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Market Update. 2018 was a bumpy ride. Buckle up for the road ahead in 2019

January 17, 2019

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Market Update. 2018 was a bumpy ride. Buckle up for the road ahead in 2019

Market Insights

I hope you found much to celebrate for a Happy New Year. For investors looking back (and down at their returns) for 2018, the celebration was a bit muted. As we noted in December, the decade-long bull run looks like it might be done — and this period of high volatility is likely to continue.

The good news for 2019: it seems that the US economy (and world economy, by and large) which hit some notable speed bumps in 2018, still has plenty of gas in the tank. That even goes for “no-pipeline” Canada, too.
What explains this difference between the market outlook and economic outlook? Stocks generally reflect market confidence in the future. Economic sentiment (which is still positive) is built around what’s happened, and what is happening right now. Keeping this time lag in mind:

  • We may be looking at slower but still positive economic growth in 2019
  • Investors may remain skittish, and volatility will continue.

We wanted to give you an in-depth retrospective for the full year. Below are our performance numbers for our specific portfolios. Then we’ll look at what has happened in the last 12 months, so we’ve got a clear-eyed view about the future.

Let’s take a look at our portfolios’ performance in December and throughout 2018.

ETF Portfolios

ETF Safety Portfolio was down -1.56% in December. It was down -1.53% in 2018.

December saw most of the year’s return pared back. The majority of the decline was in equities. Fortunately, our portfolios were positioned to reduce volatility. The highest weighted fixed income ETFs in this portfolio, VSB and VSC, both contributed positive returns of +0.79% and +0.59% respectively.

ETF Conservative Portfolio was down -2.74% in December. It was down -2.20% in 2018. 

The negative returns for the ETF Conservative Portfolio this month are attributed to equities and real estate ETFs. The Dow Jones Industrial Average ETF (ZWA) and the S&P/TSX 60 ETF (HXT) were down -8.44% and -5.55% for the year, respectively.

ETF Balanced Portfolio was down -3.66% in December. It was down -2.49% in 2018.

This portfolio further underperformed the ETF Conservative portfolio in 2018 due to the increased exposure to equities and real estate. The S&P 500 index ETF (HXS) was down -6.57% and the Real Estate ETF (ZRE) was down -4.32% in December. 

ETF Growth Portfolio was down -4.08% in December. It was down -2.50% in 2018.

The majority of this portfolio’s performance can be attributed to the greater exposure in HXS (S&P 500 ETF). With the USD having a good year against the CAD, it allowed the Unhedged S&P 500 index ETF (HXS) to outperform the US markets. This minimized the overall portfolio losses in 2018 compared to the Balanced ETF portfolio.

ETF Aggressive Portfolio was down -4.63% in December. It’s down -2.39% for 2018.

This portfolio saw lesser losses for the year when compared to the Balanced and Growth ETF portfolios. This can be attributed to greater exposure to the Unhedged S&P 500 index ETF (HXS), which was up +3.41% in 2018, and lower exposure to the Dow Jones Industrial Average ETF (ZWA), which was down -6.09% for 2018. Real Estate, Canadian and International equity ETFs provided further diversification albeit lower returns.

Private Investment Portfolio

Safety Private Portfolio was flat in December. It’s still up 2.54% for 2018.The mortgage funds provided income while reducing volatility in this portfolio.

The majority of the positive returns in this portfolio are from higher fixed income exposure. The additional diversification to asset classes in the NWM Core Fund such as mortgages, commodities, real estate and private equity remained a key component in mitigating risk.

Balanced Private Portfolio was down -0.69% in December. It’s still up 2.37% for 2018.

The position in the NWM Core Fund outperformed the S&P 500 index. The unconventional asset classes such as mortgages, commodities, real estate and private equity, provided great diversification. This helped mitigate risk, while ensuring that the returns were positive for 2018.

Aggressive Private Portfolio was down -1.28% in December. It’s still up 2.71% for 2018.

The extra exposure in the NWM Real Estate Fund generated greater positive returns for this portfolio over the Balanced Private portfolio. Furthermore, the unhedged position of the US Tactical Fund resulted in outperformance over its USD counterpart. The core balanced position still provided additional diversification to asset classes such as mortgages, commodities, real estate and private equity mitigated risk.

