THIRD QUARTER 2017 RETROSPECTIVE AND PROSPECTIVE – Ten Years Later

THIRD QUARTER 2017 RETROSPECTIVE AND PROSPECTIVE

Ten Years Later

In economics, things take longer than you think they will, and then they happen faster than you thought they could.”- Rudiger Dornbusch

It has been ten years since the great financial crisis. In the US, the S&P 500 peaked on October 9, 2007. The Canadian market continued its upward trajectory into the following year peaking in June as energy stocks were buoyed by high oil prices. While the bull market leading up to 2008 had duration of about five years, the current bull market has gone on for ten years without any significant setback.

financial crisis US S&P 500

It has been ten years since the great financial crisis. In the US, the S&P 500 peaked on October 9, 2007.

Global stock markets generally continued their upward bias in the third quarter of 2017. The US market gained 4.5% as measured by the S&P 500 Total Return Index in US dollars. A strong Canadian dollar had the effect of subduing that return to 0.5% when expressed in Canadian currency. With the exception of Spain and the UK, European markets were positive. Asian markets were very strong in US dollar terms with the Hong Kong market up 6.9% and China’s market up 4.9%. The Japanese market was pulled into positive territory by a very strong September (up 3.6%) bringing the quarter to 1.6%. Resource heavy markets such as those of Latin America, Australia and Canada improved as commodity prices generally improved. The Toronto Stock Exchange recorded an advance of 3.7% led by Energy (5.7%), Consumer Discretionary (4.2%) and Financials (3.7%).

             Canadian Dollar             US Dollar
Q1 Q2 Q3 Q4 YTD Q1 Q2 Q3 Q4 YTD
Toronto Stock Exchange 2.4% -1.6% 3.7% 4.4%
S&P 500 5.0% 0.4% 0.5% 5.9% 6.1% 3.1% 4.5% 14.2%
MSCI EAFE* 5.4% 2.3% 0.8% 8.7% 6.5% 5.0% 4.8% 17.2%
91 Day T-Bill 0.1% 0.1% 0.1% 0.3%
CUBI** 1.2% 1.1% -1.8% 0.5%
CDN/US dollar 0.8% 2.5% 4.0% 7.6%

* Europe, Asia and Far East Index

** Canadian Universe Bond Index

Global economic growth continues to strengthen in both the developed and emerging economies although at subpar levels compared with traditional recoveries. As central banks have cautiously raised interest rates, bond prices have come under pressure. Wage demands in the developed countries have not accelerated as inflationary expectations have remained low and productivity improvements have been driven by technology. In this environment, central banks may temper their enthusiasm to normalize interest rates and reduce their bloated balance sheets. Both the International Monetary Fund (IMF) and the Organization for Economic Co-operation and Development (OECD) are forecasting modestly better growth in 2018.

Among the advanced economies, Canada has posted strong growth primarily due to higher commodity prices. The Canadian dollar has appreciated against other currencies as our interest rates have gone up faster than other countries. This strength in the Canadian dollar has served to lower the returns from foreign investments.

In this environment, stock markets have continued to advance. The S&P 500 in the US has hit new highs surpassing levels from before the economic crisis. Valuation levels have also hit high levels making the search for new investment ideas challenging. Overall, we have been taking more profits than reinvesting funds, causing cash levels to increase.

A number of factors could come into play that would precipitate a more meaningful market correction than we have seen in the last ten years.

Foremost in Canadian concerns has been the resumption of NAFTA negotiations. Since the Brexit vote and the start of the Trump presidency, a backlash against global free trade has been evident, causing uncertainty in the business community, thus dampening the appetite for capital investment.

Other geopolitical factors are also of concern. North Korea’s nuclear threat and heightened discord with the US has been very prominent in the headlines as have tensions in the Middle East, Venezuela, Spain, Russia and the Ukraine. Monetary concerns in Greece, Italy, Spain and Portugal have not gone away.

