Volatility is back! January started off very positive, however the combination of a strong US payroll report, surging bond yields and trade wars (both real and threatened) triggered a dramatic market sell-off and subsequent weekly reversals. Altogether, the markets corrected down 10% from the peak in late January, with most markets ending negative in local currency in Q1.
Current volatility levels are more typical now than the ultralow levels we enjoyed for the prior 18 months. For example, since 1950 the S&P500 Index experienced a daily decline of 1% or worse 9.8% of the time and +1% or better 10.3% of the time. Also, in a given calendar year the average peak-to-trough in stocks was -14%. However, the media likes to report on the negative days and the positive news doesn’t make headlines as often. Fundamentals are still positive but not “news worthy.”
We accept that the markets will give us this type of volatility, otherwise there would be no return premium for investing in equity-type assets. What matters is how you choose to react as an investor and what your plan is. We focus on the fundamentals like corporate earnings, interest rates and economic growth in determining our mid-to-long-term strategy. In the short-term, the market is about speculation; we take advantage of this from time-to-time by rebalancing to our mid-term outlook.
There were several interesting events in Q1, most notably the tariff announcements from the US and China. While these specific tariffs are immaterial, the potential for heightened trade wars is very concerning. We will discuss this more in our “Outlook.”
Outside of North America, trade agreements are accumulating. The Trans-Pacific Partnership has increased their membership. The UK is negotiating trade deals with other countries for the 21-month transition, post-Brexit period. The $1 trillion Silk Road complex continues to develop and after a very successful Winter Olympics even North and South Korea are rebuilding their relationship.
Globalization increases trading opportunities and advancement of economies and markets; unfortunately, security issues also arise. Privacy breaches at Facebook and the influence of big data on elections are not isolated incidents. Advancement does not come smoothly or without financial casualties along the way.
China’s President Xi has appointed himself as Emperor for Life. While this may be a power grab and ego-driven, the strategy may stabilize China enough to implement difficult economic policies like austerity and anti-corruption as well as manage the transition from a manufacturing-based to service-based economy; all can take years to come to fruition.
Meanwhile, there were many changes in the US administration, most notably Larry Kudlow was appointed as the Director of the National Economic Council. At the Federal Reserve, James Powell took over the helm as Chairman.
In Q1 the CAD depreciated against the USD by 2.6%, while the USD weakened further versus other major currencies. The Bank of Canada maintained its Bank Rate at 1.25%. After growing at 2.9% in 2017, the Canadian economy is slowing down due to a cooling housing market from tighter mortgage qualifications and local tax legislation, expected rising borrowing costs and uncertainties surrounding NAFTA negotiations. January’s monthly GDP growth was -0.1%.
We remain underweight in bonds and have a short duration which mitigates price adjustments as interest rates rise. We remain fully invested in preferred shares which continue to complement the bond component of our client portfolios.
Our Canadian equities fell behind in Q1 due to what we believe are temporary corrections in Maxar, Cineplex and TransCanada Pipelines. Small Cap stocks have helped our Canadian equities to outperform the TSX composite in Q1.
We rebalanced our portfolios in late January by reducing global equities and reinvesting in emerging markets and holding some of the proceeds in cash. We continue to rebalance by reallocating the current cash holdings to Canadian and global equities in April on current weakness.
At the start of the year, the stock market was very strong as corporate earnings were revised upward on the back of the approval of US tax cuts.