Third Quarter 2018



What Worked                                                                     What Didn’t

U.S. Stocks                                                                                Canadian Energy Stocks

Health Care Stocks                                                                    Gold Stocks

Japanese Stocks                                                                        Long Bonds



Equity Markets                                                                    Third Quarter 2018 % Change (in Cdn$)              

S&P/TSX Composite                                                                    -0.6%

S&P 500                                                                                        5.8%

MSCI/EAFE                                                                                  -0.3%

MSCI/EM                                                                                      -2.7%

TSX Energy                                                                                  -5.7%

TSX Financials                                                                              3.8%


Bond Markets                                                                       Third Quarter 2018 % Change (in Cdn$)              

FTSE TMX Cda Bond Universe Index                                          -1.0%



                                                                                    What is Keeping Me Up At Night – NL

The outperformance of the Canadian stock market, as represented by the S&P/TSX Composite Index, was a pretty short-lived event as Canadian stocks once again showed a negative return for the third quarter (-0.6%). Year-to-date (to the end of September) Canadian stocks are up a staggering 1.4% (sorry for the sarcasm), but if you strip out dividends, they are actually negative on a price only basis. It gets worse. Only three sub-groups are positive year-to-date: Information Technology, Real Estate, and Health Care, which is up 29.1% due almost exclusively to cannabis stocks. Without marijuana, the TSX wouldn’t be high at all (sorry again). A difficult environment for investors to make money.

Was there any place to invest that did make money for investors? The only major market to be up to any degree has been the United States where, in Canadian dollars, total return is up 14.1% YTD as represented by the S&P 500 index. Even there the opportunities have been scarce, especially for value investors, as a select group of growth stocks have contributed most of the gains, so far.How about fixed income? Well, with interest rates on the rise, returns there have been hard to come by as well. The Universe Bond index is down 0.4% (total return) so far this year as bond prices have declined as rates have risen. The interest paid on bonds has helped moderate that loss.

Our response, for clients who hold bonds, has been to minimize our holdings to below historic levels and keep our maturities short. Most clients’ bonds mature in 1 to 7 years with most of those maturities 3 years and shorter. That protects portfolios from large losses should interest rates rise substantially and gives clients a chance to reinvest at higher rates in the next few years. Preferred shares have actually been a better investment, so far, with the S&P/TSX Preferred Share index up 2.3% YTD. We own preferred shares in many of our portfolios.

I tell people that I have been in the investment business for over 42 years. Actually, I have been in it longer if you include my brief career (15 months), right out of university, as a retail broker in 1973 and 1974. It’s a period I don’t talk about much as retail brokers are sales people, not investment professionals, and I just like to talk about my experience as an investment professional. If you are wondering why I had such a short sales career it is quite simple. I was 21, right out of university, who knew very little (I majored in Sociology and Political Science) and knew very few people with money to get as clients. Also, I finished my training just as the Arab oil embargo began, setting off a chain of events including sharply rising oil prices, increasing commodity prices, higher interest rates (which didn’t peak until 1982), stagnating economies and rising inflation (the term Stagflation was invented then). This led to me going to work every day and seeing stock prices go down and bond yields go up. I forgot to mention that trading volume dried up to the extent that an average day on the Toronto Stock Exchange was 500,000 shares and on the New York Stock Exchange 5 million shares. Hence, I didn’t stay in that end of the business very long.

Why am I talking about my past, now? Well, they say that history doesn’t repeat itself but it rhymes. Lately, I have been having trouble sleeping and it isn’t because I am worried about how the World Series will turn out. What worries me mainly are two things. First, the staggering amount of debt in the world, which is highly dependent upon interest rates remaining low. Second, an event, who knows what it is yet, that will catch the world by surprise with unknown political and economic consequences. The second is impossible to quantify before it happens and it is usually something that unexpectedly spirals out of control. At the time of writing, the controversy over the death of a Saudi journalist, allegedly by the Saudi government, could ultimately cause oil prices to spike and bring on higher inflation and cause world economies to slow or bring on a recession. Way too early to tell. Nobody knows until something like this actually happens.

