 

Toronto Stock Exchange

2.4%

-1.6%

 

 

0.7%

 

 

 

 

 

S&P 500

5.0%

0.4%

 

 

5.4%

6.1%

3.1%

 

 

9.3%

MSCI EAFE*

5.4%

2.3%

 

 

7.8%

6.5%

5.0%

 

 

11.8%

91 Day T-Bill

0.1%

0.1%

 

 

0.2%

 

 

 

 

 

CUBI**

1.2%

1.1%

 

 

2.4%

 

 

 

 

 

CDN/US dollar

0.8%

2.5%

 

 

3.4%

 

 

 

 

 

* Europe, Asia and Far East Index

** Canadian Universe Bond Index

In the first six months of 2017 the Canadian stock market has underperformed many of its global counterparts. This underperformance was more notable in the most recent quarter due to a number of factors. Oversupply in the energy sector continued to have a negative effect on pricing. In the period between February and June, West Texas Intermediate (WTI) declined in price from $54.50/bbl to $42.50/bbl. Production cuts by OPEC could not offset the expanding US shale production. In the first six months, the Toronto Stock Exchange Energy Sector has declined 13.3%; 8.3% in the second quarter. The Materials sector has been the second weakest performer in the Canadian market declining 6.4% in the second quarter, offsetting the positive first quarter, bringing the year to date to a negative 0.7%. Financials also posted a negative second quarter of 0.9% despite advancing 2.5% in June resulting in a 2.6% gain for the first six months. The Financial sector was impacted by fear mongering and concerns raised over the state of the domestic housing market, rising tensions regarding trade relations with the US, yield declines potentially impacting the Financial sectors profitability and the unfortunate handling of the disclosure timing at Home Capital Group, a major financial institution, that nearly caused its demise.

Home Capital Warren Buffett

The Home Capital situation was resolved by the participation of Warren Buffett in the solution

​Sentiment with regard to economic conditions in Canada showed signs of improvement in June. The Financial sector received a boost as the Home Capital situation was resolved and a great deal of uncertainty within the sector was reassured by the participation of Warren Buffett in the solution. Crude oil inventories started to reduce concerns in the Energy sector.

The Central Banks in Canada, Europe and the US have been recently taking a more hawkish tone insofar as hinting that economic conditions have improved to the point where interest rates may be raised in the near future. The anticipation of rising interest rates caused a sell-off in the bond markets, particularly in Canada as this is a major shift in the positions expressed by the Bank of Canada.

It remains to be seen how the economies may react to rising rates. Recessions are more often than not pre-dated by interest rate increases. Since the financial crisis 10 years ago, we have been in a slow, tepid recovery that has gone on longer than most.

The advances in the stock market this year in Asia, Europe and most significantly in the US have been driven by the Information Technology sector. In the US primarily the so-called FANG stocks have driven this sector: (Facebook, Amazon, Netflix and Google). It is apparent that technology in many guises is causing rapid disruption in many industries. UBER and LYFT are changing our relationship with taxis and the automobile, as is the concept of autonomous vehicles, Air BnB is affecting the hotel industry, etc.

As value investors, we are very cautious of concepts with little in the way reasonable valuations on profitability and growth. These companies may well go on to forge the next paradigm, but we still remember the days of the Nifty Fifty when stocks such a Polaroid, Kodak, Xerox, Sears, International Flavor and Fragrances, etc. were considered “must own” stocks of the 1960’s and 1970’s. Early in the last century there were hundreds of automobile manufacturers, but few made it. In the late 1990’s Technology stocks sold at ridiculous valuations.

We shall continue to be cautious and concentrate on what we do best: examine companies fundamentals in relation to what we are paying to buy the stock.

Continue to read our fixed-income commentary here>>

View and download our complete commentary here>>

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We believe that investment management is about managing risk, not chasing speculative returns. Like to learn more? Please contact us here>> The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.  

