Jan 15, 2020

A Decade To Remember

In our Quarterly Commentary, our research team reflects on the last decade and one of its most interesting chapters: 2019. Our team analyzes the state of the market and provides their tactical strategy for the new decade.

As we raise our glasses and ring in the new year, not only do we wave goodbye to this year’s fourth quarter, but we also close the books on 2019 and welcome the beginning of a new decade. During the quarter, in the U.S., the S&P 500 surged almost 9% (6% in Canadian dollar terms), while in Canada, the S&P/TSX was up over 2%. This resilient close to the year pushed the S&P 500 to its best annual performance since 2013, up 29% (over 22% in Canadian dollar terms). As we embrace 2020 and the start of a new decade, we cannot help but reflect on the historic era that has now come to a close. Nearing the end of 2009, investors across the globe were just emerging from the wreckage of the global financial crisis. Few could have foreseen what the next 10 years would bring for the world’s largest economy—a now infamous bull market and record long economic expansion embarking on its 11th straight year. This has also been the first decade in U.S. history without a recession. Now, at the close of 2019, the U.S. market is flirting with its all-time high, nearly triple the level of the index at the end of 2009. While it has been a decade to remember, one of the most interesting chapters was one of the most recent: 2019.

 

Following a difficult end to 2018, investors entered the new year staring up at a towering wall of worry. Coming into the year, the U.S. market was expecting up to four interest rate hikes during 2019. With plenty of recession chatter and trade war worries ebbing and flowing, the U.S. Federal Reserve (the Fed) made a dramatic pivot in early 2019, taking on a more ‘dovish’ tone and eventually choosing to cut interest rates three times throughout the year. While some flags still flashed red throughout 2019, including the inversion of the yield curve and continued uncertainty surrounding the U.S./China trade tensions, growth in the U.S. economy carried on, slowly but surely.

 

Closer to home, as we have discussed before, “as goes the U.S., so goes Canada”. While the saying still rings true, this was not the case for interest rate actions this year. Contrary to the global trend of interest rate cuts in 2019, the Bank of Canada (BoC) chose to sit on the sidelines leaving rates unchanged during the year. While the Canadian economy boasted a strengthening housing market and a historically low unemployment rate, the household debt level of Canadians is high and this could be a challenge in the future. In all likelihood, the BoC will remain seated on the bench during 2020, but a heavy reliance will remain on fiscal stimulus to offset not only the local, but the ongoing global headwinds being faced worldwide.

 

More recently, while this year’s fourth quarter brought a wave of resolutions including a phase one trade deal between the U.S. and China, a British election clearing the path for some Brexit certainty, and a signed U.S.-Mexico-Canada Agreement (USMCA) for North American trade, each comes with its own asterisk carrying more questions into the new year. Contrary to last December when investors were staring down the barrel of a bear market amid a world of uncertainty, we close the year with progress in the books and some indications of a stabilizing global economy.

As we enter a new quarter, a new year, a new decade, our mantra remains the same – stick to the long-term plan and stay the course.

 

Commodities/Currency Performance
   Q4 - 19 QoQ YoY 2018
 WTI Oil (USD/bbl)  61.06 12.9% 34.5% -24.8%

 Gold Spot (USD/oz)

 1,517.27 3.0% 18.3% -1.6%
Copper (USD/lb)  2.80 8.5% 6.3% -20.3%
 USD/CAD  0.7698 1.9% 5.0% -7.8%

Source: Bloomberg

 

Fixed Income 

2019 was a very eventful year in fixed income that saw many gyrations. Going into the year most pundits felt rates would rise and returns would be muted. As the dust settled the Canadian bond market had a fantastic year with gains near 7%. So what changed?
During the fourth quarter, the U.S. Federal Reserve (the Fed) cut interest rates by 0.25% for a third time this year, bringing the annual total to 0.75%. In Canada, the Bank of Canada (BoC) left rates unchanged during the year’s final meetings, leaving interest rates in Canada unchanged for the entire calendar year. As we begin the new year, expectations are for the BoC to give a repeat performance with no interest rate changes in 2020. In the U.S., at the Fed’s December meeting, officials cited a decreased chance of recession in the upcoming year due in large part to this year’s three interest rate cuts and a recent easing in trade tensions. This improved outlook supports the Fed’s current expectation that they will likely not need to cut interest rates further in the coming year though they remain highly aware that any extreme intensification in global tensions could have them changing their tune yet again.