The debt problem is much easier to quantify. Because interest rates around the world have been at record low levels (some even negative) since the financial crisis 10 years ago, governments have been on a borrowing binge, driving up debt to GDP levels, in many cases, to very uncomfortable levels. In Canada, provincial borrowers have been the most egregious, piling on debt at an astounding rate such that there are certain provinces whose bonds we would not currently touch as investments. Corporate debt, especially from lower quality borrowers, has also been growing and many of those borrowers are quite dependent on the economy remaining robust and interest rates staying low. Finally, there is household borrowing. Ultra-low interest rates have caused Canadian households to view their homes as piggy banks (like in the U.S. before the financial crisis), maxing out their Home Equity Lines of Credit (HELOCs) as interest rates are so cheap, so why not?

Well, the why not is the potential for interest rates to go up. A lot. And there is a whole generation of homeowners, politicians, and investment professionals who have never experienced inflation or rising interest rates. It’s been 36 years since interest rates peaked. In Toronto and Vancouver, home owners have experienced sharply rising housing prices for a very long time, long enough that again a whole generation of homeowners, realtors, and bankers don’t remember the early ‘90s when home prices collapsed and people were offside on their mortgages.

I’m generally an optimist and I hope none of this actually happens. I usually sleep very well but recently this is what has been keeping me up at night. So far, our investment reaction has been, as mentioned above, to keep fixed income allocations historically low and short. Our reaction on equities has been to remain value oriented, widely diversified, and not chase hot stocks at unreasonable valuations. Our job is not to look for home runs (e.g. cannabis stocks) but to protect our clients’ capital and hit singles that sometimes go for extra bases. It’s not fancy and sometimes boring and even frustrating, but in the long run it works. But because we have been in the business long enough to know that it isn’t always a Goldilocks market, we are prepared to act if necessary.


                                                     Identifying Bubbles (not those made with soap and water) – AC

Making investments is difficult, and it becomes much more so when there is a Bubble in a particular investment area. This is because it is very easy to see where quick money is being made versus taking a patient long-term research-driven approach.

It appears that at any one time, there is a Bubble in some area of investing. Though it is difficult to say how long a Bubble will last, perhaps there is a way of diagnosing whether a particular investment sector is in a Bubble.

I recently ran across Robert Shiller’s checklist for identifying Bubbles and I found it enlightening. For those who are unfamiliar with Robert Shiller, he is an economics professor at Yale University and also a Nobel laureate. Mr. Shiller’s checklist is in Table 1 below:


 Table 1: Robert Shiller’s Bubble Checklist

a)      Sharp increases in the price of an asset like US real estate prior to 2008 or dot-com shares in the    late 1990’sb)      Great public excitement about said increases

c)      An accompanying media frenzy

d)      Stories of people earning a lot of money, causing envy among people who aren’t

e)      Growing interest in the asset class among the general public

f)       “New era” theories to justify unprecedented price increases

g)       A decline in lending standards

Source: Adapted from “Shiller’s List: How to Diagnose the Next Bubble”, The New York Times, January 27, 2010

Using this list, it is easy to spot Bubbles when we look back in time. Cryptocurrency could be said to have been in a Bubble in 2017.

Can we use this checklist to see what Bubbles exist today? Cannabis?



Other Markets

Fixed Income                                                         Sept 2018                                June 2018

Cdn 91 day T-Bills                                                           1.55%                                            1.25%

U.S. 91 day T-Bills                                                           2.18%                                            1.94%

Cdn 10 year Bond                                                            2.41%                                            2.13%

U.S. 10 year Bond                                                           3.05%                                            2.85%


Commodities (in U.S.$)                                       Sept 2018                                 June 2018

Oil                                                                                     73.25                                              74.15

Natural Gas                                                                        3.09                                                2.92

Gold                                                                              1196.20                                          1254.50


Currency                                                               Sept 2018                                 June 2018

Cdn/USD                                                                          1.2899                                         1.3133

Cdn/Eur                                                                          1.50465                                         1.5336

© Portfolio Management, All rights reserved.
Powered by: Qualikom.