Fourth Quarter 2018

Market Review Quarter 4, 2018


 What Worked in 2018                                                                            What Didn’t in 2018

Canadian Government Bonds                                                                           German Stocks

Technology Stocks                                                                                             Energy Stocks

REITs                                                                                                                 Chinese Stocks



Equity Markets Fourth Quarter% Change (in Cdn$) Calendar Year 2018% Change (in Cdn$)
S&P/TSX Composite -10.1% -8.9%
S&P 500 -8.6%  3.7%
MSCI/EAFE -7.5% -5.6%
MSCI/EM -2.2% -6.5%
TSX Energy -17.3% -18.3%
TSX Financials -11.3% -9.3%


Bond Markets Fourth Quarter% Change (in Cdn$) Calendar Year 2018% Change (in Cdn$)
FTSE  Canada Universe Bond Index 1.8% 1.4%


Seat Belts required? – FB

Well, that wasn’t much fun. 2018 in general, and the last quarter in particular, were anything but pleasant sailing for capital market investors.  And it didn’t much matter which market or security type as red ink dominated the landscape. The volatility in the fourth quarter was violent with 500 point swings seemingly the daily norm. Hardly an environment that engenders comfort.

It’s in times like these that investors benefit from an absence of peer pressure. Yes, everyone is claiming the sky is falling.  No, it actually isn’t.  Every market environment makes someone happy – when prices are rising clients are pleased as they feel wealthier but at the same time professional investors are getting worried as prices tend to rise faster than the underlying value of the investee corporation. Conversely, the professional is pleased by falling share prices as that allows for improved long-term purchases employing cash reserves whereas the client is scared because he believes his wealth is permanently disappearing.

The two groups are separated by emotion and time frame.  Individuals usually react emotionally. Professionals, if they react at all, are more rational and more readily see the long term.  It doesn’t make one right and the other wrong, but it does explain why many individuals are prone to “buying at the top and selling at the bottom”.

The recent volatility which, for the time being ended on December 24th, was caused by several factors: Not only were equity market valuations stretched and due for a downturn but the news was full of stories about Brexit troubles, China – U.S. trade issues, economic slowdowns in Europe and Asia, an expectation of rising interest rates in the U.S., middling Canadian economic activity, and of course instability in the U.S. political arena.  Hardly surprising then that the stock market was weak.

We have held and will continue to hold a conservative stance with plenty of dry powder for a rainy day. Meaning we have plenty of cash and fixed income securities, bonds mostly, at the ready should the U.S. economy weaken. That would seem to be a long way off, but several well-respected prognosticators are expecting a recession in the U.S. in the near future so unless and until the markets provide a good entry point, we will be retaining a conservative stance as we would rather be “wrong” by being too conservative, rather than “wrong” because we were too aggressive.  Ideally, we won’t be wrong but by staying conservative, all parties should be able to sleep a little easier.


Not Our Preferred Outcome – NL

Thank goodness we have moved into 2019! For investors, 2018 is a year we are pleased to put behind us. Following the worst December for global equities in history, the S&P/TSX Composite Index finished the year down 8.9% (total return), placing Canada at 68th out of 93 world stock markets. As poor as this sounds, it is an improvement over placing 72nd in 2017. Canadian stocks actually finished the year at approximately the same place they finished 2015, a lost three years. Even worse, Canadian stocks are approximately where they were in the fall of 2008. A true lost decade for Canadian investors. Proponents of Canadian index ETFs and mutual funds would have earned practically nothing had they held them for that full period, which is what they advocate. Active managers, like ourselves, took advantage of market swings to trade stocks and raise and spend cash, allowing us to make money for our clients despite a totally uncooperative index.  At the same time, the U.S. market, as represented by the S&P 500 index, total return in Canadian dollars, actually gained 4.2% for 2018 due to the decline of the Canadian dollar. U.S. returns have been enhanced for Canadians since September 2017, when the Loonie peaked at just below US$0.83. It finished 2018 at US$0.73.

We like to point out that we are global investors and historically, diversifying our equity investments to other countries and continents, has both enhanced returns and reduced portfolio risk. Not last year. There was no relief to be found in Europe and Asia, where the MSCI/EAFE index lost 9.6% ($Cdn total return).

Why did equity markets have such a rough time? Basically, the U.S. economy has been the strongest major economy and has been literally carrying the rest of the world. Bull markets don’t die of old age (the one in the U.S. has been going since March of 2009) but usually from the Federal Reserve Board (Fed) raising rates once too often and choking off their economy. Fears that the Fed has already made that move, (or will sometime in 2019) has caused stocks to fall in recent months. The same fears, concerning the Bank of Canada (BOC), have affected the Canadian market as well. The answer to everyone’s question: Is it too early to tell whether the downdraught in share prices is merely a correction or the beginning of a bear market? Like everyone else, we don’t know either but, by holding a larger than normal amount of cash in our clients’ accounts, we aren’t taking any chances.

