Market losers were hard to find in 2019 as virtually all asset classes produced solid returns. Equity markets around the world bounced back following a market selloff at the end of 2018. North American equity markets hit new highs with double-digit gains, climbing the proverbial ‘wall of worry’ and bobbing and weaving between Presidential tweets, threats of trade tariffs, and rinse-and-repeat Brexit debates. Bond yields plummeted on recession fears and an about-face by central bankers (from hawkish to dovish), resulting in very healthy returns for fixed-income investors. Oil prices also bounced back as U.S. WTI crude prices rallied from their late-2018 lows, peaking in April at USD $66 per barrel, then sinking back to the mid $50s on fears of slowing demand growth and high inventory levels. Oil rallied into year end, finishing above USD $60 per barrel. Gold prices spiked at the height of summer’s recession fears and during the low point for trade talks (rising as high as USD $1,550 – their highest level since 2013).
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Trade tensions and central banks’ actions drove market moves
Trade tensions dominated the news and equity market narrative in 2019 until a thaw in U.S. trade tensions with its top three trading partners (China and USMCA partners, Canada and Mexico) sent equities sharply higher into year’s end. Not to be understated is the positive impact the 180-degree policy shift from various central banks [most notably the U.S. Federal Reserve (Fed)] had on equities and bond yields. Following the late-2018 market selloff, and with inflation remaining contained, January saw the Fed pivot from its rate-hiking course in the hope of prolonging the current economic expansion. The Fed ultimately cut interest rates cuts three times during the year, while the European Central Bank (ECB) cut rates further into negative territory.
Renewed “late-cycle” concerns emerged in spring and global growth showed signs of deceleration, notably in the manufacturing sector where Purchasing Manager Indices dipped below the critical 50 expansion/contraction line in most regions. Along with softer economic data, a rapid decline in bond yields flashed a warning to economic momentum as the Canadian and U.S. 10-year bond yields fell below 3-month and 2-year yields, resulting in the yield curve becoming inverted (this past spring, we penned a detailed explanation of this traditional recession harbinger; see GLC Insights – The inverted yield curve). North American bond yields continue to be weighed down by negative interest-rate policies on the part of central banks in Europe and Japan. German 10-year government bond yields fell as low as -0.71% in August and the pile of negative-yielding global debt peaked at a massive USD $17.0 trillion in the same month. Global bond yields trended higher in the last four months of the year on hopes that the U.S.-China trade battle was progressing toward a resolution and some signs that global growth was picking up (notably global PMIs had arrested their declines). Fed rate cuts saw the U.S. yield curve rise out of inversion and return to an upward sloping trajectory. The Bank of Canada (BoC) remained on the sidelines for all of 2019, leaving portions of the Canadian curve flat or inverted. Markets received an injection of monetary stimulus when the U.S. repo market ran into liquidity issues in October, resulting in the Fed growing its balance sheet again – although they were quick to point out that it was not “quantitative easing”.
Canadian equities enjoyed a robust year with the S&P/TSX Composite rising 19.1% following the 11.6% decline in 2018. Nine of the 11 sectors finished with double-digit gains, with only Health Care ending the year in the red. Information Technology led gains (for the second year in a row), helped by spectacular returns from high flying e-commerce firm Shopify (up 174%). The Utilities and Real Estate sectors produced strong returns; both sectors benefitted from lower interest rates and investors’ appetite for yield and safety. The heavyweight Financials sector delivered a 16.9% return, but still underperformed the broad market, dragged down by softer returns from bank stocks. The large Canadian banks generally reported positive year-over-year earnings growth in fiscal 2019, yet most underperformed expectations.
Canada’s other dominant sector, Energy, delivered a 16.2% return, but also underperformed the broad market. Higher-yielding pipeline and midstream stocks outperformed significantly, while exploration and production (E&P) stocks generally saw share price declines. Canadian heavy oil differentials narrowed from 2018’s extremely wide levels on the back of government-mandated production cuts; continued headwinds (in the form of pipeline takeaway constraints) weighed on sentiment.
