“Successful investing is about managing risk, not avoiding it.”
– Benjamin Graham
A strong year for stocks despite risks
How a movie ends usually defines how viewers will remember the film; fortunately for stocks, 2019 ended the 2010s with a bang. After 2018’s lousy final quarter, markets saw strong returns, particularly in the States, with the S&P 500 index ending the year near all-time highs and achieving an average annual total return of 13.6 per cent for the decade. It is a sign of investor optimism, a lot of which likely has to do with normalizing relations between the U.S. and China, who recently signed their “Phase One” agreement on trade, bringing the gargantuan trade war one step closer to resolution. Furthermore, the U.S. saw a third consecutive year of above-potential GDP growth, and the U.S. jobless rate is near its 50-year low, both of which have caused inflation to finally tick higher. Canadian markets also had a good year, though the economy suffered from some transitory issues; lower U.S. demand in the last three months likely caused flat GDP growth for fourth quarter. That being said, Canadian unemployment remains low at 5.6 per cent, and we can expect to see the USMCA trade agreement ratified early this year, something that will boost activity.
Not all is rosy, however; central banks in both countries are reluctant to increase rates given high corporate debt in the States and Canadian household debt levels, which are above 2007 peaks seen in the U.S. Furthermore, global tensions remain a hot issue - Phase One is far from a comprehensive trade agreement, and the recent assassination of an Iranian Major General, and subsequent shooting down of a Ukrainian passenger airliner have caused severe unrest. The world economy was also underwhelming in 2019; GDP growth hit a 10-year low of 2.9%, with Europe being hit particularly hard by Brexit and U.S. tariffs, all the while low central policy rates have done little to boost inflation.
And of course, there is the elusive recession we have been hearing about for most of the past decade. On the one hand, some economists believe that we have successfully “extended” the boom stage of our current business cycle, but with debt levels high, interest rates already low and global relations still strained, many believe a downturn is waiting just around the corner. Either away, there is a popular belief that markets will be lacklustre this coming decade. Only time will tell; at least we have the 2010s to look back fondly upon.
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2019 started off with a rapid acceleration for Canadian stocks, coming off last year’s Christmas slump to push past all time highs throughout the year. The S&P/TSX Composite Index ($TSX) ended the year at 17,063, just below its previous watermark of 17,180 achieved in December and up an impressive 19.1 per cent for the year, 22.9 per cent after taking dividends into account. Every sector except for Health Care earned double digit returns, with both cyclical and more defensive sectors like Utilities faring well. Information Technology offered the largest growth by far, ending the year up an astounding 64.9 per cent; sadly, the sector makes up only 5.7 per cent of the TSX index compared to Financials and Energy, which make up 32.1 per cent and 17.0 per cent, respectively.
The U.S. saw a similar, yet slightly stronger and more volatile upwards trajectory. The S&P 500 index ($SPX) ended the year up 31.5 per cent (total return) in U.S. dollar terms compared to a 4.4 per cent decline in 2018. The loonie’s recent rally, however, lowers this figure to a still-impressive 25.2 per cent when measured in Canadian dollar terms.
Stocks had a good year outside North America as well. The MSCI EAFE Index ($MSEAFE) rose 22.7 per cent on a total return basis for 2019 despite mixed news across Europe. In London, for example, Boris Johnson won a majority government; while this locks the country in for Brexit 2020, it also ends the parliamentary stalemate. Even Chinese markets, proxied by the Shanghai Composite, did well despite ongoing trade tensions with the States, rising 22.3 per cent for 2019.
Fixed Income and Interest Rates
There were no changes to the Canadian benchmark interest rate in 2019, with the target rate staying at 1.75 per cent. Bank of Canada governor Stephen Poloz seemed reluctant to reverse course after last year’s upwards rally, and while trade tensions, housing and the oil sector continue to be concerns, the governor seems content with where rates currently sit. Meanwhile, the Federal Reserve in the U.S. was quick to pull rates downwards to help bolster inflation towards its target. After pushing rates upward in 2018 and holding the target range at 2.25 per cent and 2.50 per cent for the first half of 2019, the central bank cut rates three times to the 1.50 per cent to 1.75 per cent range. Jerome Powell, the central bank chair, has indicated that rates will stay at this level for the time being; any further escalations with China or Iran may change that.
Even with interest rates staying constant in Canada, bonds experienced positive performance in 2019, albeit to a much smaller degree than stocks. The FTSE TMX Canada Universe Bond Composite ended 2019 up 6.9 per cent, with longer-term bonds faring better than shorter bonds. It would appear that even with the stock rally we have seen, investors are still interested in holding safer assets.
Meanwhile, the yield curve is currently inverted in Canada, with 2-year and 10-year Government of Canada benchmark bonds offering yields of 1.68 and 1.64 per cent, respectively. In the U.S., the yield curve has normalized, with the 2-year rate falling to 1.58 per cent and the 10-year rate to 1.92 per cent, a positive signal for markets.
It was a good year for the loonie, with the Canadian dollar claiming the title of best-performing major currency against the greenback in 2019, ending the year at $0.770 USD/CAD, up 5.0 per cent. Much of this can be attributed to the Bank of Canada’s firm position on interest rates; with other world powers lowering rates, even a steady policy can lead to an appreciating dollar. To be fair, however, the loonie did also start from a low, hitting 73 cents last December, and with oil prices rising, speculation played a big role in bolstering our fossil fuel-dependent currency.
Canada saw its trade deficit narrow to $1.1B in November, down from roughly $3.8B at the beginning of the year. While the numbers were skewed by an eight-day strike at Canadian National Rail that halted shipments of oil, grains and potash, the deficit has remained below $2.0B since March, even achieving a surplus in May. Meanwhile, the USMCA agreement is mere steps away from ending North American trade tensions. While Mexico is still the only trade partner to have ratified the agreement, it has received bipartisan support in the States, and Canada may ratify the deal as early as this month.
Oil had a volatile year, but the West Texas Intermediate ($WTIC) ended 2019 at US$61.06 a barrel, up a hardy 34.5 per cent. Rising tensions in the Middle East were a key factor; in September, we saw a temporary spike after an attack on two major Saudi oil facilities, and we have seen a steady incline amid the deteriorating relationship between the U.S. and Iran, something that reached a breaking point this January when the U.S. assassinated Iranian Major-General Qassem Soleimani.
Gold prices are also a key benefactor of conflict, with many flocking to the metal to “escape” market risk in times of turmoil. After peaking around September, prices receded slightly, ending the year at US$1520.50, an 18.7 per cent return. The shiny stuff is far from its historical peak, having surpassed US$2,000 in 1980 and again in 2011, but it does signal investor pessimism, especially given its upwards movement so far into 2020; with stock markets still reaching all-time highs, it has indeed been a strange start to the year.
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.