 

Also making headlines this year was the yield curve inversion. In the U.S., after briefly inverting in March, the U.S. Treasury 3-month/10-year yield curve inverted in mid-May and, except for one day in July, it remained inverted until early October, a total of four and a half months. This created a lot of anxiety for investors because, as we have discussed a multitude of times the past year, the inverted yield curve can be a sign that a recession may transpire in the short-term future. While this indicator has been one of the most reliable throughout history, we believe it is key to note the altering effect that years of quantitative easing has had on the shape of the yield curve.

 

As of the end of 2019, there was about $11 trillion in debt worldwide yielding negative interest rates. This means that the person or entity that owns the debt and holds it to maturity will receive an overall negative return on their investment. One result of these negative interest rates, which are found almost exclusively in Europe and Japan, is that these international investors are fleeing to buy longer term U.S. Treasuries just to receive a positive return. As more and more investors continue to buy U.S. Treasuries, this increases their price and lowers their yield. As a result, the U.S. 10-year may have fallen to a lower yield than it normally would. While we continue to closely monitor the state of the yield curve as it remains a key piece of our decision-making process, we would be remiss to note that this may not be our grandparent’s yield curve.

 

Since early Q4 and as we enter 2020, the U.S. yield curve has remained un-inverted and is now upward sloping from 1-month Treasury bills all the way to 30-year bills. We foresee the yield curve continuing to steepen throughout the new year as global growth stabilizes and we remain in our stance that we do not see a recession on the horizon. We continue to favor non-sovereign bonds as we feel they give us fair compensation for the additional risk.

 

Rates are itemized in the following charts:

 Canada
  Q4 - 19 QoQ YoY
3 Month T-bill 1.66% +0 +1
2 Year Bond 1.70% +12 -17
10 Year Bond 1.70% +34 -27
 U.S.
  Q4 - 19 QoQ YoY
 3 Month T-Bill 1.54% -26 -81
 2 Year Bond 1.57% -5 -92
 10 Year Bond 1.92% +25 -77

Source: Bloomberg

 

Equities

Following three strong, positive quarters, the S&P 500 continued its surge in Q4, posting a return of 8.5% and ending a banner year up almost 29%. In Canada, the S&P/TSX Composite was up 2.4% in the quarter, leading its year-to-date return to over 19%, the index’s largest annual gain since 2009.

 

 Stock Indices Performance
 Country/Region Index Q4 - 19  QoQ YoY 2018
 U.S. S&P 500 3,230.78 8.5% 28.9% -6.2%
  S&P 500 (in $C) 4,192.91 6.4% 22.8% 2.0%
Canada S&P TSX Composite 17,063.43 2.4% 19.1% -11.6%
Eurozone Euro Stoxx 50 3,745.15 4.9% 24.8% -14.3%
Japan Nikkei 225 23,656.62 8.7% 18.2% -12.1%
China Shanghai Composite 3,050.12 5.0% 22.3% -24.6%

*returns based on price performance ex dividends
Source: Bloomberg

 

Canada: During the fourth quarter, the Information Technology sector led the way up 10.8% while also solidifying the top performing spot for 2019, posting an incredible 63.5% return. This eye-popping performance is primarily due to a triple-digit percentage gain in Shopify, a Canadian e-commerce platform. On the flip side, the Healthcare sector continued its nose dive, down 6% in Q4. The Healthcare sector was the only major sector to post a negative return for the year, down 11.4% in 2019 due almost exclusively to Cannabis stocks as sales were weaker than investors had anticipated and industry regulations continue to evolve.

 

Another performance of note during the year was the Canadian dollar. Much to the delight of the many Canadians that travelled south of the border this year, the loonie was the best performing major currency in 2019, notching a gain of over 5% against the U.S. dollar. This strength was due in large part to the Bank of Canada boasting among the highest benchmark interest rate in the advanced world, coupled with the banality of Canadian politics. This support was able to counter the headwinds of unsteady oil prices and ongoing trade uncertainty.

