In December, global markets closed a very good year in 2019 on another good month. The flagship US market index, the S&P 500, posted a +0.7% ($CAN) performance in December to end the year up +25.2% ($CAN). S&P/TSX’s performance in the Canadian market was more modest at +0.5%, but the Canadian index still finishes 2019 up 22%.9%. For their part, international equities and emerging market equities ended 2019 with December returns of +0.9% (MSCI EAFE, $CAN) and +5.1% (MSCI EM, $CAN) and annual returns of +16.8% ($CA) and +13.2% ($CAN), respectively. In terms of the Canadian bond universe, although the return for the year was more than respectable at 6.9%, the month of December was more difficult with a negative performance of -1.2% after the interest rate turnaround, notably the 5-year rate which increased by +0.2% during the month.
2019 was a year in which market performance contrasted sharply with the climate of geopolitical uncertainty. Nevertheless, 2019 is a good example of the anticipation that financial markets can exhibit. Indeed, the expansion of the price/earnings multiple explains almost all of the performance for various regional indices, as per an analysis by the US bank JP Morgan. In some regions, particularly Japan and emerging markets, there has even been a decline in earnings. An upward movement in multiples indicates that investors anticipate an improvement in future conditions and vice versa for a contraction. In 2019, the support of the central banks to counter the manufacturing slowdown coupled with signs of a detente in trade-related tensions with a partial agreement between China and the United States are two factors that contributed to the moderate upturn in optimism occurring this fall.
Where does that leave us for 2020? The various markets, including the US market, are again at historically high levels of valuation, similar to those reached at the end of 2017. It is therefore important that actual results eventually reflect the positive expectations that pushed the markets up at the end of 2019, otherwise multiples could contract. On the Central Bank's side, the Fed has announced that for the moment, the three rate cuts of 2019 should suffice and that it is observing how things develop. On the trade front, under normal circumstances, you could expect that things would dial down a bit during an election year in the US, but the current American administration has accustomed us to unexpected behaviors. On the economic front, the service sector continues to support growth in the major developed countries for the moment and some figures from Asia, including Korean exports, seem to indicate some stabilization. We therefore continue to advocate a disciplined and prudent approach.
With the decade just ending, a look back to what has happened is in order. For financial markets, the strong performance of the US market was impressive with an annualized performance of 13.6% (S&P 500, US$) well above other regions. In comparison, the Canadian TSX posted an annualized return of 6.9% (CA$) over the decade, just ahead of international equities (+6.0%, US$) and emerging markets (+4.0%, US$). Will the next decade be similar? They rarely are, and we can be sure that a few surprises are waiting for us. With that, we wish you all a prosperous and healthy 2020.
In November, developed countries’ equity markets responded favourably to the US-China trade negotiations. The US and Canadian markets dominated with returns of +3.6% each in their respective currencies. The VIX fear index quietly declined to its lowest closing level in 15 months (November 26). In 20 trading sessions in the US (21 in Canada), the S&P 500 Index closed 14 times at a higher level than its previous day’s close (the S&PTSX 15 times). In doing so, the American index broke its record 11 times and the Canadian index did the same 8 times. International equities also performed well (+1.1% for the MSCI EAFE $ US), however, they are 21% below their pre-financial crisis record of October 31st, 2007 (in $ US). To illustrate the impressive return gap between markets, US equities surpassed their pre-crisis peak by 101% (13% for Canadian equities).
Recent employment statistics in the US contributed as well to market performances. Despite the strike at General Motors (more than 40,000 strikers), 156,000 new jobs were created in October and 266,000 in November (return of strikers). In addition, this statistic for the month of September was revised upward by 44,000 to reach 180,000 new jobs. The unemployment rate has fallen again to 3.5% and according to Bloomberg this statistic will reach 3.3% by 2020. If this is the case, it will be the lowest unemployment rate in an election year since Republican Dwight Eisenhower’s victory in 1952.
