Smart Money

The Hammer and Dance – The second quarter of 2020 featured a sharp rebound in most asset classes following the steep decline in March. Most equity categories remain negative year-to-date. However, US technology stocks managed to push into new record territory. The dramatic recovery was supported by government programs and Federal Reserve actions which expanded the Fed balance sheet above $7 trillion by the end of the quarter. While market prices improved, the economy still faces a long road to recovery. Unemployment claims hit record levels while corporate earnings are expected to fall 20% year-over-year.

Commodities rallied strongly in Q2, clawing back some of the ground lost in Q1. This was helped by US dollar weakness and temporary oil production cuts from OPEC and Russia. Copper was a big gainer, rising nearly 22%, as the demand outlook improved while Coronavirus cases in South America ramped higher.

Government bond yields remained near all-time lows. Loose monetary policy, benign economic growth and the expectation for a continuation of “the Hammer and Dance” to contain COVID-19 pushed global rates lower.

Proficiency with a Strong Foundation – It often seems that the best way to achieve a desired outcome is to focus exclusively on it. After all, results are much easier to measure and evaluate than a process. This approach however is far from optimal. Elite athletes gain proficiency at their craft by developing procedural memory – doing the same thing over and over. While this does not guarantee success, the probability of a favourable outcome improves through a disciplined process with many iterations.

Investing is a long-term process that has historically yielded the greatest rewards to those adhering to a consistent, disciplined, and replicable approach. This helps to remove the emotion involved in decision making that is often so detrimental when trying to generate a return. According to the 2010 Davis Advisor study , emotional interference has a sizeable impact on investment results. The study showed that while the average stock-based mutual fund returned 8.7% annually from 1994 to 2013, the average investor earned only 5% per year.

Think about the training process needed to achieve elite status in any field. It begins with building a solid foundation. For investing, an individual needs to have a good understanding of their current financial standing. Fair value assets should be greater than liabilities and sources of cash flows must exceed uses. This combination will allow for more capacity to invest and generally a higher risk tolerance which provides the prospects for higher returns.

Next, individuals should set clear financial goals. An investment plan is most effective when there is more detail about the individual characteristics, objectives and time frame. An investment portfolio should be constructed to achieve objectives with as little risk as possible. This allows investors to remain focused on meeting goals regardless of external factors such as job security or market conditions. The two primary decisions for portfolio design are asset allocation and investment selection.

Asset allocation determines the amount to assign across different investment classes defined broadly as equities, fixed income, real estate, commodities, and cash.

Investment selection is the step where securities that make up the asset class are chosen.

Once a framework is established, the final part of the investment process is implementation and monitoring. Establish best practices to ensure slippage is minimal. It is important to monitor both the financial position as well as the investment portfolio. No part of the process will be static. Being consistent and disciplined in evaluating and monitoring the process should not be confused with rigidity. It is important to be adaptable given an ever-changing financial position, opportunity set and market structure.

In summary, the investing process is more complex than simply buying a heavily promoted or popular stock or index. The short-term results can vary, but when assets are being managed for a lifetime, the process becomes increasingly important. The frequency of changes to external and internal factors necessitate a strong foundation. In the same way that a foundation provides confidence for an athlete to execute while outside forces wreak havoc; the portfolio process can protect the investor from destructive actions.

Our clients have listened to us preach for more than two decades that cash flow management is the cornerstone for financial independence. When savings targets are established, and a plan is in place to achieve those goals, the player and their family can confidently determine their spending priorities. In consideration of this, we analysed a sample of players to aggregate their outflows and identity how the average player spends their money. These findings are summarized in the exhibit and it may serve as a template or budget for current and future NHLers.

While there has been some intra-month volatility, and some very interesting rumbles under the hood, the S&P 500 and TSX managed to accelerate 2.8% and 1.8%, respectively.  However, European and emerging market strength combined with US dollar weakness helped the MSCI World Index race ahead by 3.9%.  From a sector and style perspective, large cap growth and technology paced the Nasdaq (+8%) as it sprinted past the 10,000 marker for the first time.

The lifestyle changes and the consumer response to the Covid crisis has intensified many of the long-term trends that were unfolding.  Nevertheless, it is still astonishing to observe the degree to which valuations are being extended.  For instance, it was noted that the combined market cap of Square, Shopify, Spotify, Zoom, and Tesla are now equal to that of Warren Buffet’s Berkshire Hathaway.  To put this in perspective the combined trailing annual revenues for the five companies are equal to Berkshire’s normalized net income.  For reference, Berkshire’s portfolio of companies include GEICO, Duracell, Dairy Queen, BNSF Railway, Fruit of the Loom, and significant minority holdings in Kraft Heinz Company and American Express.

As our readers and investors know, our priority is to safeguard capital. So, while stock markets are rallying, we are on alert for obstacles.  First, rapidly rising Covid case counts in Texas, Arizona and Florida are worrisome.  More recently, Germany and Japan have also recorded a spike in infections.  Some are calling this the Second Wave, but the First Wave hardly abated.  Optimistically, afflictions will diminish before the Fall’s traditional flu season otherwise investor sentiment will be rattled along with the fragile recovery.  Further, US-China trade issues are a lingering disturbance.

Gold seems to have escaped its consolidation pattern.  It flirted with $1,800 before ending the period at $1,792, rising 4.3%.   The metal’s year-to-date return is now over 18%.  Gold tends to outperform in periods of falling real yields.  Accordingly, the strong case continues to develop due to economic uncertainty, hints of rising inflation, and depressed bond yields that are happily confined by the Fed.

Elsewhere in commodities, the chart below highlights the appreciation of lumber, copper, and oil since April.  The trend is supported by a falling US dollar (USD), which peaked in March and dropped 3.1% this month.  The potential for a shift to a persistently weak USD, though far from confirmed, would have significant influence on the deflation versus inflation narrative.

Support for the deflation scenario comes from an over-leveraged economy and the government intervention that is required to limit increases in yields and the costs to carry the ballooning debt.  Meanwhile, the unprecedented monetary and fiscal stimulus could stoke sleepy embers of inflation. The extreme growth in US M2 is also inflationary. M2 is a gauge of money (cash, savings, money market instruments) in the US financial system.  After growing 6% per year from March 2010 to March 2020, M2 soared 18% from March to June in 2020.  Since 2008, monetary stimulus has caused inflation to show up in asset prices.  Yet, with fiscal support invited to the party in 2020, the manifestation of consumer price inflation may become an economic reality that was absent over the past decade.

Oddly, long-term bond yields in the US are stubbornly low.  The inflationary signals listed above have not been priced into 10-year yields.  After briefly touching 0.91% in early June, the yield has reversed to 0.71% as of 24-Jun-20.  The rate is still within the rising channel that began in April, but one key factor to consider is that The Federal Reserve has been buying Treasury Bonds to maintain low yields and a low borrowing rate.  This has been exceptionally important because over the same period, foreign ownership of US Treasury holdings is declining.  Without foreign buyers, The Federal Reserve’s motivation to intervene is heightened because it needs to support the economy and stabilize financial markets. But for how long can the Fed keep buying the debt issued by its parent, The Treasury?   Interestingly, Ken Rogoff, Professor of Economics at Harvard University declared in March 2019, that this favourable condition will become flawed when fiscal policy is needed to “fight a financial crisis, respond to a large-scale natural disaster or pandemic, or mobilize for a physical conflict or cyberwar”.  Perhaps, we are on the threshold of inflation becoming unhinged.

Last week’s announcement that the NHL will return to play this summer was exciting in many respects, but it also created considerable uncertainty surrounding the safety of the players and their families. In a memo released by the NHL, players were informed that any athlete who contracted COVID-19 would have their “injury” categorized as hockey-related, unless it can be proven that a player contracted COVID-19 outside the course of his employment as a hockey player. However, these circumstances are unprecedented and, as a result, there are many outstanding issues. Accordingly, GAVIN created the attached exhibit to address many of the Frequently Asked Questions.

We will describe the disorder of investing in 2020 before disclosing the market return data during the past month.

First, on 21-May-20, another 2.4 million US citizens filed for unemployment in the previous week, bringing the total to nearly 39 million.  An additional 1.1 million Americans sought jobless claims under a new ‘temporary Pandemic Unemployment Assistance Program’ so headline numbers are in fact understated.

Next, tensions with China continue to mount. Evidently, this rivalry will become Trump’s primary focus ahead of November’s election.  China’s handling of Covid-19 and the embattled trade deal are persistent aggravations for the enigmatic President.  Additionally, China’s new national security bill that increases surveillance in Hong Kong has implications for the US.  Hong Kong needs to retain enough autonomy to qualify for US tariff exemptions that are otherwise imposed on China.  Also, in Asia, military skirmishes along the China-India border have been reported throughout May.  Peace has largely existed between the two countries since their war in 1962. However, scuffles frequently erupt along the 3,488 km frontier that is generally disputed and indistinguishable.

How have these severe disturbances impacted equities?  Well, a continuation of the rally, of course!  Whether it is the US (+2.8%), Canada (+2.5%), or the MSCI Ex. US (+2.9%), global markets continue to grind higher and force bear after bear to hibernate.  There are several reasons to justify a continuation of the bounce off the March low, including the cap-weighted nature of the S&P 500, whereby the largest constituents (ie. Microsoft, Apple, Amazon, Facebook) account for a disproportionate weight in the index’s price and underlying earnings.  Tech, Healthcare, and Communications represent almost 50% of earnings for the index.  These sectors are understandably less affected by the pandemic relative to the median US company.  However, price action later in the month began to shift with sectors such as Financials, Industrials, Real Estate and Materials taking the lead while Tech and Healthcare lagged.  Surely if the economy’s reopening is as smooth as the market’s rebound suggests, this trend will likely continue.  Moreover, the potential for rapid and vibrant economic growth when the economy is fully reopened is conceivable given it is bolstered by trillions in Federal and monetary stimulus.  Nevertheless, with so much economic uncertainty, the threat of a second wave of the virus and the S&P 500 hovering around key technical resistance points, we are focused on right-sizing exposures and ensuring adequate protection.

We regularly evaluate the bond market for insight on future cross asset movements.  In May, longer-term US yields exhibited an upward trend. The corresponding chart (inspired by Jawad Mian of stray-reflections.com) maps the big decline in bond yields since the beginning of the secular downturn in rates from 1981.  The shaded areas indicate each instance where the 10-year yield retraced 61.8% of its drop during the preceding 2 to 14-month period.

Today, the 10-year has fallen from a high of 3.2% to a low of 0.4% in March, which would pin a 61.8% retrace at 2.1%, with the midpoint date in 6-9 months.

If this forecast materializes as the model implies, whether it is prompted by real economic growth or a return of secular inflation, the knock-on effects may be considerable.  It could reverse the duration trade that has supported equity markets throughout the bond yield’s historical descent; and, particularly, the fast growth-low profit stocks.  Fears of higher rates would also impact the perceived credit quality of the US, whose debt position will swell due to the $4 trillion deficit in 2020.  Rising rates will also affect the ability of corporations to service an unsustainable debt position, which has expanded by $834 billion through the end of April.  Finally, percolating inflation may jolt commodity markets which have been fighting to get out of the dumpster for years.

This outcome is speculative at best, but the ingredients are certainly present for the scenario to play out.  Further, the set-up is reinforced by massive monetary and fiscal stimulus, de-globalization, emerging cold war with China, onshoring of US jobs and the initiation of “just-in-case” inventory management.  We will continue to be vigilant and active when evaluating the prospects for inflation (and deflation) to structure portfolios that protect and benefit in different environments.

There are certain unique factors involved in managing the finances of NHL athletes. Items such as experience, time horizon and liquidity make the investment portfolio of an NHL athlete much different than the average long-term investor. However, discipline and commitment are characteristics that must be shared by all successful investors. Click the link below as GAVIN has itemized five important reminders for implementing a successful investment strategy.

After the S&P 500 and MSCI World indices fell 33.5% and 27.3%, respectively from the 20-Feb-20 high to 23-Mar-20, markets globally have shrugged off any negative economic news, leading to  rallies of 27% and 24%, respectively.  Since our last note 26-Mar-20, the S&P 500, MSCI World and TSX indices are up 14.8%, 11.5% and 9.6%, respectively.

As an endorsement to the dichotomy between the economy and the stock market, consider that one of President Trump’s economic advisors optimistically estimated that US GDP would fall 20-30% in the second quarter, and unemployment would hit 16-17%.  Yet, the broad market is off only 15% from its all-time highs, despite 26 million job losses in the US.   During the Great Financial Crisis of 2007-08, the US lost 8.7 million jobs, unemployment peaked at 10.2%, GDP feel 4.3% and the S&P500’s peak-to-trough decline was 56.4%.  Notably, the prompt and substantial rescue efforts supplied by the Fed and Congress should shorten the duration of the hardship this time around.  And, with any luck, produce a ‘V-shaped’ economic recovery.

Commodities have been an incredibly interesting space, with many revealing conflicting stories and one product making unprecedented moves during April.  Oil, as measured by the WTI May contract, fell to -$37 per barrel on 20-Apr-20, meaning an owner of a barrel of oil would pay a counterparty to take it off their hands.  Granted, volume was very low at this price point and with the expiry of the May contract just two days following, any actual economic activity shifted to the following month. However, anyone stopping their analysis there are doing themselves a disservice as the historical event is significant for at least a couple of reasons.

The primary cause is related to a lack of storage capacity for oil, which again is a function of demand falling off a cliff.  If you are a trader and cannot sell your oil contract or find someone to store it for you, you must take delivery of WTI at Cushing, Oklahoma.  Since many speculators are unable to accept delivery, and severe storage shortages exist for those willing, desperation created negative prices.

The downside of commodity financialization also contributed to the pricing dysfunction.  ETFs own a large percentage of the paper contracts for these products. In particular, US Oil Fund (NYSE: USO) owned 25% of the May futures contract.  However, an ETF can not legally take delivery of the physical commodity. Therefore, the ETF is required to roll, or simultaneously sell one month and purchase the following month in an equal amount.  This creates a natural downward push on the price of oil in any given month, and given the supply/demand imbalance in May, the prices collapsed.  So far, we are seeing a similar situation unfold for the June contract.  The price is down 23% as of 27-Apr-20.

While oil continues to fall, copper, a key industrial commodity and historically a great predictor of economic conditions, has demonstrated sustained strength through April, up 5.1% during the month.  Copper began its sharp fall in late January, which reflected the economic situation and demand destruction in China.  Its low was hit the same day that equities bottomed on 23-Mar-20, but the April rebound could hint at further gains.  Also, noteworthy is the performance of gold, which has continued to move higher after falling with stocks in March.  Gold is up 6% in April, hitting highs not seen since 2016, and is now 47% above its 2018 low.  With global monetary and fiscal stimulus surprising even the most dovish of analysts and yields falling, the stage is set for a sustained bull market in the metal.  Nevertheless, the trade is incredibly crowded, and the certainty of the predictions gives cause for concern.

We have written at length about credit in the past and to keep on top of the situation, it appears that US high yield credit spreads have once again begun to widen, albeit on a short time frame from 16-Apr-20.  Originally, the spread over Treasuries peaked at of 10.9% on 23-Mar-20.  But the support offered by the Fed and Congress, followed by the surprise proclamation of direct purchases of investment grade and downgraded high yield debt, caused yields to contract to a low of 7.35% on 13-Apr-20.  Both investment grade and high yield issuers have been on a debt issuance binge since these announcements were made, taking advantage of the opportunity to either refinance existing debt or extend the maturities  while the credit window was open.  Outside of a few failures, a large-scale default cycle has yet to materialise, even within the oil patch.  We will be monitoring spread behaviour closely as a re-widening of spreads with such large-scale Fed and Government support would be a red flag.

COVID-19 – The first quarter of 2020 will forever be synonymous with COVID-19. The rapid spread of this strain of coronavirus coincided with a swift decline in major asset classes as economies around the globe were forced to shutdown. The S&P 500, for example, registered its worst quarterly return since Q4 2008, entering its first bear market in over 10-years.

Commodity prices, other than gold, fell sharply over the quarter.  On top of a demand shock, oil was crippled when a price war erupted between OPEC and Russia. The price crumbled by more than 60%. The Canadian dollar declined against the US greenback by over 8%. Meanwhile gold prices rose 3.7% in US dollar terms. Government bonds provided some protection during the equity and commodity rout, as central banks cut interest rates and restarted quantitative easing.

The Non-linearity Of Market Returns – The old adage to “not let your highs get too high and lows get too low” is often cited by coaches to remind athletes about maintaining a balance. Over confidence often leads to poor habits while the psychological impacts of losing hope can become self-fulfilling. Whether it is sports, diets or investing, results are maximized when interests are aligned and participants abide by a precise process.

When analyzing US equity returns over the past two decades, it is easy to see how opinions about markets are formed based on individual experiences. Investors who began investing on 31-Mar-00 have a 20-year annualized return of just 4.9%. This is less than half the long-term average and the results achieved by an investor who started on 31-Mar-10. Furthermore, the investor from the March 2000 experienced two routs that caused their life savings to be cut in half twice within the first ten years of investing. Meanwhile, the latter experienced only one drawdown greater than 20%, and this occurred after compounding capital for over 9-years at 13.1% annually.

Looking back at market history, this type of return profile is far from unique. Gains over the average investment lifespan tend to cluster, in non-linear fashions. Even the strong periods face uncertain timing. For example, the more fortunate 2010 investor’s average annual return would drop from 10.2% to 6.4% if they missed the five best trading days. Five days astoundingly accounts for less than 2% of the trading days over a ten-year period.

Adding further mental strain is the period when the most pronounced gains occurred. The three worst bear markets, defined as a 20% decline, include the 1929 Great Depression, the 1972 decline which involved the Watergate scandal and Vietnam War and the more recent 2008 Global Financial Crisis. As bull markets often follow bear markets investors who sold at the bottom of these markets faced significant long-term impairments to their capital. While bull markets often last for years, a significant portion of the gains typically accrue during the early months of a rally.
Despite facing 10 drawdowns of 30%+ over the past 150 years, US equity markets have compounded capital at over 10% per annum. Throughout this period the investors made it through two world wars, a cold war, rampant inflation, extensive conflicts in the Middle East and terrorist attacks, among others. All this suggests non-linear returns tend to be the norm more often than the exception.

