• David Cockfield

Avoiding The Herd


Most investors will be glad to see the last of 2015. Canadians saw the S&P/TSX composite index fall 11.1%. The total TSX return with dividends was negative 8.32%. This was the worst performance since the great market crash of 2008. Canadian equity markets posted the lowest results of any of the world’s developed markets.

Fixed income markets that have proven a haven until the summer then began to deteriorate as credit spreads began to widen. Low or negative returns began to appear as the bull market in fixed income securities stretching back to the early 1980’s finally came to a close. With further rate increases expected from the Federal Reserve in 2016, yields in the US fixed income markets are expected to rise -particularly for corporate debt. Even if the Bank of Canada reduces short term rates, long term rates are likely to follow their US counterparts upwards.

In the U.S., while equity market returns were better than in Canada, it was still the worst year since 2008. The S&P 500 index, a good benchmark for the broader market, gained 1.38% for the year including dividends. The Dow Jones Industrial Average, which is more representative of U.S. large cap stocks, fell 0.21% while accounting for dividends. In the U.S., in the higher risk junk bond market,prices fell dramatically, prompted by the Fed rate increase and deteriorating credit quality in the junior oil sector.

Despite the poor performance of U.S. equities and bonds in U.S. dollar terms, Canadian investors in U.S. securities gained as the Canadian dollar fell against the U.S. dollar. From the start of 2015 to the end of the year the Canadian dollar fell from 86 cents U.S. to 72.2 cents U.S. - a fall of some 16% - a major plus for Canadians with U.S. dollar denominated investments.

In light of the difficult investment environment, Northland Wealth made a number of adjustments, or changes in emphasis, in its investment strategy. Given the fall in oil prices, the energy sector (which in the past had been favoured) was significantly reduced in portfolios. Positions were held in the good dividend paying stocks, in financials, utilities and telcos. Exchange Traded Funds (ETFs), securities which focus on low-volatility strategies, were maintained or increased. U.S. dollar denominated investments were maintained or increased during the year. Alternative investments played a major role in our investment strategy, particularly for accredited clients. Real estate,private debt and equity investments were solid performers producing excellent cash flows while reducing portfolio volatility.

Looking back at 2015, fear seems to have been a dominating factor, yet economic growth continued, but at a pace slower than expected. Corporate profits continued to rise in most sectors - not at an exciting pace but still rising. Some sectors such as energy had an exceedingly tough year. In Canada, being a major sector, it was a significant negative factor both in equity markets and economically.

In 2016 we expect the fear factor and market volatility to remain with us but it should moderate somewhat as the year progresses. Even with further modest Federal Reserve rate increases in store, we still see economic growth in the U.S. at a 2 ½ - 3% level, helped by lower energy costs, a recovering housing sector, and higher purchasing power due to an elevated U.S. dollar. In Canada we see more modest growth of 1 – 1 ½%, given further contraction in the energy sector. With this relatively benign economic outlook, North American and European equity markets are likely to produce modest positive returns.

As with any forecast there are unknowns that could cause a major change in expectations. An increase in oil prices, even to the $55 to $60 price range, could improve Canada’s economic outlook. This could happen if the Saudis restrict output or if the Iraqi oil fields are threatened by the nearby conflict. Any actual significant reduction in oil production could send prices back to $100 with all sorts of exchange rate, economic and market repercussions.

The other market factor still to be realized is the end of the long running bull market in fixed income securities. Debt markets over the last decade have seen market participation move from large pension funds and brokers to the general public. Despite warnings of imminent increases in interest rates, the general public continued to buy debt mutual funds, debt ETFs and debt in general. This strategy continued to produce positive returns until last year. When the realization sinks in that rising interest rates will reduce past capital gains or produce losses, what will these investors do? A sudden mass exodus from fixed income markets would be disruptive to financial markets, including equity markets as well. Only time will tell how retail investors will react.

Our investment focus will continue on creating pension like portfolios, which utilize institutional quality alternative investments, low volatility strategy ETFs, and high quality equities, with the goal of reducing portfolio volatility for a lower level of portfolio risk. This approach tends to produce, in our experience, greater predictability of cash flows and moderate capital value fluctuations. We remain flexible in our investment approach and continue to be proactive to the changing investment environment.

#DavidCockfield

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