Jerome Powel, Chairman of the FED, announced that he saw no imminent risk to the US economy which is now in its 11th year of expansion and its Q3 growth has been revised upward (2.1% versus 1.9%). However, he would like to see the US Congress improve the budget deficit in order to replenish the toolbox for the next recession. In the eurozone, economic growth in Q3 remained unchanged at +0.2%. A heavyweight of the eurozone, Germany, narrowly avoided the technical recession in the last quarter (+0.1% in Q3 and -0.2% in Q2). The pressure on German policy makers is increasing to break the “black zero” policy during this difficult period for manufacturing production.
To recap on the trade negotiations, markets were anticipating a partial agreement by the end of the month. Negotiators from both nations indicated that the lifting of certain tariffs would follow a partial agreement, of which China is in need for, as its exports to the US market are at their lowest level of the past three years. The latter has withdrawn the ban on imports of American poultry. However, it is expected that the Trump administration will impose new tariffs of 15% on $160 billion of new Chinese goods on December 15 if no agreement is reached. The market is anticipating a last-minute agreement or the extension of the deadline, of which we’ll know the developments very soon.
Equity markets carried over their positive performance from September in October, with the exception of the Canadian S&P/TSX which returned -0.86% ($C) during the month. Emerging markets, international equities and US equities all reported strong numbers with performances of 4.23% ($US), 3.6% ($US) and 2.17% (US) respectively. On the Canadian fixed income side, the overall bond universe performance was slightly negative at -0.17% whether the shorter-term universe returned a positive 0.22% for the month. This divergence can be explained by a slight steepening of the yield curve where maturities of 5 years and beyond saw rates increased slightly whether rates on maturities below 5 years stayed flat or decreased slightly. This trend of increasing rates for longer-term maturities is still ongoing in November in most developed markets (Canada, the US, Germany).
A change in narrative occurred in the market toward the end of August. This narrative is fuelled by a few themes feeding off each other. Firstly, renewed and ongoing trade optimism in the US-China trade front with the so-called phase 1 agreement hints at a potentially improving situation in the future. Secondly, we have global central banks entering into support mode to help a slowing industrial sector by easing monetary conditions, just as they did over the last 10 years for the overall economy. On this front the Bank of Canada is the exception by staying put. Finally, there are signs that some economies are stabilizing coupled with talks of fiscal support from governments, notably in Europe. Add all of this together and you get a lower US currency which tends to help emerging economies as well as improving growth prospects which in turn supports cyclical sectors where valuations were depressed, hence the better recent performance from Value equity managers versus their Growth counterparts.
With all of the above, we believe it is better to remain prudent. We keep questioning ourselves on the marginal impact that monetary policy can have after 10 years of extensive use. However, in the end what still matters for markets is how well or poorly companies are doing. On that front, with almost all numbers for the third quarter published in the US, Canada and Europe, we can gauge the situation. Overall, reported sales and profits were generally in-line with expectations, but quarter on quarter growth was weak, flat to slightly negative depending on the region. Thus, results aren’t stellar, but aren’t indicating the sharp slowdown feared in the summer. Consequently, it is reasonable to expect the global economic situation to stabilise going forward and have a moderate rebound over the next few quarters.
Led by international equities, major stock market indices rebounded in September. Canadian equities reached a historic record close of 16.899 points on the 20th and returned +1.7% (in $C) for the month. Canadian bank securities benefited from a steepening of the yield curve and returned +7.3% (as they borrow in the short term and lend in the long-term market). Energy stocks performed very well, especially the Canadian oil and gas exploration and production subsector that returned +11.6%. That said, portfolio managers with a “value” management style performed particularly well. Global value equities outperformed growth equities by +3.5%. The important gap in valuations between these two styles has become difficult for bargain hunters and strategists to ignore and a moderate price correction occurred during the month.
