After a near bear market in the final three months of 2018, we have experienced a sharp reversal during the first half of 2019, with two recent material market-shaping events.
The last quarter of 2018 was the worst quarter for stocks in seven years. Alternatively, the first quarter of 2019 was the best quarter for stocks in 10 years
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It was a challenging year for market returns and global economic growth.
2018 was the weakest year for global markets since the great financial crisis in 2008. Markets were dragged down substantially in the final three months of the year due to higher interest rates, a slowing global economy, U.S. government shutdown and continued trade tension between the United States and China. Equity markets can move up or down for many reasons but over the long term, market valuations tend to return to their fundamentals. However, the fundamentals during the past year do not justify the sell-off that we’ve experienced, which suggests that the worst may be behind us.
The S&P/TSX Composite was down 11.6 percent in 2018, driven by lower energy prices and negative market sentiment. A resolution to the North American Free Trade Agreement (NAFTA) in November couldn’t spare the Canadian index as oil, as measured by the West Texas Intermediate (WTI), fell nearly 25 percent due to increased supply driven by the United States. Although energy was the worst performing sector, the sell-off was widespread across the S&P/TSX. Eight out of ten sectors were negative for the year.
The United States
U.S. equity markets were down for 2018. The S&P 500, Dow Jones and Nasdaq were down 6.2, 5.6 and 3.9 percent respectively. One reason for the weak equity markets was a strong US economy that led to four interest rate increases of 25 basis points each. These interest rate hikes have caused concern that higher rates may dampen credit growth and company earnings in the future. Employment continued to improve in 2018 and the unemployment rate dropped from 4.1 percent to 3.9 percent.
In overseas markets, international equities fell 16.1 percent in U.S. dollars as measured by the MSCI EAFE Index. Overseas markets were driven lower due to negative market sentiment, a slowing global economy and political risks surrounding Brexit. China’s weakening economy, which was affected by tightening financial conditions and trade tensions, was a focus for investors.
Central Bank Policy
In 2018, the Bank of Canada increased its interest rate to 1.75 percent by announcing three rate increases of 25 basis points each. In 2019, it’s expected rates will increase very gradually. The Bank of Canada will wait to see the effect on the economy of the previous hikes, high consumer debt levels and the impact of lower energy prices. Interest rates remain the highest since December 2008.
The U.S. Federal Reserve raised its overnight rate four times from 1.25 percent to 2.25 percent in 2018 and lowered their forecasts for interest rate hikes in 2019 amid recent market volatility and slowing global growth. A U.S. interest rate cycle that’s likely near its end would be positive for global economies and markets since the cost of borrowing will grow more slowly.
Although the sell-off didn’t quite meet the definition of a bear market, from an investment perspective it felt like it. Sell-offs of this magnitude are caused by recessions or negative sentiment, with the latter usually resulting in a subsequent rebound in the near term. Yes, global economies have slowed, but none of the traditional elements of a recession (employment, housing, manufacturing) appear today, which indicates that the risk of a recession over the coming year has not increased materially. Long-term investors who stay the course will likely be rewarded in 2019.
As always, if you have any questions about the markets or your investments, we are here to talk.
The holiday season is about many things - including goodwill and helping others. It is the time of year that we acknowledge our incredible clients like you with a gift of thanks to recognize your appreciated trust and confidence in our team.
Without a sense of caring, there can be no sense of community and with that in mind a donation to our great community has been made of $10,000.00.
We have once again supported The Surrey Women’s Centre and their #StandWithHer campaign which supports the SMART program. Please visit: https//surreywomenscentre.ca//smart to learn more about this wonderful community organization.
This year was also a year to give back to our community of children in the public school system. My son had the good fortune of an amazing educator and vice principal while in elementary school. She has been such a gracious presence for him and she moved to another school in the community. In speaking with her it was learned that this elementary school is filled with students who have no lunches, no warm clothing, no ability to participate in field trips like many young children are able to. A contribution was made to her school to support a breakfast and lunch program, as well to support those who can’t afford to participate fin the traditional activities of elementary school.
With gratitude and thanks to you our great clients, to the wonderful team at Insightful Wealth Group, and to these amazing community groups who make a difference every day.
Volatility is not a risk, it is a certainty. Corrections are part and parcel of the investment process. They come and go, and it is imperative to take a deep breath and realize that what is most important for building wealth is not 'timing' the market but rather 'time in' the market.
Challenges in the quarter
There was a lot to digest over the past three months including NAFTA negotiations, trade tensions between the world’s two largest economies and geopolitical concerns relating to Emerging Markets. Investors were swayed by the 4 T’s – Tariff s, Trade, Turkey and Trump which provided headwinds for most global markets except for the United States. Despite the negative sentiment, the global economy remained strong which led to strong corporate profits during the period.
The Canadian stock market measured by the S&P/TSX underperformed its peers in the third quarter falling nearly 1.5 percent due to fl at oil prices as measured by West Texas Intermediate (WTI) and uncertainty surrounding NAFTA negotiations. Moving forward, the path of least resistance for oil is upward with supply constraints likely from impending sanction against Iran and economic deterioration in Venezuela which should help the S&P/TSX. The recent resolution to NAFTA negotiation should increase investor confidence but confidence may be short lived as investor’s attention will focus on the impact of higher interest rates on the Canadian economy.
The United States
New rounds of tariff s between the U.S. and China did little to impact the S&P 500 which rose in the quarter by approximately seven percent in U.S. dollar terms. Investors focused on the continued strength in the underlying economy which led to strong corporate profits. The U.S. economy grew at 4.2% in the second quarter leading to strong year over year sales and earnings growth. Strong corporate profits were a result of higher business activity and favourable tax policy. The benefit from tax cuts will roll off in 2019 and given that manufacturing is showing signs of slowing, the rate of earnings growth has likely peaked for the current cycle.
Despite sales and earnings growth of approximately 5 percent, fl at returns were driven by trade tariff fears, Italian political instability, Turkey and a strong U.S. dollar. International equities were down 0.8 percent in U.S. dollar terms as measured by the MSCI EAFE index. There has been some economic slowdown, but the underperformance has likely been overdone.
Setting aside the potential for trade wars, Europe and Asia’s economic outlook continues to be robust and this will likely flow through to company earnings. Combined with accommodating interest rate policies, this part of the world will likely experience stronger market returns.
Central Bank Policy
In the third quarter, the U.S. Federal Reserve continued raising interest rates in one increment of 0.25 percent to 2.25 percent.
The U.S. Federal Reserve is expected to continue to raise its benchmark rate one more time by the end of the year on the back of strong US economy. The Bank of Canada raised its interest rates during the third quarter by 0.25 percent to 1.50 percent.
It’s expected that the Bank of Canada will raise one more time this year.
The ‘war of words’ that have been used as a negotiation tactics in trade discussions has led to an increase in volatility in stock prices globally. As we have witnessed with NAFTA negotiations, trade war rhetoric is likely to subside as cooler heads prevail.
No one wins from a prolonged trade dispute. Over the long run, market returns will likely be driven by fundamentals and interest rate policy. Fundamentals continue to be strong—the likely explanation for higher interest rates. In this environment, equity markets will likely be positive but may not experience the above-average returns we’ve seen in the past couple of years due to higher interest rates, oil and wages.
As always, if you have any questions about the markets or your investments please don’t hesitate to contact us.
There’s no doubt equity investors were reacting daily to news about tariffs between the U.S. and China or the European Union. Despite fears of potential trade wars, the S&P 500 rose nearly three percent in U.S. dollar terms.