In today’s context, investors who have become discouraged because three years of gains were wiped out in one quarter, should not risk harming long-term returns by making short-sighted, emotional decisions. Certainly, these events can be frightening, but history shows that risk is rewarded for those who stay committed to the equity market for the long run. This is perhaps truer today than in the past, as just 5 stocks account for over 20% of the S&P 500. This is the highest level of concentration in its history.  Accordingly, opportunities are becoming plentiful.

Despite providing our last market update just ten days ago, we wanted to offer a recap of the events as governments have implemented measures to protect the economy and maintain order in the financial markets.

Here is the good news … on 25-Mar-20 the US announced a $2.2 trillion fiscal stimulus package, helping citizens through direct payments and unemployment benefits, while also supporting small and large businesses through access to credit.  These measures were delivered after the Fed cut rates to zero and announced a $700 billion quantitative easing program.  To help ease corporate funding, the Fed restarted its commercial paper funding facility, indirectly purchasing short-term obligations to lower funding costs.  In addition, the Fed announced a plan to increase Treasury purchases, and more importantly, expand their planned products to corporate bonds and the ETFs that hold investment grade issues.  So far it seems that the market has appreciated the efforts.

From its bottom on 23-Mar-20, the S&P 500 has appreciated 20%.  Accordingly, March 2020 has produced both a bear market and bull market! The TSX rose 19.5% from its low.  Despite this strength, the S&P 500 and TSX are down 19.3% and 21.6% year-to-date.

Rates have been equally entertaining. The 10-year US Treasury Yield fell from 1.91% on 31-Dec-19 to 0.50% on 09-Mar-20.    The sinking long-dated rate reflects the slowing economy.  The significance of the deceleration is amplified when one considers that the yield was 3.20% in November 2018.  At the time of writing this brief, the yield rebounded to 0.74%.

The flow of investment capital has been a significant contributor to the market volatility.  Many large players like relative value strategies, hedge funds, and commodity trading advisors (CTAs) reduced their exorbitant leverage and/or moved from a net long to a net short bias.  This indiscriminate selling to lower their exposure and leverage impacted the benchmarks to the downside. It seemed like most of this forced selling was complete late last week.  But then another large player entered the mix.  The end of March is rebalancing season for pension plans.  US pensions maintain an equity bias due to their overly aggressive 7%+ return targets.  This means that after a 25-30% selloff in equities, they must purchase more stocks to bring that content back to a prescribed level.  Accordingly, pensions need to sell Treasury Bonds to finance the stock purchases.  Goldman Sachs estimates that this quarter will be the largest dollar value of pension assets moving into equities on record (second to Dec-18), requiring $280 billion of purchases during the final week of the month.

Covid-19 is still in its relative infancy in North America.  Trump’s “Back-to-Work-by-Easter” pledge may put some at ease as it relates to the short-term economic impact of the virus. However, we fear that the human and healthcare toll will be dreadful if this promise is fulfilled.  It still does not seem that the US population is taking the threat seriously, especially given the country’s high incidence of diabetes, obesity and hypertension, relative to the Asian nations that were originally exposed to the virus.  In addition, the US just reported that an astonishing 3,300,000 workers filed for unemployment last week, a number that was more than twice as high as consensus estimates.  If Covid-19 infections accelerate exponentially, unemployment will swell, consumer spending will grind, and business activity will stall further.  A potential corporate default cycle could ensue which would render the prospect of a V-shaped recovery a fantasy.

There are two primary factors that have influence over our willingness to increase growth assets materially in our portfolios: a sustained recovery in credit and a fall in volatility.

Often credit leads the way in a recovery.  In the embedded chart, yields (represented by the black line) begin to fall late in 2008, a full four months before equities.  The S&P bottomed after a further 24% slide.  Currently high yield spreads, as measured by ICE BofAML US High Yield, are 10.11%, up 6.45% from the February low.  This level has not been seen since June 2009.

Volatility, as measured by VIX, remains above 60, which implies that there is no end in sight for these large market swings.  Humans are loss-minimizing creatures by nature, meaning the pain experienced by a loss far-exceeds that of a gain. Therefore, a continuation of high volatility suggests that uninterrupted equity market gains are not imminent.  We would prefer to see both yields and volatility come down in a sustained manner before believing the three-day rebound is anything more than a bear market rally which are prevalent across almost all historical selloffs.

In less than one month, the S&P 500 gave back almost the entire 43.7% return it achieved since the low on Christmas Eve 2018; and, it revisited levels not seen since Feb-17.  Since our last update on 20-Feb-20, the S&P 500, TSX, and MSCI Indices are down 29.3%, 31.1% and 29.8% (as at 16-Mar-20).

While the sheer degree of the pullback is newsworthy, the volatility and velocity of the move is really astounding.  In fact, the 12% drop on 16-Mar-20 marked the first time since the Great Depression that investors have seen either 6 consecutive days of 4%+ moves, or 3 consecutive days of 9%+ moves in the S&P 500.  The blowout in volatility has not been confined to equity markets either, as it has crept into gold and oil, among others.  Speaking of oil, it has experienced its own fair share of problems in March.  Russia refused to comply with a planned production cut to help alleviate the demand disruption caused by Covid-19.  In response, Saudi Arabia showed once again who truly runs the table at OPEC, announcing they would increase supply to record volumes, over 12MM barrels per day, beginning in April.  With this and planned increases from Russia, UAE, Iraq and Nigeria, the supply glut has pushed the price of WTI down 45.2%.  This will surely add strain to an already weak US Shale sector, further adding stress to weak corporate balance sheets.

In 2019, many investors became increasingly convinced that stock markets only move in the “up” direction.  They found themselves chasing a market that was running away like it stole something.  Today, these same investors are complaining that the pullback, spurred by Covid-19, is a Black Swan that nobody could have foreseen.  While foreseeing a global pandemic is difficult, Coronavirus has been newsworthy since December and it was highlighted in our newsletters since January. Irrespective of the predictability of the virus’s impact on capital markets, the economic slowdown was evident before the respiratory illness was distinguished from a Sunday morning reaction to a Corona overindulgence.

It was plainly obvious that leverage in the corporate system was becoming a potential red herring.  A rising stock market was diverting cash flows to stock buybacks rather than strengthening the balance sheet, optimizing the supply chain, or investing in PP&E.  Further, the popularity of just-in-time inventory management to better streamline working capital caused corporations to become more fragile to any interruption in sourcing and maintaining adequate inventory.  Does this mean that these aforementioned points were enough to spur a 30% equity rout? No, but it indicates that corporations and the global economy were uniquely sensitive to anything that could disturb the status quo.  Introduce a novel virus … which is uniquely contagious in its underlying ability to be spread by asymptomatic or mildly infected persons, but severe enough to hospitalize between 10-20% of the afflicted… and, you have a perfect storm for the healthcare system, credit markets, the economy, and small and medium businesses and their owners/employees.

Is this to suggest that GAVIN anticipated where the puck was going and was short equities/long duration beginning on 20-Feb-20?  We wish!  However, we have been managing our clients’ assets with prominence for downside protection.  Considering the economic factors discussed above, we maintained exposure to ‘risk assets’ (ie. individual stocks and long-only funds) to approximately 40-50% depending on our long-term investors’ risk tolerance.  Moreover, we were consistently increasing exposure to Alternative Assets, excluding private equity, as economic perils mounted.  In addition, we know each clients’ cash needs for any given 6-month period and ensure that there is always adequate liquidity in the form of cash or short-term instruments to cover these obligations.  This has allowed us to minimize our downside participation in chaotic times; and, equally important, we can monetize and reallocate to risk assets when we feel the discounts are sufficient to allow for a proper margin of safety.  This does not imply that we will time the bottom, far from it, but we have the flexibility to average into positions in great companies that we are comfortable holding through and post Covid-19.

It was difficult to field questions in 2019 about the absence of 30%+ returns in our client portfolios.  Further, our apprehension with valuations and the sustainability of the bull market caused us to miss out on new clients who were reluctant to part with their 100% equity allocation.  However, we are in the business of preserving wealth; as such, during turbulence we can demonstrate the benefit of investing through a full market and the value of active management.  It is now on us to continue to stay vigilant, and to effectively transition from the defensive zone through the neutral zone and into the offensive zone.

It’s been more than 20 years since women’s hockey joined the Olympics in Nagano, however the past decade has undoubtedly seen the sport take its greatest strides. From the emergence of the professional leagues, to the talent development outside of North America, the past 10 years has seen the women push the sport to new levels. As the sport continues to fight to “close the gap”, GAVIN has identified seven women across different areas of hockey, all working hard to make a meaningful impact on the sport.

This week has provided ample ammunition for click-bait headlines.  News of the coronavirus spreading has been the catalyst for an overdue correction in equity markets. In times like these, it is important to remember a number of truisms that are employed by successful, long-term investors. The first is that corrections (defined as a 10% decline) and/or bear markets (defined as at least a 20% decline) are normal occurrences in equity markets. In fact, corrections occur on average every 12-18 months and should be considered a great time to add to your best ideas. The second is that there is always a reason to sell. In fact, the imbedded chart shows that over the past 10-years there were numerous corrections and triggers.  Nevertheless, the market climbed over 400%.  As Warren Buffett famously stated: “Buy when others are fearful and sell when others are greedy”. All the same, we recognize investors become increasing concerned about the greatest risk of all, a permanent loss of capital.  As such, we combat these risks in multiple ways:

Multi-asset class portfolios. This means that only a portion of your capital is exposed to these large swings. For example, bonds (and cash) can not only help protect money in a bear market, their stability also provides an option to take advantage of stock discounts. If a car you wanted to buy was all of the sudden 15% off, would you be more or less likely to purchase?

Low correlation investments. Your assets include securities that may be a drag on returns when the equity markets are surging but act as a source of relative return when stocks decline. This may include farmland, gold or hedged strategies; investments that can make money regardless of the equity market’s direction.

Undervalued Companies.  We avoid “story-stocks” or over-hyped securities. An example is a business that we previously owned, Mastercard. This is a great company operating in a dynamic sector with terrific competitive advantages – it is essentially a toll road for electronic payments. However, at over $300 per share, the price implied that it would take 20-years to recover your capital at the rate the company earns a profit. Further, most of the top company’s today (Facebook, Amazon, Google) barely existed 20-years ago. More significantly, one of the most loved companies of the late 1990s, General Electric, is down 55% over that period.

We have seen the economic picture shifting dramatically since the end of 2018, with signals of a U.S. recession on the horizon combined with excessive behavior in some areas of the market. As a result, only 40%-50% of your capital is exposed to equities, we have plenty of “dry-powder” to deploy when better buying opportunities arise. This does not mean we will be unscathed, rather we are in a good position to make rational decisions. It is not about timing the market.  We employ a studious and continuous risk management process that corresponds to your investor characteristics.

With three trading days left in February, it looks like we will see our first monthly decline across global equity markets since August 2019.  As we entered February, the New Year began just as 2019 ended.  Confidence surged as macro-headwinds were easing, manufacturing data appeared to be stabilizing, and most importantly, the dynamic duo of the US Fed and Trump would be able to keep markets levitated at least until the election.  Then a potential black swan in the form of the Chinese novel coronavirus crashed the party, spooking markets and sending the S&P 500 and MSCI indices down 5.6% and 5.9%, respectively.  The TSX has fared better as a 5.6% rise in the value of gold has helped temper the fall.

Before Chinese New Year, markets became doubtful that the government could contain the outbreak.  Nevertheless, official reports from China gave the impression that restrictions on the movement of about 50 million people were limiting the spread of the virus. Unfortunately, the international case count delivered on 20-Feb-20 disclosed that the spillover was accelerating. By 25-Feb-20, the number of daily new COVID-19 cases outside China exceeded those inside the country for the first time, according to the World Health Organization.

Whether or not the human implications will be as large as some are forecasting is up for debate.  Nevertheless, less debatable is the economic implications that have and will come about as supply chains continue to be disrupted.  Corporations grind to a halt as their workers undergo quarantine and are correspondingly forced to lower their guidance.  Apple was the first market darling to announce revisions on 17-Feb-20.  Mastercard lowered its outlook on 24-Feb-20, and its stock price promptly responded with an 11.3% correction.  This will surely not be the last corporation to hint at the virus’s impact, and both the severity and duration of the virus’s spread will continue to drive the market in the coming weeks and months.  The combination of worries has offset a fairly strong Q4 earnings season.   Investor focus will shift forward to discount the potential implications of a sustained global loss of demand, and the subsequent impact on an over-levered and under-prepared corporate sector.

Certainly, equities have taken their lumps, but commodities (ex. Gold) are absorbing the full impact of the fear trade.  CRB Commodities Index is down 9.7%.  Oil has led the decline with WTI and Brent crude falling 15.3% and 16.0%, respectively.  The demand destruction from the world’s second largest economy, and potentially globally, has crushed crude prices and energy stocks.  Copper similarly experienced a 9.3% drop; although, interestingly it has stabilized since 31-Jan-20.

Meanwhile, bond yields are being bid to record lows as money flocks to fixed income during the coronavirus scare.  Fundamentally the move makes sense. As growth and inflation expectations moderate, bonds become more desirable.  Nevertheless, quick and substantial action on behalf of central banks is being initiated to soften the economic impacts of the virus.  The Chinese government has already begun to pump monetary and fiscal stimulus, announcing over C$300 billion for special re-lending funds to companies who are reporting 50-60% operating capacity.  Hong Kong announced a $15.4Bn package which included a HK$10,000 (~C$ 1,700) payment to every permanent resident 18 and older.  Treasuries seem to be forecasting a similar reaction from the US Federal Reserve to help stem any loss of economic strength.  It remains to be seen if these activities will help the economy bounce back, but JPMorgan Chase prophesised that China would grow 15% in 2Q19 on a quarter-on-quarter, annualized basis.

Interestingly, on the surface, the Chinese market has not looked back since 01-Feb-20 with the Shanghai Composite Index rising 10.2% month-to-date, essentially wiping out prior weakness.  In addition, many areas previously on lock-down have restrictions lifted over the past week as Chinese authorities shift from total quarantine to monitored surveillance.  Again, it is difficult to determine whether this is the result of a genuine health improvement or economic desperation … only time will tell.

The annual New Year’s resolution tradition motivates millions of people to make changes in their life. The enduring success of those commitments is often dubious. Nevertheless, the exercise helps set the path for progress. In the diagram that follows, we have identified the top 10 most common resolutions and assigned the financial equivalent for professional athletes. Best wishes for a successful 2020 – on and off the ice!

With the first 20 days of 2020 in the books, global markets have continued their 2019 ascent with the S&P 500, TSX and MSCI World indices rising 4.4%, 3.3% and 3.5%, respectively.  While we had cited a lack of retail and institutional participation as a reason for optimism in 4Q19, it seems that narrative has flipped as we enter the early innings of 2020.  According to the CNN Fear & Greed Index, a 7-indicator reading of investor sentiment, the 21-Jan-20 reading hit 86 out of 100. This is a remarkable rise from the 30-range in September 2019.  Moreover, it indicates extreme greed and a high level of complacency.  Interestingly, gold has maintained its upward momentum, rising 5.1% for the month.  Equity markets are broadcasting a calm signal, but gold’s shine reflects political turmoil in the middle east and the expectation for falling real rates, which boosts demand for the metal.  Fears of reflation could be suppressing expectations for real yields in the future which is typically the true influence on the price of gold.

Elsewhere in metals, the meteoric rise in the price of palladium has been attention-grabbing.  Palladium is a key component of catalytic converters.  Eighty-five percent of mined palladium is used to turn toxic pollutants to carbon dioxide and water in exhaust systems.  As governments like China clamp down on vehicle pollution, automakers have increased its usage. Coincidently, consumers are moving from diesel-powered cars which utilize platinum to carry out the same operation, to gasoline which uses palladium.  As demand has increased, the supply has flatlined as palladium is primary mined as a by-product of platinum and nickel mining, rather than a focused end product.  As automakers scramble to secure inventory, the price of palladium has risen 22.5% in Jan-20, which comes off of an incredibly strong 2019 where its price appreciated 53.6%.  In total, palladium is up 3.3x over the past three years.  Speculators have surely driven some of the momentum; nevertheless, palladium has been in a deficit since 2012 and without additional supply or a substitute product, we could continue to see strength.

Oil continues to defy expectations, falling 5.0% for the month, despite an escalation of tensions in the Middle East following the killing of Qasem Soleimani, the Iranian leader of the Islamic Revolutionary Guard.  The assassination and subsequent bombing of US command posts in Iraq temporarily boosted the oil price by 3% but it has since fallen 8.6% as of 20-Jan-20.  Both sides of the conflict have declared that a diplomatic conclusion to the dispute is preferred. As such, some market participants have cited this as the reason for oil’s composure.  In addition, the possible absence of Soleimani’s military influence provide hopes that middle east tensions may moderate in the future.  However, the situation is nowhere near solved.  Iran’s persistently threatens to withdraw from the Global Nuclear Deal if European countries refer Tehran to the UN Security Council for violating the 2015 pact.  In the meantime, Canadian oil, measured by Western Canadian Select, has fallen 13.9% during the period.  This drop has once again pushed the spread with WTI to a 40% discount – back to where it was in late 2018.  The combination of record high inventories following a recent outage on the Keystone pipeline, and a Canadian National rail strike has cast doubt on Canada’s ability to reliably access the homeland’s oil.  Record-breaking cold weather in Western Canada has added fuel to the fire.  Two large crude producers were obligated to declare force majeure when they couldn’t fulfil their contracts due to an inability to process crude at extreme low temperatures.  Natural gas is a key ingredient in the conversion of bitumen to synthetic crude, and freeze offs have restricted the supply available to producers.

More recently, reports of a new Chinese coronavirus (the virus responsible for SARS in 2003) have made headlines and are impacting global markets.  On 20-Jan-20, the World Health Organization announced it would convene a meeting to declare a world health emergency.  The virus started in the Wuhan province of China, where 258 confirmed cases and six deaths have been reported.  The virus has already spread, and it is poised to worsen as the Chinese New Year (25-Jan-20) travel rush begins.  Global markets have taken note, with the iShares MSCI Emerging Markets Index down 2.2% on 21-Jan-20.