Market Outlook – THIRD QUARTER 2016 RETROSPECTIVE AND PROSPECTIVE

Market Outlook – And The Band Played On…

“When democratic governments create economic calamity, free markets get the blame.”-Jack Kemp

“Politicians and diapers must be changed often, and for the same reason.”– Mark Twain

Thus far, the calamities predicted by the pundits that would result from the Brexit vote to leave the European Union have not been as severe as anticipated. Perhaps this is due to the building geopolitical and economic stresses that have diverted the focus from Brexit to other issues. Furthermore, the impact of Brexit will likely take some time to discern as the trade, migration, political and other ramifications evolve over the coming months and years. Meanwhile, governments globally continue in their efforts to stimulate economic growth with what appears to be diminishing results.

The Canadian stock market continued its advance for the year as the S&P/TSX Index increased 5.5% for the quarter bringing the year to date return to 15.8%. Information Technology was the leading sector up 12.2% in the quarter followed by Industrials (10.8%), Health Care (9.0%) and Consumer Discretionary (8.9%). Only Real Estate (-1.5%) and Materials (-1.1%) recorded negative results. The US market was less robust as the S&P 500 advanced 3.9% in the quarter while the Dow Jones Industrial Average recorded a 2.8% gain.

 Canadian Dollar

              US Dollar

Q1

Q2

Q3

Q4 YTD Q1 Q2 Q3 Q4 YTD
Toronto Stock Exchange 4.5% 5.1% 5.5% 15.8%
S&P 500 -4.7% 1.9% 5.4% 2.2% 1.3% 2.5% 3.9% 7.8%
MSCI EAFE* -9.5% -3.2% 7.3% -6.0% -3.7% -2.6% 5.8% -0.8%
91 Day T-Bill 0.1% 0.1% 0.1% 0.4%
CUBI** 1.4% 2.6% 1.2% 5.3%
CDN/US dollar 6.7% -0.3% -0.8% 5.5%

* Europe, Asia and Far East Index

** Canadian Bond Universe Index

 We head into the final quarter of 2016 with some trepidation. Many parts of the world are experiencing political and economic uncertainty. For the most part, stock markets have exhibited great resiliency in the face of anaemic economic growth, rising protectionist sentiment and increasing regulatory constraints.

Clinton Trump Election fever US voters presidential candidate dislike

Election fever will dominate the news as US voters attempt to decide which
presidential candidate they dislike the least

In the US, election fever will dominate the news as the voters attempt to decide which presidential candidate they dislike the least. Investors will continue to look for evidence of a strengthening economy as growth continues to be lacklustre despite relatively positive trends in employment and housing prices. It is interesting to note that despite a short rally in September following the Federal Reserve’s decision to leave interest rates unchanged, the Dow Jones Industrial Average was down 0.4% for the month. Investors continue to be concerned over declining corporate earnings that have been evident over the past six quarters in an economy that is exhibiting growth below potential. Earning per share have increased largely as a result of massive share buy backs and dividend increases that have been delivered at the expense of lower capital investment.

Europe is dealing with more problems than just the aftershocks of Brexit. The ongoing migration crisis continues to bolster extremist political rhetoric while the underlying financial instability of the European banking system continues unabated. The most recent shock has come from Germany, which up until now has been the economic engine of Europe. The US has levied a fine of US$14 billion against Deutsche Bank for its participation in selling mortgage-backed securities in the US in 2008. A fine of that size would be close to the bank’s total market capitalization of US$18 billion while expectations are for a settlement in excess of US$5 billion. The failure of Deutsche Bank would have the potential to be very destabilizing to the world’s financial system. Deutsche Bank has the second largest derivative exposure in the world after JP Morgan. As the Bank’s creditors and depositors concerns grow, it remains to be seen if a bailout or refinancing will be forthcoming.

In Eurasia, the Russian economy continues to deteriorate under the pressure of low energy prices. The Russian response has been to exhibit bravado in the Ukraine and the Middle East, particularly in Syria. Whether these actions are anything more than posturing remains to be seen but tensions with the US and its allies are escalating.  China continues to exhibit hegemony in the South China Seas to the chagrin of neighbouring states. The US has responded with stationing a naval presence in the area only to have Chinese aircraft fly by in close proximity. North Korea continues to build on its nuclear energy program much to the entire world’s consternation. These demonstrations add to geopolitical tensions even if they turn out to be mere sabre rattling.

