Smart Money

Our regular summary of the capital markets. Check back each month for new updates.

Smart Money

January 21, 2019

Staying The Course Proves Useful Early In New Year

Market Recap & Boxscore

So far in 2019, everyone, except the shorts, has made money.  From global equity markets, to commodities, treasuries and gold, markets have started the year on a cautiously optimistic tone.  Within equity markets, the TSX led the way up 8.5%, bolstered by a 17.5% appreciation in the price of oil.  The S&P 500 followed suit, printing an 8.4% gain, while the MSCI World lagged with a...

So far in 2019, everyone, except the shorts, has made money.  From global equity markets, to commodities, treasuries and gold, markets have started the year on a cautiously optimistic tone.  Within equity markets, the TSX led the way up 8.5%, bolstered by a 17.5% appreciation in the price of oil.  The S&P 500 followed suit, printing an 8.4% gain, while the MSCI World lagged with a still impressive 7.5% showing.  Justification for the rebound include the easing of US-Chinese trade tensions, optimism that the US government shutdown is nearing an end and a possible slowdown in the Fed hiking cycle.   However, we know full well that no single explanation can justify a rally, and the rationale for renewed optimism boils down to “the price is up.”  While we do not rule out the re-testing of highs on the S&P 500, especially considering the unified level of pessimism built into market over the final quarter of 2018, we also cannot discount the importance the market has placed on commentary coming from an increasingly unpredictable Federal Reserve.  Investors should tread carefully in 2019, but keep in mind that the past three months have highlighted that maintaining exposure to potential upside surprises is prudent, especially when the headlines suggest running for the exits.

Oil seemed to reach a near-term bottom when it briefly touched $42.50 in Dec-18.  Since then, it rallied 26.8% in just under a month to $53.90 as of 21-Jan-19.  While there has been commentary regarding OPEC’s planned supply cuts, the more important driver has been the continued rig count reduction in US Shale regions.  On 18-Jan-19, Baker Hughes reported a 25-rig reduction in the US, representing a 2.4% decrease.  However, the rig count is still up 14% year-over-year.  Further, for the week ending 11-Jan-19, the EIA estimated US production to be a record 11.9 million barrels per day.  Accordingly, we would not forecast an imminent rise to $100.  Nevertheless, low oil prices and higher interest rates are two primary factors that will weaken the region.  With the oil price now rising and rate increases taking a breather, the renewed optimism may have created an opportunity for profit-taking and right-sizing positions ahead of a more long-term trend.

The Canadian dollar benefitted from the aforementioned commodity strength, climbing 1.7% over the past month and reversing a prolonged period of weakness since mid-2018. The sharp rebound has caused CAD to trade near the upper-end of its 2018 range; but it could be ripe for a pullback, especially considering recent fundamental news. The Financial Post reported that Canadians owe nearly $1.78 in debt for every $1 in disposable income. This regrettable situation is likely weighing on housing according to CREA, the average home price fell 4.9% in 2018. Also, in December, a US hedge fund, Crescat Capital, reported that over 80% of nonfinancial corporations in Canada reported negative free cash flow in the past twelve months. Looking forward, the prospects for a stronger loonie rest on continued vitality in oil prices or a reversal in the US Federal Reserve’s interest rate course. Otherwise, the overextended consumer, struggling corporations and a dovish Bank of Canada suggests that the movement will be to the downside.


Elsewhere in commodities, gold continued its upswing, bumping-up 1.6% to $1,280 and marking five consecutive months without a monthly drop, corresponding to a cumulative 10% surge since its July 2018 low. There are many factors converging in gold’s favour, namely the perceived Fed reversal (or at least a pivot to dovish policy), tepid inflation and a general rise in political risks and market volatility. However, gold’s breakout has been less tied to 10-year Treasury yields and the price of copper. Copper’s many industrial capacities link it to economic activity. Accordingly, copper prices often signal opposite trends for gold. Similarly, Treasury yields will fall along with copper prices when a downtrend is anticipated. This phenomenon has been on display since Sep-18, as the US 10-year yields fell from 3.23% to 2.68% as of Dec-18. However, since the calendar turned, copper has rallied 5.9% while gold seems to be flattening and longer-term bond prices have fallen. Meanwhile, equity markets have rebounded from a hellish December. Correlations and causations may be murky, but this turn of events highlights the risks of committing to an exclusively bearish strategy – sometimes the road not taken is the better choice.

