The Market

US and Canadian markets, proxied by the S&P500 and TSX Composite indices, respectively, surpassed all-time highs in August. Both equity and bond markets continue to keep investors pinned back in their seats on the roller coaster ride that started last October 2018 as they digested several continuing geopolitical and macroeconomic issues during the quarter.

Slowing global economic growth, partly due to continued US-China trade conflicts, motivated the US Federal Reserve to cut the key US lending rate by 25 bps to 1.75% on September 18, 2019, a move widely expected by market participants. This is the second rate cut by the US Fed since 2008. In contrast, the Bank of Canada held the overnight rate steady at 1.75% on September 4, 2019, with no mention of future moves for the next rate decision on October 30, 2019. Statistics Canada announced an unchanged GDP in July 2019 after three months of growth, primarily due to suppressed activity in the Alberta oil and gas industry.

The US-China trade war continues to top investors’ minds in terms of stifling global growth as both US President Trump and Chinese President Xi play a game of cat and mouse with retaliatory tariffs on new and previously declared goods.

Elsewhere on the global front, we loom closer to a no-deal Brexit, currently scheduled for October 31, 2019 which would have economic consequences due to disruption in major supply channels between England and the rest of the EU. At this point, there are talks of delaying Brexit for the third time to prevent a no-deal Brexit from occurring.

The table below shows the market performance as of September 30, 2019 in Canadian dollar terms.

Performance

Due to our conservative stance, on a year to date basis, the YouFirst Growth composite at 10.6% and the YouFirst Conservative Growth composite at 9.2% trailed the FPX Growth and FPX Balanced benchmarks by about 1½ percent, respectively.

Portfolio Activity

During the quarter we added BTB REIT 6% 31Oct2024 (BTB.DB.C – TSX) to several portfolios. As a smaller REIT, it carries somewhat more risk so the size of the holding in portfolios is lower than is typical. BTB owns 66 commercial, office and industrial properties in eastern Canada. It pays a 6% interest yield and matures on October 31, 2024.

Outlook

At the end of September, the S&P500 index was only 2.8% higher than where it was exactly one year ago. This narrative naively hides the volatility of the Q4 2018 market pullback followed by the impressive market rally in 2019. More recently, the financial markets have been cautiously treading water while presented with continued geopolitical woes and conflicting economic signals.

Portfolio returns only tell one side of the story. Through our experience, we have found that most investors tend to sleep better at night when their portfolios experience minimal volatility while we strive to achieve reasonable risk-adjusted returns (portfolio returns measured per unit of market volatility).

We continue to monitor macroeconomic developments globally that have the potential of affecting future expected portfolio returns.

Important items to note:

• The US Purchasing Managers’ Index (PMI) fell from 52.1 in July, to 49.1 in August and 47.8 in September. A reading below 50 indicates contraction in the manufacturing sector, which accounts for about 12 per cent of the U.S. economy. The latest reading pointed to the steepest contraction since June 2009. However, the ISM PMI remains above the 43 level, which economists typically associate with a recession.
• US and Canadian Treasury (government bond) yield curves continue to be inverted, a situation where short term 2-year interest rates are higher than medium term 10-year rates. Increasing pessimism is causing investors to move into bonds, driving up their prices, thus lowering the yields. Historically, a lengthy 2y-10y inverted treasury yield curve scenario has reliably predicted a recession.
• $12 trillion of treasury bonds in Europe and Japan have negative yields with policy makers in the US contemplating allowing their treasury market to follow suit by introducing more quantitative easing. The demand for safe haven treasury bonds is so high right now that bond prices have skyrocketed driving their yields sub zero. Imagine lending your bank $1 to only receive $0.90 back in one year (you are paying the bank to hold your money). It simply doesn’t make rational sense, however if quantitative easing expands, we would eventually expect an increase in stock market prices.

While we don’t have a crystal ball to predict the future, we can say with conviction that uncertainty in the global financial markets will reign. We continue to maintain a conservative posture for all portfolios until a reasonable opportunity to increase market exposure presents itself.

Benjamin Graham, often considered the father of value investing once stated, “The market is a pendulum that forever swings between unsustainable optimism (which makes stocks too expensive) and unjustified pessimism (which makes them too cheap). The Intelligent Investor is a realist who sells to optimists and buys from pessimists.” As such, we will actively monitor market conditions and top up equity investments at the time we believe that growth can be purchased at a reasonable price (i.e. when enthusiasm in the market wanes).

If you have any questions or comments regarding items discussed in this newsletter please let us know.
 

Doug Garner, P.Eng., CFA
President, Portfolio Manager

Jane Garner, BA, EPC
VP Operations and Client Experience

Simon Chun, P.Eng., Passed CFA Level III
Investment Analyst