We would like to wish you and your family a happy new year. We hope to provide you with a brief overview of how investment markets have performed over the past year and to look ahead at what we can expect for 2019.
How did markets do in 2018?
After an unusually calm year of solid performance for capital markets in 2017, investors experienced a much bumpier ride in 2018. Downward volatility resurfaced in the first quarter, and though markets moved generally higher through the summer months, a sharp sell-off in the fourth quarter meant that most asset classes registered negative returns for the year. For Canadian investors in foreign markets, losses were mitigated somewhat by the weakness of the Canadian dollar, which declined about 8% relative to the U.S. dollar for the year.
U.S. equities posted some of the best results among global assets in 2018, with the S&P 500 Index reaching an all-time high and setting a record for the longest bull market on record in the third quarter. After the fourth quarter sell-off, however, the index finished the year with a loss of 4.4% (a gain of nearly 4% in Canadian dollar terms).
Canada’s S&P/TSX Composite Index, meanwhile, was weighed down by themes that included plunging energy prices as well as weakness in materials and financial services. The Canadian benchmark finished the year with a loss of 8.9%. The MSCI World Index, a broad measure of developed market equities, fell 8.2% in U.S. dollars (-0.2% in Canadian dollars).
Central banks in North America continued to gradually raise interest rates throughout 2018. 10-year U.S. and Canada government bond yields rose and peaked early in the fourth quarter but fell through November and December to end lower for the year. The FTSE TMX Canada Universe Bond Index, which broadly reflects results for the Canadian government and investment-grade corporate bond market, gained about 1.4% over the 12-month period.
What’s in store for 2019?
In contrast to last year’s consensus outlook that pointed to a synchronized global economic expansion, many experts now believe we are in the late stages of the economic cycle, with global growth slowing and downside risks increasing. Nevertheless, developed economies are expected to grow throughout the coming year and inflation remains moderate. Global interest rates are still low by historical standards, allowing corporations the flexibility to strengthen their balance sheets and invest in their businesses. These conditions suggest a cautiously optimistic outlook for markets in 2019.
Economy: Although markets decreased last quarter and the yield curve has flattened (interest rates of short and long duration bonds have narrowed – seen as a leading indicator of a recession), the consensus is that there is a low chance of a recession occurring 2019‐2020. Strong economic fundamentals, combined with expansionist fiscal policy and accommodating monetary policy, should make for prolonged U.S. business expansion and above trend growth in 2019 (+2.4% expected versus about 3% seen in 2018).
Regarding the global economy, a deceleration of economic growth (around 3.3% in 2019 versus a projected 3.7% in 2018) is likely given the deceleration underway in China and geopolitical uncertainties (Brexit in Europe, U.S. Government shutdown, etc.).
Equities: Assuming there are positive developments in U.S.-China trade negotiations and a more pragmatic Fed, the volatility observed since last quarter should gradually reduce in the first half of 2019. History has shown that in the absence of a recession, Wall Street should recover a significant portion of the recorded losses (‐19.8% since its peak) within a reasonable period (between 9 and 12 months).
Interest rates: Due to the recent tightening of financial conditions (drop in equities and corporate bonds), the Federal Reserve should take a pause in the first half of 2019, even more so as its current leading rate has basically moved back close to the “neutral” zone and inflationary pressures remain muted. The Bank of Canada should be more active given the delay in its interest rate normalization process.
Currencies: With the Fed temporarily taking to the sidelines and given the scope of budget and foreign imbalances (close to 8% of the U.S. GDP), downward pressure on the U.S. dollar should gradually increase in 2019. At the same time, the Canadian dollar should rebound closer to 80 cents U.S., even more so because the Bank of Canada should continue to normalize its rates.
Investment strategies: In the absence of a recession, equities should outperform government bonds in 2019. At current valuation levels, the Canadian market offers a better risk‐return ratio than the U.S. market. From a simple forward price-earnings standpoint, it is estimated that the Canadian market is trading at a 10% discount versus the U.S. market. Also, the dividend yield of the S&P/TSX is 2.8%, which is almost 1% higher than the S&P 500.
For the fixed-income sleeve, reduce exposure to corporate bonds due to tightening credit conditions and the increased cost of loans to corporations. Increase exposure to government bonds, which are now offering positive real yields after years of low interest rates.
The bottom line: A lot of bad news was priced in during last quarter’s 20% market decline, which tells us that any positive surprise (like the Fed slowing down its remaining rate hikes or a faster than expected resolution to the U.S.-China trade dispute) could lift the market.
It can be difficult to set aside short-term distractions and maintain a long-term perspective when negative headlines dominate as they have in recent weeks. But looking back over the longer term, the most recent market decline may simply be a small setback in a strong run upward overall. From its lows reached following the financial crisis in March 2009 to the end of last year, for example, the S&P 500 was still up more than 270%.
The fact is, market volatility is not always a bad thing. Portfolio managers often welcome market declines as a necessary ingredient for positive returns as it creates opportunities to add to existing positions or buy higher-quality businesses at reduced prices. In 2017, asset prices remained elevated, providing few opportunities to shop for “bargains.”
We believe the most important action to take as an investor is to create a sound, diversified investment plan that takes your time horizon and tolerance for risk into account, and then to stick to that plan through periods of short-term volatility. As asset classes do not typically perform in a correlated fashion, diversification can help to insulate your portfolio from the highs and lows and provide a smoother experience over time.
If you have any questions or concerns about your investments, or if your personal circumstances have changed, please do not hesitate to contact our office.
Sources: CI Investments, IA Clarington
This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.