Technology is also having an increasing impact on businesses and consumers. Disruptions in the retail trade are changing the way supply and delivery systems operate. The hotel and taxi industries are threatened by innovations such as Uber and AirBnB. Financial technology is changing traditional banking. Artificial Intelligence (AI) threatens to cause massive changes in employment.

Demographics are also going to have an affect on employment and retirement as well as government finances. As the population ages, the growing shortfalls in funding for health care and pensions will become critical.

All of these factors lead us to exercise caution and prudence in our investment practices. We will continue to scour for well financed, well managed and reasonably priced companies in which to place our funds.

THIRD QUARTER 2017 FIXED INCOME COMENTARY

“Be thankful we’re not getting all the government we’re paying for!” ~ Will Rogers

Fixed income markets have started to react to the shifting winds of interest rate policies. With two rate hikes so far this year and indications that the Federal Reserve will be slowly unwinding its quantitative easing program, the trend seems to be firmly in the tightening mode. In light of this, markets are now considering the increasing likelihood of one more hike in December by the Federal Reserve.

As we have stated in the past, much depends on economic variables both domestic and international. Similarly, the potential impact of geopolitical events can have outsized shock effects on markets.

While President Trump has not been much of a supporter of Chairman Yellen, whose term expires in January 2018, it may well be that a steady hand at the tiller will win the day. As Vice Chair Stanley Fischer has recently resigned due to personal reasons, there are now two other vacancies in the Reserve. Filling the Board to its full complement in a short period with members who may not be as well known in the markets, could cause turbulence.

In Canada, Governor Poloz’s seven year term has three more years to run. Influences on his decision making may well be coming from domestic economic factors which may be heavily influenced by the impact of changing trade agreements and taxation policies.

The situation in Europe remains unclear. Chancellor Merkel’s majority has been significantly reduced by the ascendancy of the nationalist AfD party. Their ascendancy may not directly affect her ability to form a government; however it will influence her political decision making going forward. Increased caution will likely be the German approach to a number of vexing European issues.

The enormity of the Brexit project is starting to sink in and indications are surfacing that there may not be enough time for an orderly negotiated divorce. The spectre of a disorderly breakup is definitely focusing the attention of various financial institutions and international corporations who are making their own alternative plans in the absence of a clear direction from officials.

The total return performance of the bond market as measured by the FTSE TMX Canada Universe Bond Index for the third quarter was a decline of 1.8%. 91-day Treasury bills returned 0.1% over the same period. The benchmark ten-year Government of Canada bond yield increased by 0.35% over the course of the quarter to end with a yield of 2.1%. During the third quarter the Canadian dollar appreciated by 3 cents from 77.1 cents US to 80.1 cents US.

You can view and download a copy of our market commentary here:

What is Successful Investing? Learn more here>>

We believe that successful investors focus on the quality of the assets they buy. Speculators focus on guessing the future prices. 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.

 

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>>

What is Successful Investing? Learn more 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.  

MARKET COMMENTARY – FIRST QUARTER 2017 RETROSPECTIVE AND PROSPECTIVE

MARKET COMMENTARY : The First Ninety Days

We can ignore reality, but we cannot ignore the consequences of ignoring reality.”- Ayn Rand

“Recognizing risk often starts with understanding when investors are paying it too little heed.”- Howard Marks

Since the inauguration on January 20, we have all been inundated by media reports on the first one hundred days of the Trump administration. While stock market participants entered the year with apparently high expectations, towards the end of this 90 day quarter there has been wavering of sentiment as the realization that not all of Trump’s campaign promises are likely to be delivered.