One area of investment in particular should be addressed, and that would be preferred shares. More precisely, fixed-reset preferred shares. As I have explained in previous issues of Commentary, fixed-reset preferred shares pay a fixed dividend, which is reset every five years, depending on the yield of 5-year Canada bonds plus a percentage, which differs with each preferred issue. We own these shares in a number of clients’ accounts as a way to benefit from rising interest rates. Up until the end of September, these preferred shares were excellent investments, especially when compared to bonds. Things changed dramatically and swiftly in the fourth quarter as Preferred Shares finished the year down 13%-14% from their September highs. A perfect storm of events was the cause. First, interest rate differentials between government bonds and corporate bonds began to widen as investors sold corporate debt (and preferred shares) and moved their money into government bonds. This caused yields on government bonds, which everyone had expected to rise, to decline, which in turn caused prices of fixed-reset preferred shares to decline as the assumption of higher reset rates began to fade with the bond yield decline. A result of this was wholesale liquidation of ETFs that invest in preferred shares. The ETF liquidation took preferred prices down quickly as preferred shares are relatively illiquid and normally don’t trade much. Add in year-end tax-loss selling (their price drop bottomed on December 27, the last day for 2018 tax-loss selling) and we ended up having a horrific fourth quarter for this asset class. Again, like the stock market, we cannot predict the future, but there has been price recovery since year-end. We will watch how events unfold for preferred shares in the next few months but we are currently more inclined to lighten our positions in the hoped-for continued price recovery rather than adding to our existing positions.

Jason Trennert is CEO at our economic consultant in New York, Strategas, and he has come up with an investor’s wish list for 2019 which I have partially Canadianized (and added to) and listed below. It would be wonderful if most of these came true:

  • A Fed and BOC pause
  • A trade deal with China
  • Greater regulatory oversight of computer-based trading
  • More capital spending and less share buybacks
  • Real pro-growth policies in Europe
  • A real effort to stop the scourge of the opioid epidemic
  • Stock splits/greater volume from regular investors
  • Signs to world investors that Canada is actually open for business


Double, Double, Toil and Trouble – Is market forecasting worth the effort? – AC

With the new year upon us, market forecasters are busy offering us predictions of what they see coming in the year ahead. I won’t be making these kinds of forecasts – it’s impossible to know what the year-end closing level will be of the TSX or where U.S. interest rates will be at the end of 2019. For example, earlier in the fall of 2018, the market expected four interest rate hikes from the U.S. Federal Reserve in 2019. Today, expectations are for none.

Another example of forecasting comes from the tech world. In 2007, former Microsoft CEO, Steve Ballmer, said the following:

There’s no chance that the iPhone is going to get any significant market share. No chance.”

Looking back on this, with hindsight, in 2019, we know that the story unfolded differently. However, the news media only picked up on part of Steve Ballmer’s forecast. His full quote is as follows:

“There’s no chance that the iPhone is going to get any significant market share. No   chance,” said Ballmer. “It’s a $500 subsidized item. They may make a lot of money. But if you actually take a look at the 1.3 billion phones that get sold, I’d prefer to have our software in 60% or 70% or 80% of them, than I would to have 2% or 3%, which is what Apple might get.”

Though Steve Ballmer may have gotten the market share estimate wrong, he did get the profit-making call right: Apple has made a lot of money with the iPhone since 2007.

There are many problems with forecasts, but I’ll highlight just two. In Steve Ballmer’s forecast, people tend to flock to the headline-grabbing one sentence forecast, but ignore the nuances, subtleties and other details that may come with it, such as They (Apple) may make a lot of money. The second issue with forecasts is the fact that there are just too many variables involved. Let’s think for a moment about forecasting year-end interest rates in Canada – a good forecaster needs to know how the Canadian economy will do, how the global economy will do, the path of U.S. interest rates, etc. There are just too many variables involved and each of these variables require making estimates of items that in and of themselves are hard to predict.

As Yogi Berra once said, “it’s tough to make predictions, especially about the future.”

My conclusion when it comes to forecasting is to spend time elsewhere. That elsewhere is analyzing investments from the bottom-up, understanding companies and industries, evaluating competing investment options and understanding what implicit forecasts are being made in the analysis. The less forecasting and the simpler the forecasting involved, the better the investment tends to be.


Regime change – RD


2018 TSX quarterly returns.

1Q       -4.5%

2Q       6.8%

3Q       -0.6%

4Q   -10.1%

We have previously written that we felt the low volatility in the markets for 2017 would change and 2018 returns demonstrated that in spades. The abnormally calm markets of the last few years vanished and short term focused quarterly returns offering increased volatility are back.

We were anticipating some market weakness but were taken aback with the swiftness of the December decline. Some investors had been lulled into a false sense of market expectations despite signs that the market calm could not persist. For ourselves, we thought things were going well up until the end of September. Then started a sustained market sell-off culminating with the worst December in the markets since 1931. It is important to remember though that during a typical year stocks decline from a prior peak level by an average of 15%. Suffice to say the calmness of 2017 was abnormal.

