As the yearly returns can attest this year has been something rarely seen, SIMULTANEOUS GLOBAL GROWTH. The economic numbers from around the world have been steady as the result of monetary stimulus taking hold and elevating the markets. Not surprisingly, equities have been the place to be, because with new money being pushed into the market (quantitative easing) and zero or negative interest rates (guaranteed losing return); where else could you get a return on your investment?
Savings accounts are essentially negative, fixed income (bonds) are flat, Canadian residential real estate stumbled after a fiery start to the year, and equities were really the only performers (besides BITCOIN). This is the year where anyone could have blindly chosen to put money into any ETF and not lost any money. While looking back, the surprising part has been all the near misses, which felt a lot like a Stormtrooper firing at Luke Skywalker, that could have derailed the market in 2017. Many investors felt confident as the markets went up and up but in reality there were many instances that had us holding our breaths. Let’s take a look at the events that could have shocked the market:
Sources: Thomson Reuters, Bloomberg, Google Finance, Trading Economics, Seeking Alpha, National Bank, Yahoo Finance, CFA Institute
- US Politics – If you had placed a bet that Trump couldn’t become president, you most likely would have doubled down on the bet that there would have been a major political catastrophe as a result. He has fired countless politicians, avoided a government shutdown, angered foreign leaders and citizens etc. With all this excitement nothing came to light; no impeachment, no Russian comingling, no sexual harassment suit against him. Best of luck next year! Without a major setback the market kept on trucking. Potential catastrophe level (5/10)
- BREXIT – With zero progress Britain has a 2 year timeline to work out the kinks, while something could have happened it was unlikely to come up this year. This will be addressed in 2018. Potential catastrophe level (4/10)
- EU Explosion – There was a series of elections that could have started the unravelling of the formidable EU. Germany, France, and Netherlands who are major contributors to the EU voted and elected officials that were pro to remaining in the EU. These are vital organs to the EU and any removal could cause a complete dismantling to the EU economic system as we know it. But, with the votes cast favourably, another problem was avoided and the markets kept rolling. Potential catastrophe level (9/10)
- North Korean Nuclear War – With missiles fired around Japan and threats over Twitter, Donald Trump and Kim Jung Un went toe to toe in what could have been the first attack with nuclear warheads in over 70 years (World War II). What would be the fallout to a North Korean War? Would either China or Russian come to their aid? Would this trigger a World War? Possibly a second US/Russia cold war? Could the US fund another war? While this remains an issue, no attacks to write about, it remains a topic of concern in 2018, but until then the market continues to side step. Potential catastrophe level (9/10)
- NAFTA – A year ago, the now US president ran on the campaign that he would tear up NAFTA as Mexico was stealing jobs from the US and Canada was taking advantage of a broken system while the poor US was stuck in the middle. For Mexicans and Canadians this could have severely hurt businesses as the US is the largest trading partner of both countries. Without NAFTA there would have been increased costs for international business as goods and services travel over both the borders. Since then, the alarms have quieted and both the Canadian dollar and Mexican peso have rallied. Potential catastrophe level (6/10)
- Inversion of the yield curve – While this does not make newspaper headlines, this has predicted 7 out of the last 8 recessions. Traditionally, the yield curve bends upwards, meaning the long term rates are higher than short term rates. In November of 2017 the yield curve was the flattest it’s been since the recession of 2008. This was mainly tied to a government shutdown in December but this has been flattening since 2012.Â If this were to invert, it would most likely indicate stormy days ahead. As interest rates go up, the short term rates will increase and hopefully the long term rates will follow suit; but until then the market will continue to rise. Potential catastrophe level (8/10)
- Canadian Real Estate – Residential real estate has been on the rise for the better part of 20 years (with exception of 2008). The last real estate recession in Canada was a 7 year period between 1990 and 1996. While many people blank out this period, it did in fact happen with real estate slowly depreciating in value. With higher than ever debt levels, how long can the Canadian market hold on? But without a major recession and oil on the rise, the Canadian markets continue to move forward. Potential catastrophe level (7/10).
Last year was a combination of very good economic conditions, a strong risk/return equity market and a handful of near misses. This combination lead to a low volatility upward trending market, which is an anomaly is the investing world as there is usually at least one event to correct the market per year.
Technology Leading the Charge
While the macro conditions were strong, 2017 was driven by technology. As technology advances, companies are finding ways to become more and more profitable and drive higher earnings than ever before. Innovative technology traditionally drives profits higher. In 2017 the push seems to have come from massive growth in existing technology usage (online purchases, electronic payments, mobile media usage, etc.). While in the 90s and 2000s these were budding industries, 2017 has shown the massive adoption of these technologies. Companies like Alibaba, Amazon, Google, Facebook, Visa, Square, Shopify have all continued to show dramatic growth in 2017. With this transition there was the emergence of new exciting technologies to make the existing technologies even more efficient. Cloud servers, artificial intelligence, and blockchain are all stealing headlines as companies take another step forward.