The Health Care sector was the extreme outlier, down double-digits for the year. An early-year jump in cannabis stocks made Health Care the top-performing sector in Canada right up until the end of May before a massive shift in sentiment saw this reverse. The highly volatile cannabis sector sold off sharply as investors grew impatient with continued financial losses and delayed expectations for profitability. In November, we published a comprehensive look at the investment risks and opportunities in GLC Insights: The Green Rush – Exploring Canada’s Cannabis Industry.
On a style basis and cap-size basis, growth stocks tended to outperform in Canada, while Canadian small caps stocks underperformed largely due to weaker Energy sector returns as cautious energy investors gravitated to more defensive, larger market cap names.
The S&P 500 rebounded strongly following sharp losses in Q4 2018, marching to new record highs to extend its current record-long bull market run. Now into its eleventh year, the S&P 500 is up a cumulative 377.6% or 15.5% CAGR from the March 9, 2009 low of 676 (in May, we spoke to market considerations for late-cycle investing in GLC Insights: Riding the backside of the U.S. bull market). The 28.9% price-only return (U.S. dollars) marked the best calendar year performance since 2013, with the year’s gains largely book-ended by strong Q1 and Q4 performance.
The Fed’s policy pivot was a key factor in flipping investor sentiment. An early-year shift in guidance was followed up with rate cuts at 3 successive meetings in June, September and October. Investors fearing a slowdown in economic growth welcomed easier monetary policy, while lower bond yields increased the relative attractiveness of equities. Investors appeared to largely look through the trade-related noise, hoping (and expecting) a truce in the trade war. Similarly, investors largely ignored falling 2019 corporate earnings estimates, patiently pushing those earnings expectations into 2020, but paying up front for them now.
All 11 S&P 500 sectors finished in the green, with only the Energy sector failing to reach double-digit returns. The Information Technology sector led gains, helped by strong returns from mega-cap names, such as Apple, Microsoft, Mastercard and Visa. The Communication Services sector also performed well, with notable contributions from Facebook and Alphabet. The Financials sector benefitted from a stable macro environment and a healthy U.S. consumer. U.S. bank stocks performed particularly strong from August onwards when the yield curve steepened, and when value stocks outperformed. Despite the 34.5% jump in U.S. WTI crude oil prices, investors continued to largely avoid Energy equities – the 7.6% gain for the Energy sector was, by far, the biggest laggard within the S&P 500.
Style rotation later in the year saw U.S. value stocks catch up with their growth counterparts to end the year roughly in line – a break from the past 6-year trend where growth stocks outperformed.
A Surge in IPOs – Some worked, others WeWorked
IPO activity surged, with the market rally providing founders and owners of private companies a window of opportunity to go public.
Among those that eventually worked? The listing of Saudi Arabian state-owned Saudi Aramco, marking the debut of the world’s largest company and biggest IPO in history (with proceeds of USD $25.6 billion topping the USD $25 billion set by Chinese e-commerce giant Alibaba Group in 2014 and the USD $1.88 trillion total market cap besting the previous records set by Apple and Microsoft at roughly USD $1.2 trillion). Aramco’s listing wasn’t without difficulties: it was shunned by foreign investors and markets (the hoped-for cross-listings in the U.K, U.S. and Asia have yet to happen, leaving the main listing on the Saudi Tadawul Stock Exchange). However, the company’s post-IPO price did soar, cresting the psychologically important USD $2 trillion mark.
Among those that didn’t? Many other IPOs struggled following their public listings, notably ride-sharing giants Uber and Lyft. The biggest private equity story of 2019 was the fever-pitched hype, and then ultimate failure-to-launch IPO from the office-sharing firm WeWork. As investors dug into WeWork’s prospectus document, glaring financial losses and governance red flags became more evident and things began to unravel for the company. WeWork’s founder/CEO was ousted and the company’s valuation tumbled from a high of ~$47 billion earlier in the year to lower than $7 billion when Japanese investment firm Softbank bailed them out. While the WeWork and Aramco stories are interesting, in and of themselves, many investors were quick to point to WeWork’s collapse as evidence of investor exuberance that had gone too far and that extreme valuations for these concept growth stocks are starting to be questioned. Indeed, the trepidation of large foreign institutional investors toward Aramco were based on valuations, specifically an insufficient dividend yield.
