Market View



Market Review Quarter 4, 2017


 What Worked in 2017                                                                        What Didn’t in 2017                 

Canadian Dollar                                                                                             Natural Gas

Emerging Market Stocks                                                                               Energy Stocks

Non-Canadian Stocks                                                                                   Value Stocks


                                                                       Fourth Quarter                        Calendar Year 2017

Equity Markets                                         % Change (in Cdn$)                    % Change (in Cdn$)

S&P/TSX Composite                                               4.5%                                                    9.1%

S&P 500                                                                   6.8%                                                  13.8%

MSCI/EAFE                                                             4.5%                                                  17.4%

MSCI/EM                                                                 7.7%                                                  28.7%

TSX Energy                                                              0.7%                                                  -7.0%

TSX Financials                                                         5.7%                                                13.3%


                                                                       Fourth Quarter                        Calendar Year 2017

Bond Markets                                           % Change (in Cdn$)                    % Change (in Cdn$)

FTSE TMX Cda Bond Universe Index                        2.0%                                             2.5%

It’s No Mystery – RD

The holidays were a fun respite for my family this year.  I purchased a board game named Clue for under the Christmas tree.   For those of you who may not be familiar with this game, it involves guessing who committed a crime, with what weapon, in what room and brings back fond memories of playing it as a youngster.  After the excitement of unwrapping all sundry of gifts, my family gathered around the table in anticipation of playing.  I eagerly unwrapped the cellophane from around the game and we stared into the box with puzzlement.  The actual board for this board game had not been put in the box.  So, in fact, it turned out to be a disappointment, as you can imagine.

I relay the above year-end anecdote as we were disappointed with the modest year-end rate of return reflected in client portfolios as this was lower than the last few years.  Our goal is to strive for a healthy long term annual average rate of return.  Our investing approach is to achieve this increase in wealth over the long term while at the same time balancing this increase with minimal risk to both the initial capital and the portfolio increases gained from prior years.  Looking at our annual average rate of return since the market plummet in 2008, it was roughly in the upper single digit range for the typical balanced client portfolio.

With the uncertainty of how the markets would fair in the first year of Donald Trump’s U.S. presidency, we were content to be more defensively positioned to withstand negative market reactions.  Normally Presidents don’t have an outsized impact on economic policy, but Trump is not your typical President from the perspective of experience or temperament.  However, despite Trump’s dangerous Twitter rants, and an ‘I win you lose’ philosophy, the markets put governance and bipartisanship concerns aside to have a long run of smooth upward stock price moves.  The S&P 500 index did not experience a daily decline of even 3% for the entire year, breaking the prior record for low volatility streaks.  As a value investor we look for market drops to enter positions when they reach sale prices based on solid price to earnings valuations.  It is highly unusual to not have a number of these opportunities each year.  We purchased fewer new positions in 2017 compared to the typical year as a result of a lack of market pull backs that would have presented more attractive valuations.

Finding bargain opportunities when the stock markets are in their 9th year of recovery from the significant market drop in 2008 has proven challenging.  However, we believe that we are close to a reversion to the mean in market volatility which will provide us with more opportunities going forward than we have been seeing of late.

Our portfolios typically contain lower risk stocks, i.e. companies that better withstand market volatility.  These companies tend to have good balance sheets and more dependable earnings.  Steady, solid dividend paying stocks, although less glamorous, provided our clients with peace of mind during market declines in 2008, 2011 and 2015.  However, those type of stocks were not driving the market in 2017.  Technology stocks in North America were huge drivers pulling stock markets up and were responsible for 38% of the U.S. markets move up.  We did well with Taiwan Semiconductor (now sold) and we are optimistic about Qualcomm, its replacement, but that wasn’t enough to compete with the high-flying market drivers like Facebook, Amazon, Netflix and Google.  These stocks trade at inflated price to earnings levels and are factoring in a perfect operating environment.  However, the U.S. government has signalled that technology is their number one target for increased regulation.  That regulation can be expected to slow the growth rates of these companies which will not bode well for continued optimism in their share prices.

After 9 years of recovery it would seem to us that risk levels should be ratcheted down, not up.   We don’t believe the laws of investing have been suspended.  Making money seemingly easy (e.g. bitcoin) isn’t sustainable.  Piling in to stocks without research on traditional financial and quality metrics (e.g. marijuana) is high risk and speculative.  We want companies with a proven business model of making money, not a hoped for one.

The upcoming year looks promising in U.S. markets for our holdings.  A bona fide positive change for our equity positions occurred just recently. Trump was able to get a tax reduction package through Congress.  This will increase earnings for a whole host of companies that we hold, and high tax paying U.S. companies like Gorman-Rupp and our U.S. financial stocks will benefit.  It is hoped that higher resulting profits can be invested for a virtuous cycle of economic growth.  At some point lower U.S. government receipts due to reduced taxes will need to be met with lower government spending but that can is being kicked down the road.  Secondly, interest rates may finally be rising from historically low levels.  Last year concerns were for the opposite – deflation not inflation.  How far interest rates move is important in knowing how stock valuations will react.  High dividend paying stocks will be valued less favourably, if and as when rates rise, because there will be reasonable alternatives for fixed income that haven’t been available for some time given the lengthy low interest rate environment. There is some as yet unknown higher level of interest rates that will begin to pressure stocks.  Eventually, too high interest rates will lead us into the next economic downturn but, at these low levels, it does not appear imminent.  For right now, I worry more about something going awry with the leadership in the world’s largest economy and that valuations are not incorporating a cushion of safety.