Since 2008, the global central banks have intervened in the economy through maintaining low interest rates in their efforts to stimulate economic growth and spending. In this environment, asset prices have been bid up on the back of easy money and debt, both in the public and private sectors. The build up of debt, much of it at negative interest rates, has reached proportions that make the contemplation of higher rates ever more alarming. Low rates used to be a sign that investors were less risk averse whereas now they appear to reflect an insurance premium paid to park money for a period. With or without productivity growth, lenders will want to be compensated at some point and governments will be forced to curtail their voracious spending appetite.

More worrisome is the propensity of politicians to exploit unrest in the electorate by blaming business, free trade and globalization for their plight. Trust must be fostered in the economies in order to promote investment, job creation and economic growth. The enabling of barriers to trade will do little to engender greater trust and investment.

Longer term, technology will continue to generate great opportunities and great dislocations. Rapid technological advances that are reshaping media, retailing, manufacturing, and administration and service delivery are impacting whole industries. These changes will cause greater stress as the skills required for employment evolve and leave many people behind. At the same time, the faster speed and volume of business will foster economic growth and prosperity.

The emerging economies are lifting vast numbers of people out of poverty into middle and upper class consuming environments. Aging populations in the developed world are putting greater pressure on health care and service delivery as lifestyles and consumption habits evolve.

So, despite our near term trepidation we think that investors will have many opportunities. It is through these periods of greater uncertainty and disequilibrium that our efforts will be directed towards identifying investments to enhance portfolio profiles towards meeting investors’ goals and objectives.

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The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.

 

Stock Market Outlook 2016 – Brexit Decision

Stock Market Outlook 2016 – Can Politics Trump Economics?

“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.” –Groucho Marx

“The expected rarely occurs and never in the expected manner.”- Vernon A. Walters

It didn’t go the way the pundits predicted. As the second quarter came to a close, people in the UK voted to exit (Brexit) the European Union by a narrow margin. Despite the narrow differences in the polls, global markets and the mainstream press indicated that the opposite outcome would prevail in the days leading up to the vote.

Investors hate uncertainty. The immediate reaction to the Brexit vote was severe and negative. However, stocks recovered to a great extent over the following week.

Stock Market Outlook 2016 Brexit decision

Stock Market Outlook 2016 – Brexit decision will continue to weigh on market sentiment for some time.

In North America, stock markets ended the quarter in positive territory. The Canadian market was up considerably with very strong results in the Materials (+26.9%), Energy (+9.5%) and Utilities (+7.0%). The laggards in Canada were primarily in Health Care (-15.3%) and Information Technology (-5.9%). In the US, Energy (+10.8%), Utilities (+5.9%), Telecommunications (+5.9%) and Health Care (+5.8%) lead the way while Information Technology (-3.3%) and Consumer Discretionary (-2.0%) lagged.

Canadian Dollar


               US Dollar
Q1 Q2 Q3 Q4 YTD Q1 Q2 Q3 Q4 YTD
Toronto Stock Exchange 4.5% 5.1% 9.8%
S&P 500 -4.7% 1.9% -3.0% 1.3% 2.5% 3.8%
MSCI EAFE* -9.5% -3.2% -12.4% -3.7% -2.6% -6.3%
91 Day T-Bill 0.1% 0.1% 0.3%
CUBI** 1.4% 2.6% 4.1%
CDN/US dollar 6.7% -0.3% 6.4%

* Europe, Asia and Far East Index

** Canadian Bond Universe Index

The Brexit decision will continue to weigh on market sentiment for some time. The vote result was a wake-up call to politicians of every stripe as the rationale for the outcome is debated and dissected. The vote reflects an underlying current of discontent within populations in the developed democracies as politicians have sought to engender resentment over wage stagnation, disappearing jobs and a growing inequality of outcomes. (Politicians looking for trouble and finding it everywhere.) The result has been a focus on the very trends that have sustained wealth and economic growth over the post-WWII period: globalization, free trade and migration. The same style of political rhetoric is evident in the US as they prepare for the presidential election in November.

