Source: Yahoo Finance
As in 2018, 2019 also brought many big headlines to cause fear in the market. The biggest difference between both years was that the US Federal Reserve ignored all the headlines in 2018 and accepted the risks it presented to the market. However, in 2019, they quickly changed their tune, adjusting their stance and slowly cutting rates to accommodate for those potential risks, adding a layer of protection in case they were to transform into something larger than just a headline. This action by the US Fed gave investors’ confidence once again to invest and companies to continue to borrow at low-interest rates which lifted stock prices. One of the most prominent headlines was the trade war between the US and China. What often seemed like a back and forth skirmish on imports and exports, became a battleground for both sides, with each increasing tariffs on traded goods to “punish” the other. As the two largest economies in the world, trade between each other is very important for global economic health and this trade war put a damper on it. As trade decreased and companies need to adjust. We could write pages on this topic but at the end of the day, the trade war still exists. However “phase 1” suggests that they will remove some tariffs and agree to purchase some of each other’s goods in a structured format, with many topics still on the table.
Another budding trade war that has been put on hold for an entire year, was the new NAFTA of the USMCA trade agreement, (more letters pretty much the same thing with a few updates). This was a bit of a political sideshow more than anything but the agreement was updated to increase domestic car production inside North America, decrease dairy restrictions in Canada, extend intellectual property rights, and a few more aspects, however nothing too impactful. Also, stated was an increase in Mexican autoworker pay to allow for a more competitive labour market in the automotive industry. To us, this appears to be President Trump doing what he can to come through on his promises on trying to save the auto industry in the United States more than anything else. Through all this, they have maintained tariffs on steel and aluminum that cross the border which potentially could save some steel factory jobs he also promised during his campaign. With the new “phase 1” US/China deal, China has also agreed to purchase more agricultural goods from the US, which in turn could potentially help farmers. Every “deal” does appear to be made with the 2020 election in mind. President Trump is a man of many personal and business flaws but at the very least he is consistent from his election campaign to his current state in office.
This brings us to the next market rattling headline, President Trump, and US politics. What a rollercoaster this has been, Mueller investigation, constant firing and quitting, Ukraine, a couple of impeachment attempts, 4 am tweets, as this has been reality TV at it’s finest. All this has given investors an uneasy feeling, as the top officials in the world’s largest economy act in a very unbecoming way from what you would expect out of people in their positions. The continued divide between the left and the right in the US seems to have widened, as each side is constantly trying to get the upper hand on each other. We could go through the stories one by one but it seems to be irrelevant at this point, as many investors have decided to ignore these headlines and focus on the numbers until something concrete happens. History dictates that economic fundamentals matter more and politics has repeatedly had minimal effect on a company’s returns.
One headline that has normally served as a good economic indicator did take place during 2019 that gave investors quite the scare and that was the inversion of the yield curve (which took place in May). This event has predicted 7 of the last 8 recessions, but while this is a good indication of the future, those recessions took 6-36 months to come. So while there are reasons to be cautious, other indicators did not point to an immediate recession as we stated in market reviews around that time. The US Federal Reserve has many ways to help the economy in such times when bond traders are signaling that they are weary since then the yield curve has steepened slightly but we do have more room to go until we are fully in the clear. Until then it would we can watch other indicators of recession such as employment, inflation, commodity prices, etc.
BREXIT has been a headline for a long time and was expected to cause a lot of market fluctuations but given 3.5 years to prepare the market was well aware once this came to an almost conclusion. In January, they will vote to leave the EU and it appears that after that they will be on their way out (barring EU approval). Once both sides are good to go, the United Kingdom is scheduled to officially leave in December 2020, making this ordeal 4+ years in the making. But it appears we can finally put BREXIT to bed and have certainty on what the future looks like for the two entities.
Justin Trudeau is once again our Prime Minister. The Liberals won in minority fashion this past October, giving Justin another 4 years at the helm. The Liberals did have a good platform to run on and after trailing in the polls earlier in the year and overcoming “blackface” they succeeded, however with fewer seats than this time 4 years ago. It will be interesting to see how they navigate into the future as Canada continues to push “green” initiatives and increased health care. Both are great for our future and are very important but with a potential tax cut for the middle class on the table, it could become difficult to pay for these with a decrease in tax revenue. This is will be a tough balancing act when economically Canada is keeping up with our neighbours in the south. Unemployment has begun to creep up and it has begun to come close to 6%, which we have not seen since 2017. Month over month GDP also went negative as per the last numbers in December, which is signally the Canadian economy is in need of a boost. We would expect the government to react, with 1-2 interest rate cuts most likely sometime next year if this were to persist. The government over the past 2 years has done what it can to avoid this, as lower rates will most likely have an inverse effect on housing prices causing them to rise once again in 2020. This may bring on more talk of a housing bubble, a narrative that we all thought we left behind in 2018.
