On this podcast, we sat down with Brent Joyce to review how the market performed in 2017. GLC's Chief Investment Strategist gives his insights on a number of factors that impacted the market last year.
Hello, I’m Christine Wellenreiter,
Vice-President of Marketing and Communications at GLC Asset Management Group. On today’s podcast we will be taking to Brent Joyce, GLC’s Chief Investment Strategist.
Hello Brent, Happy New Year!
Brent, today we are looking for an update on how the markets performed in 2017. We want to hear some context for when we look at our investment statements and look into how the various components of our portfolios performed. I also think a market
review helps set the stage for what to expect in 2018.
In 2017, you and I sat down and chatted regularly about a number of topics, including equity markets
making new all-time highs, the longevity of the S&P 500 bull market, what to make of high valuations for stocks..….I’m not going to say it got old, but…discussing new stock market records …well, it was getting pretty repetitive… Brent, how would you summarize a year like 2017 for the markets?.
Brent: Last year’s narrative often sounded like a broken record, pun intended! The 106 month old bull market for the S&P 500 is now the second longest on record and that benchmark did rack up an impressive 62 new all-time highs. Many other equity markets also made new
all-time highs during the year including Canada’s S&P/TSX Composite. But we should recall that outside of the U.S.… International, Canadian and Emerging market benchmarks are not in the ninth year of a bull market, these all had bear markets as recently as 2016.
What we witnessed last year was a powerful combination of synchronized global economic growth for the first time since the 2008 financial crisis and when that is coupled with modest inflation and generally accommodative monetary policy the result is robust corporate earnings growth. That mixture is very positive for equity markets to produce gains. Against this backdrop, government bond yields rose slightly, but the search for yield and a risk-on tone, drove credit spreads narrower, helping bond market total returns. In the end, what we saw were equity and bond returns that exceeded the expectations I had at the outset of 2017.
Christine: What about volatility….didn’t we set records there too…just not in the way we might have expected with all the political, terror and devastating weather events experienced during the year.
Brent: Yes, volatility was very low. The largest peak-to-trough drawdown for the S&P 500 was 2.8%, the mildest since 1995. It was similarly a calm year for Canadian investors. The S&P/TSX had a max drawdown of 6.1%, the mildest since 1993. This was despite on again – off again enthusiasm over a pro-business agenda from the new US administration, uncertainty surrounding trade and immigration policies, a failed attempt at healthcare reform, and a war of words with North Korea.
Christine: That seems odd doesn’t it?
Brent: What is interesting is this lack of equity market volatility is not unusual. Equity markets in the latter stages of the business cycle, where I believe we are, have historically exhibited this kind of dampened volatility, especially when supported by exceptional earnings growth, improving economic fundamentals and absent inflation.
Christine: In your recent annual market review – you talk about two dominant themes that really drove market results in 2017, effecting both stocks and bonds, and mostly in contradicting ways. Can you tell me about those themes and how they affected markets in
Brent: Sure. On one side was a theme that came to be known as the ‘reflation trade’. This is the notion that with the world economy in synchronized economic expansion; that will bring inflation and as a result central banks will normalize monetary policy through interest rate increases or reduced quantitative easing, a.k.a money printing. You add on top of this, expectations for a growth and inflation boost from expansionary fiscal policy in the U.S., namely tax cuts. When this theme ruled, bond yields rose and pro-growth economically sensitive cyclical equity sectors financials, energy, materials and industrials benefitted. Markets like Canada and emerging markets were beneficiaries of the reflation trade.
Christine: And what was the other theme that played out?
Brent: On the other side was what we call the “secular” growth trade. This view holds that economic growth would fade, inflation would remain elusive, and stimulative U.S. fiscal policies wouldn’t see the light of day. When this view was in vogue, bond yields fell, and investors looked for companies whose growth that isn’t so dependent on the business cycle; so called, secular growth stories. These are companies with growth prospects unique to the company’s business model. Many of these stocks are found in the information technology and health care sectors. The two themes don’t have to be mutually exclusive. We are talking more about their relative performance, which is why broadly diversified markets like the U.S. and even emerging markets in Asia were able to be top performers – as they saw a double shot of adrenaline from both trades.