While a divorce from the European Union, if indeed it ever comes to fruition, may take years to negotiate, investors will deal with the inherent uncertainty that will surround the negotiations. In the immediate aftermath of the vote, volatility increased as did bond prices as yields spiked lower and the US dollar increased in value along with gold as investors sought a safe haven. The British Pound is hovering near a thirty year low against the US dollar. Once the initial shock had subsided, share prices recovered as investors became reconciled to the fact that this will be a long process, the results of which may not be as devastating as the pictures painted by pundits prior to the vote.

Although overshadowed by Brexit at the end of the second quarter, other things of note were occurring during the period.

As noted in our last Retrospective and Prospective, the Federal Reserve in the US had gone from a more aggressive posture with respect to raising interest rates to a less certain posture by the end of the first quarter. In the second quarter, more evidence of a slowdown or weaker economy is likely to reduce the prospects of higher interest rates even more. On the positive side, the first quarter GDP figure was modestly higher and housing markets appeared to be firm. More banks passed tests of capital adequacy, improving prospects of dividend increases. However, both industrial production figures and capacity utilization figures disappointed investors as did unit labour costs and productivity numbers. Employment figures disappointed with large withdrawals of people from the workforce. Manufacturing inventories were higher than expected while auto sales declined.

Commodity prices strengthened over the quarter bolstering the shares of Material and Energy companies.

Companies announced a number of employee reductions, including Daimler, the London Stock Exchange, Ralph Lauren, Wal-Mart and Dow Chemical.

In Japan, sales tax increases were postponed due to fears of a weakening economy in the face of lower machine orders and lower exports.

In this environment, the yields of stronger issuers were pushed lower. In Germany, the 10 year bonds went into negative territory and Swiss bonds were driven to a negative yield all the way out to 50 years. There are now in excess of US$10 TRILLION in negative yield bonds in circulation!

Stock Market Outlook 2016 – In this environment, what is an investor to do?

The dynamics and benefits of a diversified portfolio are evident. As we witnessed during the Brexit aftermath, when stocks retreated, the value of the US dollar, gold and bonds went up. Assets react to events and capital flows to where it is treated best. The interplay between bond yields, credit spreads, stock prices, currencies and liquidity will continue to be impacted by economic conditions, energy and commodity prices, changes in central bank and political policies and demographics. Technology will continue to change the shape and nature of employment. As much as the Luddites would like to turn back the clock and take isolationist stances, technology will advance domestically and abroad.

Over the longer term, there will undoubtedly be winners and losers. Stronger companies will survive and prosper. During the Brexit incident, we placed bids below the market in order to try and capture opportunities that may have been presented.

Investors that are prepared will prosper.

You can view and download your own copy of our complete market commentary here:

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Download Our Free Special Report – How to Hunt For Value Stocks. Michael Sprung will share with you 5 stocks set for long-term gains here>>

We believe that investment management is about managing risk, not chasing speculative returns. Like to learn more? Please contact us here>>

The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.

 

Stocks – THIRD QUARTER 2014 – RETROSPECTIVE AND PROSPECTIVE – Cyclical Behaviour

“The house of delusions is cheap to build but drafty to live in.”- A.I. Housman

“Anyone who lives within their means suffers from a lack of imagination.”- Oscar Wilde

It all seemed so easy. The elixir of low interest rates and successive rounds of quantitative easing by the central banks created an environment wherein stock and real estate prices have risen, private equity and credit deals proliferated, corporations lowered their cost of capital with low rates and sub-prime borrowers regained access to capital. Until this quarter, investors were content to drink this elixir as markets steadily climbed out of the depths from 2008. The politicians taking credit and the central bankers implementing these policies cannot be accused of a lack of imagination.