With all the issues stated above the market continue to rally higher, volatility decreased on the back of many of these issues becoming less threatening as the year went on. The biggest driver of the market higher was the decreasing of interest rates and the stance the US Federal Reserve gave of being more patient of further increases in the future. These decreases gave businesses the ability to borrow at cheaper rates, decrease costs for businesses, and reduce the desire for investors to save rather than invest. The US/China trade is far from over but the new “phase 1” deal gives investors hope that this will not get much worse. The political headlines have not gone away but with the upcoming US elections in 2020, the focus has turned to optimism for both parties hoping that they will come out as the victor. With hopefully fewer headlines to be concerned about in 2020, there would be little in the way of stocks increasing, as stocks very seldom go down because they are “too high”, they are more likely to decrease when there is a reason to be pessimistic about that future.
Predictions for the New Year
1. Commodity prices to increase further in 2020. Last year we predicted commodity prices to rise and there were some increases: Oil up 29%, Gold up 17%, Silver up 15%, Lumber up 23%, Coffee up 30%, Milk up 40%, just to name a few. We expect this trend to continue into the upcoming year as cheap money continues to enter the market.
2. Interest rates to remain low. There has been every indication around the globe that the central banks would like to keep the interest rates low and potentially decrease. This should help the above but most likely will not be the trend for the entire year if inflation begins to creep up eventually the tune may change to begin raising rates once again in 2021.
3. US politics to dominate the headlines. This is not much of a gamble, it has been true for years and with an upcoming election, that we will all become experts in US politics. It is important to understand their platforms as in every election year many business sectors become battlegrounds with each candidate promising change. Pharmaceuticals was a major issue in the last election and caused a great sell-off in the sector as both parties set their sights on drug prices.
4. Canadian Real Estate prices to increase. With interest rates potentially decreasing, the government doing what they can to help first time home buyers, Justin Trudeau pushing for 1,000,000 immigrants over the next 3 years and the recent increase in housing sales at the end of 2019, we are setting up for another increase in housing prices in Canada. Long term we would prefer slower growth but the inputs do not justify that.
Potential Problems in the New Year
1. Employment. This is the major indicator in North America, Canada has been losing some jobs and will need to turn that around or we could be facing a problem. The United States continues to add jobs as workers continue to come out of the woodwork. If these were both to become negative we would need some wage inflation to keep everything running well.
2. US/China trade war. While “phase 1” is complete but not yet signed, it really wasn’t anything groundbreaking. The real issues regarding product “dumping”, barriers of entry into China, and intellectual property have yet to be dealt with and neither side has a way of disciplining the other if the agreement isn’t honored. We could see some reversion in 2020.
3. Debt. Debt levels could become a problem, but with cheap interest rates, this is fine for now, as long as interest rates remain low, however, the debt eventually needs to be paid. If debt levels continue to grow, a rate increase in the future will be more costly, thus burdening taxpayers and companies and slowing growth.
4. US Election. It is a little early to tell how this will play out but drastic changes that the market is not anticipating will cause volatility in stocks. Technology is on the radar this year, this is something definitely to be wary of as technology stocks have led the market for the last 10 years.
Potential Catalysts in the New Year
1. Low-interest rates. If the narrative of lower for longer remains than you can expect stocks to continue to rise. As stated above this will cause increased debt but that will be pushed to a 2021 problem.
2. Capital Expenditures to increase. This can happen from two sources, companies putting their massive cash hoards to use on long term assets (buildings, projects, machines, etc.) or the government spending on infrastructure and buildings. Both have been dismal in the last 3-4 years but an increase in this could spur another leg up in the market.
3. A solution to the US/China trade war. While solving every issue seems to be a challenge, further progress would be very positive for the markets.
In summary, 2019 was a good year as many issues were resolved. Looking back, it’s best to look at the market in the past two years and take an average, as a 28.8% market return in the S&P 500 does not happen without a large decrease at the end of the prior year, nor should we be expecting it going forward. Stocks are valued higher than before but this does not mean everything is going to fall apart. We are not coming out of a recession but that does not mean we are ready to enter one right away. There are still areas for growth and as of right now as the US and Canadian consumer is healthy, it’s ok to be optimistic. There will be more volatility going forward and we will adjust accordingly.
Our investment thesis remains the same with a balanced approach (Public vs. Private Investments). We believe every investor should hold a diversified mix of Equities, Alternatives, and Fixed Income just like the pension funds and endowment funds do. At the time of writing this, there are still a lot of great opportunities, even at these levels in the equity markets, but investors should be much more selective going forward. For more information, please do not hesitate to contact us.
Konrad, Justin, and Merriel
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