A look back at market factors in 2018 and a look ahead to 2019 

A number of factors affected markets in 2018. Here are the important ones, which we will explore below:

  • The toll of quantitative tightening
  • Interest rates rose with a good (but no longer great) economy
  • Trump brings on the tax cuts
  • Trade disputes, trade deals and something in between
  • As oil price drips down or bubbles up, so goes the market
  • Brexit, more trade deals and economic growth around the world

Looking back at the market overall, 2018 may have started with a bang. However, we endured a number of whimpers since then. By early February 2018, investors saw higher volatility and a sudden correction. The Dow plunged by 1,000 points not once, but twice. 

By March, the US tech sector that had led the market for years slid downward with data privacy scandals. Tech was particularly hard-hit. However, by the fall, the tech sector recovered most of its losses. Titans like Apple and Amazon cracked the $1 trillion valuation ceiling.

Longer-term and on a bigger (if less apocalyptic) scale, trade disputes between the USA and some of its closest trading partners as well as China disrupted markets at different times (See our extended commentary below on trade). As the deadlock with China ramped up in the latter half of 2018, we saw significant and ongoing market volatility from October until recently.

For 2019, we expect this volatility to continue, though we are not predicting a crisis or recession. Investors will be well served by an approach that focuses on diversification and mitigation of risk. Indeed, when markets zig down temporarily, there will be opportunities to invest at a discount, before it zags back up.

For now, let’s dig deeper into some of these individual market factors mentioned above.

The toll of quantitative tightening

Remember the downturn of 2008 to 2009? Of course you do. It was the greatest financial crisis since the Great Depression, wiping out trillions in paper value and threatening to wipe out trillions more. 

It was a crisis. And in that moment of crisis, the US Federal Reserve began its quantitative easing strategy: buying trillions in bonds, to pump money into the markets. The aim was to reduce volatility — and arguably, it did the job.

In 2014, quantitative easing stopped. And this year, it went into reverse, with quantitative tightening. The US Fed began selling its giant stockpile. As day follows night, volatility returned, big-time. These jitters investors are feeling? It’s basically withdrawal symptoms in the market after years of injections of sweet, addictive money.

The US Federal Reserve and other central banks don’t seem keen on repeating this program, at least with no actual crisis facing them. If anything, quantitative easing has turned into quantitative tightening
Assuming trends continue in 2019, we will see the US Fed and other central banks continuing a slow but steady sell-off of treasury bonds, ideally keeping markets pleasantly propped up without a hangover.

Interest rates rose with a good (but no longer great) economy

When the economy is doing well, economists get nervous about inflation above 2 percent. Rising prices make for unhappy citizens. So, they pump the brakes with rises in interest rates. 

In most of 2018, the US economy went from strength to strength (again, the stock market is not the economy). In July, the US jobless rate went to 3.8 percent, an 18-year low. Canada lagged behind at a still-impressive 5.8 percent (technically, that rate is still considered full employment for everyone who wants a job). Robust growth in North America helped economies around the globe.

By the fall, the US Federal Reserve issued a positive statement about the economy’s performance. For the most part, that positive prediction has come true. The result? 

As we noted in our summer Market Update, interest rates rose and continued to rise through 2018. In the US, they’re at 2.5 percent. In Canada, the benchmark rate is 1.75 percent.

As inflation tapers off, we expect interest rates may not rise as quickly, though we’re likely to see some divergence between the USA (where rates may continue to rise), Canada (where rates may be stable or even fall back slightly) and elsewhere. It seems reasonable that in Canada, rates will not go down much lower, barring a more serious downturn. 

Interest rates are still low from a historical vantage point — leaving slack in the markets for investors who are willing to take a risk in a volatile year.

Trump brings on the tax cuts

US President Donald Trump’s administration had argued that a heavy corporate tax regime made the US uncompetitive. This encouraged companies to invest and set up abroad, putting American jobs and capital at risk — or so went the argument. 

Accordingly, they implemented the biggest corporate tax cut in US history, dropping the rate from 35 percent to 21 percent. This super-charged companies bottom lines and provided the fuel for a stock market rally. Major companies engaged in stock buybacks, but also reinvested in equipment and infrastructure — and in the USA, Canada and elsewhere, unemployment dwindled to record lows. 

