Portfolio Manager's Commentary - 2019 year in review
Stock and bond markets in 2019 were both very buoyant, a distinct change from the sharp drop of late 2018.
14 January 2020
Europe’s economy teetered somewhat mid-year as consumption growth, the largest part of a developed country’s economic accounts, ground nearly to a halt in the four main continental European countries. However, consumption growth improved in the third quarter and preliminary indications are that overall European economic growth was positive, though modest, in the fourth quarter.
After receiving a resounding majority from UK voters in the December election, Boris Johnson seems poised to quickly move ahead with Brexit, removing Britain from the European Union. If done sensibly, Brexit will likely pose little economic damage to either the UK or the European Union. Moreover, any uncertainty overhanging the British economy due to the seemingly perpetual Brexit delays should quickly dissipate.
The Canadian economy grew at about a 2% pace through the first three quarters of the year. Job growth in the rest of the country slowed considerably from its scorching pace of 2018 but remained quite strong. In contrast, Alberta’s job growth was barely positive despite an oil price that remained in the $US 55-60 per barrel range for most of the year.
Nearly all indicators showed the US economy to be very robust. Job growth remained strong albeit at a slightly slower pace, one consistent with an economy close to full employment. The US unemployment rate was 3.7% or lower through the second half of the year, something not achieved since 1969. Moreover, the workforce participation rate among Americans aged 25-54 has nearly recovered to its levels prior to the 2008/09 financial crisis and global recession. Despite the strong economy, US inflation showed no signs of acceleration.
The US central bank, the Federal Reserve or “Fed”, lowered its target short-term interest rate three times between July and October and then signalled that further reductions were not imminent. Central bank rate cuts are normally reserved for periods of economic weakness, not the rolling US economy of 2019. However, the Fed was thought to be largely acting preemptively out of concern about the US/China trade dispute and slowing economic growth in other parts of the world.
Bond markets experienced outsized returns this year, due largely to the decline in both government and corporate interest rates (“yields”) on long-maturity bonds. Bond returns about 4%, 9% and 8% for federal, provincial and corporate bonds respectively seem all the more remarkable because those three components began the year with yields of only 2%, 2.8% and 3.5%.
When bonds significantly outperform their initial yield because their price rose, some of the return prospects get transferred from the future to the present. Bond prices rise only because their yields fall, which in turn leaves less interest income for the future. Bond yields at the start of each of the last 3 decades were lower than they were 10 years earlier, and bond returns in each decade were also lower than in the prior decade. Now that bond yields are in the low single digits, bond returns will likely be the same.
Stock prices had largely recovered by the end of April from their late-2018 dip, and then advanced through the rest of the year. In their local currency terms, Canadian and overseas stock returns exceeded 20% for the year and US stocks exceeded 30%. The decline in foreign currencies relative to the Canadian dollar only slightly blunted this impact.
Although low interest rates limit the potential returns of fixed income investments, they should help stocks in the mid-term by removing the economic uncertainty that started stirring earlier in 2019. There are few economic storm clouds on the horizon. If anything, share prices in some industries might be showing early signs of overenthusiasm. For example, share prices of US information technology (“IT”) companies rose by 50% last year although their underlying profits barely budged. This is a far cry from the late 1990’s, when IT share prices rose an average of more than 50% a year for five consecutive years and then went nowhere for the next sixteen. However, after a ten-year economic expansion that seems set to continue, equity investors need to be aware of the beginnings of froth.
The Compass Portfolio returns for 2019 ranged from about 8% for the most conservative to 19% for the most aggressive, which reflects the strong performance of both bonds and stocks through the year.
Although investors are far more upbeat now than at this time last year, the lessons from our 2018 year end commentary are equally applicable to both periods. Indeed, we like to think that those lessons “never go out of style.” Our words were that “an investor’s most appropriate plan of action is to not spend time and energy trying to predict the unpredictable. Instead, the path to success involves investing in a portfolio with appropriate return and risk characteristics, and then letting time work to one’s advantage.”
One year later, we can’t claim that we knew that stock prices would recover from their late-2018 dip within just four months, or that the Fed would lower its target interest rate three times and thereby provide additional insurance to the US and global economy.
What we knew then, however, is what we’ve known ever since Compass’ inception in 2002: the path to investment success involves many twists and turns. The natural human reaction to those twists and turns, the “gut instinct” to immediately fight or flee that served our distant ancestors so well on the savannah, is wholly unsuitable to financial markets. Instead, the best reaction to financial market gyrations is usually no reaction at all.
If we stand accused of being boring as we repeat this mantra, then we plead guilty as charged! As the last twelve months showed yet again, boredom and investment success go hand-in-hand.
Cheers to you in the New Year!
Chief Investment Officer
ATB Investment Management Inc.
This report has been prepared by ATB Investment Management Inc. (“ATBIM”) which manages the Compass Portfolios and ATBIS Pools. ATBSI is a member of the Investment Industry Regulatory Organization of Canada (IIROC) and the Canadian Investor Protection Fund (CIPF). ATBIM, ATB Securities Inc. (“ATBSI”), and ATB Insurance Advisors Inc. are wholly owned subsidiaries of ATB Financial and operate under the trade name ATB Wealth.
The mutual fund performance data provided assumes re-investment of distributions only and does not take into account sales, redemption, distribution or optional charges or income taxes payable by any security holder that may reduce returns. Unit values of mutual funds will fluctuate and past performance may not be repeated. Mutual Funds are not insured by the Canada Deposit Insurance Corporation, nor guaranteed by ATBIM, ATBSI, ATB Financial, the province of Alberta, any other government or any government agency. Commissions, trailing commissions, management fees, and expenses may all be associated with mutual fund investments. Read the fund offering documents provided before investing. The Compass Portfolios and ATBIS Pools includes investments in other mutual funds. Information on these mutual funds, including the prospectus, is available on the internet at www.sedar.com.
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