While Cloud service is not new, it has driven the profits of such companies like Amazon and Microsoft as data moves from a company’s server room and into the cloud. Artificial intelligence also is not new but with the new massive amount of data we now use through the cloud, social media, online purchase, etc. the need to automatically sort and organize this data has become a necessity. This industry continues to grow with the need and is beginning to become very apparent in everyday life. From Amazon selecting recommended products for you based on your previous purchases to Google maps mapping out entire cities based on video collected without having a human to enter the data. AI is taking over many high volume menial tasks performed by humans and will only become more prevalent as it begins to operate vehicles, give opinions, and assists in our everyday tasks.
Blockchain and its most popular child cryptocurrencies (ex. BitCoin, Ethereum, Ripple, etc.) really began to take hold with many currencies erupting and delivering returns in the thousands of percent. Our view is that these will continue to be very volatile investments and come with a very high level of risk with a potential for high levels of return. It would be very important to watch these very carefully as today’s treasure could be tomorrow’s trash. It is our view that this technology is here to stay as blockchain provides very significant advantages in business and transactions but which cryptocurrencies will survive will be up to speculation and the eventual government intervention.
Lastly, we had to add in that marijuana stocks have been a very pleasant surprise especially for Canada as these stocks rallied hundreds of percent higher. Canada has been the breeding ground of many of these companies as US regulation makes it very difficult for marijuana companies to operate. As more US states make the sale of marijuana legal and Canada prepares to federally legalize it, these stocks will be able to grow sales at exponential levels. While the actual participation level is unknown many analysts are predicting higher than expected levels as new products get introduced daily.
In with the new and out with the old. With all this technology what is falling behind? What changes need to be made? Online shopping has taken its toll on brick and mortar stores, companies like Kroger, Wal-Mart, Best Buy, Costco, Footlocker, etc. have had to adapt to avoid being named the next Blockbuster video. It was a volatile year for all these companies as there were large swings in either direction throughout the year, with the well run companies being able to weather the storm. Best Buy and Walmart both ramped up their online store fronts to complement their stores. While companies like Costco try to solidify their consumer base by offering more and more bulk products at a better price.
Old giants have been under attack and also have been forced to adapt. IBM has seen its once dominant mainframe and server business mature with the cloud business now taking over. They have put a lot of efforts into AI and blockchain as they transition to a company of the future. General Electric, AT&T, Comcast, Disney, GM, the list goes on and on as these companies are on a roll adapting to the current and future trends for fear of being left behind. While the future may seem dim, these companies have not survived decades or in some cases centuries without the ability to adapt and grow. It will be interesting to see how their business strategies play out into the future.
Canada, has not just seen growth only in the marijuana area but also in many technology companies. With relatively easy to obtain government technology grants Canada has seen many young technology companies spring up with investments in AI and blockchain. While we have been very dependent on the price of oil, hopefully Canada can foster these industries and grow.
Housing continues to be the hot topic though, as we had a meteoric rise in the first 3 months of the year only to see a drop and taper off throughout the remainder of the year. This will be a very sensitive balancing act over the next couple years as the government must try to maintain a growing housing industry without introducing too much regulation. The Canadian government has already introduced new more restrictive mortgage rules starting January 1st, 2018 which could put a damper on potential growth in this area.
Unfortunately, for the time being, the economy in Canada will be largely dependent on the price of oil and the economic demand of the United States (our largest trading partner). While oil improves, NAFTA will be a headline in 2018 and the effect that has on trade.
With many major elections in the rear-view, it appears the EU will remain intact for the foreseeable future. The current EU government will continue to stimulate their economy until September 2018 and this should give them the extra money to invest in projects around Europe. Hopefully, this will allow them to continue on their path to stability. The largest event will be the implementation of BREXIT, which could be very abrupt if Britain and the EU fail to reach a deal in 2018. While a smooth transition would be ideal from a third party perspective, the EU will most likely want to leave the impression that leaving is not in the best interest of any country.
China’s massive economy has continued to move upwards with some areas exceeding that of the United States. Their transition into a consumption based economy opposed to manufacturing is taking hold and it would be expected to become more economically independent in 2018 than in prior years. Their pro-China political stance has been very positive for Chinese companies and their citizens; 2018 should be another strong year as they begin to branch outside of China.
Upcoming This Year
This year should be more interesting than last year. Additional new technologies will be implemented and start to take form; well-run companies will expand with them and the rest we wish the best of luck. The US and other countries are expected to continue to raise rates while the EU will taper quantitative easing as the rest of the world begins to decrease monetary stimulation. This is a good sign because it means the economic picture is progressing and central banks believe it can handle taking the foot off the gas. This alone should create volatility as there will be areas in which to make money other than just equities. Unlike this past year, 2018 should prove to require investors to be much more selective as less attractive companies will get sold for other investments. Several unresolved issues will get pushed forward into 2018 and will eventually need to be addressed. This could bring some downside surprises that 2017 never brought us. While we expect more volatility, simultaneous global growth should propel markets higher as it should overshadow most negative headlines.
We continue to believe that a globally diversified portfolio is the best approach. Equities favoured over fixed income as bonds enter into a difficult long term environment. We favor the US equities over Canadian, with a mix of private investments that reduce overall market volatility and provide consistent returns.
Konrad Kopacz, Justin Lim, Merriel Dean