Stocks Accelerated Into Year End – The final quarter of the decade delivered impressive returns as trade tensions alleviated between China and the United States. The S&P 500 experienced its best annual performance since 2013 while Canada’s benchmark posted its biggest percentage rise since 2009. The improved global economic data combined with a weakening US dollar sparked a year-end rally in Emerging Markets.

The US Treasury Yield Curve began to steepen in the fourth quarter. The Federal Reserve cut short-term interest rates in October for the third time in 2019. Investors felt the impacts of easy monetary conditions with an improving economic and inflation picture. The 10-year Treasury yield ended the year at 1.92%. The Bank of Canada bucked the global trend and chose to keep their target rate steady.

Can Ample Liquidity Overcome the Risks in 2020? – The remarkable returns in equity markets for 2019 were not driven by strong earnings growth. In fact, sales growth slowed while costs accelerated. This applied pressure on margins, causing overall earnings per share to remain flat. Despite this headwind, global markets surged to new all-time highs on multiple expansion. Investors were willing to pay more per share for a dollar of earnings.

Multiple expansion typically signifies higher growth prospects or at the very least improving economic and financial conditions. In this instance, multiples were extending because more than half of central banks cut interest rates in 2019. This was the largest amount of easing since the 2008 financial crisis. Monetary conditions were relaxed in response to persistent weakness in global manufacturing. The sector recorded its longest downturn in seven years.

The combination of low but improving growth with loose monetary conditions benefitted the Growth style of investing over value-oriented strategies. Furthermore, passive investing continues to constitute more of the market. As such, the valuation premiums enjoyed by large, liquid companies over lower float, less liquid, smaller capitalization companies should endure.

The “phase one” trade deal between the US and China may help restore corporate confidence. If management teams are more comfortable making long-term investment decisions, capital expenditures will boost revenues. The timing might even coincide with a rebound in global manufacturing which will also lift corporate profits.

With loose monetary policies, peace in the trade war and improving prospects for corporate spending, investors are anticipating an earnings recovery over the next few quarters. However, the threat of inflation and the US election cycle may extinguish the flicker of hope as the year progresses.

If the manufacturing sector has troughed and loose monetary conditions boost growth, the economic slack that restrained inflation may be eliminated. This would force the Federal Reserve’s hand into raising rates. In 2018, the Fed executed too quickly, and markets faltered. Inflation may arise from an energy shock, for example, if tensions rise between Iran and the US; or, from food prices, which are vulnerable to climate change, higher oil prices and a depreciation in the USD.

As for the election, if leftist economic policies gain support and either Bernie Sanders or Elizabeth Warren win the Democratic nomination, markets will be spooked. These policies are likely to hit at the heart of the current economic cycle, hurting corporate profit margins of large firms.

On balance, the bull-market appears to remain intact in the very short-term with ample liquidity, neutral expectations and reasonable valuations. As the calendar advances, we expect to become less constructive on risk assets. Our bond outlook remains steadfast and is summarized in our January 2019 Outlook.

Outright prohibition of cannabis began in the United States in the 1920s.  However, over the past several years cannabis legalization has been rapidly occurring across the United States, at the state level.  In Canada, it is already legal for both recreational and medicinal purposes. The cannabis sativa plant has almost 500 natural components; as many as 70 of which are cannabinoids, chemicals that are unique to the plant.   The push for legalization is led in large part by the medical discovery in the early 1990s of the endocannabinoid system, a complex cell-signaling system inside the human body.  The possible applications for the constituents of cannabis are plentiful and vary across many industries, including healthcare, beverages, manufacturing, beauty & cosmetics, farming and more.   Accordingly, growth in the cannabis sector could push upwards of 10 times over the next decade.  Unfortunately, cannabis stock prices have crashed by over 70% from early-2019 peaks.  Valuations are now in line with peer groups that have nowhere near the growth potential.

In the lead up to the Canadian legalization of cannabis for recreational purposes in 2018, the enthusiasm for cannabis stocks mimicked technology during the Dot-Com bubble in 2000. Nearly all the publicly listed companies operated without revenue, nevertheless speculation elevated prices without regard to fundamentals.  However, capital support and investment from behemoth companies such as Constellation Brands, Anheuser-Busch and Altria, to name a few, fueled the excitement in the sector.  Through 2018 and 2019, fundamentals improved, and firms reported sales growth ranging from 10x to 200x the levels earned in 2016.  Despite the progress, profit expectations have not materialized and share prices have fallen precipitously.  Access to capital and regulatory restrictions on interstate growth and acquisitions have also been harmful to valuations.
In the United States, cannabis remains illegal under federal law for any purpose as it is classified as a Schedule I substance, a category reserved for substances with a high potential for abuse and no accepted medical use. Despite the federal classification, the United States is the fastest growing market for cannabis as individual states have legalized cannabis for both medicinal and recreational purposes. The confusing system means that a business head-quartered in a legalized state, may simultaneously violate federal laws and be non-compliant in neighbouring states. The tangled legislation restricts capital and products from flowing across interstate borders.
As at December 2019, 40 states have allowed some form of legalized cannabis.  State legalization has grown from just 17 at the end of 2010. Adoption has accelerated in large part due to the amendments of the Cole Memorandum, named the Rohrabacher-Farr amendment which bars federal prosecution of individuals who comply with their state’s medical cannabis laws. The rapid growth has created additional pressure for the federal government to address the legal discrepancy. This sets the stage for cannabis to be used as a political weapon in the 2020 election.
Current Democratic front-runner, Elizabeth Warren, introduced the Strengthening the Tenth Amendment Through Entrusting States Act (STATES Act) in June 2018. This legislation prohibits Federal interference with cannabis corporations operating legally within state guidelines. The STATES Act enjoys the most bipartisan support, this includes backing from President Trump. Further, in December 2018, Trump signed the omnibus Farm Bill, which redefined hemp as an agricultural product rather than a Schedule I substance. Hemp is a strain of the Cannabis sativa plant species that is grown specifically for industrial uses of its derived products.

On September 25, 2019, the House of Representatives voted in favour of the SAFE Banking Act, a bill aimed at giving clarity for financial regulations across the United States. If approved by the Senate, US operators would gain access to capital and can purchase common social services for employees such as insurance. The Bill however has not made it through the Senate, and if it is pushed until 2020 the process for approval will reset. Current Senate Banking Committee Chair Mike Crapo has been steadily softening his once hardline position on the subject. State Attorney Generals are pushing for change, as it is becoming more difficult to oversee the industry with no financial guidelines.

In addition to the momentum for legislative changes in the United States, there is a global push for rescheduling cannabis by the United Nations. In early 2019, the World Health Organization called for the whole marijuana plant to be removed from its most restrictive category of a 1961 convention. Such a shift by the United Nations would be a positive catalyst as additional nations would likely be more inclined to scale back or repeal their prohibition laws. It should be noted, however, that legalization for non-medical reasons would still violate global conventions and the vote which was scheduled for March 2019 was postponed with no clear indication on a new vote date.

Within a 24-month time frame, the cannabis industry has transitioned from stretched valuations to panicked selling. The thoughtless flogging is reminiscent of the beating undertaken by Amazon and Booking Holdings (formerly Priceline Group) when the Dot-Com bubble went bust.  When Priceline IPO’d in 1999, it soared to a $23 billion market value. But by 2002, tanking tech stocks devalued its market cap to about $150 million. Today, the company’s value is approximately $85 billion.  It would be reckless to suggest that Booking/Priceline history will repeat with the whole cannabis complex. Nevertheless, sentiment is approaching extreme negative levels at a time when growth is accelerating and structural impediments are fading.  We anticipate that momentum will shift, as legislation and access to capital improve, and today’s investors will enjoy favorable outcomes in the long-term.

The 2019 calendar years is shaping up to be the strongest year since 2013 for the S&P 500. North of the border, the TSX should post its strongest year since 2009.  The results would have seemed unthinkable during Q4 of 2018 as markets were crashing and a recession was all but guaranteed.  For the month ending 17-Dec-19, the S&P 500 and MSCI World indices gained 1.3% and 0.6%, while the TSX was flat.

Equity strength continues to defy expectations despite lingering recession concerns.  However, the economic slump sentiment seemed to subside when the employment survey from the US Bureau of Statistics was released on 06-Dec-19. The jobs market showed a very healthy gain of 266,000 (vs. expectations of 187,000) nonfarm jobs in November, along with an unemployment rate at 3.5% and a 3.1% bump in hourly earnings.  While employment data has historically been a fairly backward-looking statistic, the news seemed correlated with a 1% rise in the S&P 500 for the day, and a break above the previous high for the month.  A secondary, or perhaps primary, driver for the market was the Fed’s declaration that it would allow inflation to run above the 2% policy target. The justification that the rate has remained below target for enough time that allowing it to run above will bring the average to 2%.  Readers may now wonder why a plan to let inflation rise may be good for markets, especially if they have read our past commentaries, but in this case it comes down to the lens with which a participant wants to view the market.  In the short-term, this translates to sustained accommodation and zero quantitative tightening.  If history repeats, this means prolonged asset inflation and a rise in equity markets.  We won’t beat a dead horse, but if market participants decide to apply a longer-term lens, the implications of higher inflation could signify lower corporate margins, additional consumer stress through higher costs if wages don’t keep up, and the inevitable Fed scramble to temper expectations through make-up tightening down the road.  It is easy to see the forest for the trees, but 2019 does not provide much of a reason to expect an imminent change in focus.

Speaking of inflation … ok, fine, just a couple more shots at said horse … rates and commodities seem to have started to sniff out a pickup during December.  The US 10-year and 30-year yield both rose 10bps for the month as the yield curve steepened, meaning longer-term yields are rising via a perceived pickup in growth or inflation, while the short-term continues to be suppressed through dovish Fed policy.  Elsewhere, copper climbed 5.3%, while weakness in the CRB US Spot Raw Industrials index reversed course, rising 2.6%.  This one is fairly noteworthy as it includes things like steel, tin, burlap, cotton, cloth etc., in addition to copper, which is a diversified gauge of key economic inputs.  Now one month does not a trend make.  However, employment has historically been a lagging indicator, these commodities are a fairly accurate leading indicator, and can help form judgements of how things may unfold in the coming months.

Moving on to oil, WTI demonstrated strength during the month and moved through the $60 ceiling, up 4.6%.  Helping drive the move was the result of December’s OPEC meeting.  The 14 country cartel agreed to cut an additional 500K barrels per day, bringing the total cut to 1.7MM barrels per day, above consensus.  Media outlets have suggested that the improved trade situation between the US and China could also impact expectations for global growth, and in turn demand for oil.   Possibly related and likely more impactful, persistent negativity surrounding the trend in US shale oil productivity.  Global supply has been profoundly impacted by shale over the past few years. Accordingly, weakness should be bullish for oil prices in the long-term. Shale basins lose 70% of production after year 1, and 35% of the remainder in year 2.  The short life cycle of shale operations means that the taps could turn off even quicker than anticipated.  Rapid depletion and tighter lending standards within the industry have caused concern for the US’s ability to grow production and pace global supply growth.  As a result, there has been renewed enthusiasm in the narrative north of the border, with the S&P/TSX Energy Index rising 6.5% for the period.

Among professional athletes, hockey players are often viewed as philanthropic leaders. Take for instance the league-wide involvement in this past month’s Hockey Fights Cancer campaign, or the unrivaled participation in the always popular Movember competition. As the holiday season approaches, hockey players, like many others are reminded of their fortunate situations and the importance of supporting those less fortunate. To better understand how you can give back, GAVIN has outlined a variety of options and some important financial factors to consider.

Coming into the seasonally strong end-of-year period, markets have so far toed the line. The S&P 500 (+3.5%), TSX (+4.2%) and MSCI (+3.0%) all posted strong gains in November.  This marks a third consecutive month of strength for the S&P 500 and MSCI World Index as reduced impeachment risk and trade war optimism helped support the advances.

BNP Paribas recently reported that outflows from equity mutual funds and ETFs surpassed $150 billion during the past 6 months.  Previous peaks in outflows occurred in 2016, 2011, 2008 and 2000 when markets were strikingly different than the all-time highs that are present today. As themarketear.com highlights, strong outperformance typically follows periods where outflows exceed $50 billion. Accordingly, the massive retail redemptions suggest that robust equity performance may persist.  However, in this instance, negative fund flows could imply that markets are preparing to rollover.  It is no secret that corporate buybacks have supported the upward momentum and that easy access to credit has funded the buybacks.  At this point, the data does not indicate that the trend will reverse anytime soon.  BBB and high yield issuers continue to have significant access to debt financing and spreads remain tight.  Although,  borrowers rated CCC and below have experienced widening spreads since Sep-18, but this portion of the market represents only 3% of US corporate debt outstanding.  Comparatively, the BBB-B component of the market accounts for 66% of debt and most of the buyback flow. As a result, more attention is dedicated to the importance of the spread movements in those constituents.

The TSX index shrugged off a tough October to post a 4.2% gain for the current period, good enough to lead US and the MSCI Indexes.  Energy rebounded slightly during the month as the sector increased 4.2%.  However, the 9.4% improvement in the Tech sector paced the TSX. Constellation Software (TSE: CSU) jumped 9.8% for the month to all-time highs on strong earnings, while Shopify and CGI both registered convincing returns.

Thank you to Kevin Muir, the macrotourist, for drawing attention to Canada’s inverted yield curve.  When the US yield curve first inverted in April, many declared that this signaled a looming recession.  Since then, the US curve has steepened, helping to alleviate some worries.  But, yields in Canada continue to be inverted which essentially demonstrates that short-term lending conditions are too tight in relation to expectations for slower long-term growth, or a future reduction.  Nevertheless, Canadian economic numbers continue to surprise to the upside; as such, the yield curve remains uncharacteristic for bullish forecasts.

Commodities generally had a quiet month, as oil maintains the $50-60 range ahead of OPEC’s meeting in early December.  Demand for oil has cooled in 2019 due to slowing global growth.  Supply has been held in check by planned OPEC cuts which are set to expire in March 2020.  There are many reasons to believe US oil production will taper at some point, but so far this has not been the case.  Unless OPEC’s production cuts persist, oil prices will struggle in 2020.  Nonetheless, on a rate of change basis, we note that late Dec-18 marked the low for oil at $46, a steep decline from $76 in Oct-18. So, while rangebound in 2019, on a year-over-year basis we are exiting a period of weakness into a period of strength, which could have implications on inflation expectations to begin 2020.  Bond markets were beginning to sense this in October and November as the US 10-year yield rose 41bps to 1.94% on 11-Nov-19, but have since backed-up to 1.77%.  Copper similarly fell in November after a strong month in October.

Copper and oil, along with the CRB US Spot Raw Industrials index, will be closely monitored for signs of inflation.  Inflation is present and growing at the consumer level, but its impact has not yet obstructed corporate fundamentals (margins, input costs) or influenced Fed policy from a macro perspective.  One underappreciated commodity that has “logged” impressive gains is lumber, soaring 27% from its May low. Falling mortgage rates in the US sparked the housing market and  intensified demand for lumber.

For good reason, team captains are well paid. The approval of teammates and management is a reward in itself, but the player’s contract also provides compensation for the added responsibility. Whether the big money arrives before the “C”, or after, there is a strong relationship between the pay cheque and the designation. As we have illustrated in the attached exhibit, NHL captains earn 370% more than skaters who are without a letter.

Up and Down, then Up Again – US equity markets registered new all-time highs in July, fell in August as risk-off price action took hold and ended the quarter back near their peaks. Similar themes caused the roller-coaster quarter.  The on-again/off-again US-China trade war dominated the headlines as well as weak global growth, recession fears and central bank monetary policy. Canada’s S&P/TSX Composite continued its strong 2019. However, energy stocks persistently underperform as crude prices slipped 8.5% during the quarter. Outside of North America, markets struggled to combat a slowdown in China that is reverberating through much of the globe.

The Federal Reserve embarked on a new easing cycle with two rate cuts. The long-end of the US yield curve fell dramatically, causing a temporary inversion of the 10-year and 2-year spread.  The Canadian dollar slipped during the quarter, but still remains approximately 3% higher than at the beginning of the year against the US dollar.

Paradigm Shifts & Turning Points – Following-up on our July 2019 issue, we continue to evaluate investment opportunities that are expected to outperform or at least be prevalent over the next decade. To recap, structural shifts in consensus beliefs appear to occur every ten years or so. This time frame applies to the formation of a championship hockey team and to investment allocation strategies. The transition often rewards early adopters. Eventually excessive optimism of the “New Paradigm” forms and mimicking becomes widespread. Ultimately, profits erode and the bubble bursts.  This cycle was coined by George Soros as the theory of reflexivity.

The current investment views have been formed by events over the last decade. This period witnessed the failure by the US Federal Reserve to sustain inflation above its 2% inflation target, while wage growth has been 180 basis points less than the decade previous. Meanwhile since 2010, the S&P 500 Index has outperformed the MSCI World-Ex US Index by an average of 70 basis points per month. The Technology sector has been the leader with a 15.2% average annual return. Finally, the trade-weighted US dollar index is at its highest levels since tracking began, up over 30% over the trailing 10-year period.

Inflation

• Consensus

US core inflation rate has not breached 3% since the mid-90s. Debt, demographics and tighter monetary policy in developed economies will lead to a continuation of the current deflationary environment

• Contrarian View

Low labour costs (China and excess workers in US) along with falling commodity prices have masked inflationary pressures. If inflation picks up, long-term bonds are most at risk while commodity equities have both relative and absolute upside.

US Equities & Dollar

• Consensus

The US economy will continue to outperform, perhaps due to more desperate issues around the world. A shortage of US dollars will send the greenback higher eliminating the need to hedge currency risk.

• Contrarian View

The twin deficits in the US may come in to focus causing an outflow from the dollar should there be a sustained loss of confidence in US growth or fiscal prospects. International equities appear better relative plays while gold could stabilize a portfolio if economic uncertainty persists.

Technology

• Consensus

The top seven companies by market capitalization are technology firms. With near zero cost of capital and operating within oligopolies, technology giants will continue to expand their empires and profits.