Market sentiment wavered realization Trump campaign promises

Market sentiment has wavered with the realization that not all of Trump's campaign promises are likely to be delivered. (DoD photo by U.S. Marine Corps Lance Cpl. Cristian L. Ricardo)

North American stock markets finished the quarter in positive territory.  The enthusiasm in the US propelled the S&P 500 up 5.5% (6.1% in US dollars) as investors focused on the prospects of lower taxes and reduced regulation that were the cornerstones of the Trump campaign. The Canadian market was not as robust. Weak energy prices and faltering economic prospects in Alberta and Ontario weighed on the enthusiasm of investors in Canada. The Toronto Stock Exchange recorded an increase of 2.4% in the quarter lead by Utilities (7.3%), Consumer Discretionary (7.0%) and Information Technology (7.0%). Health Care (-10.0%) and Energy (-5.5%) were the only sectors with negative performance.

 

 

                     Canadian Dollar

US Dollar

 

 

Q1

Q2

Q3

Q4

YTD

Q1

Q2

Q3

Q4

YTD

 

 

 

 

 

 

 

 

 

 

 

Toronto Stock Exchange

2.4%

 

 

 

2.4%

 

 

 

 

 

S&P 500

5.0%

 

 

 

5.0%

6.1%

 

 

 

6.1%

MSCI EAFE*

5.4%

 

 

 

5.4%

6.5%

 

 

 

6.5%

91 Day T-Bill

0.1%

 

 

 

0.1%

 

 

 

 

 

CUBI**

1.2%

 

 

 

1.2%

 

 

 

 

 

CDN/US dollar

0.8%

 

 

 

0.8%

 

 

 

 

 

* Europe, Asia and Far East Index

** Canadian Universe Bond Index

MARKET COMMENTARY : Can the Trump Administration Deliver on Campaign Promises?

Contrary to the predictions of the pundits in the media, the US stock market entered a period of euphoria following the US presidential election in November. Expectations appeared to be focused on the promises made during the campaign with respect to health care reform, tax reductions, regulatory relief and massive government spending programs on infrastructure and the military. That sentiment persisted through the first two months of 2017. In March, political reality began to sink in as discussions on health care reform began in earnest and the administration planned to present a Bill on March 23rd. As support for the legislation began to break down, confidence in the Trump administration’s ability to garner approval for their agenda began to falter. As market participants focused on these deliberations, the S&P 500 gave up a third of the gains achieved in the first two months of the year.

In Canada, investor sentiment was more muted. The Toronto Stock Exchange participated with the US market post the election until year-end. Thereafter, Canadian investors became concerned as energy prices came under pressure and fears of the impending NAFTA trade negotiations came to the fore with the resurgence of the “age old” softwood lumber dispute. Investors felt some relief as the federal budget was less dramatic than feared and did not contain any increase in capital gains taxes that had been rumoured. The release of GDP economic indicators stronger that expectations were corroborated by the fact that the Canadian dollar was able to modestly appreciate against its US counterpart by 0.8%.

European stock markets were reflecting increasing optimism in the economy as factories exhibited greater activity. The positive economic trends superceded investors’ anxieties over the election in the Netherlands where fears that the populist candidate could have prevailed, but didn’t. Upcoming elections in France and Germany will also test those anxieties as populist candidates in both countries are doing well in the advance polls. While some positive economic indicators are a relief, serious financial constraints and immigration issues will continue to influence investors’ sentiment.

The Asian economies also reported some positive indications that factories were busier. Exports from Taiwan, South Korea and China were up significantly compared with a year ago. Japan increased its outlook for economic growth over the coming year.

There are certainly reasons to be optimistic on the global economy. Orders for capital equipment are on the rise and employment has been improving. It has been almost ten years since the financial crisis of 2008. Climbing out of the financial abyss has been slow and painful for many as adjustments have taken time to work through the economy, as is often the case following financial crisis. The result has been reflected by the increase in populist politics as evidenced by the vote for Brexit and the election of Donald Trump. While the Netherlands managed to stem the populist tide, there are still the elections in France and Germany ahead.

Politics and economic cycles are often out of sync. The politics of populism are not as accommodating to the concepts of free trade and globilization that have sown the seeds for the current recovery; yet those very politicians may point to the recovery and take credit where none is due. In fact they may sow the seeds for the next downturn.