Although we thought we were defensively positioned it wasn’t enough to avoid the broad global market sell-off. As Norman discusses above, our dividend paying preferred shares were particularly hard hit in the 4th quarter and did not cushion the pressure in the equities markets as had been hoped. Our bonds and cash provided insulation but could not sufficiently cushion the equity market decline. Asset mix was the key determinate for returns last year. Generally speaking, the more cash and high quality bonds, the better.

Economic cycles continue to exist. The decline in stock markets around the world during the fourth quarter moved a significant way towards pricing in an economic slowdown. Analysts expect declining growth rates going forward. Stock markets don’t like declining levels of sales and/or slowed earnings growth even though they may still be growing.  This matters more to valuations of high expectations stocks than to stocks already predicted to be slower steadier earnings growers.

After a swift decline in the fourth quarter, stocks appear to be pricing in an economic slowdown but are in no way pricing in a recession. If we are entering a recession stocks will continue to get cheaper but they will inevitably recover. Recessions usually play out relatively quickly while growth cycles last longer. As per Anish’s article above, there are too many variables to know which scenario will play out i.e. slowdown or recession.

I will, however, go out on a limb (despite the folly of forecasting) and make a call on a regime change. I suspect that the previous high growth stocks, Facebook, Apple, Amazon, Netflix and Google, (the FAANG’s) will no longer be the primary market drivers. Slowing growth hurts growth stocks. These so called FAANG stocks have led the market over the last 5 years and by 2017 were virtually the only stocks pulling up the S&P 500 stock market index. That is not to say their stock prices can’t go up, it is just that they won’t be key market drivers. With the market previously so narrowly focused on the FAANG stocks, good companies with solid but less exciting stories were ignored.  I believe that other companies, outside of the FAANG’s, will attract more investor attention and matter again as drivers of stock market returns.

We had some stock misses this last year but we also had some unheralded wins.  Having a portfolio of differentiated stocks helps. One such company is Gorman Rupp, an unassuming maker of industrial pumps. Up until Oct. 25, the stock was down, like most everything else, from its previous Dec. 31st levels.  However, on that day the company announced it was increasing its regularly paid quarterly dividend by 8%. This is its 46th year of consecutive annual dividend increases.  In addition, because the company has no debt, it also announced a special one-time $2.00 cash per share dividend payable to all shareholders. You may not have noticed the substantial one-time payment received in cash in December. Not surprisingly, the stock price also moved up on the dividend news and ended the year higher. With the announced increase in quarterly dividend and the one-time special cash dividend, our clients received an approximate 7% dividend yield from this stock in 2018 in addition to the stock price appreciation. This doesn’t generate front page headlines but we thought it was worth calling this one out.


Administrative Issues and Reminders – FB

The end of another calendar year brings some administrative issues to the fore.

Tax package – as usual we will be providing 2018 income tax information to clients or directly to their tax preparers. Unless otherwise informed we will deliver yours to the same address as last year.  If your tax preparer has changed, please remember to let us know. The package is due to be mailed by the end of February.

Contribution deadline(s) – the deadline for making an RRSP contribution and having it eligible for deduction against 2018 income is Thursday March 1 2019 but in order to avoid last minute confusion please have your contribution cheque or instructions to transfer from a cash account to your RRSP in our office by Monday February 25th.  The maximum RRSP contribution for 2018 is $26,230 and, if you are contributing “ahead” the maximum for 2019 is $26,500. If contributing by cheque, please make cheques payable to NBIN  (cheques made out to NBCN or National Bank cannot be accepted and will be returned. This could result in a missed contribution).

Each January Canadians are allowed to contribute additional funds to their TFSA. The 2019 contribution amount has increased to $6,000. We recommend that clients, assuming they have the financial means, do that across the board.  If we do not already have standing instructions to make your TFSA contribution from your taxable portfolio, please get in touch shortly. If contributing by cheque, please make cheques payable to NBIN  (cheques made out to NBCN or National Bank cannot be accepted and will be returned).

Should you wish to contribute to your portfolio, a trend we encourage by the way, this may be done by cheque (made payable to NBIN), from your bank account or by bank wire transfer.  Please contact us for further information if needed.

As always should you have any questions, concerns or would like more information on any topic concerning your portfolio or on “things financial” please get in touch.  We do enjoy catching up and doing our best to alleviate any worries.


Other Markets


Fixed Income December 2018 December 2017
Cdn 91 day T-Bills 1.67% 1.05%
U.S. 91 day T-Bills 2.42% 1.45%
Cdn 10 year Bond 1.95% 2.03%
U.S. 10 year Bond 2.69% 2.40%


Commodities (in U.S.$) December 2018 December 2017
Oil 45.41 60.42
Natural Gas 2.94 2.95
Gold 1281.30 1309.30



Currency December 2018 December 2017
Cdn/USD 1.3645 1.2568
Cdn/Eur 1.5642 1.5001

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