“You can’t predict. You can prepare.”
–Howard Marks, Founder, Oaktree Capital
All-round a better than expected year
Like 2016 when U.S. voters ignored experts’ predictions, in 2017 investors clearly leaned against the naysayers’ outlook for stocks. Not even geopolitical tensions, devastating natural disasters, non-stop political drama in Washington, or tighter monetary policy rattled investors’ confidence as global equity markets delivered robust returns, with record low volatility to boot. The current market cycle lives on.
Markets drove higher on optimal macro-economic conditions. 2017 was a year of global synchronized growth, low inflation, and strong corporate profits. The ISM Purchasing Managers Index, an indicator of industrial activity, saw 97 per cent of countries showing expansion in factory orders for the first time in nearly 10 years. The International Monetary Fund expects global, gross domestic product growth to finish at 3.6 per cent for 2017, a level not seen since 2011. Corporate earnings were bolstered by the global economic upswing as the S&P 500 Index finished the year with around 12 per cent earnings growth. According to HSBC Global Asset Management Investment Outlook December 2017, over 90 per cent of global equity performance in 2017 can be explained by better corporate fundamentals.
In some regions more than others, many analysts worry over these lofty markets as global valuations reach above average levels. So, it is fair to wonder how long this run will last. It is as hard to know as ever. Markets, like a teeter-totter, tip as forces change on either end. On the up-side bottom-up conditions are ripe for continued modest earnings growth, given the supportive interest rate environment and low inflation. On the down side valuations are higher leaving less margin for error and lower potential returns. An appropriate level of caution, combined with discipline and a focus on quality businesses—are the tools we believe will best prepare for whatever may come.
As always, we thank you for your support and continued confidence in WDS.
After a sub-par start to the year, the Canadian market played quick catch-up. The S&P/TSX Composite Index ($TSX) closed 2017 at 16,209, up 6.0 per cent. Adding dividends, the TSX delivered 9.1 per cent total return to investors. Energy, the second-largest sector, finished with a negative 7.0 per cent total return, as oil-price volatility hampered the first half’s performance. Despite this, 2017 saw a 15-year high for job creation and strong consumer spending, fuelling an impressive 22.8 per cent total return from the consumer discretionary sector. Industrials also achieved a notable 19.7 per cent total return in 2017, despite trade concerns with the U.S.
America outperformed in 2017, with business investment spending hitting an all-time high. The S&P 500 Index ($SPX) ended the year at 2,674, slightly below its record high of 2,695 in December. In U.S. dollars, SPX earned a 21.8 per cent total return. However, foreign exchange risk factored prominently last year. Canada’s strengthening loonie lowered SPX total return to 13.9 per cent in Canadian dollar terms. Information technology and consumer discretionary led the charge earning an astounding 38.5 and 22.9 per cent ($U) total return, respectively. Powering results were the FAANG companies (Facebook, Amazon, Apple, Netflix, and Google) who all ended 2017 near all-time highs. U.S. financials recorded 21.5 per cent ($U) total return with lower taxes, higher interest rates, and deregulation benefiting the sector.
Despite uncertainties, international markets saw a stark improvement from 2016 levels. On a similar, uninterrupted trajectory as SPX, the MSCI EAFE Index ($MSEAFE) gained 17.2 per cent (C$) in 2017, including dividends. The Eurozone, Japan, and emerging economies all benefited from record trade flows. Government spending is also on the rise in China. The country continues to rollout its 5-year plan with social services, pensions, and healthcare coverage expected to see a boost.
Fixed income and interest rates
Bank of Canada Governor Stephen Poloz raised the benchmark interest rate by 25 basis points twice in 2017, doubling Canada’s policy rate from 0.50 per cent to 1.00 per cent. Poloz cited Canada’s stronger-than-expected economic performance in the year as reason for these hikes. The domestic yield curve (see Government of Canada chart) shifted upwards again this year with the 2-year and 10-year Government of Canada benchmark bonds closing 1.69 per cent and 2.04 per cent, respectively.
In the U.S., Fed Chair Janet Yellen will finish her four-year term in February 2018. Before leaving, Yellen hiked rates three times—March, June and December—ending at 1.50 per cent. Dr. Yellen cited a tight labor market (U.S. unemployment rate 4.1 per cent) and strong economic growth for these increases. In response, though, the U.S. yield curve flattened. The 2-year U.S. Treasury yield rose to 1.88 per cent, while the 10-year yield fell to 2.40 per cent.
Though bond demand modestly improved, the potential for 2018 rate hikes weighed on fixed income performance. The FTSE TMX Canada Universe Bond Composite Index earned 2.5 per cent return for the year. Longer term bonds fared better again this year, with the Long Composite Index achieving 7.0 per cent return. Longer term bonds face maturity risk and often reward investors for the added uncertainty.
The Canadian dollar started off continuing 2016’s downward trend, falling below $0.73 per U.S. dollar. As prices stabilized in the energy sector, the loonie rebounded. Our dollar also gained support from rising interest rates and low unemployment at home. The Canadian dollar ended the year at $0.80 per U.S. dollar, up 7.0 per cent.
A strong loonie theoretically leads to lower exports, as Canadian goods become more expensive for major trading partners. This seemed the case in November, as the Canadian trade deficit jumped from $1.6 billion in October to $2.5 billion. The Canadian dollar continues to be threatened by U.S. protectionism, as over 75% of Canada’s exports are sent to the U.S. Ongoing NAFTA negotiations are a focal point for 2018.
Oil had a dynamic year. In the first half, the West Texas Intermediate ($WTIC) light crude oil price fell from the US$53 per barrel level—achieved in 2016’s 45 per cent rally—settling at below US$43 per barrel in June. In the second half, a strong rebound, with inventories falling and OPEC extending its production cuts in November. WTI finished the year at US$60 per barrel, on the higher end of forecasts. While optimistic, analysts are cautious to label this level the new norm—short-term influences, such as Venezuela’s production issues and Iran’s protests, may have contributed to this recovery.
Gold experienced a bit of a redemption in 2017, too. The commodity climbed ($GOLD) throughout the year, finishing off at US$1309 or 13.6 per cent higher. This rebound may reflect the changing risk appetites of investors—with international tensions growing and cryptocurrencies demonstrating absurd volatility. In such times, the presumed safe haven properties of gold hold appeal to many.
This report is provided for your information. Conclusions and opinions given do not guarantee future events or performance. Facts and data provided are from sources we believe to be reliable, but we cannot guarantee they are complete or accurate. This report is not to be construed as an offer to sell or a solicitation of an offer to buy any securities. Before making an investment or adopting an investment strategy, each investor should review his investment objectives with their investment advisor. Watson Di Primio Steel (WDS) Investment Management Ltd. and individuals and companies who are related may, at any time, buy or sell securities that are hereby described in this report.