The past month marks 10 years since the start of the financial crisis – a time that will be indelibly marked upon the minds of those of us who invested (both personally and professionally) through it. Since then, the global economy has grown in fits and starts, responding to the experimental treatments of central banks and local governments as well as natural, organic growth. The American economy became both a beacon of hope and a leader in global growth. The US is currently in the midst of the longest period of economic growth in history, but it hasn’t been pretty, predictable or peaceful. Indeed, it humbled many market experts.
However, when we look back at the decade as a whole, respectable gains were made. In fact, there was an unexpected beauty in the faultiness. Similarly, the Japanese aesthetic of wabi sabi is where beauty is described as imperfect, impermanent and incomplete and there is an acceptance of this transience and imperfection. Thus, it may not have been the preferred path to economic renewal and recovery but a decade later the US has enjoyed a 2.3% growth rate, inflation was positive, yet well-anchored while corporate earnings grew robustly, business capital expenditures rebounded smartly, and banks became better capitalized and now lend at higher standards. Furthermore, the consumer is more confident and less indebted, solid gains were made in the housing market, employment is healthy, and income advances have been steady.
Diversification works both ways. Both the last decade and the most recent quarter were terrific for US returns but a grind for most of the rest of the world, including Canada (see chart below). We have been able to capture the high YTD US stock market return in your portfolio. However, by being globally diversified as the US is only one market means our client’s portfolios also captures some of the lower returns in the other markets like Canada, Europe and Asia.
In contrast, in the prior decade emerging markets were robust and the US was the laggard with its “lost decade” and 0% return (below). This serves as a reminder of the cyclicality of the market and the importance of remaining diversified, which in the long run is a winning strategy but comes with bumps along the way.
During the past quarter, two of the three big risks that we previously identified came to bear: the rise of the US dollar and increased trade tensions. The US and China engaged in several rounds of trade tariff exchanges as well as a lot of sabre rattling. This, along with the fallout from issues in Turkey, Argentina and slowing growth concerns in China, continued to hamper emerging markets performance (although less so than in the first quarter). Contagion fears were felt as far away as Europe where numerous banks have exposure to these economies. However, by mid-September, after a significant sell-off, the broader market appeared to shrug off such risks. Thus, the US outperformed the rest of the world. Fixed income performance was negative while both the Fed and the Bank of Canada raised their benchmark lending rates by 0.25% during the quarter and are expected to continue the rate-hiking trend; all eyes are on inflation which is yet to manifest.
The biggest event, however, took place on the last day of September: an 11th hour trade agreement with Canada and the US that will be added to the previous US-Mexico agreement. The USMCA will replace NAFTA. From the market perspective, the deal is significant as it definitively illustrates President Trump’s proclivity to make trade agreements and thus diminishes the threat of never-ending global trade wars.
The quarter was also a grind for us here at Kinsted. We were early in initiating an overweight position in emerging markets which detracted from our performance. Our Canadian equities had a negative quarter and lagged the TSX composite. Our global equities were positive in the quarter but underperformed the MSCI World benchmark due to small-cap exposure. On the positive side, the bond portfolio preserved capital much better than the Bond Universe. The preferred share portion of the portfolio added value and was the star of the quarter, which illustrates why we have been underweight bonds and like preferred shares as a good bond complement.