“Endurance is patience concentrated.”

– Thomas Carlyle

A year of volatility and uncertainty

In August, the current bull market became the longest running expansionary market in American stock history, turning 3,492 days old at the end of the third quarter. Just in December, however, the S&P500 came within 2 points of bear market territory, as the index experienced it’s worst December since 1931. It is needless to say that the current market is one of mixed signals and uncertainty. On the positive side, the labour market is still giving off encouraging signals. In December Canada’s jobless rate remained at its record low of 5.6 per cent while the U.S. added 312,000 new jobs, almost double the expected 177,000. Wages are also finally showing signs of improvement; in December hourly earnings increased by 2.0 per cent and 3.2 per cent y/y in Canada and the States, respectively.

Despite these seemingly positive developments, there’s no denying that we are entering the later stages of the business cycle. While the U.S. achieved above-potential GDP growth in 2018, CIBC is forecasting that the U.S. economy’s real GDP growth rate will slow from 2.9 per cent most recently to 2.1 per cent and 1.5 per cent in 2019 and 2020, respectively.

Central banks have also spent most of 2018 weaning the markets off of low interest rates, something that will likely put pressure on earnings growth near-term. Rate hikes have also contributed to the flattening of the yield curve, a negative economic signal that hurts the profitability of banks and can dry up credit availability. A flat (or inverted) curve is also known as a precursor to recessions, so its no coincidence that markets have tumbled as the slope has almost turned horizontal.

It is impossible to know for sure whether or not a recession is around the corner. Nonetheless, investors certainly seem to be trading as though that were a risk, with the anguish of Canadian energy companies, Brexit, and slowing growth in China only stoking investor pessimism. Not all is so dire, however; with the signing of the USMCA agreement, ongoing talks between the U.S. and China, and the revival of the Asia-Pacific trade agreement, trade tensions appear to be simmering. In lieu of guessing when the next recession will be, we’ll remain focused on high quality investments that should hold their own through thick and thin.

As always, we thank you for your support and continued confidence in WDS.

Equities

Canadian markets have been abnormally volatile this year, falling steeply in January and again in the final quarter of 2018. As a result, the S&P/TSX Composite Index ($TSX) ended the year down 11.6 per cent. Even after we take dividends into account, the index’s total return was a negative 8.9 per cent. Financials and Energy, which alone make up roughly half of the entire S&P/TSX Composite index, were down 9.3 and 18.3 per cent respectively. In fact, only three of Canada’s eleven sectors (Consumer Staples, Information Technology and Real Estate) achieved a positive total return in 2018.

Even the strong American economy was unable to avoid the widespread market pessimism. The S&P 500 index ($SPX) ended the year down 4.4 per cent (total return), a stark contrast to the 21.8 per cent achieved in 2017. It would appear, however, that weakness in the loonie more than offset this decline; in Canadian dollar terms, the S&P 500 achieved a positive total return of 3.7 per cent.

The MSCI EAFE Index ($MSEAFE) fell 13.4 per cent on a total return basis for 2018, reflecting protests in France, Brexit uncertainty, tighter financial conditions and trade tensions across the Euro zone. Meanwhile, Chinese markets, proxied by the Shanghai Composite, fell 24.6 per cent in 2018 as trade uncertainty plagued investor confidence, though talks with America and the current tariff truce may improve sentiment for the region.

Fixed income and interest rates

Interest rates saw significant movement in 2018. Domestically, Bank of Canada Governor Stephen Poloz hiked the benchmark interest rate 3 times, bringing the target rate to 1.75 per cent. South of the border, the Federal Reserve hiked their own rate four times in 2018, bringing their target range between 2.25 per cent and 2.50 per cent. Jerome Powell, the central bank’s Chair, continues to guide for two more rate hikes in 2019, though further hikes in both countries may be put on hold amid the ongoing trade tensions between the U.S. and China and the current oil glut in Canada. Rising rates tend to apply pressure on the economy, increasing the cost of debt for both households and corporations.

The FTSE TMX Canada Universe Bond Composite ended the year up only 1.4 per cent. Bond prices exhibit a negative relationship with interest rates, falling as rates increase. With central banks pursuing higher policy rates, it’s no surprise that the bond market has experienced supressed returns.

Yield curves have flattened in Canada and the U.S. At home, the 2-year and 10-year Government of Canada benchmark bonds currently offer yields of 1.86 and 1.96 per cent, respectively. In the States, the 2-year and 10-year bonds ended with yields of 2.51 and 2.69 per cent. A flattening curve is considered a negative market indicator.

Currencies

The loonie experienced its worst annual performance since 2015 this year, ending 2018 at $0.733 USD/CAD, down 7.8 per cent. The prime culprit appears to be the current domestic oil glut, which has compounded global weakness in the sector and more than offset the influence of rising interest rates, something that typically increases the value of a currency. Reflecting the bottlenecks in the energy sector, the price of Western Canadian Select hit a remarkable low of $11.43 (US$8.59) in November, a staggering 83.9 per cent discount from the U.S. WTI.

Canada’s merchandise trade deficit increased from $1.2B in October to $2.1B in November, reflecting the domestic oil price plunge and lower exports in eight of Canada’s eleven sectors. There has been some progress in improving trade for the country in 2018, however; the signing of the USMCA agreement seems to have largely removed the risk of a U.S.-imposed tariff on automobiles, something that would have been otherwise devastating for the two trade partners.

Commodities

Oil experienced a drastic inflection this year. At first, a rally; Q1 to Q3 of 2018 saw the West Taxes Intermediate ($WTIC) climb 21.1 per cent from US$60.42 to US$73.25, with some speculating that prices would finally return to US$100.00 a barrel. However, hopes of a sustained price recovery were quickly slashed in the last quarter of the year, as record output from Saudi Arabia/U.S. and rising production from Iraq dropped prices to US$45.41 a barrel.

Prior to the final quarter, gold prices were trending downwards, falling from US$1,303.46 at the start of the year to just above US$1,180.00 in August. However, the precious metal’s reputation as a “safe haven” investment seems to have helped prices recover. While the commodity is still down 1.7 per cent year-to-date, gold ended the year at US$1,281.34 and is trending back towards the US$1,300 price level.

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.