May 27, 2019
Financial sages often warn investors not to succumb to fear or greed. You have to wonder what planet they’re living on, especially after a tumultuous year like 2018, when stock markets veered from one extreme to the other with barely a pause for a Valium in between. Both the Standard & Poor’s 500 Index of leading U.S. stocks and Toronto’s S&P/TSX Composite tumbled in the first quarter, rallied in the summer and then plunged into a tailspin last fall to end the year down by 9% and 12%, respectively. Yet in the first quarter of this year, they surged back up to about the same levels they were at in January 2018.
“The markets are giving us a lot of information on a silver platter,” says David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates in Toronto. Well, yes, they're certainly moving in intriguing ways, but analyzing the trends doesn't yield a consensus forecast. Some experts believe markets will climb even higher this year; others say they'll struggle or slump. As is often the case, many of the disagreements among them are based on differences in basic attitude.
Rosenberg, who has a developed a reputation as an often-far-sighted bear in his three-decade career on Wall and Bay Streets, has been warning for two years that the U.S. bull market in stocks appears to be near its end. While not exactly gloating, he notes that the S&P 500 peaked near the 3,000 barrier twice in 2018—once in January and once in September—yet failed to crack it. Yes, the benchmark index made it back to 2,800 this March, but Rosenberg says that looks like “a very firm ceiling,” and U.S. and Canadian markets will likely keep drifting sideways at best. "If my forecast of a recession in the coming year proves to be prescient, then there’s more downside to this market than upside,” he says.
Yet there are still optimists to be found. Candice Bangsund, a vice-president and portfolio manager of global asset allocation, says the dominant force worldwide in 2019 will be “synchronized global expansion.” This will be led by China, she says, which is aggressively stimulating its economy and seems determined to conclude a trade deal with the Trump administration—or to reduce tensions, at least. Canada, in turn, should benefit from the new United States—Mexico—Canada Agreement (assuming it is ratified by legislatures in each country). Fiera forecasts a 5.6% return for U.S. stocks and a hefty 17.3% for Canadian stocks in 2019. “I realize this is a very out-of-consensus call,” Bangsund says.
Her projection for Canadian stocks is certainly a stretch, given the Canadian market's sluggish performance in recent years. The Canadian market is dominated by financials, energy and materials. By and large, the Big Six banks recorded solid increases in revenue and profits in 2018. They have soared since the financial crisis, in part because of low interest rates. But the share prices of many energy and mining companies continued to struggle last year, weighed down by weak prices for oil, metals and other commodities.
Much of the 2019 outlook depends on projections for interest rates and commodity prices. Rosenberg is alarmed by a traditional warning sign of an impending recession and market correction: “The U.S. and Canadian yield curves are as flat as a pancake,” he says. The Federal Reserve and Bank of Canada have hiked short-term interest rates over the past three years, and in March, yields on short-term U.S. Treasury bonds moved above those for 10-year bonds for the first time since 2007. Long-term rates tend to be based more on market expectations for economic growth and inflation, and those yields have sagged—hence the flat curves. To Rosenberg, that means “we’re past the peak on growth, past the peak on inflation and past the peak on interest rates.”
Central bankers also started the year cautiously. In the Bank of Canada's official statement about keeping its policy rate at 1.75% in March, it noted consumer spending, business investment and exports were all weak, and that “continues to warrant a policy interest rate that is below its neutral range"—meaning no more rate increases any time soon. Federal Reserve chair Jerome Powell was more straightforward in an interview on 60 Minutes: “We don't feel any hurry to change our interest rate policy,” he said.
Bangsund is more upbeat. To her, there is an elephant on the global stage, and that is “the massive amounts of stimulus in China over the past six months"—injecting money into its banking system, keeping interest rates low, cutting taxes and spending big on infrastructure. Assuming there’s no trade war with Trump, and possibly a trade deal, global growth should accelerate, commodity prices will rise and central banks may very well have to start raising rates again in the second half of the year to contain inflation.
In Canada, the key commodity price is crude oil, and it has cast a pall over Alberta since collapsing in 2014 and 2015. After bottoming near $30 (U.S.) a barrel in early 2016, the benchmark price of West Texas Intermediate (WTI) crude climbed back above $70 (U.S.) last fall. But it then sank below $50 (U.S.) in December, before working its way back to $60 (U.S.) in March.
Even without that kind of volatility, the trouble for Canadian producers is that the Western Canadian Select (WCS) benchmark price is stuck in a range lower than WTI, reflecting a shortage of pipeline capacity to transport oil and gas to coastal export terminals and southern U.S. markets. In December, WCS plunged to absurd lows near $5 (U.S.) a barrel, though it's recently made it back above $40 (U.S.).
Les Stelmach, an energy expert and portfolio manager, is impressed that many producers continued to earn solid profits last year. Stelmach says some smaller companies have additionally learned to become more efficient during a slump, such as midsize Arc Resources. “I think it is doing an admirable job managing a business through a tough period,” he says.
Stelmach says sentiment among oil investors won’t improve unless whichever party wins the federal election this fall does more to get pipelines built. Like a lot of executives and money managers in Calgary, Stelmach is puzzled by what he calls the Trudeau government’s “conversion factor of importance” for job losses. “Nine thousand hypothetical SNC-Lavalin jobs seem to be greater than 100,000 jobs in Western Canada,” he says. “I’m sorry, but that’s what it feels like to a lot of people here.”
For value investors in particular, if companies or entire sectors are trading at low multiples—as many energy, mining and forestry firms are on the TSX—that ought to provide opportunities. But George Athanassakos, a professor of finance and the Ben Graham Chair in Value Investing at Ivey Business School in London, Ontario, says Canada presents some unique challenges. Value investors focus on individual companies and often don’t pay much attention to the economy or other big-picture variables. But commodity price cycles and economic forecasts are critical factors in valuing Canadian resource providers. “You almost have to be a market timer,” Athanassakos says.
Timing is always difficult—it often takes a long time for fundamentals to reassert themselves in markets.
As in years past, for opportunities in sectors that aren’t well-represented on the TSX, such as tech and health care, experts say you need to turn to the United States or markets overseas. But U.S. markets look highly valued, while emerging markets appear cheaper but more volatile. Investing successfully is rarely easy, whatever strategy you pursue. Keep calm and carry on.
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