The equity market responded favourably to the announcement that the US and China would meet in Washington on October 10th for a 13th round of negotiations. In acts of goodwill, both nations have been mitigating their tariff interventions. The United States delayed a tariff increase originally scheduled for October 1st until October 15th, and China gave the green light to its companies to acquire American agricultural goods, notably pork and soybeans. According to Bloomberg Economics, the impact of not reaching an agreement by 2021 is estimated at -0.6% on US economic growth, -1% on China’s growth and -0.6% on the world economy’s growth. If an escalation of this trade war involving tariffs of 30% on all exchanges were to arise, the impact on growth would be -1.4% in the United States, -2.1% in China and -1.3% for the world.
Aware of the consequences of this trade war, the FED and the European Central Bank (ECB) intervened again. It was a divided FED committee that reduced its target rate range to 1.75-2% (down 25 bps). Citing the strong labour market as well as the resilience of consumer spending, the FED still sees a favourable economic outlook for its economy which grew by 2% in the 2nd quarter. This second and possibly final rate decrease for the year is considered an additional insurance policy. In the eurozone, economic growth is barely observable: 0.2% in the 2nd quarter and 0.1% of expected growth for the quarter just ended. As mentioned in our August market review, Germany is suffering from the weakness of the manufacturing sector and the ECB intervened in September by lowering its policy rate to -0.5% (10 bps decrease). It has also restarted the quantitative easing program as it will start buying back 20 billion euros worth of government bonds each month.
These events improved the slope of the interest rate curve, increased rates and the Canadian Bonds Universe lost -0.8%. All in all, although the stock markets took advantage of easing trade tensions and appreciated the measures central banks are taking, they remain very sensitive to the developments of the trade war.
Markets started August on a strongly negative note before recovering slightly towards the end of the month. The trade tensions between the United States and China, the situation in Hong Kong and the dismal political spectacle taking place in England have all contributed to a more turbulent month in the markets. This nervousness was reflected in the market’s volatility where the S&P 500 experienced 11 days moving down or up by more than 1%. However, it is worth remembering that such volatility is not abnormal and is historically observed on average for one month out of ten. Consequently, performance is generally negative with the Canadian market the only one that achieved a slightly positive return with +0.4% (S&P/TSX, in CAD), while the US market (S&P 500, US$), the international market (MSCI EAFE, US$) and emerging markets (MSCI Emergent, US$) disappointed with performances of -1.6%, -2.6% and -4.8% respectively.
This rise in tension got reflected in interest rates which moved sharply downward, in part due to an anticipation of intervention by the world’s major central banks. In Canada, the 5-year rate fell by 0.26%, resulting in a monthly performance for the bond universe and the corporate universe of +1.9% and +1.2%, respectively. The US 10-year and 2-year rates even inversed momentarily in mid-August. Historically, such a reversal generally preceded the onset of a recession in the United States by about a year, although the most recent reversal was brief. However, an unusual phenomenon is currently occurring in the global bond markets where 60% of all global bonds are trading at less than 2%, with 25% trading at negative rates. This is what happens when the entire German yield curve is negative and large portions of those of many other developed countries are also negative (Japan, France, Sweden, etc.). This is a perverse consequence of the negative interest rates we see in Europe and Japan, where now the lender is paying to lend money. Closer to home, the Bank of Canada decided to keep its key interest rate unchanged at the beginning of September.
The various growth-related fears mentioned above partly explain the unusual situation we are seeing in interest rates, but also explain the performance differential to the advantage of US equities over international equities, particularly in Europe. The structure of the European economy is based on exports, which account for about 40% of the region’s GDP, while in the United States exports account for only 10% GDP. So, any slowdown in world trade, of which China is a major player, has a sizable impact on the European economy, particularly on German manufacturing activity. For the moment, the services sector seems to be taking over and supporting growth, but the market anticipates that the European Central Bank will have to intervene, hence the pressure on rates. Part of the solution could also come from a fiscal stimulus on the German side since this government generates surpluses.