The bottom line? Key company fundamentals like profitability and shareholder return are being pushed up the list of investor priorities, something we see as an encouraging development.
International equities produced positive gains but trailed their North American peers. EAFE (Europe, Asia, Far East) equities were supported by accommodative monetary policy, most notably by negative policy rates in Europe and Japan where economic growth and inflation remain subdued.
Populist political pressures remained front and centre in Europe: Italy and the E.U. battled over fiscal targets; street protests continued in France; and, elections in Spain (the fourth election in the last four years) failed to produce a majority government. The euro weakened relative to the U.S. dollar to provide support for European exporters, while European equity markets generally brushed off the rising political noise. Germany, France and Italy were some of the standout regions within European equity markets, all up over 20% for the year.
March and October Brexit deadlines came and went with both sides unable to come to a deal. Boris Johnson replaced Theresa May as Prime Minister before seeking and gaining a fresh majority from the British electorate that’s expected to see Brexit come to fruition in early 2020. The exporter-heavy U.K. FTSE 100 Index was a lagging performer due to lower odds of a no-deal Brexit that helped strengthen the British Pound.
Emerging market equities produced strong returns but trailed their developed market peers. Trade uncertainty and Chinese growth concerns weighed on export-focused multinationals across the globe and had an especially outsized impact on Asian firms heavily reliant on China. Political protests in Hong Kong further added to uncertainty and weighed on sentiment.
The FTSE Canada Universe Bond Index produced strong returns in 2019, with the 6.9% total return marking the best calendar year performance since 2014. North American bond yields moved lower for the first half of the year, continuing a trend that began in the fourth quarter of 2018. An August reversal saw yields grind higher for the remainder of the year, but they still finished the year well below their 2018 year-end levels. The bull-flattening yield curve (long rates falling more than short rates) saw long-term bonds outperform relative to their shorter maturity counterparts. Corporate bonds slightly outperformed relative to government bonds, with credit spreads narrowing on the back of increasing investor risk appetite and the thirst for yield. Provincials and municipal bonds outperformed Federal bonds within the government sector.
Despite the three rate cuts from the Fed, the BoC left rates unchanged in 2019. The BoC entered the year with some breathing room vis-à-vis the Fed, with the Fed’s three rate cuts bringing the upper bound of the Fed Funds rate down to match the Canadian overnight rate at 1.75%. The BoC continues to monitor developments – both domestically and abroad (most notably trade frictions), including a yet-to-be ratified USMCA. The BoC is showing some reticence to cut rates, not wishing to encourage further borrowing amongst already indebted Canadian businesses and households. Narrowing interest rate differentials between the U.S. and Canada pushed the Canadian dollar higher against the greenback, leaving the loonie as one of the best-performing developed world currencies in 2019. U.S. 2-year yields were higher than their Canada counterparts by as much as 0.85% in March before a steep U.S. yields drop turned the differential negative, finishing the year at -0.13%.
GLC’s 2020 Capital Market Outlook
Green shoots – We believe the current economic slowdown should come to an end in 2020. The global economy is showing signs (the so-called ‘green shoots’) that growth in 2020 should pick up modestly, aided by a détente in global trade frictions and stimulative central bank policies. We see an economic environment where corporate earnings growth will be sufficient to support equity market gains. We expect that bond yields will remain low but have a modest upward trend, commodity prices will improve, and the U.S. dollar will weaken.
We recommend a neutral stance with a slight defensive tilt toward fixed income over equities (risk-tolerance aligned) that continues to offer exposure to participate in equity market growth without overreaching for risk. For region and sector specifics insights on what capital markets may hold for the upcoming year, please see GLC’s Capital Market Outlook: Green Shoots Mark Modest Improvement for 2020.
2019 Sector Returns
S&P/TSX Composite (CAD)
S&P 500 (USD)
2019 Canadian and U.S. Equity Performance
2019 Canadian Bond Market Performance
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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.