Christine: Brent, do you see those same two themes driving capital markets in 2018?
Brent: To some extent, yes. With a couple of caveats. I feel that the global economy has enough momentum and that inflation and financial conditions will remain accommodative long enough that the ‘reflation’ trade will continue and I think it will take the leadership. The secular growth trade can remain intact, but given valuations, I find it difficult to justify it outperforming. Volatility is likely to rise, as inflation becomes more of an issue and central banks continue to tighten policy. In turn, the interest rate sensitive sectors of telecom, utilities, real estate and consumer staples that were not really a drag in 2017 are likely to weigh this year.
Christine: You touched on bond markets briefly. I recall, at the start of this past year, expectations were not rosy at all for bond returns – so in the end, how did fixed income investments fare?
Brent: Yes, last year I called for a sub-1% total return from Canadian bonds and the benchmark FTSE/TMX Universe Bond Index ended-up coming in with a total return of 2.5%. Longer-term government bond yields rose to 2.04%, shy of my 2.25% forecast. While shorter term bond yields were lifted substantially by the about-face at the Bank of Canada, who raised interest rates twice. The real savior was in Provincial and investment grade corporate bonds as credit spreads there narrowed further, from already low levels, driving the better result. High yield bonds were the standout performers, benefitting from their higher running yield and narrowing credit spreads.
The bond market did see a fair degree of volatility, with a mid-year peak-to trough move of -3.55%. So, depending on how and when you invested in fixed income over the year, results may vary widely.
Christine: Staying with Canada, but moving from bonds to stock, I suspect a few Canadian equity investors are feeling a bit disappointed. I mean, the S&P/TSX composite still had positive returns, but they just seemed underwhelming compared to the results coming out of the States and Europe. Why did Canadian equities lag their global peers?
Brent: I get frustrated when I hear lamenting over Canadian equity performance. Now, I understand the sentiment, especially when two-thirds of the way through 2017, Canadian equities had a slight negative price only return. This complaining prompted me to pen the 8 Best Reasons to Like Canadian Equities paper we published. But let’s set the record straight. First-off, after responding to the ‘reflation’ trade and higher oil prices in the last four months of the year, 2017’s price only return came in at 6%. Given our solid dividend yield the total return run topped 9%. And yes, this is less than half of the S&P 500’s 21.8% total return and we will discuss why in a moment. The main thing I believe Canadian investors should realize is that equity markets don’t hand-out returns in neat calendar year bundles. The S&P/TSX was an exceptional performer in 2016, up 17.5% vs. 9.5% for the S&P 500. What should really matter to Canadian investors are their total returns in Canadian dollars, here Canada is the clear winner. Over the past two years, the S&P/TSX stands a cumulative 32% higher versus a 24% total return in Canadian dollars for the S&P 500.
Christine: Okay – so a bit of setting the record straight!
Brent: So, now I will climb down off my soapbox and we can discuss why Canada did lag its international peers last year. For Europe and Japan, the basic story is one of catch-up. These markets had yet to respond to the better growth environment in both their home countries and globally, each coming off of a sub-1% return in 2016. For the S&P 500 and emerging markets it is really a case of relative exposure
to the two dominant themes we discussed earlier: reflation and secular growth, with the secular growth theme accounting for most of the difference. Many secular growth companies are tech companies and information technology is the largest S&P 500 sector at 24%. When compared to the S&P/TSX’s 3% weight, we just can’t keep up. After struggling to keep up with their developed market peers for most of the past six years, emerging markets were 2017’s top performer.
Christine: They’ve evolved dramatically over the years.
Brent: Emerging markets have changed over the past 10-years. They were once primarily a cyclical trade, dominated by financials, energy and materials – similar to Canada. Tech companies in Asia are now a dominant factor in emerging market equity benchmarks. These are now referred to as the ‘BAT’ stocks internet giants Baidu, Alibaba and Tencent; Asia’s version of the U.S.’ ‘FAANG’ stocks. Today, information technology is the largest sector in the MSCI Emerging Markets Index at 28%. Meanwhile, emerging markets still retaining significant exposure to the reflation trade through their cyclical sector weights. Add it all together and throw in a weak U.S. dollar for added juice and emerging markets pop by 34% in U.S. dollar terms.
