The market bull (well, ok, that's water buffalo in the picture, not a bull) is going to have to work hard for the money in 2019. Taketomi-jima, Yaeyama Islands, Japan. Copyright © 2018 Felix Choo / dingobear photography. Photo may not be reproduced without permission.
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No two ways about it, the last quarter of the year was tumultuous for most investors out there, and it's already been well-documented that December 2018 was the worst month for equities since 1931. What will 2019 hold? Read on, for our quick view. As always, thank you for reading
The Canadian Convertible Debentures Project.
Important disclaimer: Like everything else on this website, content here is provided as information and opinions only and not intended to be a provision of investment advice or a recommendation of any investment action in any form. As with all information concerning investments, it is highly recommended that an individual consult with a qualified investment professional before making any investment decisions.
Outlook 2019
Well, if the first trading week of the new year is any indication, investors will be on a roller coaster of a ride in 2019. First, the market ratcheted down sharply on the heels of weak economic news and Apple's surprise revenue warning, but then rebounded on a dime Friday thanks to Fed Chairman Jerome Powell's more dovish-than-expected comments. Hang on - I tend to think at least the first half of 2019 is going to be quite bumpy.
Three broad themes to look out for in 2019: central bank policy, (geo)politics, and the economy.
First, central bank policy. Here at the Canadian Convertible Debenture Project, we were of the opinion that the Bank of Canada would raise rates at a slower pace than consensus in 2018, and I we ended up being correct on that guess. The Canadian economy grew moderately, but there seemed to be a disconnect between that rate of growth, associated inflation and the hawkish talk coming Stephen Poloz, who seemed dead set on hiking rates right on up to neutral. The bottom falling out of Canadian oil markets and the trade grief pushed upon Canada by our southern neighbour put a pause on those plans. Canadian bond yields fell pretty sharply in December with the 10-year Canada actually finishing the year below 2%; yields have only continued to go lower in the early days of 2019, with the latest print on the 10-year Canada registering in at a paltry 1.83%.
Because of a red-hot US economy that was fueled in part by a totally unnecessary, unbalanced, deficit-ballooning tax cut in late 2017, the US Fed didn't have much choice other than to steadily tighten rates in 2018, no matter how many tweet tantrums came from the US President on the subject. The perceived difference in tightening schedules between the Bank of Canada and the Fed was one of the reasons why we had been largely bearish on the loonie in 2018, and that view actually did pan out, with the Canadian dollar sliding some 8% for the year.
The US midterm elections in November 2018 got a lot of press coverage and for good reason - they were arguably the most important elections south of the border in recent memory. In our opinion, the Democrats recapturing the House was an important result for checks, balances, democracy, and the institutions of American society. US political headlines could continue to unsettle markets in 2019, especially with a President that seems increasingly isolated and defiant, and more conclusions from the Mueller investigation looming.
In itself, the continuing (as at the time of writing) US government shutdown will have a minor negative effect on US economic growth, but should it be prolonged, the consequences will increase, and in any event represent another attack on American institutions by the ruling party in Washington. All of this ... for a wall. Think about that for a second. Maybe this is just another political headfake to distract from the Mueller investigation?
In Canada, there were marked right turns in provincial elections in Ontario, Quebec, and New Brunswick in 2018, and we'll see if this trend continues with federal, Alberta, and Prince Edward Island elections in 2019. I don't know what the results of these elections will be, but the campaigns are likely to be very tough with plenty of mudslinging (especially in the federal and Alberta elections), and I think it's disappointing that some of the questionable tactics that have had experienced electoral "success" in the US are making their way up here, too. The Canadian constitution mandates peace, order, and good government - not winning at all costs and putting party before country. We will see what happens.
Economically, one thing is for sure: the global economy is slowing, but the question is, how much? Inciting unnecessary trade wars and slapping tariffs on this, that, and everything is 1930s-esque policy, and threatens to bring back 1930s-esque economic performance. The trade actions instigated by you-know-who in 2018 will start to bite as we proceed through 2019 and into 2020, possibly shaving off points of global economic growth for what - the political benefit of a certain few? Ridiculous. Already, we already seeing inversion on several points of the US yield curve, and I don't think it's an impossibility that there's a US recession in 2020. As we understand it, measures of of the US tax cut will start to run off by next year, which will remove fiscal stimulus from the economy. The threat of trillion dollar US deficit is proof again that tax cuts, in itself, doesn't pay for itself and the US could fine itself in a pickle in a year's time. Already, one can argue that the volatility in US equities of the past three months is a reaction to the economic uncertainty the market sees 12 to 18 months out.
Here in Canada, we aren't in the best situation either. This auto sales cycle has already peaked, our most valuable export commodity (oil), remains pipeline-constrained, and our largest trading partner under the current administration has suddenly become as less reliable trading partner. A renegotiated NAFTA (i.e., USMCA or CUSMA or NAFTA 2.0 or whatever you want to call it) that wasn't terribly punitive helps lend to stabilize the trade outlook, but note the agreement still needs to be ratified and may not be until the middle of 2019. A small sliver of good news: Canada did manage to conclude two important deals in 2018, CETA with the European Union and the CPTPP with 10 other Pacific Rim nations (Australia, Brunei, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, and Vietnam). This is a step in the right direction to diversifying our trade.
Canadian equities concluded a really tough year in 2018, returning about -9% after taking into account dividends. The silver lining is that valuations are actually quite decent now, and despite expected volatility in the first half of the year (which I'd expect with US and international equities as well), I'm gonna stick my neck out here and say that Canadian markets will outperform US markets by the end of 2019. Large, high quality, Canadian companies that operate in regulated and/or protected sectors seem like decent value for longer term investors. Specifically, the banks, railroads, telecoms, renewable energy producers, and infrastructure companies look compelling to me in this context, and for those interested in higher-risk bottom-fishing, there may be opportunities in energy as well. As per usual, precious metals exposure remains insurance against unexpected circumstances in an uncertain world. Our wild guess for the S&P/TSX Composite Index in 2019: a +8% return, after dividends.
Even though the Bank of Canada may want to increase rates, I think it'll be hard for them to do so any more than maybe once in 2019, given the economic backdrop. As such, fixed income may not do terribly, and though yields are low, bonds may work as a capital preservation play in 2019 just as they largely did by the end of 2018. Our wild guess for the FTSE Canada Universe Bond Index in 2019: a modest +3% return.
This brings us to convertible debentures, and the thinking here is the same as it has been for quite awhile: emphasize higher quality, lower credit risk issues, and moderate expectations for capital gains. Here at the
Canadian Convertible Debentures Project, we're currently hard at work at developing a little something that may help some of you out there to get a better gauge of how the Canadian convertible debenture market is performing; stay tuned, we'll have details in our next post. In the meantime, our wild guess for Canadian convertible debenture market in 2019: a +6% return.
Thoughts?
So what do you think will happen in markets, convertible debenture or otherwise, in 2019? Feel free to share your thoughts in the comments below. Thanks for continuing to read this blog. We wish you all the best in your investing in 2019; good luck, it's challenging out there.
Any additional questions or comments? As per usual, please feel free to drop us a line through the comments form below or by sending us an email.