In the United States, with a few months after Europe, the leading indicator of manufacturing activity contracted while that of services remained positive. The Fed has reported being vigilant and is probably feeling a little pressure coming from the White House, but with unemployment remaining near historical low and wage growth close to 4%, the critical consumer sector should remain strong and continue to support the US economy.
In July, North American equity indices rose while international and emerging market indices declined. Canadian equities returned +0.3% (S&P TSX in CA$), US large cap +1.4% (S&P 500 in US$), technology stocks +2.2% (NASDAQ in US$), international equities -1.3% (MSCI International in US$) and emerging market equities -1.1% (MSCI emerging in US$). US stock indices reached new records as the S&P 500 broke the 3,000-point mark while the Dow Jones did the same with the 27,000-point mark. Growth-style global equities outperformed value-style equities by +1.3% bringing the underperformance of value versus growth to -9.5% year to date. On the foreign exchange market, the Canadian dollar lost -0.5% against the US dollar but gained +1.8% against the euro. In the bond market, interest rates rose slightly throughout the curve in Canada and the United States. The Canadian Bond Index returned +0.2% while the Corporate Bond Index returned +0.4%.
Several issues caught investors’ attention in July including US 2nd-quarter earnings season. As ¾ of S&P 500 companies reported their performance, 78% of them beat earnings forecast while 60% exceeded sales expectations. Year on year, earnings growth was reported at +2.0%. The price-earnings multiple expansion to 18.0 times profits (15.4 times at the beginning of the year) remains the main contributor of the S&P 500 year to date performance. International (14.1), emerging (12.9) and Canadian (15.2) equities are dealt at smaller earnings multiples.
Nevertheless, US economic growth for the 2nd quarter grew faster than expected (+2.1% versus +1.8%). Upheld by a strong labor market, the American consumer, which accounts for 70% of the economy, increased its spending by +4.3% during the quarter. The US economy created 164,000 new jobs in July reducing the unemployment rate to 3.7% and pushing the consumer confidence index to a very high level of 135.7. In Canada, economic growth at the end of May was estimated at +1.4%. 24,200 jobs were lost in July, raising the unemployment rate to 5.7% (5.5% in June).
As for the Federal Reserve, it modified its fed fund rate on July 31st. The Fed cut its rate by -0.25%, a first decrease in more than 10 years (2008). Although not surprised, the market would have preferred a -0.50% cut and a more dovish statement from Jerome Powell, the bank’s president.
As to the trade saga between the United States and China, despite a positive meeting at the G20, President Trump announced on July 16th that the two nations were still far from an agreement and that additional tariffs on Chinese goods could be implemented. This forewarning broke momentum for the S&P 500, which was up +2.6% (US$) for the month beforehand.
August 1st, Trump detailed his tariff threat, he announced 10% tariffs on all remaining untaxed Chinese goods as of September 1st. The stock market responded negatively, losing -2.3% (in US$) as of Friday, August 9th.
In June, most stock market indexes recovered the May losses. Canadian equities earned +2.5% (S&P TSX in CAD), US equities +7.0% (S&P 500 in US$), international equities +6.0% (MSCI International in US$) and emerging market equities +6.3% (MSCI Emerging in US$). Growth-style global equities (+6.9% in US$) slightly outperformed value-style equities (+6.3% in US$). The VIX “fear” Index closed the month of June at 15.1 points, down from a high of 23.4 points in May. On the foreign exchange market, the Canadian dollar appreciated by +3.4% against the US dollar and +1.4% against the euro, in turn reducing the returns for Canadian investors on their foreign assets.
Helped by the Federal Reserve and the Chinese Ministry of Commerce, the stock market took a shape uptrend in early June. The S&P 500 index ended the first week of the month up +4.5% (US$). The Chinese Ministry of Commerce issued a press release on the trade dispute with the Americans. It stated that both parties would benefit from resolving their differences through dialogue, with respect and mutual benefit. It was viewed as a step forward towards the resolution of this conflict. Also, Jerome Powell, President of the Federal Reserve, stated that the governors were closely monitoring trade disputes between the United States and their main partners and were ready to intervene to maintain economic growth. Although this message came as no surprise and no direct reference was made about interest rate reductions, it was regarded as a safety net for the economy or what the market also called “The Powell Put”.
