The final quarter of the decade closed out one of the best years for global equities in several years. While most global equity markets have not surpassed their all-time highs, the S&P 500 kept hitting new record highs throughout the months of November and December. While the broad Canadian fixed income market had a stellar year overall, performance in the fourth quarter was a bit soft, down 0.2%.
Looking back at the full year of 2019, one must admit that it was quite an eventful one, particularly for the capital markets. The headwinds facing the global equity markets were numerous:
Yet, given these headwinds, the capital markets outperformed most investor’s expectations. At the end of every year, we believe it’s educational for us to reflect on our interpretation of macro-economic news, be it right or wrong.
Regarding the inverted yield curve, while we recognized that it’s had a good track record in forecasting recessions, we discounted the significance of it this time for a number of reasons (refer to the Q1 commentary), and thus did not buy into the media’s interpretation that a recession was imminent. We were proven right in our assessment as the yield curve is no longer inverted, and a recession in the U.S. isn’t on the horizon.
We highlighted in our Q2 commentary that ongoing global trade tensions (especially between the U.S. and China) were one of the biggest risks to the equity markets in 2019. At the time, our view was that while we didn’t believe any substantial agreement would be reached in the short term, we were hopeful that tensions would ease. To the relief of most of us, the U.S. and China did agree to a “phase 1” agreement in December that has helped remove a certain amount of risk from the markets.
While it feels like political uncertainty has been with us for the past 3 to 4 years, we felt that these risks tend to be more transitory in nature and thus not something that should influence our longer-term thinking. As it turned out, Trump was impeached by the House of Representatives, and in the U.K., Boris Johnson won the election in a landslide fashion, promising that he would pull the U.K. out of the European common market by the end of January. Though there may have been some very short-term impact on the markets at the time, these events have had little lasting impact.
Our biggest concern of the year was the slowing global economy. Global growth is the lifeblood that sustains the equity markets. While we acknowledged that global growth was anemic outside of the U.S., our belief was that we would see a gradual pickup in Chinese growth (Q2 Commentary). This, we believe is a requirement to spur economic growth in Europe, Japan and Emerging Asian economies. As it turns out, we are seeing tentative signs that economic activity in China has bottomed and is starting to recover, which bodes well for the global economy in 2020.
For some time now, we’ve been underweight bonds, given their poor risk return profile. Our assessment did not change during the quarter, and thus we remain underweight. In fact, we believe that if we do see a gradual improvement in economic conditions in 2020, bonds will perform very poorly. We continued to trim more of our preferred share exposure and reallocated it to non-traditional income-oriented asset classes such as private lending and mortgage loans. While preferred shares performed nicely in the quarter, we believe the dynamics of the asset class has changed over the past 4-5 years, negatively impacting its risk/return profile.
Within equities, we eliminated our exposure to emerging market equities, reallocating it to our Real Asset pool and Strategic Growth pool. We mentioned in our last commentary that while we’re not outright negative on equities, there wasn’t a convincing reason to be overweight equities either. We are now starting to see a more compelling reason to be overweight equities vs. bonds. With that said, while equities look better over the next year versus bonds, private real estate, agriculture, infrastructure and private equity offer even better risk/return profiles than equities over the longer term.
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.
With this outlook, we will focus on our longer-term view of the capital markets and the implications. While many investment gurus of the past have seen their fortunes wiped out by believing that “it’s different this time”, we do believe the world of portfolio management has changed and is becoming more challenging.