• Contrarian View

Sheer size alone warrants caution as bigger organizations face more bureaucracy and government scrutiny. Meanwhile, China and the US now appear to have chosen technology supremacy as a matter of national security. Underweight US technology while focusing on smaller, more disruptive companies.

While positioning does not ensure annual outperformance, the probability of success increases due to a commitment to the process. A well diversified portfolio has an objective of long-term wealth creation rather than outperforming in any single year.

The 2019-20 NHL season starts tonight! To ensure a player is financially prepared for the upcoming season, GAVIN has updated our annual Preseason Primer. The exhibit provides current and relevant financial data for the upcoming season; including pay periods, escrow rates, income tax rates, NHL group benefits and retirement contributions. Feel free to share The Preseason Primer; and, as always, let us know what you think.

Global equity markets continued their whipsaw action; however, this time the movement was to the upside. The TSX, S&P 500 and MSCI World indices rose 5.4%, 5.3% and 4.8% during the period.  A reversal in fund flows supported the stock markets, as recession fears faded and hopes for a U.S.-China trade deal grew.  Accordingly, the US 10-year Treasury Yield climbed, initially rising 45bps to 1.90bps by mid-September before moving back down to end the period at 1.66%.  Geopolitics returned to the headlines and contributed to the large move in bond yields.  The most newsworthy event revolved around the attacks on two major oil facilities in Saudi Arabia on 14-Sep-19.  While Yemen’s Houthi rebels claimed responsibility, the US and Saudi Arabia seem convinced of Iran’s involvement.    As the accompanying chart illustrates, there has been an alarming growth in military exports of equipment to Saudi Arabia.  As such, it is surprising that either Iranian or Houthi drones were able to cause such drastic damage.  Recall that in 2017 President Trump brokered an arms deal with Saudi Arabia that was estimated to be worth $350 billion over 10 years. The agreement signified the economic alliance between the two countries and also served as a response to Iran’s malignant activity in the region.

Oil benefited from the tensions in the Middle East as WTI spiked 14.7% on the day. Recently the price has retreated due to reports that the infrastructure is being repaired more quickly than anticipated.  WTI finished the period up 6.1%.  Bond yields are also responding to the action in oil prices.  Oil is a key input for most consumer products and, as a result, it has an outsized impact on inflation.  Inflation continues to be disregarded but a turnaround could spark a rout in bond prices.

During the week of 16-Sep-17, it was reported that repo and money market rates shot up to almost 10% on an overnight basis.  Repurchase Agreements (repos) are used by banks to handle short-term cash needs. Banks borrow cash overnight in exchange for collateral (Treasury Bonds).  Normally, these activities are carried out daily without interruption.  However, the temporary spike in rates signaled that banks were short on cash.  As such, these entities had to pay a large premium to access cash.  The repo rate is influenced by the Fed Funds Rate (FFR), which is targeted to be 1.75%—2.00%. So, it is significant that the actual rate charged for banks to exchange their assets for cash spiked near 10%. Many reasons were cited as the cause for the disruption in the bond market.

There was a large increase of US bond issuance after the debt ceiling was raised in July.  Since, banks are the primary dealers, they are legally required to purchase Treasuries with the intention to sell to end users.  Consequently, cash had to be used to buy the Treasury Bonds.

Regulations have forced an enlarged requirement to hold reserves at the Fed since the Global Financial Crisis, limiting the ability for banks to provide liquidity in the repo market.

During the Fed’s Quantitative Tightening phase, cash that was previously added to Bank balance sheets in the form of reserves, has reversed and been drained to further stress liquidity.

Whatever the reason, the disorder forced the Fed to re-open their repo operation on an overnight and term basis to become the lender of cash.  These measures calmed the market in the short-term, but longer-term uncertainty persists.

For the primary dealers who are buying US Treasury Bonds, is there inadequate investor demand to allow the banks to sell their inventory?  Government debt as percentage of GDP has topped 100%, and it will become even higher given the prospect of federal deficits of at least $1 trillion.   Is there enough of an investor appetite for more US bonds?

Also, how much capacity does the Fed have to support the repo market?  Does this mean another round of Quantitative Easing to stabilize balance sheets and fund the deficits?  Besides the Fed, Japan, China, and ETF holders (Vanguard/Blackrock), are the largest holders of Treasuries, so relying on continued foreign investment into the US is critical.

In summary, the cause for the repo market disruption is complicated and wide-ranging. And, ultimately, the short-term consequences may be benign – however, we learned in the Global Financial Crisis of 2007–09 that inadequate liquidity can jeopardize the survival of any bank.

The 2019-20 NHL season is right around the corner.  Players and their families are preparing to depart for various NHL cities to attend training camp and to make sure their kids are ready for the start of school.  These semi-annual moves can cause plenty of stress and confusion. To keep players organized for this summer’s travel, GAVIN created the attached checklist. Click the link below to review the many planning considerations.

Equity markets took a breather in August as investors seem to be considering the risks facing the global economy, while trade talks between the US and China became more aggressive.  The MSCI World (USD) and S&P 500 led the declines, down 4.4% and 4.0% respectively for the period.  The TSX’s 2.2% loss was softened by a 9.0% rise in the price of gold.  Outside of precious metals, weakness in commodities is persistent due to reduced global demand.  Copper fell 5.5%, and the CRB US Spot Raw Industrials Index slumped 1.3%.  Both gauges have ignored equity market strength in 2019, which suggests that equity returns and inflation will be suppressed in the near future.  WTI oil also slid 2.1% as it appears to be stabilizing around the $55 mark after a significant 25% decline from its October 2018 high of $75.  Outside of primary markets, cannabis continues its lackluster 2019 campaign, with HMMJ sinking 14.5%.  The sheen may have come off in the near-term but the long-term commitment is endorsed by political advances and medicinal progress.

US Government Treasury Bonds were a primary recipient of investor proceeds over the past several weeks.  The 10-year and 30-year bond yields dropped to 1.49% and 1.97%, respectively.  The yield on the 10-Year Treasury achieved a new three year-low, while the sub-2% yield on the 30-year bond is an all-time low. These low rates reveal the bond market’s expectations for tepid economic growth in the coming years. Further, there has been an abundance of media focus on the yield curve inversion and its proficiency as a precursor for a recession.  Pundits debate whether the 2-year vs. 10-year is a better predictor than the 3 month vs. 5 year; but for investors; here is what you need to know.

1. 1. The short end of the yield curve (0-2 years) is controlled by the Federal Reserve or simply the central bank of the United States.
   2. The long-end (10-30 years) is much more fundamentally-driven, with two primary inputs; (1) growth of the economy and (2) inflation expectations.
   3. For simplicity, let’s assume there is no inflation, the bond market is pricing in sub-2% growth annually for the next 30 years.
   4. Overreliance on debt to fund growth acts to suppress future growth and carries disinflationary impacts.  Accordingly, this contributes to the forecast for sub-2% growth.  The current policy response to this low growth outlook and to defend against a recession is, ironically, to add more debt.  While we don’t know if a recession is one, five, or ten years out, we do know the bond market is pricing one in.  So, considering the bond market’s track record, it would pay to listen.

In summary, with the 30-year yield at all-time lows in the US, $15 Trillion in global debt yielding negative rates, manufacturing data contracting globally and most equity markets outside of the US in negative territory over the past year, we can be fairly certain a recession, or something close to, is forthcoming.  However, the market is nowhere near euphoria.  The S&P 500 put/call ratio, which is a measure of how much downside protection is being purchased in the option market, is at 2.15.  Over the past year, this level has been typically reached when markets are close to a bottom.  CNN’s Fear & Greed Index, which uses seven market indicators to gauge investor’s bullishness from a rating of 0 (Extreme Fear) to 100 (Extreme Greed), is at a sufficiently fearful grade of 21.  What does this tell us?  It tells us that investors are right to worry, and perhaps this is not the time to be 100% allocated to equities, but investor positioning could be hinting it is not quite time to dig a bunker and clear out Costco for its canned food.  We remain cautiously optimistic and believe that the fear currently over taking the markets may be overdone in the short-term.  The S&P is only ~5% off its highs, but fear has caused the stock of many companies to correct much further.  Accordingly, many more long-term investment opportunities are being created by short-term fear.

Volatile But Solid Quarter – Equity markets were broadly higher last quarter despite an escalation in US-China trade tensions and concerns of a global growth slowdown. The US once again led the group, returning 4.3% during the quarter and 10.42% over the trailing 12-months. The market rally was driven mostly by major central banks shifting their tone more clearly toward an easing bias as they acknowledged the weak global economic backdrop.

Safe-haven assets such as government bonds and gold were also among the biggest gainers on expectations of interest rate cuts and the possibility of further monetary easing. The Canadian dollar advanced 5.66% against the greenback as US interest rates collapsed and the Canadian economy recovered from its first quarter stall.

Paradigm Shifts & Turning Points – For those that have followed the National Hockey League closely, the paradigm shifts with regards to how the game is played have ebbed and flowed. The transitions from the “Run & Gun Era” (1984-‘94), to the “Dead Puck Era” (‘94-2004), the “Golden Era” (‘05-’15), and finally the “Precision Era” (’15-Today), required changing skill sets to generate success. During each turning point, teams that drafted and prepared well for the shift benefitted the most; Edmonton Oilers, New Jersey Devils, Chicago Blackhawks and Pittsburgh Penguins.

Analogous with eras in hockey, markets experience long-term changes that require structural modifications to portfolios. Early adopters typically see the largest benefits as teams/capital begin to accept and eventually mimic/support the strategy. In due course, a “New Paradigm” is declared because individuals become heavily influenced by current events. It is assumed the existing view will persist but the vast majority fail to anticipate shifts caused by the law of diminishing returns. The transition to a new path begins when a consensus view creates excessive optimism, encourages abnormal risk-taking and distorts valuations.

The 10-year time frame works in hockey and it also appears to hold up well in markets. Looking back at the last four decades there are distinct beliefs that become psychologically engrained in society. These prominent convictions become reflected in markets through valuations that teeter into “bubble territory.” Accordingly, avoiding the previous dominant themes and the largest stocks associated with the era can lead to outperformance over the next 10-years. The table below demonstrates this phenomenon.

1980 to 1989

• Beginning

Inflation exceeded 10% and bond yields were rising rapidly. Top 10 global stocks included five energy companies and nine were US domiciled.

• Ending

The best allocation decision was to underweight the US to hold zero energy companies as inflation receded.

1990 to 1999

• Beginning

Japanese equities dominated, owning eight of the top 10 equity positions by size while accounting for 45% of the global index. The core belief was Japan’s corporations held superior management techniques and banking systems.

• Ending

Simply underweighting Japan allowed a global investor to outperform as the Tokyo exchange peaked in 1990.

2000 to 2009

• Beginning

The internet and housing boom fostered the “new economy”. Technology, media and telecom stocks (TMT) comprised more than one-third of the MSCI World.

• Ending

Investors that performed well in the 2000s owned commodities and sold TMT.

2010 to 2019

• Beginning

Quantitative easing stoked concerns of inflation once again, while China’s growth and talk of peak oil helped push Chinese and commodity equities into the top 10.

• Ending

Best trade for 2010s was to underweight China and to be short commodity stocks.

Paradigm shifts do not signal a bleak future; conversely, the transition often leads to net gains. Technology stocks once again dominate the top 10 board by market share and the US now accounts for 56% of the MSCI World Index. However, the seeds that were sowed for this decade’s rich harvest are beginning to become unviable, similar to the one-dimensional enforcer in today’s NHL.

Markets continued to perform well in July with the US leading the way.  The S&P 500 posted a 3.6% gain for the period.  The MSCI World and TSX lagged but still recorded strong gains, at 2.6% and 1.8%, respectively.   In the US, technology (+7%) and financials (+6%) were leaders while healthcare and energy trailed.

Expectations for lower short-term rates are a significant factor in the markets upward trajectory.  Growth sectors, such as technology, disproportionally benefit from lower rates because the cost of funding and discount rate produce a higher present value for these businesses.  Financials are assessed differently because their valuation is derived from the yield curve, or the difference between long and short-term interest rates.  Banks borrow on the short end and lend on the long end of the yield curve.  Profitability is boosted when longer-term interest rates are higher than short-term.  This worked against the financial sector in 2018 as the Fed sought to increase rates while the markets continued to price in low growth through suppressed long-term rates.  In 2019, the trend has reversed.  If the Fed allows inflation to “run hot”, the case can be made that the yield curve will steepen further, and momentum in financials will persist.  The yield for the US 10-Year Treasury rose 11bps during the month, while WTI oil softened 2.6%, despite inventory data the was fundamentally strong.

Second quarter earnings season kicked off during the month.  General expectations for Q2 were fairly bleak, especially lapping a robust 2018 when earnings were boosted by Trump-enacted tax cuts.  Further, wage pressures, increased raw material (oil) costs, and global weakness in manufacturing and economic data were foretelling dim results.  However, most companies have beaten expectations on both top and bottom-line numbers.  Also, on 26-Jul-19, the US declared initial Q2 GDP growth of 2.1%, overcoming Wall Street estimates.  With companies broadcasting solid results, a stubbornly resilient US economy and a supportive Fed, equity markets have potential to maintain an upward path.  The downside case is supported by valuations that exceed historical averages and underlying indicators (inventory builds, government outlays, weak imports) that reveal softness in the economy.

As it relates to potential weak spots, the auto industry should be on the top of investors’ list of canaries.  In the US, Ford disappointed and its stock lost up to 9% on the day of its earnings release.  Guidance was cut and hints about capacity reductions continue.  Overseas, Daimler (Mercedes-Benz), reported its first quarterly loss in a decade, though from a volume perspective, things were not as weak as headline numbers indicated.  The company absorbed a €4.2 billion charge on diesel vehicle and air bag recalls.  In the UK, stock of Aston Martin collapsed over 40% due to a reduced profit forecast.  Meanwhile in Japan, Nissan announced 12,500 job cuts, or 10% of their workforce, as operating profit fell 99%.   Globally, auto markets are one of the largest employers.  Accordingly, when the sector faulters, it augurs poorly for consumer health, and in turn the economy.

Precious metals had an interesting month as gold took a breather after a very strong June. Conversely, silver ascended 7.2%, in an attempt to close the gap with gold in 2019.  It is important to try to make sense of the fuel that is propelling gold.  According to Commitment of Traders report, speculators and producers are crowded on the long side, while expectations for rate cuts from the Federal Reserve are at extreme dovish levels.  This has been the case for most of the bull run, yet prices withstand the strain.  In a slow growth, benign inflation world, where $15 trillion of global bonds exhibit negative yields, gold becomes an enduring and attractive asset.

In contrast to gold, industrial metals, are used in a wide variety of construction and manufacturing applications. As such, copper prices, for example, can be a barometer for the economy.  In July, at a time, when gold prices paused, copper may have found a bottom in its downward cycle that began in early 2018. The price movement of these two metals could have predictive power for the course of growth and interest rates.

A player will find themselves in one of two situations when their NHL contract expires, either an unrestricted free agent (UFA) or restricted free agent (RFA). UFAs have the ability of select from among the teams who have offered a new contract. However, this luxury is only tendered to players who meet the minimum age and/or service requirements. For those classified as RFAs, the ability to negotiate is much more limited. Check out the link below as the rights for an RFA are explained.

While our headline generation may be called into question, the question of whether the Fed’s rate hiking cycle is over was temporarily put to bed in June, helping to lift markets globally.  The S&P 500, MSCI World, and TSX indices all ended in the green, up 4.4%, 4.0%, and 1.4%, respectively as the TSX gave back its May outperformance.  Beginning with some hat-tipping from Fed members and concluding with the Fed statement on 19-Jun-19, investors were calmed as the probability of a 2019 rate reduction moved to 100%.  Two primary beneficiaries of the news were gold and US treasury yields.  Gold bugs celebrated as it initially broke through its 2011 downtrend line and since held above the $1,400 level, ending the month up 10.3%.  The US 10-year yield broke through 2%, ending the month down 145bps to 1.99%, a meaningful decline from 3.23% in Oct-18.  The movement in yields and gold prices validate the Fed’s message – the future rate path of interest rates will be downward in the absence of inflation.

An interesting dichotomy has developed in markets in 2019; market exuberance driven by a dovish Fed contrasted with a sluggish economy that is forcing the Fed to provide stimulus.  Global manufacturing has decreased materially, with the Markit Economics Composite World PMI shrinking to 51.2, approaching its 2016 lows.   This has been compounded by questions around the soundness of Chinese bank liquidity, a slowing global auto market and perhaps most importantly, a continued decline in the CRB Raw Industrials Spot Price Index.  This CRB index is a gauge of the prices of key industrial inputs and ‘boots on the ground’ measure of economic activity.  Geopolitically, the US and Iran are one bullet away from military conflict.

However, one key lesson learned since 2009 is that data alone does not necessitate a market pullback, and in the absence of a spark, euphoria can and will continue.  The prospect of easing US/China trade tensions, perhaps as early as the July G-20 meeting, and an amicable Fed could sustain the tailwind.  The Fed’s preference for a weaker US dollar will be valuable for improving the competitiveness of domestic exporter and for boosting corporate margins.  Foreigners who are servicing USD denominated debt will also get relief from a lower greenback.

One sector that has not read the “everything must go up” memo in 2019 has been lumber and its producers.  After a strong period of outperformance beginning in late 2016 to mid-2018, these companies have been struggling to find a bottom, with industry leaders Canfor and West Fraser losing 67.9% and 38.2%, respectively.  The “outperformance” of West Fraser highlights the issues facing the industry as a confluence of environmental and political realities hit the BC lumber market, where Canfor has staked the largest claim.  First, the mountain pine beetle epidemic destroyed large swaths of timber across BC.  However, lumber remains economically viable for up to 8 years after the tree is dead, so supply available to loggers increased up to 2017.  The beetle created more dead timber, lowering input costs and increasing capacity.  Since then, the trend has reversed, which when combined with an increase in wildfires has drastically reduced supply, increasing stumpage rates and reducing margins and capacity simultaneously.  Compounding this has been an anticipated increase to stumpage rates on 01-Jul-19 and the passage of Bill-22 in BC.  The bill restricts the ability of companies to transfer their tenure, or logging rights, to another company.  These factors have combined to create massive uncertainty in BC and daily announcements of mill shutdowns or curtailments.  Canfor CEO Don Kayne estimates that up to two billion board feet of lumber capacity will have to be eliminated to match market forces, which points to further shutdowns upcoming.  We are beginning to see green shoots in the industry, as lower interest rates have potentially stabilized housing demand. The corresponding demand for lumber, combined with capacity cuts pushed composite lumber prices up 32.5% this month.  That said, the index is still down 34.8% from its May-18 high.  Lumber provides a lesson in market cyclicality and the opportunities and risks inherent within it.

