Market Commentary - Q4 2019

Here is our investment team's commentaries on market conditions as we close out 2019. 

Equity Markets This last year has been rewarding to equity investors. Fear around weakening global growth and continued global trade tension had investors on their toes to start the year but this abated quickly. Sentiment is a powerful driver and investors’ optimism persisted throughout the year. Instead of worrying about US-China relations, market participants chose to focus on a potential re-acceleration of global growth and supportive monetary policies around the world. The result was strong returns with moderate volatility. All major equity markets delivered healthy results for both this last quarter and for the year with US equities standing out as the strongest of the group for both periods. This was a strong year for Canadian equities with every quarter delivering positive returns. The final quarter of the year was no exception with a 3.2% return, bringing the annual return of the S&P/TSX Composite to 22.9%. This was the best calendar year since 2009. The asset class benefited from a generally constructive macro environment for equities but also from improving energy prices. Breadth was strong with seven of eleven sectors posting gains during the quarter. Technology (+11%) led the way but was closely followed by Materials (+8%), Energy (+7%) and Industrials (+5%). Health Care (-6%) and Consumer Staples (-4%) were the weakest sectors. For the year, sector breadth was exceptionally strong with only one sector in negative territory (Health Care, -11%). The ten other sectors offered returns ranging from +13% to 65%. Interestingly, the two top performing sectors, Technology (+65%) and Utilities (+37%), were sectors with very little in common. Investors were risk seeking and pricing in lower interest rates simultaneously, which would be traditionally viewed as inconsistent. In the US, this year highlighted the importance of having a long-term view on equities. The sluggish performance in the last quarter of 2018 was followed by a very strong 2019. US equities rebounded nicely finishing up 31.5% in USD and Q4 was no exception with the index up 9.1%, which translated into a 6.8% return in CAD due to the strengthening loonie. Investor confidence increased after the US and China agreed on a “Phase 1” trade deal, putting a pause on President Trump’s proposed tariff hikes. As the market gained more confidence in global growth re-accelerating in 2020, we saw a clear rotation into more cyclical stocks. The Information Technology sector (+14%) led the index higher once again, offering the best sector return in the index. We also saw strength in Financials (+11%) and Communication Services (+9%) with the latter driven by “growth” names like Netflix and Facebook. Sectors we see as bond proxies, like Real Estate (-1%), Utilities (+1%) and Consumer Staples (+4%), all lagged the index. The main exception this quarter was Health Care (+14%), which was quite strong as anticipated announcements from the Trump Administration turned out to be less impactful than feared. International equities also performed well in 2019, finishing up more than 15% in Canadian dollars. The final quarter of the year was strong with a 5.9% return. Aside from positive trade developments, equities benefited from Boris Johnson’s victory, winning a majority government in the UK. This gave the market much-needed confidence that a trade deal would be secured with the EU, avoiding a hard Brexit that could result in further global growth disruption. We saw a similar rotation into cyclicals within the international market. Information Technology (+10%), Materials (+8%), Industrials (+8%) and Consumer Discretionary (+7%) all outperformed the index. On the contrary, Staples (0%), Real Estate (+2%), Communication Services (+3%) and Utilities (+3%) were all laggards. The only exceptions this quarter were Healthcare (+10%), which was one of the best performing sectors and Energy (+2%), not keeping pace with the index despite a strong rebound in the price of oil. Performance was aided by favourable currency movements as the British Pound’s strength relative to the Canadian dollar was partially offset by the weaker Yen. Equity investors might have been shaken in 2018 but the strong returns of 2019 have lifted optimism across the financial markets. What does 2020 have in store? Now that the Fed has cut interest rates repeatedly in 2019, we believe the ingredients are there to extend the business cycle further. Although economic growth is not as robust as it once was, it does seem to be rebounding while inflation remains in check for the time being. This suggests a positive environment for equities. Our enthusiasm is moderated slightly by how late we are in the business cycle, as well as continued trade and election uncertainty as we navigate the year. We continue to carry a healthy weight in equities but feel that it is important to favour more defensive business models and stronger balance sheets even more so than usual.

Fixed Income Markets The last quarter of 2019 closed the year with bonds markets on a relatively bearish note as yields rose to their highest levels in over six months. The outlook for the economy was supported by the reduction in the potential impact from several event risks that dominated headlines throughout 2019. Most notably, there was an agreement in principal to the “Phase 1” US-China trade deal and further clarity on a UK Brexit. While details for the “Phase 1” US-China trade deal have not been finalized (expected in Q1 2020), the agreement in principal by both parties represents an important reversal to the mounting risks of a trade war, which was a theme that dominated headlines and economic outlook throughout 2019. In addition, a global move toward additional monetary policy accommodation and added support from fiscal policy measures to spur growth and meet inflation targets has been increasingly accepted by central bankers. During the year, the US Federal Reserve responded quickly to concerns of slowing growth by easing through three consecutive 25 basis point rate cuts, with the most recent cut in October 2019 to a Fed Funds rate of 1.50-1.75%. Canada remained on hold throughout the year as one of the only central banks that did not ease, maintaining an overnight rate of 1.75%. The accommodative actions of the US Federal Reserve in supporting liquidity and growth through policy intervention will form an important component of the economic outlook over the next year in an effort to offset the impact of weakening economic data and spur growth. The front end of the yield curve in Canada and the US remains well anchored (low yields for longer) as central banks in both countries remain on hold, with added flexibility to act quickly in the event of further weakness in economic data. The lag effects of the rate cuts by central bankers throughout 2019 are expected to support the economic outlook in the first half of 2020, although the full extent of the impact of the recent trade conflicts on business confidence remains to be seen. The overhang of uncertainty produced by the breadth and severity of such trade conflicts will continue to impact the performance of the economy with a lagged effect in the latter half of 2020. Most importantly, the uncertainty on business confidence could have a direct impact on fundamentals driving growth, in particular, direct investment in income producing assets that could lead to weaker consumer confidence and spending. During the quarter, Canadian inflation remained near target at 2.2% year over year while housing remained strong with good gains in key markets. Unemployment weakened slightly to 5.6% in December while GDP growth in Canada, reported in October, slowed more than expected to 1.2% year over year and was negative for the month at -0.1% month over month. Overall, GDP growth in Canada is expected to weaken to 1.6% for 2019 and then grow to 1.8% in 2020 while growth in the US is expected to come in at 2.3% in 2019 and weaken to 1.8% in 2020. Labour markets in the US remain tight with unemployment approaching a fifty-year low of 3.5% which should help support consumer confidence to some degree as layoffs relating to declining business confidence have not yet materialized. The inversion of the yield curve in Canada reverted to a flatter, slightly positive sloped curve as sentiment improved and yields moved higher. During the quarter, two-year Canada bond yields increased 12 basis points to 1.69% while five-year yields increased 29 basis points to 1.68%. Ten-year Canada yields increased 34 basis points to 1.70%, while thirty-year bonds where also higher by 23 basis points at 1.76%.