 

Regardless of the global havoc sending shockwaves across the world, throughout 2019 the Canadian economy continued to show its resilience. After a slump in 2018 due to new, tougher mortgage rules and higher interest rates, the Canadian housing market strengthened throughout the year fueled by lower mortgage rates, a strong labor market, and population growth. While the economy remains relatively robust, one area of vulnerability is Canadian private debt. As we know, the BoC did not follow in the footsteps of the Fed with any interest rate cuts in 2019. This decision was due in part to the fact that outlook was not nearly dire enough to justify the risk that lowering interest rates may result in another credit binge for Canadians.

 

Coming into the new year, we expect the Canadian economy to continue its slow growth and the BoC to remain steady. While uncertainty still looms globally and some economic concerns remain, we are optimistic of several areas of the Canadian market for 2020 including a possible ratification of the USMCA, ramping up of the construction of the Trans Mountain Pipeline expansion, gradual lifts on Alberta oil production curtailments, a continued revival of the housing market and stimulus from fiscal policy.

 

U.S.: Similar to Canada, the Information Technology sector not only was the best performing sector in the S&P 500 in Q4, up 14%, but also posted the strongest annual return for 2019, up over 48%. This surge in the tech sector was led by gains in Apple (up 80%), Microsoft (up 55%) and several climbing semiconductor stocks. Posting the weakest quarterly performance was the Real Estate sector, the only negative sector in Q4, down 1.3%. For the year, all major sectors within the S&P 500, except Energy, posted solid double digits returns.

 

Considering the outstanding year for the U.S. market, it is interesting to look into what led to these strong gains. When a stock rises, it can be a result of one of two things: multiple expansion, meaning investors are willing to pay more for the stock, or earnings growth, the company is earning more money. In the case of 2019, almost all of the growth in the U.S. stock market was due to multiple expansion. Investors were willing to pay more for company’s stocks this year notwithstanding a year of essentially no earnings growth. Looking into 2020, to see a rise in the stock market, we believe returns must come primarily from corporate earnings growth as multiples remain stretched.

 

While fearing to sound like a broken record throughout 2019, the U.S./China trade war shook markets worldwide and remains a key concern in the global landscape. During the quarter, a phase one trade deal was reached with expectations of it being officially signed in early January. While this agreement has eased tensions for now, and negotiations of a phase two deal are expected imminently, we do not expect the trade war to be completely resolved in the near term.

 

Adding to the spectacle surrounding President Trump, this year’s fourth quarter saw the House of Representatives vote to impeach the President on charges of abuse of power and obstruction of Congress. The stock market has continued to shrug off the news as the Senate gears up for the impending impeachment trial, but the Republican-controlled Senate’s numbers mean it is almost certain Trump will be acquitted.

 

Entering 2020, the theme of unending political commotion will no doubt continue. Taking center stage, the U.S./China trade conflict, an impeachment trial, and now, a U.S. election year. We expect to see political uncertainty gradually ramp up as November 2020 nears. Riding on the back of the longest bull market in U.S. history, this array of geopolitical uncertainties will likely be the make or break of another positive year for the U.S. economy.

 

International: International markets posted strong positive returns during this year’s fourth quarter. Of the major global equity markets, Brazil’s Bovespa index showed the best performance, returning 10.4%. As we closed the books on 2019, all major international markets worldwide boasted positive annual returns.

 

During the quarter, British citizens hit the polls and elected Boris Johnson as their new Prime Minister, supplying him a solid majority. Many have labeled this vote as an almost pseudo referendum on Brexit with Johnson’s powerful mandate to get Brexit done clearly speaking volumes. With Johnson at the helm, expectations are for the divorce deal to be done before the end of 2020, erasing a great amount of uncertainty that previously has plagued the U.K. market.

 

Despite the global economic commotion surrounding the U.S./China trade war, Trump’s impeachment inquiry, the continuing Brexit news, and the approach of a U.S. election, markets worldwide posted some of the highest annual returns seen within the decade.

In Canada and the U.S., GDP continued its climb in 2019 and we expect 2020 to be another year of slow growth. While we continue to believe that a recession is not impending, the risks do remain prominent. Reflecting these views, our tactical asset mix shift slightly out of equities remains in place and the portfolio remains in a slightly more defensive stance. While risks in the international market constantly rise and fall, we maintain our focus on high quality companies with strong balance sheets, low leverage and stable earnings and cash flows.