There are certainly more differences than similarities between athletes and your typical 9-to-5 employee. Nevertheless, both face important financial decisions and possibly the most important is when to buy a home. For an athlete, the choice often surfaces at a much younger age albeit with more financial flexibility and disposable income. But because you can afford it, does it always make sense to buy? Click the button below as we consider the true cost of home ownership.

We also included a couple of links to short videos that prospective home buyers should watch.   Enjoy!

How much did you make selling your house? Are you sure?

Is Renting A Waste of Money?

“Sell in May and go away” rang true in 2019 as markets gave back their April gains.  This marks the first down month in markets for 2019, with the S&P 500, MSCI World, and TSX all dropping 3.3%, 3.1% and 1.3%, respectively.  It seems that global growth concerns are back on the table, with tensions between US and China highlighting the issue during the month.  On 8-May-19, President Trump raised Tariffs on $200Bn worth of goods from China from 10% to 25% in hopes of hastening the signing of a trade agreement between the two countries.  While many foresaw the tactic working and a quick end to the negotiations, it seems that it has done nothing more than further solidify each party’s position.  Caught at the center of the negotiations are questions surrounding the prospect of a new technology cold war.  Trump struck the first blow, inking an executive order to restrict US tech purchases by foreign adversaries deemed a national security risk.  There is no secret that the target is Chinese alleged State-Owned Enterprise Huawei, as the move cuts off Huawei’s supply of key inputs such as semiconductors and Google’s Android operating system which are mission critical to the future of the business.    Perhaps, more importantly, this could end its reign as the leader in global 5G next generation technology.  One would think Trump, who sees the stock market as his primary report card, would want a quick end to the negotiation should markets weaken further.  He has never been one to take the high road so time will tell.  Treasuries and copper are both telling us trade wars are bad for the economy, with copper down 8.1% in May, and the 10-year treasury yield down to 2.32%.

Equity investors were not the only ones left licking their wounds, with oil reversing consecutive 11% gains to drop 10% on the month.  Chinese buyers were reported by Reuters to be refusing to sign long-term supply agreements with US producers, instead utilizing supply out of Iran, Russia, and evidently Saudi Arabia, who reported a 43% increase in oil exports to China in April.  This may help explain the relative outperformance of Brent Crude, down 5.0%, outperforming WTI by 5.0%.  Also impacting fundamentals is seasonal refinery maintenance, moved up this year by IMO 2020.  IMO 2020 refers to new shipping regulations requiring the use of more environmentally friendly fuel.  Many refiners are expecting increased pricing for the product, front-loading maintenance to operate at full capacity ahead of the Jan-20 switch, helping to increase crude and fuel inventories.

The outlier in equities was the TSX, with financials, energy, and mining all taking a hit, on the surface one would have expected the TSX to be down materially vs. its global peers.  However, during the month the index was propped up by technology and industrial shares.  Industrials were boosted through airline M&A as WestJet agreed to be taken private by Onex Corp and reports swirled of an Air Canada takeover of Air Transat.  Tech strength was driven by CGI and Shopify.  SHOP is now up 107% year-to-date as their e-commerce solution continues to drive strong revenue growth.  SHOP is looking to corner the market for all their merchant’s needs, including Shopify Shipping handling the shipping needs of over 40% of merchants, and Shopify Capital providing $87.8MM in merchant cash advances and loans during Q1, in addition to the launch of a new chip reader.  Investors seem to be confident in SHOP’s ability to execute on all angles, with Price to Sales based on guidance for 2019 coming in at 24.9x, vs Amazon at 3.3x.  We also note that on 4-Apr-19, short-seller Andrew Left of Citron Research came public with a short report which sent shares down 6% on the day, citing competitive pressure from such companies as Microsoft, Square, and Facebook in a market where SHOP was operating in unison previously.  There are two winners from this report, the investors with the foresight to buy the dip and realize a 43% gain since, and the Robin Hood Foundation where Mr. Left promised to donate $200,000 if SHOP traded above US$ 200 in 12 months’ time (US$ 275 as of 27-May-19).

One of the most popular summer pastimes for an NHL athlete is the sport of golf. Accordingly, we are often asked to provide guidance for players who are considering a private membership. From a financial perspective, it is impossible to justify the ongoing costs associated with a golf membership. However, professional athletes with otherwise disciplined cash flow habits, can afford this type of indulgence. After all, everyone needs a hobby! It is important to engage in a healthy distraction after the stress and grind of an NHL season. Click the link below to learn more about the world of private golf.

The equity rally stretched for another month as the MSCI World, TSX, and S&P 500 posted gains of 3.4%, 3.5% and 3.9%, respectively.  On a total return basis, the S&P 500 is now up 24.4% from its Christmas Eve low and 16.6% year-to-date.  Even more interesting, earnings season has only just begun and with an absence of positive signals from a macro perspective, these gains have been driven purely through multiple expansion.  Despite calls for a stock market reversal from some of the smartest minds in finance; share repurchases, hedge fund short covering and retail fund flows have fueled the advance.  SentimenTrader tracks retail flows via the Dumb Money Confidence Index. The indicator has been climbing steadily and it recently reached its highest level in a decade.

Fundamentally, we cannot refute the ‘smart money’ call for a re-test of the December lows.  A slowdown in global GDP growth forecasts, potential margin compression and weakness in industrial production for export-driven countries (Germany and South Korea) support the bearish scenario.  However, fundamentals act more as a rudder rather than a motor in the short to medium-term.  Accordingly, fund flows remain the market’s engine, specifically corporate buybacks are fueling the machine.

What is driving the buybacks and potentially the market?  The embedded chart illustrates the growth of US corporate debt issuance since 1996.  Following the 2007 crisis, US debt issuance has been on a sustained upswing, while the growth of high yield debt over the same period has been even more pronounced.  Notably, corporate debt issuance diminished in 2011 and 2018.  The chart does not capture the drastic slowdown in corporate debt in late 2015, in anticipation of the Federal Reserves’ first rate increase in December. As a result, a backlog of mergers and acquisitions that had yet to be financed slid from $246bn at the end of September to more than $900bn.  Coincidently, these calendar years (2011, 2015 and 2018) were the three years since 2008 where the S&P 500 was either flat or down.

So, what is happening 2019?  At the recent March meeting, the Fed Committee announced their intention to halt any further rate hikes in 2019 and complete its balance sheet roll-off program by the end of September.  While many cite the Fed’s surrender to the stock market, it seems like credit market conditions were the impetus.  Mr. Powell did not hesitate to raise rates in Dec-18 following a 10% drop in equity markets in Oct-18.  However, when there was a 90% decline in credit issuance, the plan for hike rates and balance sheet runoff was quickly cancelled.  This pivot seemed to hit the mark as credit markets opened-up. Investment Grade issuance rose from $9.1Bn to $106.6Bn, month over month.  Similarly, high yield issuance leaped from $0.9Bn to $20.4Bn.  Equity markets followed suit; after the 9.18% collapse in Dec-18, the S&P500 has jumped 16.6% in 2019.

Which leads us to another piece of the puzzle, that being inflation and the underlying commodity prices that drive it.  April brought on a second consecutive 11.0% rise in the price of WTI oil to $65.50. The latest bump was in response to Trump’s call to end any waivers on countries importing Iranian oil. Not only does this escalate the current feud between the two countries but it essentially removes Iran’s 1.5MM barrels of oil per day from the market.  With oil continuing to trend higher, the potential short-term effect on inflation and on interest rate policy will be noteworthy.  An uptick in inflation could have a knock-on effect through the erosion of corporate margins.  Further, if it forces the Fed’s hand, or alters the markets’ expectations from the Fed, debt markets will come under pressure.  Within precious metals, both gold and silver took a breather in April, down 2.9% and 2.6%, respectively.

Markets Snap Back After Federal Reserve Pivot – While the fourth quarter of 2018 produced some of the worst data since the Great Depression, the first quarter of 2019 reversed that, posting its best start in nearly 20 years. Although the clouds around Brexit are still hanging over the global market, there is increasing optimism surrounding the US-China trade talks and a turnaround in the US Federal Reserve’s monetary policy stance. After stating interest rate hikes were on autopilot, Federal Reserve Chairman Powell reversed course with a rate hike pause and followed-up with news that quantitative tightening would come to an end by September. US equity markets continue to outpace global counterparts, although a higher dollar and wage cost increases will likely pressure corporate margins in the quarters to come.

US Treasury bond yields continued their descent, boosting returns to both high-quality and high-yield bonds. The all-important yield curve continued to invert during the quarter, with the 10-year Treasury bond yield falling below 3-month Treasuries.

Yield Curve Inverts Signaling Economic Slowdown – During the first quarter, 10-year Treasury yields fell below 3-month Treasury yields, inverting the yield curve. Curve inversions have preceded the past seven recessions.  However, on 10% of the occasions, an inversion does not lead to a recession. So, what does an inverted yield curve actually mean?

The main yield curve reflects government bond yields across a time series that is as short as one day and extends out to 30-years. Front-end, or overnight, rates are set by the Federal Reserve while all other rates are determined by the market. The importance of these “risk-free” rates cannot be understated as they determine the price of all other asset classes.

When the front-end interest rate rises faster than the market-setting long-term rates, it impacts markets and the economy in two ways. The first is the impact on asset prices and the second is the effects on lending. The first impact is more intuitive, as the reward for holding cash rises, long-duration asset prices decline due to funds flowing into cash. Long-duration assets include both bonds and real estate as well as stocks, in particular growth equities which are priced as the present value of future cash flows.

The second impact takes a bit more explaining. As the yield curve flattens, this causes a strain on lending as well as the broader economy. Banks for example borrow on the front-end and lend at the long-end, when the curve is inverted the spread becomes negative. Less lending is almost assured to slow the economy and because this is reflexive – the slowing economy will beget more restrictive lending.

Tightening credit/liquidity is often felt in the riskiest areas of the economy first. This could explain the current flood of initial public offerings (IPOs) that are coming to market. Companies like Levi Strass & Co., LYFT, UBER and Pintrest are possibly raising capital in public markets because private markets cannot keep pace with liquidity needs or have no further capacity for financings.

Since 1965, however, the time between inversion and recession has varied significantly, ranging between 8 and 33 months, with an average of 19. A top in the US market has typically preceded recessions by only an average of seven months. Most of the stock market damage is incurred prior to the recession. The average peak-to-recession lost is -14.6%.  Meanwhile, stock market performance during a recession is generally flat on average. Additionally, there have been two “head fakes” in which the curve steepened, and expansion continued.  The 10% anomaly is perhaps upon us.

For investors with short-term needs for cash, the timing for taking profits in long-term assets is suitable especially given higher yields in short duration securities.  For long-term investors, the yield curve inversion, should not be a signal to hastily dump stocks.  Opportunity is becoming more apparent in value-based equities because these rely less on higher residual values.

As April approaches, the on-ice focus of most professional hockey players remains on their upcoming playoff push. In the player advisory world, the April tax deadlines are our version of a playoff push. Many fail to consider the complexity involved in filing taxes for a professional athlete. While some complain of federal and provincial filing requirements, an NHL athlete often has a filing requirement in each jurisdiction in which they play. This means a typical NHL player can file upwards of fifteen tax returns! Check the links below to view our checklists, designed to simplify your annual obligation.

Canadian Tax Checklist

US Tax Checklist

Equities continued to climb through the first few weeks of the month, although enthusiasm has been slightly more muted.  The S&P 500 and MSCI World rose 2.7% and 2.3%, respectively, while the TSX took a back seat for the first time in 2019, rising 1.7% for the period. 

Within the US, tech shares were resurrected, ascending 8% over the past several weeks.  Utilities and REITs also continue to outperform, lifted through falling rates and growth concerns.  Related to growth, industrials have been the primary drag as manufacturing data begins to sputter.  On the commodities front, oil continues to grain momentum, up 3.1% for the month and now 27.8% on the year as OPEC supply cuts and some positive weekly data offset global growth fears.  Gold was a tale of two tapes, dropping 1.9% overall but recent strength was derived from resurfacing economic worries and the Fed’s pivot (discussed below).  Cannabis stocks continue their market-leading ascent; Horizons Marijuana Life Sciences Index ETF (HMMJ) increased 9.3%.  The proxy has now registered a 63% gain for the year and hit its Oct-18 highs.  Many anticipate that new peaks will be reached as policy momentum builds south of the border.

One of the largest macro stories during March was the ‘dovish’ Fed statement made on 20-Mar-19.  Most market participants seemed to be clinging to the belief that the Fed President, Jerome Powell, would be different.  Many believed he would turn the tide of accommodative leaders and tighten monetary policy irrespective of the sentiment in capital markets.  However, any remaining optimism was washed out when the Fed delivered a triple whammy; lowering growth expectations from 2.3% to 2.1%; eliminating calls for any additional hikes in 2019 (vs. two previously estimated); and, announcing they would continue to roll over principal payments for Treasury securities, effectively ending the tapering program.  While some understood that any two out of three statements were possible, the overly dovish stance seemed to have taken many by surprise.  Predictably, the main beneficiaries were gold and Treasuries.  By surrendering the tools to manipulate rates and lowering growth expectations, the Fed effectively pushed longer-term yields down.  With neither concern over growth or inflation, longer-term yields will remain under pressure prompting fears of a yield curve inversion and the prospect of a rate cut to counteract any steepening.  Nevertheless, we remain focused on inflation, as a shock may be on the horizon if oil prices relentlessly grind upward.

Despite rising equity markets, some of the underlying trends have been less constructive.  The German Manufacturing Purchasing Managers Index, or PMI, data released on 22-Mar-19 revealed a third successive month of contraction.  Being a primarily export-driven economy, the deterioration has fanned the flames of global growth fears.  Cracks seem to be forming in Europe’s strongest economy.  Germany faces trade negotiations not only with the US, but also China, and an impending UK Brexit.  Terrible timing given recession signals growing in France and Spain, while Italy’s economy has slipped into its third recession in a decade.  The automotive industry represents a large proportion of Germany’s exports.  As such, profit warnings from Daimler AG and BMW, intensified the distress.  These alarms have compounded to drive German 10-year bond yields into negative territory.  European banks become reluctant to lend in this environment as their earnings from interest rate spreads are compressed.  European companies rely more heavily on bank lending to fund operations as compared to the US who borrow more heavily in wholesale markets. 

A staggering Europe and weak Chinese data hint that the US outlook may be fading as well.  The US 10-year bond yield confirmed this sentiment, dropping to sub 2.5%.  Given German bond yields are below zero and the Fed’s dovish posture, it would suggest that the differential in 10-year government bond yields is too wide.  Unless there is an uptick in inflation, the US yield will have to move lower as we enter the second quarter of 2019.

The strobe lights stayed on through February as cupid came and refused to leave. The S&P, TSX and MSCI World Indices registered strong gains across the board, rising 6.3%, 5.4% and 4.5%, respectively. Two political tailwinds have been cited as reasons for optimism. First, the January US Federal Reserve minutes were published which referenced a “patient” stance when it comes to further rate hikes and balance sheet deleveraging. Comments related to interest rates generally grab the headlines when the Fed issues a report. However, the markets got a shot of dopamine when it signaled that the end to balance sheet reduction would occur in 2019. Next, progress in Chinese trade talks were repeatedly awarded front-page status. On 25-Feb-19, President Trump stoked expectations for a successful conclusion to trade talks, saying he anticipated signing an agreement with Chinese President Xi Jinping “fairly soon.” This statement followed the cancellation of tariffs that were originally planned to go into effect 1-Mar-19. The import levies were slated to rise to 25% from 10%. The change would have significantly increased the trade war’s economic costs. In response to the positive developments, the Shanghai Composite soared 5.6% on a single day.

Gold continues to shine, rising 4.1% in February and a 12.3% from its low in September 2018. There has been no shortage of reasons to justify the price movement, from geopolitical concerns, central bank purchases, and perhaps most of all the continued momentum building behind governments (further) embracing debt as a tool to support public policy. Despite a swing from a US$236 billion surplus in 2000 to a US$779 billion deficit in 2018, the dire consequences of irresponsible and unnecessary spending have not appeared. Accordingly, the absence of these ill-effects is being interpreted as confirmation of successful fiscal engineering. As public policy is increasingly inclined to support a deficit, potential currency impacts could surface, which will increase the allure of gold as a store of value. Copper’s strength persisted into February, rising 12.6% during the period. The recent move was triggered by stockpiles held in warehouses operated by the LME dropping to their lowest level since 2005. A large jump in imports by China may explain the drawdown, which supports the positive impact that the country’s recent stimulus measures are having on global trade and global equity markets. Oil once again echoed this sentiment, rising 3.8% for the month despite record inventory reported.

Credit spreads in the US are replicating the optimism in equity markets. The ICE BofAML US Corporate BBB OAS dropped another 13bps to 1.71%, down from 2.05% at the start of the year. After a sustained contraction from over 3% in 2016 to sub 1.2% in early 2018, the measure is now riding along the bottom level of its 2018 range so the next move will be interesting to monitor. Highlighting the enthusiasm that 2019 has brought on has been the strength in WeWork’s 2025 bonds. WeWork seems to be somewhat of a fashion symbol for easy access to capital. To simplify the business model, WeWork will lease office space around the globe, fix it up to create a collaborative work environment, and then sublease on an as-needed basis to small businesses. The business required a heavy investment. IT reported net loss of $723 million for the first half of 2018 and rent commitments of $18 billion over the next decade. The Japanese multi-national conglomerate, SoftBank Group Corp. planned to acquire a majority stake in WeWork, but it needed to curtail its investment after it faced opposition from two main investors. The decision had a significant impact on WeWork bonds, as yields rose from 8.5% at its April issue date to 10.8% on 16-Jan-19. However, as credit markets rallied along with equity markets, the yield on these bonds have followed suit, dropping to 9.25% as of 25-Feb-19. For a business with large commitments and little security in revenue (tenants may terminate their agreement in one month), the availability and more importantly, cost of financing will certainly have a big impact on their ability to operate. We fear that the future of these bonds may correlate to many companies financed by cheap debt and questionable business models.