After which little news had the grip to undermine the market euphoria. The disappointing job creation statistic released in June for the month of May (75,000 new jobs versus 175,000 expectations) was counterintuitively seen as good news, reinforcing the likelihood of the Federal Reserve supporting the economy. This type of reaction is not uncommon at the end of an economic cycle as market mood sways between euphoria, denial and fear.
As for the bond market, US interest rates declined throughout the curve but more sharply in the short- and medium-term issues. In Canada, rates remained relatively stable, rising slightly in the short to medium term and slightly falling in the long term. The Canadian Bond Index returned +0.9%, while Corporate Bonds returned +1.1%. Inflation in Canada move up to 2.4% (2.0% for the previous month) while the 10-year bond rate is at 1.5%.
Tensions in the middle east pushed oil prices up by +9.3% in June as two oil tankers (Japanese and Norwegian) were attacked in the Strait of Ormuz on the 13th of the month. Held responsible by the Americans, Iran, hurting from the US withdrawal of the Iran nuclear deal, is threatening to close off this vital marine access to the Middle East oil trade. This is a delicate matter as Iran shot down a US military drone June 20th “in or near” their air space.
Among financial superstitions is the well-known adage of sell in May and go away. This year it would have been wiser to sell in April. As noted in our letter last month, performance since the beginning of the year was particularly high and the month of May corrected all this. Among the main indices, Canada fared relatively better with a performance of -3.06% for the S&P/TSX followed by the MSCI EAFE which did - 4.66% (US$, developed countries ex-North America). For the US and emerging markets, more specifically China, it was more difficult with returns of -6.35% (S&P 500, US$), -7.23% (MSCI Emerging, US$) and -13.05% (MSCI China, US$), respectively. Seeing such figures, it is easy to see that uncertainty related to the impact of the US -China trade dispute took over in May. It seems that we will have to get used to it for the next few months, if not for the next few years. It is worth remembering that since the onset of friction on this front in early 2018, most markets have not climbed past their peaks reached at that time apart from the US.
This nervousness is also illustrated by the downward pressure on interest rates as government bonds are perceived as a safe haven. The yield curve for maturities ranging from 1 to 10 years was inverted in Canada at the end of May. As an example, the 5-year rate for Canadian Federal Bonds fell by -0.18% in May to close the month at 1.36%, a level below inflation which stood at 1.9%. This strong downward shift in rates obviously affected positively the performance of the Canadian bond universe and the universe of corporate bonds which returned 1.69% and 1.31% respectively during the month.
In the US, the reversal in rates is particularly notable. At 1.91% at the end of May, the US 5-year rate fell by -0.37% in 1 month and -0.83% in 12 months. It is currently difficult to assess the impact of the various tariffs and other measures put in place by the Americans and the Chinese. Conventional economic theory states that the impact of tariff barriers is passed on to consumers through price increases which ultimately should have a negative impact on consumption. Thus, price increases should be reflected in the inflation measures, but as of now this is yet to be case. However, more volatile economic data such as PMI or job creation figures point to slower growth. The bond market has therefore taken a stand and clearly anticipates a negative impact on the economy that would lead to a Fed intervention. The market therefore expects that the Fed, starting this summer, will lower its key interest rate by 0.25% between 2 and 3 times by the end of 2019 in order to support the economy. Like the Fed, both the Chinese and European Central Banks have indicated their readiness to act.
It should be noted that at the end of May, US authorities also indicated that they were evaluating antitrust measures against major technology groups (Alphabet, Apple, Amazon, Facebook, etc.). It is still too early to know whether concrete actions will be taken, but the effect on their stock prices was immediate. However, these companies have demonstrated an ability to bounce back quickly and maintain momentum over the last few years.