Geopolitical events continued to buffet investors’ concerns. While the fight between the Ukraine and Russia appeared to abate to some extent, conditions in the Middle East continued to deteriorate as the US started to pressure allies to support renewed intervention. Ongoing concerns in the South China Sea remained prevalent while investors’ attention was diverted to the potential fallout from the Scottish vote on independence and a surge of pro-democracy activity in Hong Kong. In addition to these events, a resurgence of the deadly Ebola virus appeared toward the quarter end.

In September, markets deteriorated as investors sought to protect profits earned to date.

Canadian Dollar US Dollar
Q1 Q2 Q3 Q4 YTD Q1 Q2 Q3 Q4 YTD
Toronto Stock Exchange 6.1% 6.4% -0.6% 12.2%
S&P 500 5.9% -1.4% 6.1% 14.1% 1.8% 5.2% 1.1% 8.3%
MSCI EAFE* 4.0% -0.6% -1.8% 1.5% 0.0% 2.9% -6.4% -3.6%
91 Day T-Bill 0.2% 0.2% 0.2% 0.7%
DEX** 2.8% 2.0% 1.1% 5.9%
CDN/US dollar -3.9% 3.5% -4.7% -5.1%

 

* Europe, Asia and Far East Index

** Canadian Bond Universe Index

As investors began to bolt from the equity markets, they sought a safe haven in the US dollar. The Canadian dollar depreciated 4.7% against the US dollar in the quarter, largely reflecting softening energy and commodity prices. Against other currencies, the Canadian dollar performed relatively better as they were hit even harder. Are we witnessing a race to the bottom as governments try to spur economic activity and exports through lower currency values? Certainly, it will be difficult to raise interest rates significantly in this environment.

Inflation has yet to appear despite the expansion of central bank balance sheets by some $US7 to $US8 trillion since 2007. Government deficits continue to exacerbate already extremely high debt levels globally. France will post a 4% deficit this year while Japan will post close to 8%. In the US, the deficit is approaching 6%; slightly ahead of the UK (5.3%) and Spain (5.5%). As a result of these accumulating deficits, Japan now has over a 250% debt to GDP ratio! Debt to GDP is through 100% in the US and through 90% in the UK. In Canada, we are approaching 90%. How long will the bond markets continue to allow these debts to expand at these low interest rates? Yet, in many countries, deflation remains a valid concern as some prices fall. In the longer term, demographic headwinds in the developed economies will certainly contribute to these deflationary concerns.

In Europe, economic stagnation has yet to be conquered by attempts to stimulate growth in part by devaluing the Euro. Signs of slowing growth in the emerging economies and especially China have put pressure on commodity prices. With this in mind, energy prices have hit a near perfect storm in the short term with fears of waning demand at a time of record production and high inventories. In Canada, Energy and Materials were the worst performing sectors this quarter declining 7.3% and 10.5% respectively.

Market volatility has picked up in this environment. There has been greater activity in mergers and acquisitions and Initial Public Offerings (IPO’s). The largest IPO ever was floated in the quarter as Alibaba went public raising $25 billion. Despite this renewed level of activity, markets retreated sharply in the latter month of the quarter. During these market declines, emerging markets and smaller companies have been the hardest hit.

Is this the pullback that we referred to as a possibility in the last quarter?

To a large extent, we think that it is just that; a pullback. As noted previously, valuations were running somewhat ahead of fundamentals. We had been taking some profits and building cash positions. As the US economy continues to expand, Canada will be a beneficiary. We are sticking with our valuation discipline and monitoring many situations seeking opportunities to deploy cash.

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Is Your Stock Broker Acting in Your Best Interest? Read more here>>

Exchange Traded Funds Expose Investors to Unexpected Risks. Read more here>>

Investment Management – Risk vs. Return. Read more here>>

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The opinions expressed here are ours alone. They are provided for information purposes only and are not tailored to the needs of any particular individual or company, are not an endorsement, recommendation, or sponsorship of any entity or security, and do not constitute investment advice. We strongly recommend that you seek advice from a qualified investment advisor before making any investment decision.