GAVIN manages approximately 25% of each client’s portfolio with direct exposure to between 15 and 25 companies that are publicly traded in North America. The equity portfolio has achieved an annualized, 4-year return of 11.7%, as at 31-Dec-18. These results handily beat the benchmark’s 5.8% return. In addition to high potential returns, managing a segregated equity portfolio provides cost savings, the greatest flexibility for tax planning and improved transparency. Check out the fact sheet to learn more about GAVIN’s equity portfolio.

GAVIN manages approximately 25% of each client’s portfolio with direct exposure to between 15 and 25 companies that are publicly traded in North America. The equity portfolio has achieved an annualized, 4-year return of 10.5%, as at 31-Dec-18. These results handily beat the benchmark’s 5.8% return. In addition to high potential returns, managing a segregated equity portfolio provides cost savings, the greatest flexibility for tax planning and improved transparency. Check out the fact sheet to learn more about GAVIN’s equity portfolio.

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.

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.

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!

So far in December, investors have harnessed memories of childhood as they eagerly anticipate the Santa Claus rally that has so often come to pass over the past ten years. However, so far it seems that St. Nick may be lost in the clouds as global indices hint towards another down month and if things hold, a negative 2018. The MSCI World and TSX Total Return indices led the way to the downside, both posting 1.6% one-month decreases from 20-Nov-18, while the S&P 500 fared slightly better, down 1.4%. YTD on a total return basis, the S&P 500 is down 0.9%, while the TSX and MSCI World will have a tough time eking out a gain for the year, down 7.4% and 5.9%, respectively. To make matters worse, bonds have failed to provide the diversification benefit investors have come to rely on, with the Barclays Aggregate Bond Index registering a 0.9% drop for the year. The Canadian investor relying on a 60/40 portfolio and who failed to diversify globally has certainly taken a hit in 2018, as this portfolio would be down 4.1%. At this point cash may end up being the 2018 investment of the year which is interesting considering the pressure some of our managers were getting a year ago for holding cash. It is always interesting to see how sentiment shifts with the direction of the stock market arrow. This time is no different as the consensus has swung from global synchronized growth to an all-but-guaranteed recession early in 2019. Analyzing ETF fund flows helps put some context to the impact that these headlines have on investors. As markets took a dive in the last week, ETFs focused on industrials and energy reported large outflows while utilities and staples attracted new investors, which is to be expected. Gold and silver continue to be strong, up 1.6% and 2.0%, respectively. Support for precious metals is derived from weak equity markets and the Federal Reserve positioning shift. Despite positive headlines, Cannabis-related stocks have been weak, signaling either a tapped-out retail investor or overly ambitious hopes.

We commented in November on the turnaround that was surfacing in Emerging Market equities. Interestingly, December was another strong month, as measured by EEM, which was up 0.9%. The gains oddly came on the back of a rising USD (+0.7% for the month) and despite the trade talk impasse. The improvement could be related to Fed Chair Powell’s disclosure that the path for any further rate increases is uncertain. During the November meeting, language changed from the benchmark rate being “far from neutral” to “just below neutral”. The commentary pushed short-term rates lower; the 2-year yield slipped 20bps to 2.65%. And, it impacted longer-term rates, the 10-year yield dropped 25bps to 2.83%. Many intelligent pundits were citing 3.25% as the yield which if crossed, would trigger a long-term breakout in rates but this has not come to pass. For the time being, macro fundamentals have directed the ship as the global growth narrative has shifted to one of slowing growth.

Oil has been a consistent area of focus for both this newsletter and Canadian market participants for some time, particularly the price and discount of Canadian Western Select. During December however, Canadian oil came roaring back, up 116% as Alberta Premier Notley announced an 8.7% oil production cut, reducing oil output by 375K barrels per day beginning 01-Jan-19. These cuts will remain in force until the 35MM barrels currently sitting in storage are shipped to the market, likely until the spring. In addition, by year-end 2019, the government plans to purchase railcars capable of transporting 120K barrels per day.
Despite the development, Canadian oil companies continue to languish. The BMO Equal Weighted Oil & Gas ETF fell 8.6% during the month. The absence of a rebound in equities indicates that the bounce may be unsustainable – probably due to the lack of pipeline and export capacity. Elsewhere, WTI oil was down 3.9% during the month, despite the announcement of a 1.2MM barrel per day cut from OPEC. It seems that many are skeptical of OPEC’s ability to follow-through on the announcement or the prospect of increasing supply of US Shale.

With their visible salaries and powerful social platforms, it is not surprising to learn that professional hockey players are prime candidates for early-stage businesses that are seeking direct investments. Accordingly, as the Hockey Wealth Specialists, significant resources and time are dedicated to evaluating opportunities. Whether the opportunity is brought to the player from a family member, friend or teammate, a rigorous due diligence process is needed before any investment is made. Check out the brief summary for some fundamental considerations for those who are curious about private investment.

October weakness continued through to Thanksgiving in the United States. The S&P 500, MSCI World and TSX fell 2.4%, 2.1% and 0.9%, respectively, during the first few weeks of November. The large market cap names who piloted the rally were also the drivers on the downside; Apple (-19.2%), Netflix (-17.9%), Amazon (- 15.4%) and Facebook (-12.2%). Digging deeper into the eleven sectors of the S&P 500, only Health Care (+0.8%), Materials (+2.5%), Real Estate (2.8%) and Utilities (0.2%) were positive.

It seems that Emerging Market equities may have turned a corner despite the challenges in global developed equity markets. During November, iShares MSCI Emerging Markets Index ETF (EEM) gained 0.8% despite the heavy weighting in Technology. Elsewhere, gold and US Treasuries both exhibited strength, with bullion rising 0.6% and US 10-year yield dropping 8bps to 3.06%, marking two consecutive months of strength following the 3.20% 5-Oct 2018 peak in yield. Despite gold’s performance, most commodities were down. The slowing global growth narrative was stoked by dim hard data measures such as the Purchasing Managers’ Index and Durable Goods purchases.

Fears of slowing global growth spilled over into oil markets as WTI followed a 12% drop in October with an 18% plunge. There have been no shortages of headlines to justify the decline.

• President Trump’s support for Saudi Arabia has reduced anxiety in the Middle East.
• OPEC’s ability and/or willingness to cut production has diminished.
• Forced liquidation of long oil/short natural gas positions by large investment funds.

We remarked in past commentaries that most investors seemed to be on the bullish side of the oil trade. Certainly, timing a reversal is rarely successful, but recognizing the risk of a shift helps protect wealth over time. Sentiment was such that any of the above headlines could have caused a setback for oil, while few upside surprises remained.

Fundamentally, it is interesting to observe the chart of oil consumption vs. production from 1970 to 2017, and contrast it with global growth’s impact on overall demand for oil. Despite almost 50 years and six recessions, consumption of oil has been fairly consistent – only the 1973-75 OPEC production cut-driven recession had a material impact. We understand the potential long-term impact of alternative energy and electric vehicles, but in the near term, we still anticipate consistent demand being met by production that runs slightly below the consumption line. As the chart on the left demonstrates, there would have been an oil shortfall without the ramp in US production originating in 2008. Most of the advancement in US oil production has come from shale. Any hiccup with extraction of shale oil could become a catalyst for a sharp price move to the upside. Further, there are unappreciated cost-sensitivities in the shale industry. The highly indebted sector is beginning to experience a rising interest rate environment; and, the land in the Permian has appreciated from $2,000 per acre in the early 2000s to $95,000 per acre in November 2018.

Speaking of indebtedness, the market has finally acknowledged the massive corporate debt load that escalated thanks to easy borrowing terms and an unquenchable thirst from investors. Without an extension in the unprecedented low interest rate environment or the cash flow to pay off existing balance sheet debt, companies such as General Electric, Ford Motor Company, or Anheuser Busch have become candidates for downgrades. Current interest rate coverage ratios support stability and the economy remains strong but rising borrowing costs or a slowdown in business can quickly become problematic for over-levered organizations.

For those with the means, most parents prioritize saving for their children’s education. Many families accomplish this by opening a non-registered investment account (or bank account). These accounts have the benefit of simplicity and flexibility, but are not structured optimally for tax efficiency or asset protection. Alternative strategies include establishing formal trusts, investing in permanent life insurance policies or taking advantage of income splitting through family businesses. However, governments in Canada and the United States have established prescribed programs for promoting post-secondary education savings. The infograph below provides a cheat sheet for persons on both sides of the border.

“Markets take the stairs up and the elevator down.” While many were starting to believe that the upward sloping stairs may last forever, October brought a harsh reality to market participants, with the S&P 500, MSCI World, and TSX down 9.6%, 9.6% and 8.2%, respectively. Rising rates, trade wars, and emerging market narratives contributed to the downside momentum. But the concerns expressed by management teams in third quarter earnings calls accelerated the slide. A constant drumbeat of increased cost pressure has tempered expectations for earnings growth, despite approximately 77% of companies beating expectations thus far. Earnings have been lifted by tax cuts and cost cutting – many firms have reduced expenses to year 2008-levels. As a result, options for earnings growth come down to good, old-fashioned revenue growth. Consequently, the true strength of the economy will have to come to the forefront.

Offsetting equity weakness, traditional protection mechanisms acted as-expected during the month, as the US 10-year bonds strengthened, and gold finally caught a bid. Gold was up 3.4% during the month, while the US 10-year yield has come back from 3.25% to 3.08%. Also pressuring longer-term yields was a weaker-than-expected US GDP print. It was revealed that government spending and inventory building was responsible for growth, rather than strong consumer demand.

Oil stumbled during the month, with WTI oil prices leaking by 11.5%. We commented previously on the incredible long bias in oil markets over the past few months. Though it is impossible to time when market positioning can reverse, the sensitivity to downside moves was witnessed in October. The backdrop for bullish sentiments was the combination of US sanctions on Iranian exports (effective 04-Nov-18) and persistent turmoil in Saudi Arabia. However, worries about slowing global GDP growth and Russian comments regarding maintaining production, were the catalysts for the recent selloff. Whether its oil or any other market, this month’s move shows that while timing a reversal is often futile, reducing exposure is ever-important when a good run becomes tired.

Beyond long-term rates, Central Bank maneuvers on both sides of the North American border had large implications on the short-end of the yield curve. Following the US Federal Reserve’s 25bp increase on 26-Sep-18, Canada followed-suit in October. Governor Poloz signaled confidence in the economy with a 25bp increase in the benchmark rate, which now rests at 1.75%. The removal of uncertainty around the revised trade agreement with the US and Mexico was also declared as a reason for rates to rise towards the stated neutral rate of 2.5% to 3.5%. Even though rates remain at historically low levels, the consumers’ capacity to withstand sequential rate increases is questionable due to household debt levels in Canada. A recent Bloomberg article cited that Canadian household credit growth was 3.6% in September year-over-year, the slowest since 1983 and below the 8.1% historical average. While the data is only representative of one month, it could indicate that Canadians are unable to add incremental leverage at higher interest rates. Now more than ever, credit growth acts as a primary indicator of GDP strength so it will be interesting to observe the data point’s impact on the Canadian economy and the prospects for further rate increases.

The Bank of Canada and its Governor, Stephen Poloz, carry out monetary policy by raising and lowering the target for the overnight rate. In the US, the Federal Open Market Committee has similar responsibility. However, there is a growing impasse between President Trump, Fed Members such as Neel Kashkari of Minneapolis and the Federal Reserve. Those who oppose the Federal Reserve are lobbying for a pause in rate hikes and less monetary tightening. Low borrowing costs are needed to help prolong the growth cycle, especially since the Trump administration has already used its primary bullets (tax cuts and relaxed regulations) in the middle of midterm elections. This internal conflict will be an extra source of volatility as the world economy plateaus.

The 2018-19 NHL regular season schedule will commence on 03-Oct-18. To make certain players are fiscally prepared for the upcoming campaign, GAVIN Hockey Wealth Specialists have once again updated The Preseason Primer. The infographic below provides current and relevant financial data for the 2018-19 season; including the highest paid players after-tax, pay periods, escrow history, currency forecasts and players’ group benefits.  Feel free to share The Preseason Primer!

Interest Rates Rise Amid Geopolitical Risks – Markets had a lot to digest over the past three months as trade tensions grew, NAFTA negotiations reached a resolution and European stability was again tested in Italy. Global growth remained solid as the U.S. economy forged ahead posting 4.2% real GDP growth. As a result, the yield curve in the U.S. shifted over 20 basis points (0.2%) higher and the 2-year note touched its highest level since 2008.

New rounds of tariffs between the U.S. and China did little to impact the S&P 500 which set new highs over the third quarter, appreciating 7.7% . The Canadian stock market, measured by the S&P/TSX, under-performed its peers in the third quarter falling nearly 1.5% due to flat oil prices and a widening discount to Western Canadian Crude.

Technology Stocks Are Breaking Down – The US equity market has fallen nearly 10%, twice in 2018. While these types of pullbacks, labelled as corrections, happen on an annual basis, the market leaders are now beginning to show some weakness. Seven big technology leaders – Amazon, Nvidia, Apple, Microsoft, Facebook, Alphabet and Netflix – have contributed more than half of the 60% increase in the S&P 500 since the end of 2013. The parabolic advance that began, ironically during the taper tantrum, appears to have been broken. If this sell-off continues there is a high probability that it manifests into greater losses for the broader market.

Over the last six to eight months there has been growing backlash against data collection and privacy violations by the technology giants. Mainstream media sounded off about the violations following news that Facebook shared user data with Cambridge Analytica. This data was then allegedly used to influence voters in the US presidential election. Lawmakers summoned Facebook CEO, Mark Zuckerburg to appear before congress for questioning. However, the hearing turned into a side-show as Senator’s displayed a clear lack of understanding of Facebook’s operating model.

The Facebook business model, which centers around data collection, has allowed the company to capture nearly 20% of US digital ad spending. Meanwhile its main competitor, Alphabet, garners nearly 40%. The duopolistic nature of the digital add industry is not a one-off. Alphabet and Apple provide 99% of mobile operating systems while Apple and Microsoft supply 95% of desktop operating systems. This has formed a far different fundamental environment for technology shares than the market’s experience during the dot-com bust (2000-2003).

Historically low interest rates combined with dominant market positions have propelled technology earnings. Unlike the dot-com era, technology firms today possess strong fundamentals, revenues and earnings rather than speculation. Going forward, analysts project the five biggest US tech companies—Apple, Alphabet, Microsoft, Amazon and Facebook, which account for 44% of the Nasdaq index—will see their profits grow to $170 billion and cash holdings reach $680 billion by 2020. This implies an average forward P/E ratio of 20x, which is reasonable given their growth especially when considering that Amazon is an outlier.

However, antitrust has also become one of the major focal points. And, Europe appears to be leading the charge on the regulatory side. Alphabet was hit with a record-breaking $5 billion fine by European Union (EU) regulators for alleged anti-competitive Android bundling. The EU is also addressing data and privacy with its General Data Protection Regulation (GDPR) rules. The antitrust backlash has led to numerous calls to beak-up the likes of Facebook, Google and mostly Amazon. Amazon is the most unique case as the company has essentially disrupted every industry in which it has become involved.

Jumping into large technology names following their massive price ascent should be approached with position sizing and timeframe top of mind. The firms are currently generating strong growth and have solid earnings however the environment appears to be changing. More importantly perhaps, these market generals have become increasingly important to the broad market indexes. Therefore, it stands to reason that further weakness here could make for a more difficult equity environment in general.

The MSCI World and S&P 500 recorded solid gains in September, rising 0.8% and 0.6%, respectively, while the TSX lagged with a 0.7% drop for the month. Financials performed well in Canada following strong third quarter earnings, but weak gold (down 1.0%), NAFTA trade concerns and relative underperformance of Canadian Western Select Oil hurt the energy sector. Commodities in general were positive during the month as the Bloomberg Commodity Index rose 2.0%. Emerging Markets, reflected by iShares MSCI Emerging Markets Index (EEM) on the NYSE, caught a bid and stabilized after a 3.4% drop in August.

Oil continues to be a tale of two tapes – the main indices (Brent or WTI) versus Canadian Western Select. WTI and Brent were boosted during the month when OPEC commented that production would not increase to offset reductions from Iranian sanctions and Venezuelan turmoil. The decision came despite Trump’s Twitter plea for OPEC to expand supply. Given the military protection that the US provides to the Middle East, Trump declared that lower oil prices should be the implicit compensation. It is questionable whether civilians residing in Yemen, Iran, Iraq or Syria are enthusiastic about the US presence in their country. But politics aside, the US is expected to maintain hostile oil price rhetoric as the economic expansion enters the final innings. Western Select continues to lag as no progress is made on pipelines to move the product. Western Select registered a 14.1% drop in September as WTI prices were boosted by 3.8%. These movements brought the price differential between the two to $35.50, a 49% discount. Correspondingly, Canadian producers are being clobbered and a major factor in the TSX’s weakness during the month.

The 30-year US Treasury Bond yield matched the May 2018 highs and moved decisively above 3% to 3.25% in September. The US Federal reserve not only increased the discount rate at their scheduled meeting, but they ratcheted-up the target range of the Federal Funds Rate to 2-2.5%, signaled one more hike in December and three lifts in 2019. The 2 and 10-year yields also continue to rise, with the 2-year at 2.8% (up 89bps from Jan-19) and the 10-year at 3.1%. Yields ticked up into and on the news of the Federal Reserve decision but have since moderated. Beyond the news flow, it is interesting to monitor Treasury pricing in the context of the Federal Reserve’s initiative to shrink their balance sheet. The third quarter marked a planned increase in the amount of securities the Fed planned to roll off their balance sheet, up to $50 billion per month. The yield on the 30-year Treasury has risen considerably since this time, and a similar move can be observed in the 10-year. Uncertainty about the future is often an explanation for rising yields. The anticipation of large budget deficits, over supply of Treasuries, trade wars and tariffs promote uncertainty.