There remain many geopolitical and economic issues yet to be resolved: North Korea, Russia and the Ukraine, Syria, debts in China, Italy and other nations. Valuations in the stock market have reached high levels on the basis of the favourable economic trends continuing. Perhaps it is not wise to ignore the other issues.

We remain cautious in the current environment.

Continue to our fixed income commentary here>>

You can view and download a 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.  

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.

You and view and download our third quarter commentary here:

What is Successful Investing? Learn more here>>

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 successful investors focus on the quality of the assets they buy. Speculators focus on guessing the future prices. 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 – FOURTH QUARTER 2015 RETROSPECTIVE AND PROSPECTIVE

MARKET OUTLOOK – FOURTH QUARTER 2015 RETROSPECTIVE AND PROSPECTIVE

Market Outlook – Foggy Weather

“If you’re not confused (on the economy), you don’t understand things very well.”- Charlie Munger

2015 was a tough year to be an investor, particularly if you were in a country where the economy and stock markets were exposed to energy and other commodities. Nearly two-thirds of the commodity futures recorded negative returns in 2015; more than half of which posted returns that were down by double digits. For the second year in a row, oil prices reflected one of the worst performing commodity groups. Crude oil, as measured by Brent contracts declined by 36% in the year. Metals’ prices averaged declines of over 22% as measured by futures in the major metals; gold, silver, copper, platinum and palladium. Iron ore, nickel and steel faired even worse.

Market Outlook 2015 energy commodities

Market Outlook – 2015 was a tough year for investors exposed to energy and other commodities.

In the fourth quarter, investors continued to be buffeted by the volatility in the global markets that resulted from indecisive economic indicators and increasing geopolitical instability. Tensions continued to build in the Middle East. The terrorist attack in Paris on November 13 only served to exacerbate global concerns over the refugee crisis.  Investors also remained concerned with respect to the uncertainty regarding the slowing growth rates in the Chinese economy, particularly following the meltdown in the Shanghai Stock Exchange in August. Prices remained volatile and were on a downward trajectory at the end of the quarter relinquishing much of the gains achieved in the quarter. In the US, the Federal Reserve finally initiated a modest interest rate increase while indicating that more increases will follow. In Canada, a decisive victory by the federal Liberal party on a tax and spend platform added to investors’ concerns over the economy due to the repercussions of anaemic economic growth stemming from weak commodity prices.

         Canadian Dollar          US Dollar
Q1 Q2 Q3 Q4 YTD Q1 Q2 Q3 Q4 YTD
Toronto Stock Exchange 2.6% -1.6% -7.9% -1.4% -8.3%
S&P 500 10.1% -1.2% -0.2% 11.2% 20.7% 1.0% 0.3% -6.4% 7.0% 1.4%
MSCI EAFE* 13.7% -1.8% -4.8% 8.4% 15.1% 4.2% -0.4% -10.7% 4.4% -3.3%
91 Day T-Bill 0.3% 0.2% 0.2% 0.1% 0.6%
CUBI** 4.2% -1.7% 0.2% 1.0% 3.5%
CDN/US dollar -8.5% 1.6% -6.2% -3.8% -16.0%

* Europe, Asia and Far East Index

** Canadian Universe Bond Index

Pessimism continued into the first trading day of 2016 when the markets in China suddenly fell close to 8% following news that Chinese manufacturing had declined for the 10th consecutive month in December. Other global markets followed. In the US, the Dow Jones fell 1.6%, its biggest opening day loss since 2008. In Canada, the TSX declined 0.6%.

Apparently, investors are approaching 2016 with low expectations. There are many reasons for this forlorn outlook.

Although the S&P 500 in the US managed to post a modest 1.4% gain in 2015, that gain was sustained by exemplary performance of very few stocks. On an equal weighted basis, the return would have been closer to negative 4.0%. The broader market indexes were even more negative as indicated by the NYSE Composite  -6.4%; the Value Line Geometric –11.2% and the Russell 3000 more than –20%.

