In the 1993 movie Groundhog Day, the main character finds himself reliving the same day, over and over again. That accurately describes how we’ve felt writing this commentary over the past year. While the quarters may change, everything else remains the same. Trade frictions are still there; concerns over slowing global economic growth are still there; geopolitical concerns are still there, but even in the midst of all of this, the markets continue to eke out positive returns. With that said, those positive returns have been accompanied by significant ups and downs. Look no further than the Canadian TSX Total Return Index, it finished up 2.5% for the quarter, and 19.1% YTD, spectacular returns in the face of these headwinds. Lengthening out the time horizon to 12 months, sees the return go down to +3.6%. One must be willing to ride those ups and downs in order to participate in the equity markets. This is similar to the US stock market which is back to where it was on September 30, 2018.
As mentioned in our last quarterly update, as the market cycle gets longer in the tooth, market volatility is amplified by incoming news, be it good, or bad news. Unfortunately, until we get some concrete evidence that global economic activity has bottomed, and is on the mend, this risk on/risk off environment will continue to characterize the capital markets.
We’re going to illustrate this risk on (buy equities) and risk off (buy bonds) market behavior by using the TLT ETF. TLT is a 20+ year U.S. Treasury bond ETF. TLT tends to be purchased for its downside protection characteristics. For the last quarter, TLT had a return of 7.9% (in USD). But that doesn’t tell the whole story. Between June 31st and August 28th, TLT was up 12.3%. Between that high and September 13 (only 16 days later), TLT was down 8.3%. We believe this illustrates the kind of markets that exist today. Several pieces of negative news send equity participants to the exits, while a couple of pieces of good news send them back into the equity markets. These environments tend to have the largest impact on wealth destruction for investors who react to short term news.
One of the largest contributors to current economic anxiety is the softness in the global manufacturing sector. At this point, there is no tangible evidence that it has started to turn, leading many pundits to extrapolate the weakness into a full-fledged recession. While there are no certainties this scenario won’t pan out, we do have our doubts.
Ongoing trade tensions in the first half of the quarter had a significant impact on market sentiment, only to see that simmer later in the quarter as both China and the U.S. agreed to further trade talks in early October. How that resolves itself is a complete unknown. Will the Chinese continue to kick the can down the road in the hopes of dealing with a different President, or will the Americans delay an eventual deal until closer to election time, giving Trump a win when he needs it most? Time will tell!
The attack on the Saudi oil facility had a significant, and potentially ongoing impact on the capital markets. While high oil prices no longer have the same drag on global growth as they have had in the past, their impact should not be underestimated. Any acceleration in military conflict in the middle east may send oil soaring, impacting global economic growth in a decidedly negative way.
In summary, the third quarter was very similar to past quarters, where market volatility was exacerbated by all the positive/negative news relating to geopolitics, trade tensions, central bank policy, corporate earnings and global economic growth. We don’t see these factors dissipating anytime soon.
We remain under exposed to bonds given our long held view that they continue to offer a very poor risk return profile. Over the course of the quarter, we continued to reduce exposure to preferred shares, and reallocating it to the strategic income pool which is highly diversified amongst income asset classes such as bank loans, mortgage debt, factoring and private debt.
Similar to last quarter, we took the opportunity to reduce exposure to both emerging market equities and Canadian small cap equities. Both of these asset classes are very high on the risk spectrum and given the continuing lack of clarity on the direction of global growth, we believe prudence is warranted regarding overall portfolio risk.
In our last quarterly outlook, we said: The keys to Capital market performance over the balance of the year are two-fold: central banks must remain on hold, and more importantly, it’s imperative we begin to see signs of a pickup in global growth.