It’s up for debate whether this tax cut created a long-term advantage, a short-lived sugar high or a permanent drain on the US treasury with little to show for it. Nonetheless, the Republican administration is still seen as business-friendly. Recent Congressional elections handing Democrats a partial win have not erased that perception. So long as corporate America remains optimistic regarding taxes and regulation, they are more likely to continue to invest in their own success, with a positive outcome for the interrelated global supply chain.

Trade disputes, trade deals and something in between

Until recently, global trade had what seemed like an unstoppable momentum. Today, the old trade deals under renegotiation — apparently, under threat of trade tariffs going up. At least, that’s what may have occurred as the US imposed import duties on Canada. Within months, NAFTA gave way to the USMCA. That new deal was great news, helping pump up currencies and stocks, at least temporarily.

This high-stakes approach might explain the on-off trade dispute between the USA and China. In the meantime, it is causing collateral damage in developing markets in China’s supply chain, as well as turmoil in China itself. With its economy in disarray, Beijing may now be inclined to negotiate

The trade conflict between the USA and China has had a spillover effect, causing China, Japan and Korea to examine ways to insulate themselves from the US tariff regime. Developing economies have been more vulnerable to the tariffs.

If the US manages to hammer out a deal with China and avoid a full-fledged trade war, this should help moderate markets and provide the reassurance many investors are looking for, both here and abroad. Certainly, it would seem that the US and China are on track to do just that — and markets (perhaps prematurely) are responding well thus far in 2019.

As oil price drips down or bubbles up, so goes the market

Oil greases the wheels of the world economy — but the price of oil can affect markets in different ways. Too low and exporters suffer. Too high and practically everything we buy — naturally, including fuel,  gets expensive. 
For the US and Canada, which are both energy exporters, a high oil price in the mid-$70s/barrel range helped charge up energy companies’ profits in October and November. 

But since then, a glut of oil on the world market has sent prices into a downward slide, closer to the $60 mark today. While Trump tried to highlight the positive (“Like a big tax cut for America and the world”) a too-low oil price could contribute to an economic downturn. 

Presently, oil is hovering around the $50/barrel mark — which is, as mentioned above, sub-optimal for petro-economies and energy stocks. That said, the last five US recessions have coincided with rises in oil prices. So long as the price of oil remains relatively low or even stays in the mid-$60 or $70 range in 2019, there still can be room for growth in both the market and the economy.

Brexit, more trade deals and economic growth around the world

Between economic powerhouses like China, Germany and Japan, shifts in political winds from Britain to Brazil, as well as emerging markets like Turkey, there’s a much wider world for investors to consider.

The big story in Europe in 2018 (as in 2017) was Brexit, or to be specific, nearly-deadlocked negotiations that might have led to a dead-on-delivery agreement. If the UK votes against the Brexit deal, there is lack of clarity around what happens next. Certainly, none of the worst predictions about Brexit have come to pass yet. Still, investors prefer a clearer picture.
On the other side of the English Channel, Europe generally had a good year, with the German economic powerhouse providing effectively full employment.

However, political upheavals had an effect throughout the Eurozone. By the end of 2018, partly due to Brexit fears, its critical auto manufacturing sector faced challenges. As Angela Merkel prepares to leave and newspapers allege that the good times are over, populist parties in Germany, Italy, Greece and elsewhere have created economic uncertainty. 
In Latin America, Argentina and Brazil had unremarkable performance in much of 2018. Turkey saw its building boom turn into a slump. Developing economies were rattled by trade disputes. 

In Asia, aside from trade issues, political upheaval often intervened. For instance, there was blanket news coverage of North Korea’s nuclear threat in the summer and fall. As Trump called off a planned nuclear summit with the one he called Little Rocket Man, stock markets fell. Then the North agreed to a nuclear test freeze (notwithstanding a recent thaw) and markets bounced back – attesting, at the very least, to the idea that many investors have short attention spans.

With so much volatility, we foresee slower growth in 2019. However, taking advantage of a world of opportunities is part of a diversified investment strategy. 

Market update. Conclusion

In 2018, markets were unsteady, with trade issues and political crises fraying investors’ nerves. In 2019, we will need to be prepared for slower growth. However, there is still potential to enjoy positive returns going forward.

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