The US dollar has been particularly strong against other major currencies appreciating 9% in 2015 following a 13% increase in 2014 (against the Canadian dollar: 19% in 2015 following 9% in 2014). This strength in the US dollar may serve to weaken the earnings of US companies, particularly if they are doing business abroad. Pressure could be put on margins as wage demands increase while limiting the ability to increase prices. This could put pressure on price to earnings (P/E) ratios as current cyclically adjusted P/E’s are higher than average at present. This would lower the outlook for GDP growth from 2015’s expected level of 2.4% to closer to 2.0% in 2016. If this occurs, foreign investors would lighten up on US holdings.

China’s debt to GDP ratio is estimated by The Economist to be in excess of 240%. If current trends continue, it would be difficult for China to escape a hard landing (a severe drop in GDP growth). This would put further pressure on their currency that is already anticipated to decline as a result of weaker economic growth. Given that this is an election year in the US, pressure would be put on politicians to consider protectionist measures that would lower the outlook for trade globally.

Reugee crisis is exacerbating discord in the European Union as they scramble to deal with the over one million refugees that have arrived already. Discord was already present as a result of the sovereign debt crisis that centred on Greece, Spain, Italy and Portugal. This refugee crisis stems from upheaval in the Middle East that has resulted in the US, Russia and China taking polarizing stances on how to defuse those tensions.

Investors in Canada continue to suffer from the fallout of low energy and metal prices. Estimates of GDP growth for 2016 of 1.8% following the anticipated figure of 1.2% in 2015 would reflect only the second time since World War II that two consecutive years have fallen below 2%. The ratio of the value of exports to the value of imports prices has reached its lowest level in twelve years.

Market Outlook – Is there any reason for optimism in the face of all these negatives? We think so!

Europe has its problems, but recent data point to improving manufacturing conditions and employment. Increasing measures of security will make large-scale terrorist attacks more difficult. The US economy continues to expand, perhaps at a more moderate pace, which should be of benefit to Canada.

Energy prices have been weak in the face of over supply, but low prices have already caused cutbacks in capital expenditures and companies in weak financial condition are selling distressed assets. Stronger companies will take advantage of these sales. Saudi Arabia has been maintaining high production levels to shake out excess capacity. The recent Saudi budget reflects a 13.5% deficit to GDP ratio assuming a US$40/barrel; the second successive double digit deficit. They have also hiked domestic prices of petrol, water gas and diesel. Given the desire of Saudi leadership to contain domestic unrest, their willingness to keep prices low will wane.

In the US, the junk bond market has imploded as yields have skyrocketed and prices have collapsed. Investors will also tire of share buybacks, non-strategic merger and acquisition activity and corporate tax inversions that serve the short-term interests of management ahead of the longer-term interests of shareholders. More funds will be utilized for capital investment and research and development.

Canadian investors are concerned that the new government is promoting tax and spend policies. While this is a legitimate concern, the Canadian economy is in relatively good health. Deficits could total some $140 billion over the next five years without severely impacting the debt to GDP ratio. However, the new government will be constrained by the current weak business conditions in Canada, particularly in Alberta and Ontario. Policies will have to be devised to attract business to stay. Corporate Canada is sitting on $482 billion in cash, or 8% of assets, that needs to be given incentive to go into capital expenditures and research and development. The weaker dollar should enhance exports of industrial machinery, motor vehicles, aircraft and consumer goods.

How quickly these initiatives will prevail, we have no idea. We do not predict markets nor do we get overly confused and tangled in economic statistics. We try to look through the foggy weather and identify companies that will benefit from the current environment and have the potential to prosper in the years ahead.

It is during these periods that staying with your investment discipline is paramount. While it is difficult to ignore the negative sentiment that often comes to the fore, it is precisely during these period that investors should be repositioning their portfolios for the next market cycle. One need not rush into buying whole positions; it is prudent to be prepared to add to positions in companies that are financially strong and well managed.

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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.