We will reference President Trump to summarize the current impasse in NAFTA negotiations. The President’s recent comments include the country’s displeasure with the Canadian negotiating style and a claim that he refused a one-on-one meeting with Prime Minister Trudeau.  As negotiations are extended, concerns linger around issues such as trade dispute mechanisms and dairy, casting doubt on the Canadian dollar and certain sectors within the country, particularly auto parts manufacturers and lumber producers. Producers have repeatedly used the World Trade Organization trade dispute process to address anti-dumping complaints from the US and if the mechanism is altered, this could impact exports into the US, especially without a new Softwood Lumber Agreement in place.

eSports are organized video game competitions where the participants are professional gamers. And, the sport is booming. Forecasts suggest that revenue will exceed US$1 billion as early as 2019. While that figure may not approach the US$14 billion that was generated by the NFL in 2017, the global eSports audience is expected to reach 380 million in 2018. The audience consists of 165 million enthusiasts and 215 million occasional viewers. To put that into perspective, Super Bowl LI broadcasted by NBC in February 2018 had a viewership of 103.4 million. The popularity of eSports has even garnered the attention of the IOC, who is openly considering adding the competition as a demonstration sport for the 2024 Olympic Games in Paris. Click the link below to view more eSports facts and figures.

Tariff talk once again helped boost the S&P 500’s relative performance versus global equity benchmarks. With a 3.1% gain in August, the S&P 500 outpaced both the MSCI World (1.0%) and TSX (0.8%). The MSCI World Index was affected by relative weakness in emerging markets and Europe; excluding the US, the index was down 1.1%. Softness in foreign markets was driven by US dollar (USD) strength to begin the month, as the DXY was up 2.2% and MSCI World down 3.7% through 15-Aug-18.

The USD has been buoyed by several factors; (1) rising interest rates in the US are diverging from the rest of the world, (2) tariff and protectionist policies, (3) shortage of USD overseas. The robust USD environment affects emerging market economies who have large US dollar debt service obligations and those that need to import USD-priced inputs and services. Europe also weakened due to Turkey’s political spat with the US that led to worries about sanctions and the impact on the country’s banking system. In addition, concerns in Italy continue to mount. Moody’s extended its review of the country’s bond rating and rumours suggested that Italy would seek additional ECB support to purchase its bonds. In Canada, a relatively benign commodity environment helped to suppress the TSX. Within commodities, oil registered positive results, rising 3.1% following a weak July, while gold and silver both were down. Gold’s woes have lingered for more than 6 months, dropping 11% from its high of $1,345 in February 2018. The US 10-year Treasury yield took a step back during the month, dropping 9bps to 2.87%, while the spread between it and the 2-year narrowed to 21bps.

NAFTA has been prominent in Canadian headlines. President Trump announced his intention to enter into a new bilateral US-Mexico trade agreement, which indirectly applies political pressure on Canada to succumb to US trade demands. Canada’s Minister of Foreign Affairs, Chrystia Freeland, has been in lengthy discussions with US representative, Robert Lighthizer, despite Trump’s posturing. Ms. Freeland’s history opposing Russian oligarchs helps provide some insight into her ability to withstand political pressure and bullying tactics.

After a slow first half in 2018 and many cutting their losses in cannabis, a mid-August announcement from Constellation Brands suddenly sparked a rally that helped lift the sector 24% for the month. Constellation Brands (NYSE:STZ), sporting such brands as Corona and Modelo, followed an earlier $200 million investment in Canopy Growth Company (TSE: CGC) with a follow-on $3.8 billion investment. As part of the transaction, STZ will nominate four directors of the seven-member board, which allows the company control over CGC. Later, news broke that global spirit powerhouse Diageo (NYSE: DEO) was evaluating a potential investment in the space, helping to add fuel to the speculative fire. Many are now identifying names such as Pepsi, to Big Tobacco as potential acquirers in the future. The potential for M&A has, for the time being, caused prices and volumes to spike across the space and BNN Bloomberg to focus much of their attention on the topic. A constantly changing regulatory environment and greater disclosure on the medical benefit will inspire Big Pharma to enter the market. A joint research project between a Washington, DC based data analytics firm and London UK biotech firm reported that 7 of Canada’s top 10 cannabis patent holders are major multi-national pharmaceutical companies. With valuations in Canada already sky-high, either fundamental performance, or additional M&A will be needed to keep things moving.

The role of family, and particularly the spouse, is often overlooked when a player achieves success. Truthfully, a strong and supportive partner is essential for an athlete to achieve their on and off-ice dreams. Similar to the player themselves, the better-half needs to be disciplined, persistent, diligent and organized … not to mention patient and selfless. GAVIN spoke with Shannon Tucker and Lauren Giordano to gather some insights on their experience as the wife of an NHL hockey player. Click below to read what they have to say!

Sustained strength in equities was offset by overall commodity weakness in July. The S&P 500 led the way, up 3.3% for the month, with Consumer Staples finally catching a bid. Technology shares were the frontrunners, as early gains compensated for company-specific weakness later in the month. The MSCI World Index only slightly trailed with a 2.9% gain, while the TSX was dragged down by weak oil to finish the month up 1.2%.

While earnings season started very strongly, some unlikely names changed the narrative in the final two weeks of trading. First, Netflix reported less than expected subscriber growth, ending the month down 16% in the final two weeks. Next, Facebook was down a cumulative 21% since it reported its lowest quarter-over-quarter user growth since 2011. Some shrugged off recent negative press related to such events as Cambridge Analytica or advertisers looking to reduce social media spending. However, with stalled user growth for four consecutive quarters, fears of a growth plateau are building. It remains questionable that the company reports that half of all Americans and Canadians, including infants and seniors, use Facebook on a daily basis. But, assuming this is correct, Facebook and its investors may need to start adjusting assumptions of continued growth in its userbase. The company’s ability to innovate is second-to-none; so, by no means is this story complete. Twitter, although less of a darling, also reported slower user growth than the market expected, losing over 25% of their market cap since 26-Jul-18. Despite these large misses, overall earnings have been positive. Nevertheless, the negative reaction to quarterly earnings misses by tech leaders causes one to reflect on the proximity of a bear market.

We would be remiss if we did not at least mention tariffs during a 2018 monthly commentary. As the US pursues the America First policy, some countries caught on the other end of President Trump’s tweets have decided to work together to try to offset some of the impact. Most important to Canadians, is the nation’s union with Mexico, Japan, South Korea and the EU to address tariffs on vehicles and vehicle parts exported to the US. The US has cited threats to National Security as reasons to justify tariffs on these goods. Warning of tariffs up to 25% will surely add a significant amount to the price of vehicles. We continue to question the impact this would have on the American consumer, but it seems like voters are supportive of an aggressive President who will continue to beat the drum to encourage the momentum.

2018 has not been good to either silver or gold, with both losing their luster through the first half of the year. It is clear that the popular US Dollar and the prospects for rate increases have produced much of the weakness. A rising Federal Funds Rate makes the relative attractiveness of yield-bearing instruments greater than that of gold. However, an absence of movement on longer-term yields reflects the bond market’s feelings towards the Fed’s ability to continue to raise rates. Further, an uneasy European political situation and the steady drumbeat of the inflation narrative all point to a potential opportunity for precious metals. While the USD, as measured by the DXY, takes a pause on its year-to-date uptrend, it seems gold and silver have both stabilized at their current levels. Certainly based on current correlations the US Dollar Index (DXY) should be the primary determinant of the next move for bullion prices, but opportunities are brewing for outside influences to start providing a tailwind.

GAVIN Hockey Wealth Specialists, a wealth management and advisory firm for NHL athletes is teaming up with CB1 Capital Management LLC. CB1 invests in the supply chain of cannabinoid-based wellness solutions, products and therapies that address a wide range of unmet medical conditions and use-cases.

“Professional athletes understand the conundrum of modern-medicine,” stated Todd Harrison, Founding Partner and Chief Investment Officer of CB1 Capital Management. “Cannabinoid wellness has shown tremendous promise in addressing indications ranging from pain relief to traumatic brain injury (TBI) without the adverse effect profile of conventional treatments.”

GAVIN’s first-hand knowledge of professional sports creates a strong alignment with the focus of CB1 Capital Management.

“As a former player, I am very familiar with the solutions that are used to address aches, pains and injuries. Accordingly, we also understand the need for novel and progressive medical treatments.” said Stew Gavin, President of GAVIN Hockey Wealth Specialists, “We believe this is an opportunity to support the research and development for these therapies and to align the best interests of our clients and investors with potentially safer and more efficacious solutions for professional hockey players.”

A seven-year study published in 2011 by the Canadian Medical Association Journal tallied a total of 559 concussions over seven NHL regular seasons; that’s 4.6 to 7.7 concussions per 100 NHL players per season. Those numbers are tame compared to American football; a 2017 study found that 99% of studied NFL brains were diagnosed with CTE.

CB1 Capital Management does not touch the cannabis plant. Investment verticals include cultivation & dispensaries, biopharmaceutical applications, GMP compliant labs, industrial hemp & farming, extraction & nutraceuticals, pet foods & supplements, and more.

About GAVIN Hockey Wealth Specialists
Based in Toronto, Gavin Management Group, Inc. (“GAVIN”) is an SEC registered investment adviser. Through its planned-approach to financial independence, GAVIN has been working to create and sustain long-term financial success for professional hockey players since 2003. Please visit www.gavingroup.ca for more information.

About CB1 Capital Management, LLC
Based in Port Washington, NY, CB1 Capital Management, LLC is an investment adviser that invests in securities of public companies in the cannabinoid-wellness space.

Important Note
This material is provided for informational purposes only and does not constitute a personal recommendation by GAVIN and/or CB1 to you. Nothing contained in this release is intended as a solicitation to invest.

Over the past year, we endeavoured to partner with two industry leading investment managers to provide a unique opportunity for our clients. The primary motivations that inspired us to undertake this mission were as follows.

1. To provide return enhancement potential when the historic equity bull market falters; and,
2. To participate in the economic benefits that will arise from the application of cannabinoid-based drugs to treat epilepsy, brain cancer, dementia and a host of other diseases.

Accordingly, in July 2018, we launched GAVIN Special Opportunities Fund and made our initial investments in Horseman Global Fund and CB1 Wellness Fund LP.

CB1 Wellness Fund is a cannabis-focused hedge fund operating from New York. Portfolio holdings are focused on cannabinoid-based solutions and biopharmaceutical applications and therapies. Prior to his work with CB1 Capital, founding partner and chief investment officer, Todd Harrison spent almost three decades on Wall Street managing risk and researching financial market strategies. He was also the founder and CEO of Minyanville Media Inc., an Emmy-winning financial media company covering global markets in real time.

Based in London, England, Russell Clark has been managing Horseman Global Fund since February 2001 with a distinct and unparalleled strategy. Uncommon investment opportunities are identified by focusing on breakdowns in correlations. Historically, this approach has delivered results that are not synchronized with broad equity markets. For example, during the financial crisis from October 2007 to March 2009, when the S&P lost more than 50%, Horseman Global returned over 35% to its unitholders. Since the fund’s inception, investors have earned an annualized return of 10.75% (as of 30-Apr-18).

For more information on this exciting investment opportunity, please click the link below to view profile page.

Important Note
This material is provided for informational purposes only and does not constitute a personal recommendation by GAVIN. Nothing contained in this release is intended as a solicitation to invest.

Markets Make Their Comeback – After a volatile 1Q18, developed markets regained their upward trajectory in the second quarter. Although, headlines related to trade wars and weakness in emerging market caused brief pullbacks, every selloff seemed to create a bid. Entering the third quarter, markets may find more momentum in corporate earnings or become vulnerable to tariffs and rising interest rates.

Following the most recent Fed interest hike in March, Fed Chair Powell indicated to Congress in July that they would continue to raise rates. In addition, the Bank of Canada raised its benchmark by 25bps to 1.5% and are expected to follow-suit with the US. Short-term yields have risen accordingly, but the 10- and 30-year yields continue to hold steady. This has the potential to invert the yield curve, often seen as a harbinger of recession. However, with the continuation of quantitative tightening and the increased issuance of longer-dated bonds in 2H18, eventually the US government will be forced to pay higher interest on its tragic debt piles. Accordingly, higher long-term yields needed to keep a positive curve are conceivable.

Cannabis Prepared to Enter the Limelight – The impending Canadian Federal recreational legalization on 17-Oct-18 represents a sea change in governmental attitudes towards cannabis. Numerous studies are broadening the momentum as the efficacy of cannabis’s abundant active ingredients are being emphasised. The plant’s benefits are being proposed as therapy for epilepsy, cancer, autism, schizophrenia, concussions, Alzheimer’s, Crohns, depression and more.

During 2Q18, GW Pharmaceuticals (NYSE: GWPH) announced FDA approval for their childhood epilepsy drug, Epidiolex, the first such approval of its kind. The next step to availability in the US will be rescheduling of Cannabidiol (CBD), the active ingredient. Currently cannabis carries Schedule I classification under the Controlled Substances Act, indicating high potential for abuse and no medical purpose.

Rescheduling carries with it many potential medical implications. First and foremost, lifting restrictions on the supply of cannabis will allow researchers to pursue medical testing. With the ability to test and discover new medical benefits, the opportunities for medical applications grows exponentially, and with it the investment thesis. Second, it should help increase public support for cannabis which continues to grow, as evidenced in the political universe. Cannabis’s popularity among groups as varied as military veterans and parents with sick children provides significant political motivation with US mid-term elections in November. Further, its prospective economic impact is difficult to ignore, as is its potential as an offset to the opioid epidemic.

Of course, it is important to evaluate both sides of an investment argument, and no doubt supply and demand will eventually rule out. Estimates for Canadian cannabis consumption seem overextended, which has helped extend the valuations for Canadian-listed equities. In addition, increased research will not exclusively focus on the benefits of cannabis. New and potential negative side effects will also become uncovered.

As always, it is critical to understand the industry and the competitive landscape of a targeted investment. Moreover, determining a valuation that provides a suitable margin of safety at which to invest requires complex financial models. Even small changes in a few variables can alter an outcome enormously. For a new sector, where regulations are evolving, and forecasts for demand are largely promoted by persons with a vested interest – the uncertainty for fundamentally predicting results is immense.

In summary, we have no doubt that opportunities in this budding sector are incredibly promising. But, we are very cognizant of the optimistic assumptions currently being used to justify some company’s valuations. The Horizons Marijuana Life Sciences ETF (TSE: HMMJ) has fallen 33% since its peak in January 2018. Investing is not for the impatient, and this story should be no different.

[1] “It’s About Getting Well”, Todd Harrison, Chief Investment Officer of CB1 Capital Management

June mirrored May as far as equity markets were concerned with the TSX again leading (+2.5%) the way on the back of oil strength. The S&P 500 and MSCI World Index registered gains of 0.1% and 0.4% as we enter Q2 reporting season.

More than 200 domestic Chinese stocks were included in the MSCI World Index beginning in June. However, it wasn’t a promising start, as both the Shanghai and Shenzen stock exchanges officially entered a bear market during the month, falling over 20% from their January highs. Trade tariffs and the slide in yuan have been popular reasons to justify the decline, but it is hard to overlook Chinese banking regulator’s clampdown on Rmb 13.8Tr (USD 2.13Tr) of entrusted lending business. These loans are often made by shadow banks and the restriction specifically prevents them from being used to buy equities, bonds, or derivatives by the borrowing company.

Oil once again experienced increased volatility. The 22-Jun-18 OPEC announcement provided a tailwind to the commodity, rising 11.2% in the final five trading days prior to 27-Jun-18, ending the period with a 6.8% gain. Energy’s weight in the TSX is almost 20%; as such, the benchmark’s outperformance is largely attributed to the sector. The main catalysts for oil were the anticipated sanctions on Iran (cut off supply) and the announcement of a lower-than-anticipated combined production increases from OPEC and Russia. Fundamentals were further confirmed when the 27-Jun-18 inventory report revealed a higher-than-expected drawdown. All this comes at a time when US oil exports reached a record 3 million barrels per days and production achieved 10.9 million barrels per day – more than any country, except Russia.

The USD continued to strengthen in June, with the US Dollar index (DXY) rising 1.3%, bringing its performance from its February low up to 7.7%. Some have cited the relative monetary policy positioning (tightening vs. loosening in EU and Japan) as the primary driver as US dollar supply shrinks. However, it may be a short-term break in a long-term downtrend. Certainly the US fiscal position should continue to weaken with Trump’s tax policy and the possibility of a massive infrastructure spend if the Republicans are successful in the November mid-term elections. Either way, Emerging Market equities have been impacted due to their reliance on USD-denominated debt. The iShares Emerging Markets ETF dropped 7.6% in June and 13.7% since the DXY hit its February low.

In Canada, a historic bill was passed on 20-Jun-18 to legalize the recreational use of cannabis as of 17-Oct-18, representing a sea-change in government attitudes toward the plant. Beyond the recreational side, another historic milestone was achieved with the FDA’s approval of Epidiolex, GW Pharmaceuticals’ (NYSE: GWPH) drug derived from cannabis which provides children with two rare and serious forms of epilepsy a new treatment for the disease. However, the major development will occur when the Drug Enforcement Administration’s reschedules Cannabidiol (CBD), which is anticipated within 90 days. CBD is the active ingredient in cannabis and it is currently a Schedule 1 drug, which indicates that it has no therapeutic value. Rescheduling will open the door for the ongoing testing and potential availability of treatments to address a variety of ailments, with indications ranging from epilepsy to cancer, autism, MS and schizophrenia, among others.

spe·cial·ist

A person who concentrates primarily on a particular subject or activity; a person highly skilled in a specific and restricted field.

When it comes to managing the financial affairs for professional hockey players, we are the Hockey Wealth Specialists. We are steadfast in our belief that financial success is achieved through a comprehensive plan. We customize these strategies for players to make certain that their cash flow is balanced, their taxes are minimized and their families are protected. We professionally manage investment accounts in Canada and the United States to make sure your savings are working for you. And, we have the expertise, the experience and integrity that you would expect from people who have been around and in the game their whole lives. Click on the links below to learn more about GAVIN Hockey Wealth Specialists.