January 01, 2019

Equities Set-Up for Better 2019, But …

Fourth Quarter 2019 Newsletter

Economic and Geopolitical Concerns Catch Up to Markets – The final quarter capped off a volatile 2018, with most asset classes producing negative returns for the year. Global equities fell sharply during the fourth quarter with some indexes entering bear market territory (20% or more below their 52-week high) in December. The one month drop in US stocks in December was the largest mon...

Economic and Geopolitical Concerns Catch Up to Markets – The final quarter capped off a volatile 2018, with most asset classes producing negative returns for the year. Global equities fell sharply during the fourth quarter with some indexes entering bear market territory (20% or more below their 52-week high) in December. The one month drop in US stocks in December was the largest monthly decline since February 2009 and the worst December since the Great Depression. This shift was triggered by the base case economic outlook that a global recession was on the horizon as car sales fell 10%, crude retreated 45% from its recent peak and housing starts declined over 6%.
US government bonds and gold provided investors some insulation against the global selloff. The 10-Year US Treasury yield began the quarter around 3.07% but finished the quarter at just 2.69% while investment grade bond prices also turned higher after a difficult nine-month period.

Set-up More Positive Than 2018 But … – While forecasts are often a fool’s game, particularly in the short-term, we can for the moment enjoy a victory lap on our 2018 predictions. In our outlook letter, we stated “a 10% setback is plausible if the Price-to-Earnings multiple backs up to 16.5x, even with a $150 earnings figure. However, at this point it appears that any pullback will be merely corrective as the emergence of a recession in 2018 is doubtful.” With no recession emerging, the market experienced two 10% corrections, with new highs re-established following the February decline. Furthermore, our preference for bonds over stocks was also applicable, although our short duration did not result in a meaningful performance upgrade.

That was then, however, and this is now. Following a 20% decline in US equities from 09-Sep-18 to 24-Dec-18 and a solid corporate earnings year, valuations have been restored to more reasonable levels. The plunge also caused the State Street Investor Confidence Index to sink to its lowest level since 2012 and market breadth is at a level that is most often associated with turning points – the number of stocks trading above their 200-day average is just 20%. Nothing changes sentiment like price. This set-up bodes well for at least a short-term rally and we are slightly more constructive on US equities for 2019.

However, US stock valuations remain at the upper levels of historical ranges. The often cited cyclically-adjusted price-to-earnings (CAPE) multiple sits at 27.5x versus the 40-year average of 21.7x. Meanwhile, the Warren Buffett Yardstick (US equity market cap-to-gross national product) stands at 128%, well off its recent highs but nowhere near the 65%-75% range that has marked the last two major bottoms. Accordingly, valuations are not inexpensive and potential mean reversion in margins provide headwinds for material gains over the next four to five years.
After growing in sync for the last few years, economies around the world are now set for a downturn. Ned Davis Research, among a plethora of brokerage firms, are predicting a high probability of a global recession. Many international markets, particularly emerging markets, have already adjusted. Within our growth allocation, we prefer corporations with global exposure as well as commodity-linked equities given their favourable relative and absolute valuations, including energy, agriculture and precious metals.

GAVIN will maintain a disciplined and meaningful allocation of short-duration sovereign bonds as our bias is for a continued, albeit slow, cycle of rate increases over the next few years. US companies have ratcheted up $9 trillion in debt since 2008/09, or 46.2% of GDP, from about $5 trillion in 2007. There are $3 trillion of triple-B (BBB) bonds outstanding, comprising nearly half of the Investment Grade universe, up from about 20% a decade ago. If the cycle turns, investment grade corporate debt appears to be vulnerable.

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December 21, 2018

The Business of the WJHC

Smart Money

Every December, many passionate hockey fans switch their attention from the NHL to the World Junior Hockey Championships. The tournament provides an opportunity for viewers to catch a glimpse of tomorrow’s NHL superstars as they battle for their respective countries. With the endless coverage and constant spotlight, GAVIN took a closer look at the business side of the exciting e...

Every December, many passionate hockey fans switch their attention from the NHL to the World Junior Hockey Championships. The tournament provides an opportunity for viewers to catch a glimpse of tomorrow’s NHL superstars as they battle for their respective countries. With the endless coverage and constant spotlight, GAVIN took a closer look at the business side of the exciting event. Check it out below!

The Business of the World Juniors