Neither equities nor bonds are cheap relative to history.  Yet, lower U.S. tax rates will boost earnings for many of our U.S. holdings.  That’s helpful for price to earnings ratios.  A higher level of global economic activity will boost earnings for a number of our other holdings as well.  Looking forward, in the vast majority of years, earnings estimates at the beginning of the year fail to live up to optimistic expectations.  With that knowledge we expect, and are ready, for a resumption of good old market volatility.

We’re Number 72! – NL

As value investors, we are glad that 2017 finally came to an end.  And, as Canadian investors, we are also happy 2017 has ended.  Canada had the dubious honour of being the 72nd best performing market last year, and it would not have even been that high (pardon the pun) had it not been for the meteoric rise in the price of marijuana stocks.  The U.S. market, on the other hand, was one of the best but about half of its gains last year, for Canadians, were erased by the strength of the loonie.  Unfortunately, that trend has continued as about a quarter of the U.S. market’s gain so far this year has also been lost to our strong currency.  Actually, it’s more the U.S. dollar that is weak, as it is down versus almost all major currencies.

Hopefully 2018 will be kinder to us, both as value and as Canadian investors.  While 2017 was kind to growth investors in both the U.S. and Canada, unfortunately, that is not how we invest and we were not about to change our long-successful strategy because of a one-year anomaly.  Thankfully, as 2017 was ending, value stocks were finally starting to show some life and that has continued into early 2018.  Value investors didn’t suddenly get stupid last year.  Some years growth stocks perform better, some years value stocks perform better and some years they both perform well.  2017 clearly favoured growth investing.  While we are not happy that Canadian stocks, as measured by the S&P/TSX Composite Index were amongst the worst performers in the world, in a way we actually are happy as it demonstrates to investors that you can’t have all your eggs in a Canadian basket and that global diversification is not only a good idea, it is a must.  Hopefully, 2018 will be kinder to both value and Canadian investors but our expectation is for modest returns, so our emphasis on companies that increase dividends regularly, not necessarily those with high yields, will be even more important.

Administrivia – FB

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

Tax package – as usual we will be providing 2017 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.

Contribution deadline(s) – the deadline for making an RRSP contribution and having it eligible for deduction against 2017 income is March 1 2018 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 February 27th.  The maximum RRSP contribution for 2017 is $26,010 and, if you are contributing “ahead” the maximum for 2018 is $26,230.

Each January Canadians are allowed to contribute another $5,500 to their TFSA.  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.

Since I joined Portfolio Management our marketing efforts have best been described as similar to those of a professional practice.  Meaning, we let the world know we are interested in additional business and then respond to inquiries.  Again last year, even in spite of the market zigging while we zagged, our firm received a bunch of referrals from existing clients which was heartening.  A very sincere thank you to anyone who passed our name along.

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.

Abracadabra – Pulling Rabbits Out Of Hats? Making Money Out Of Thin Air? – AC

Many of you may not have heard of an investing area called venture capital.  But, you have heard of terms like blockchain, bitcoin, ethereum and cannabis amongst others.  These could be considered venture capital investments. Generally, more money flowing into an area tends to depress future investment returns.  And more money has certainly been flowing into venture capital.

The real question in venture investing is the following: will investors get their money back versus a return on their money?  Based on some industry statistics, almost two-thirds of the time, venture capital investors either just get their money back or lose money.  The investing issue relates to the ability to predict future cash flows with a reasonable level of certainty.  This is not easily done; hence, venture capital can be a tough place to make money.

It may be that the best time to do venture capital investing is when prices in venture capital markets are falling.  That doesn’t appear to be the case today.

An update on bonds:

In the Q3 newsletter, with respect to fixed income, we discussed subtleties and nuances, a phrase that certainly came to the forefront in Q4 with the lesson that even government bonds can be risky.  Puerto Rican bonds serve as the Q4 example.  Puerto Rico (an unincorporated territory of the United States) was struggling with its high debt load even before the tragic hurricane in the Fall of 2017.  The graph below depicts Puerto Rico’s debt struggles:

Puerto Rico

Source: Bloomberg

Puerto Rican bonds were originally sold at $100 with the promise of being repaid at $100 in the future plus annual interest payments.  Puerto Rican bonds did trade around that $100 value early on but as Puerto Rico’s debt levels rose while its economy stagnated, its bond prices fell.  The investment view now is that the promised $100 repayment will not be met. Bond holders are expecting less than $30 back.

When investing in bonds (or equities or in any area for that matter), there are always subtleties and nuances.  Even government bonds can become risky investments.

Other Markets

Fixed Income                                                       December 2017                        December 2016

Cdn 91 day T-Bills                                                          1.05%                                                    0.47%

U.S. 91 day T-Bills                                                          1.45%                                                    0.56%

Cdn 10 year Bond                                                           2.03%                                                    1.72%

U.S. 10 year Bond                                                           2.40%                                                    2.44%

Commodities (in U.S.$)                                        December 2017                        December 2016

Oil                                                                                        60.42                                                     58.80

Natural Gas                                                                           2.95                                                       3.74

Gold                                                                                  1309.30                                                1152.30


Currency                                                               December 2017                        December 2016

Cdn/USD                                                                         1.2568                                                   1.3425

Cdn/Eur                                                                           1.5001                                                   1.4119


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