Markets continued to grind higher in May, led by North America. The S&P 500 recorded a 1.5% gain, while the TSX advanced 2.2%, buoyed by continued strength in commodity companies despite relatively flat performance of their underlying commodities. The MSCI World Index lagged, albeit with a 0.3% gain. Political turmoil and the market’s next “Exit” story stole the headlines in Europe. Gold’s price movement was benign throughout the month, recording a 1% move on only one day, and ending the period down 0.5%.

Oil’s 0.3% price change concealed a volatile month, as the price plunged 7% over the final four trading days. Market participants who were long oil were spooked by Saudi Energy Minister Khalid Al-Falih’s speech in Russia, when he announced that supply caps could be scaled back and the possibility of supply increases. However, it will take a unilateral decision to enact any official supply increase out of OPEC and we anticipate continued volatility as news leaks. Markets will eagerly anticipate the results of the OPEC meeting on 22-Jun-18, while closely monitoring inventory numbers to determine whether the recent price above $60 has served to quell demand.

Volatility in equity and fixed income markets ramped up as political turmoil in Italy resurfaced another Euro-exit scenario. The Italian 10-year yield has been consistently below the US benchmark since crossing in early 2014. However, yields rose rapidly above 3% on 29-May-18 when populist Italian political parties failed to produce a new coalition government. At the same time, the US 10-year completed a 30bp retreat from its recent 3.1% high to 2.8%. While Italian credit is questionable at best, it is fairly easy to reconcile the yield differential given the European Central Bank (ECB) has purchased €341Bn of Italian bonds since 2012 and it continues to buy an additional €4Bn each month. One can also visualize the potential damage that an Italian exit could produce. We realize the risk is likely overblown, and there are constitutional hurdles present that make the result unlikely. However, we also understand the risk-reward tradeoff and continue to question whether the current 3% rate, or the 1.6% average rate since 2015 is anywhere close the reward required to compensate for the low likelihood event of potential default. With €2.3Tr of outstanding debt, a debt-to-GDP ratio of 132% and persistent political turmoil, investors are relying first on the ECB, and second on a political turnaround, to provide returns that still lag US government bonds.

Closer to home, the Liberal government’s decision to purchase Kinder Morgan Canada Ltd.’s Trans Mountain Pipeline expansion for $4.5Bn was a last-ditch effort to save the proposal. The pipeline will extend from the oil sands of Alberta to a port in British Columbia. It would allow Canadian crude to gain greater access to foreign markets and higher prices. The project adds a much-needed 590K barrels per day of capacity from the current 300K, which will ease some of the backlog in Canadian oil markets. Canada will retain key personnel from Kinder Morgan and begin the undertaking this summer, but will actively seek a buyer for the project.

For those competing every other night during the NHL’s second season, the total prize money for the playoff marathon has been increased by $1,000,000. The NHLPA has set aside a bonus pot of $16-million for the Stanley Cup Playoffs. Unlike other professional sports in North America, the truly unique feature is that NHL players and management decide how a club’s share is divided among the team members. Click the link below to learn more about playoff bonuses along with other interesting financial considerations surrounding the 2018 Stanley Cup Playoffs.

The market turnaround that started in March continued into April with global markets rising in tandem. The TSX led the way again in April, up 2.0% on strong commodity performance, particularly oil, with WTI recording a 4.7% gain to follow the 5.4% gain seen in March. The MSCI World (USD) gained 1.4% and the S&P 500 1.0% as earnings season kicks off. So far, the season has been a positive one, with 79.4% of companies that have reported exceeding estimates, according to FactSet. Oil’s move helped drive the 1.8% increase on the Bloomberg Commodity Index for the month, offsetting weakness from soft commodities dragged lower by an appreciated USD. As measured by DXY, the USD was up over 2% during the month, stemming some of the weakness that began in late 2016. Aluminum was locked into the centre of Russian-related sanction headlines. The US imposed sanctions on Russian billionaire Oleg Deripaska and several companies which he has influence on, including Rusal, the world’s second largest aluminum company by output. The prospect of such a large volume of US imports coming offline initially forced aluminum prices to their highest level in six years. However, Mr. Deripaska agreed in principal to relinquish control by selling his stake below 50%, allowing prices of aluminum to drop over 10% on 27-Apr on hopes of reduced sanctions.

Rates continue to make headlines, and this month’s breach of 3% on the US 10-year was the first time crossing of the 3% threshold since 2014 where it briefly hit 3.0% before dropping back below 1.5% in Jul-16. However, in 2014 the Fed was still actively pursuing QE and many are watching closely to see what direction it takes in the coming weeks. On the short-end, the 2-year yield adjusted sharply higher during the month to 2.5%, up 56 bps year-to-date as recent inflation and GDP data have increased investors expectations for Fed rate hikes in 2018 (up to 4). While the short- and intermediate-term rates continue to see large moves, the 30-year’s move has been more muted. At 3.1% to end the month, fixed income markets may not be convinced of the long-term growth thesis.

An interesting divergence continues to take place in Canadian oil names. While intuitively, and historically, moves in Canadian oil stocks have followed WTI fairly closely, oil’s rally to end 2017 and into 2018 has not been reflected in the stock prices of Canadian companies in that market. We wrote in Dec-17 about the widened spread between Canadian and US traded oil contracts. However, even after the spread stabilized, it was not until April that Canadian companies started to perform in line with oil, often seeing gains on days that oil saw weakness. Looking at recent price movement and the long-term trend, there may be an opportunity in Canadian oil and gas names that could benefit even if oil stabilizes here.

The Return of Volatility – Equities began the year by extending their 2017 gains. But, in late January, accumulating uncertainties and rapidly rising yields eventually pushed equity volatility up and drove prices down. Nearly all major stock and bond categories finished the period in negative territory. Following an unprecedented streak of 19 consecutive months without a 5% correction for the S&P 500, the US equity benchmark fell nearly 10% in just 10 trading days in February. A brief recovery in stocks in the latter part of February was interrupted again in March by concerns over a potential trade war between the US and China.

In March, the Federal Reserve raised rates for a sixth time since the end of 2005. Nevertheless, developed-market sovereign bond yields have remained stubbornly low until recently. As inflation began surfacing in US consumer reports, yields started to climb. The 10-year US Treasury Yield hit 2.95% in March, a level it hasn’t reached in almost 3-years, which followed the original “taper tantrum” sell-off.

Displacing Deflation from Investors’ Mindset – Inflation trends have been declining for the better part of three decades. However, the millennial year marked the flatlining of the core consumer price index. As a result, central bankers have become obsessed with raising the level of inflation beyond the 2% trend rate experienced since the turn of the century. The great financial crisis of 2009 served to intensify the fixation.

High inflation can be harmful to an economy when it is not accompanied by rising wages. Equally, low inflation can hamper corporate pricing power which restrains earnings. Accordingly, the Federal Reserve attempts to boost the long-run growth rate by exercising control over inflation, as it is transparent and linked to the health of the economy. The problem is that inflation cannot be measured by an increase in the price of one product or service, or even several products or services. Rising costs are not spread evenly between businesses and industries, which contributes to the absence of inflation in government data.

Since the early 1980s, inflation has slowed in developed economies for a variety of reasons including demographics, technological advances, M2 money supply declines and higher corporate concentration. Further, given the swath of retirees over the next decade as well as the likely displacement of jobs due to robotics and artificial intelligence, runaway inflation is an unlikely concern in the foreseeable future. It is no wonder inflation fears have become so subdued. As a result, relative to financial assets, hard assets and commodities have only been this cheap twice in the past 50 years – 1970-1972 and 1998- 2000.

So, why are we doubtful about the disregard for an inflation surprise?

• Over the last few quarters, corporate earnings reports have stated concerns about tight labor markets and emerging inflationary pressures. This is a decisive shift from the deflationary tones of 2015 and 2016. Management strategy discussions frequently involve methods to pass on price increases from materials and labour.
• China is contributing to global inflation due to increasing factory prices. Historically, China exported deflationary forces to the world with lower labour costs. Looking forward, the country is also set to deliver on right-sizing industrial capacity in sectors that were previously oversupplied; such as aluminum, coal and steel.
• A wide range of reflation-markets and related-indicators have been breaking from long-term patterns. After declining over 60% from peak-to-trough from 2014 to 2016, oil prices stabilized and are now up over 100% from the January 2016 low. Oil is a key input not only for transportation but also feed stock and plastics.
• On 02-Feb-18, the Bureau of Labor Statistics reported a 2.9% increase in average hourly earnings.

With government data now picking up the inflationary signals, bond yields quickly moved higher causing a bond sell-off. The impact was also felt in equity markets, given the potential shock higher costs would have on corporate profits. As such, investors should remain nimble and cognizant of inflation’s impact on both asset classes.

As April approaches, the on-ice focus of most professional hockey players remains on their upcoming playoff push. In the player advisory world, the April tax deadlines are our version of a playoff push. Many fail to consider the complexity involved in filing taxes for a professional athlete. While some complain of federal and provincial filing requirements, an NHL athlete often has a filing requirement in each jurisdiction in which they play. This means a typical NHL player can file upwards of fifteen tax returns! Check the link below to learn some quick facts about how an NHL athlete files their taxes.

Global markets had mixed returns for the month ending 22-Mar-18. The TSX lead the way with a 1.6% gain spurred by commodities.  The S&P 500 index was up 0.5% while the MSCI fared worse with a 1.4% loss as Asian markets experienced weakness.  Korean automobile manufacturers were particularly impacted on trade war worries, while Japanese equities experienced Yen strength as a headwind during the month.  On the commodity front, Oil reversed a 2.5% slide to gain 5.1% on the back of strong inventory data, while gold strengthened by 1%.  As stock market volatility increased, the price of gold climbed.  Gold is notoriously known as a safety asset.  Accordingly, it tends to rise when there is a meaningful slump in the market. Investors often take shelter in non-yield-bearing gold as a buffer against risk.  The US 10-year Treasury Yield appreciated 5bps, bouncing back over 2.90%.

Trade wars have been a constant theme weighing on markets in 2018.  On 1-Mar-18, Trump announced a 25% tariff on steel imports and a 10% tariff on aluminum to help shore-up weakening domestic  industries.  Though Trump walked-back part of these measures as they relate to Canada and Mexico, pending final NAFTA negotiations, some have hinted at the move being a direct message to China.  Chinese steel production has been curtailed dramatically for environmental reasons.  This has contributed to steel exports into the US falling from 400K metric tons/month in 2014 to 60K.  However, many are looking beyond this announcement to potential follow-on effects, including the announcement of an estimated US$50Bn in tariffs against China over intellectual property violations.  The amount was based on estimates of economic damage caused by China through the theft of US technology and intellectual property. China has not yet made any counter-announcements, but they have hinted at retaliation.  China is not the only country affected by the tariffs either, as leaders from other countries such as those in Europe have also hinted at retaliatory measures.  Inflation, which has already shown signs of strength, is a notable consequence of trade wars.

We have previously commented on increased market liquidity (QE-driven) and its positive affect on markets.  With the Fed embarking on a QE unwind and potential impacts of USD repatriation starting to take hold, signs of USD shortages are beginning to show.  This can be seen in the US LIBOR-OIS spread, or the differential between the rate banks charge to each other to lend (LIBOR) vs. the overnight risk-free rate (OIS).  With the majority of loans priced off LIBOR, a rising rate may reveal reduced USD liquidity. In turn, the willingness for banks  to lend into the market may be diminished.  The 55bps spread hit on 21-Mar-18 reflects the highest spread seen since the Global Financial Crisis in 2007, which is material, though the cause can only be approximated.  Either way, it is something to monitor as any liquidity shortage could have pronounced implications on asset prices and credit risk/borrowing capacity in general.

During this period, market participants were reminded that the stock market and the economy are not the same thing. The US Labor Department’s January jobs report showed that 200,000 new jobs were added in the first month of 2018.  Meanwhile, the historic rise in global equities came to an abrupt halt.  An unprecedented streak of 19 consecutive months without a 5% correction was finally broken.   Following the Labor Department’s report, which also showed that wage growth jumped 2.9% year-over-year, global benchmarks fell over 7% during the next six trading days. The fear that wage growth will lead to higher inflation, and higher inflation will lead to the US Federal Reserve raising rates more quickly resulted in the S&P 500 giving back all of 2018’s gains as it entered a correction. A correction, which is a 10% pullback from a market peak, occurred on 26-Jan-18.  Market corrections typically occur every other year, on average.  However, the last correction for the S&P 500 was almost two years ago. Interestingly, the correction occurred less than a week after investors poured record amounts into exchange-traded funds in January.

Despite raising rates five times since late 2015, developed-market sovereign bond yields have remained stubbornly low until recently. As inflation began showing up in US consumer reports, yields started its ascent. Adding fuel to the inflation narrative, US President Donald Trump unveiled his $1.7 trillion infrastructure spending plan that will take place over the next 10-years and the US dollar depreciated nearly 15% against a basket of its key trading partners. As a result, the 10-year US Treasury Yield hit 2.92%, a level it hasn’t reached in almost 3-years, which followed the original “taper tantrum” sell-off. More significant perhaps, the equity market correction was not accompanied by rising bond prices – bonds did not act as the “hedge” that many strategies and allocation models assume.

Over the course of the last few years, many investors have abandoned traditional hedging strategies as the cost of insurance made it difficult to outperform a constantly rising benchmark. Rather, many investors tried to exploit the rising trend by selling volatility or buying inverse volatility strategies through exchange traded funds/notes (XIV Index). As a result, participants were caught off-guard and on the opposite end of the violent unwind that ensued in February. The sell-off resulted in the largest single-day point drop (not largest percentage drop) for the Dow Jones Industrial Average and wiped out nearly six years’ worth of gains for the XIV Index. More concerning for long-term investors is the outcome for these rules-based or “smart-beta” strategies, which include styles like risk parity. These strategies incorporate volatility to define the allocation of capital to different assets and rely on liquidity.  A dangerous feedback loop may arise as the underlying securities can’t provide the liquidity promised by the exchange traded notes/funds as investors stampede out of the strategies.

The NHL trade deadline has grown to become one of the most exciting days of the NHL season. While teams in the playoff race look to bulk-up for a late season push, teams waving their white flags seek to unload salary and acquire young assets. What many on the outside fail to consider is the immediate lifestyle changes faced by the players who are traded. To assist with this change, check out our Traded Player Checklist below!

This weekend, the NHL’s best players will gather in Tampa, Florida for the 63rd NHL All-Star Game. The fan-frenzied weekend will end with the popular 3-on-3 tournament, displaying teams from each of the four divisions all competing for a $1 million prize. As the 44 selected players prepare for the exciting event, check out our infographic providing some interesting numbers surrounding the annual All-Star Game.

A Synchronized Global Recovery – Global equities experienced a near-perfect backdrop of steady global growth, low inflation and continued accommodative monetary policy in 2017, leading to strong performance. For the year, all major equity categories and sectors ended the year with double-digit gains; shaking off nuclear threats, populist uprisings and a stalled Trump Administration agenda.

Commodities closed higher on the year, led by gains in crude oil, with WTI rising 12.5%. Precious metals and copper also posted gains, while agricultural commodities were mixed. The US dollar index, which compares the greenback to a basket of global currencies, slid about 10% last year after rising for nearly three years.

Despite fears of US Federal Reserve tightening and fiscal reform leading to higher growth, most US bond indexes closed the year higher. The US yield curve, which has historically been an important indicator of recessions by inverting prior to the previous seven recessions, flattened by about 100 basis points.

Approaching Levels of Significance – The equity bull market is now deep into its ninth year, the second-longest on record. The third (and perhaps final) phase of the bull market kicked off in 2016 as global economic momentum strengthened to include more sectors and countries. The improvements were broad based as nearly every major global economy expanded in 2017. Lower corporate taxes in the US and a continuing rally in commodities bolstered the outlook for 2018.

Strategist forecast S&P 500 earnings to be between $139-$150 per share, an approximate 10.3% increase from 2017 forecasts. Similarly, the earnings multiple has increased, to nearly 18x the next four quarters’ expected earnings.  The long-term average multiple is 16.5x; moreover, the multiple was 17.1x one-year ago.  Statistically, 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.

The ISM Manufacturing Index is often used as a guide for the business cycle.  In the US, the ISM is currently experiencing the third-longest expansion in history and its reading is at the second-most elevated level in the last thirty years. Meanwhile, the Conference Board Leading Economic Indicator Index continues to increase while the US Treasury curve remains upward sloping – despite recent flattening. Given the strong economic backdrop and the need for governments to “inflate-away” their debt, we believe commodity-linked equities, including precious metals and agriculture, will outperform.  Additionally, this sector is exhibiting favourable valuations.

Volatility may be resurrected in 2018. Possible triggers for spontaneous instability include;

• Failure for capital expenditures and hiring/wage increases to underpin growth.
• Excessive debt levels.
• Accelerated interest rate increases.
• Defiance to the “America First” rhetoric.

The first signs of erraticism may surface in the currency markets. A surge in the US Dollar index is likely in the near-term as tax repatriation increases demand. However, net-investment positions may trigger a USD sell-off while many countries are already seeking alternatives to the dollar system. China and Russia continue to stockpile physical gold while hinting at problems with the Eurodollar system. Meanwhile, the two countries are negotiating with Saudi Arabia for a Yuan-backed oil contract.

In the near-term, bonds are somewhat attractively priced. Originally, economic growth forecasts caused prices to slide and yields to rise. More recently, yields rose when the U.S. Senate reached a short-term compromise to end the government shutdown. The 10-year bond now sports its highest rate in over one year. Longer term, we do not anticipate traditional fixed income to benefit the portfolio from a total return perspective. Yields remain near historic lows and an increase in supply will pressure prices. Deflationary pressures have been prominent recently, as millions of baby boomers leave the workforce; but, a recent IMF research report anticipates that population aging will become very inflationary due higher health care costs. Nevertheless, bonds provide a reliable stream of income, uncorrelated performance and low-cost portfolio insurance.