Christine: But our economy did well, and oil prices improved. I don’t get it. Why didn’t we see Canadian energy stocks do better?
Brent: Canadian energy stocks suffer from a couple of problems, both of which I see as temporary. First, global energy investors have yet to embrace the Canadian stocks. This is understandable, given the uncertainty brought on by NAFTA renegotiations. But more than that, energy investors are still reeling from the 3three-year collapse in oil prices. The first place global energy investors will venture when they tip-toe back into the energy space are into the large global energy giants, and shares of our larger energy companies performed well. The second item is more uniquely Canadian. While WTI and Brent oil ultimately ended the year up 12% and 18%, it wasn’t a straight line. WTI Crude oil entered bear market territory in June, before rallying 42% to the end of the year. Unfortunately, due to a series of uniquely Canadian issues (mainly pipeline related) Canada’s crude oil benchmark (Western Canada Select) slide 21% at the end of 2017 to finish 8.5% below the opening year price. Thankfully, WCS is rebounding – up 13% so far in 2018 and our energy stocks have started the year on a positive note, up 1.4%.
Christine: What about investors who have international funds? They will want to know about the UK, Europe and Asia – can you shed some insight into how those markets performed?
Brent: Sure, I mentioned the catch-up story that was going on, so investors here should be happy. More broadly, constructive political developments and surprisingly strong European economic growth lifted European equity markets to a 6.5% return in local currency, 13,6% in Canadian dollars. Investors let out a sigh of relief in May when pro-euro candidate Emmanuel Macron won the French presidential election only to have their resolve tested again by uncertainty over German and Spanish politics later in the year. While politics grabbed much of the headlines, the market was more focused on the continued economic recovery in Europe. Growth and inflation picked up in 2017, while unemployment ticked down to cycle lows. Equities were also supported by continuing easy monetary policy in the region. The ECB only made baby steps in gradually removing stimulus measures, while the euro currency benefited from the improving economic environment and was up 14.1% versus the U.S. dollar for the year.
For the United Kingdom, the UK FTSE 100 delivered a middling 7.6% performance in Sterling and 10.2% in Canadian dollars. Brexit continues to cloud the outlook for businesses, and falling real incomes (a result of rising inflation and stagnant wages) has dented consumer spending and confidence. Brexit negotiations did take a positive step forward in December. Some issues were resolved, but investors are acutely aware that there is still much work to be done.
Japanese equities were strong performers up 19.1% in yen and 15.6% in Canadian dollars. Much of the gain came in the final four months of the year. The move higher coincided with Prime Minister Shinzo Abe’s victory in a snap election in October. With inflation still nowhere near the Bank of Japan’s 2% target, Abe’s victory points toward a continuation of loose monetary policy and economic reforms known as “Abenomics”. Things have been quietly improving for the Japanese economy, with a rebound in business and consumer spending resulting in seven straight quarters of growth and an unemployment rate at 23 year lows.
Christine: So where does that bring us Brent? We’ve got a picture of how markets performed in 2017 - a strong year for capital markets by almost every measure. We are less than 2 weeks into 2018, and still we see market strength. Do we see this going on much longer?
Brent: Heading into 2018, we believe the world economy and financial markets are progressing through the later stages of the business cycle. We feel that the global economy has enough momentum and that inflation and financial conditions will remain accommodative long enough that we continue to favour equities over fixed income. Within that outlook, we acknowledge the attractiveness of equities over bonds on a risk-adjusted basis has narrowed. The result strikes a balance - a tempered risk-on position with a slight overweight in equities.
Christine: Thank you, Brent – I appreciate you helping us put into context the year that was and setting the stage
for the new year.
Don’t go far Brent, because in our next GLC podcast, we’ll be talking to you in more detail about your views and GLC’s Capital Market Outlook for 2018.
In the meantime, if any of our listeners want to read more about how markets fared in 2017, you can find our 2017 market review and more on GLC’s website, or follow us on LinkedIN – it’s posted there too.
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This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.