**January 8th Issue of The JMRD Market Observer**
In This Week’s JMRD Market Observer
- JMRD Strategy Comments
- 2015 review and a look ahead at 2016
- NBF Economics – 2016 Outlook
- NBFM Forex – USD surge raises risk of market turmoil
- Retirement Corner
- Week at a Glance
- Reads of the week
- Economic Calendar
- Earnings Reports
JMRD Strategy Comments
We wrote the majority of this week’s Market Observer in the final week of 2015 but we would be remiss if we didn’t discuss this week’s events in the market. In fact, the market’s move this week made history, but for all the wrong reasons. Yesterday we saw this stat from CNBC: The first 4 days of 2016 have been the worst first 4 days of any year for the Dow ever on record. The Dow is down 5% so far in 2016. That headline gets an investor’s attention.
One of the primary reasons for the decline is related to China, the same reason for the volatility in August/September of 2015. China’s economic growth has come into question once again and the country has taken measures this week to instill confidence in its own equity market as well as global equity markets. The opposite has happened. Adding to the uncertainty and volatility are rising tensions in the Middle East, specifically between and Iran and Saudi Arabia as well as North Korea allegedly testing a hydrogen bomb.
That said, the US employment data came out this morning much better than expected and this is positive for economic growth in North America. Canada’s employment numbers were OK.
In general, we continue to hold excess cash and are proactively making changes in the baskets as the situation dictates. We would like to remind you that in times like these it’s best to tune out the headlines and wait for the dust to settle.
Now onto our 2015 wrap up…
So long 2015!
As far as the financial markets are concerned, 2015 will not be missed or remembered fondly for much of anything.
Many Canadian investors were left bruised after being side-swiped by a triple whammy that left the major indices in negative territory for the year. The effects of these factors will be felt into 2016 and will most likely leave these same benchmarks weaker for the time being.
The trifecta actually started before the beginning of 2015. Let’s go back to June 2014 when the price of oil was over $107. Using the closing price of $37 for oil as of December 31st, 2015 the decline from the high to the lows has been an astounding 65%. The damage from this decline is difficult to quantify but one only needs think of how energy companies, pipelines and communities reliant on jobs directly linked to energy have fared over the past 12 to 18 months. So, energy weakness kicked things off and is largely responsible for what came next.
Stephen Poloz from the Bank of Canada spoke at the Richard Ivey School of Business in early 2015 shortly after lowering the overnight lending rate by 25 basis points to 75 basis points. JMRD was on hand for his speech where he described the rate cut as an insurance policy to help offset the unexpected collapse in oil prices. Well, as we all know, energy prices fell further and a second rate cut was made in the summer taking the bank rate down to 0.50%. Should energy prices remain weak, more cuts are not out of the question.
The key interest rate cuts were unexpected and had negative implications for certain asset classes. Perhaps the most negatively affected were the rate-reset preferred shares. Meant to be a conservative investments providing tax efficient income and protection from increasing interest rates, the rate cuts left this sector (iShares Canadian Preferred Share Index) with a negative 16% total return for the year (including dividends). Many JMRD clients had exposure to preferred shares as a complement to their low risk GIC holdings and we believe on-going monitoring is required. Note that the Canadian banks have been issuing new preferred shares that look attractive with 5.50% dividend yields and generous reset levels. This new supply of preferred shares with better terms is also another reason that previously issued reset preferreds have declined in value, as they look less attractive, in comparison. The main risk going forward is additional rate cuts. Even though the new preferred shares pay healthy dividends, caution is still warranted but we are seeing some signs that the worst may be over for these investments.
The oil collapse led to the interest rate cuts which had a devastating result on the value of the Canadian dollar. In 2015 the CAD declined of over 19% relative to the USD. From our perspective, there are more losers than winners from this drop and the outlook is not clear as further energy weakness ‘could’ result in another rate cut here at home. The timing couldn’t be worse as the Federal Reserve in the US has started raising rates. This difference in the expected direction of interest rates in Canada and the US is not positive for the CAD dollar.
Clearly, the future is uncertain for oil prices, interest rates in Canada and the direction of the loonie as 2016 begins. Some stabilization in oil prices and the levelling off US dollar would go a long way to improving the outlook for our financial markets.
The bottom line is that clients must remain diversified by asset class and geography.
Below are two charts that show data points from last year. The first chart is one that is a regular part of our weekly Market Observer email that shows the rates of returns for various markets and classes.
Another note: the TSX Venture Index was down 24% in 2015.
The second chart shows in numbers how the Canadian market fared by sector last year. There was very little to celebrate.
JMRD manages four of our own Baskets and over the coming weeks, more time will be dedicated to providing full updates. This week will present year end results for each and a reminder on how important diversification is.
As you can see, the top performing Basket had a return of 16.4% while the laggard of the foursome posted a loss of -7.8%.
Many of our clients own at least one and in most cases two of our baskets since the first one was launched in 2003. The issue in the past two calendar years was that many of our clients did not own the particular JMRD Baskets with the best return.
Our recommendation for 2016 is that investors consider having some exposure to all of the Baskets. At the very least, focus on putting in place an appropriate asset allocation whereby a portfolio is constructed using a multi-asset class approach.
As an example, if an investor had put 25% of their portfolio in each Basket at the start of the year (2015), the portfolio return would have been 6.5% (in CAD).
JMRD Models Awaken
We believe the best way to get exposure to appropriate allocations of all of our JMRD Baskets as well as our other best investment ideas is our evolving JMRD Models. JMRD has been offering models to new clients and has been working on our improved MODEL program for much of 2015. We are very close to being able to roll them out in a more widespread way for current clients. The models are offered on a discretionary basis. This means the day to day decisions are made by the Team for one all-inclusive monthly cost. The asset allocation and performance are discussed with clients quarterly and adjusted as needed. We are confident this will translate into better performance as changes are made in a more timely fashion and the models make use of three of our Baskets plus some additional external expertise from outside managers.
You will be hearing more about these based on our comments above but participation is not mandatory and your relationship with JMRD can stay as it has always been, if that is preferred. We are excited to discuss the models should you have any comments or questions.
There will be a model available for each risk profile i.e. Conservative, Balanced, Growth and Maximum Growth. As mentioned above, we will be utilizing our own Baskets, standalone exchange traded funds (ETFs) and investments offered by other external managers in different proportions based on each unique risk profile. We feel that using external managers to complement JMRD’s own ideas will add further diversification and risk reduction to each model profile.
NBF Economic Outlook – Winter 2016
- While China’s rebalancing will continue to have ripple effects around the globe, the world economy should nonetheless find some support from low oil prices which not only gives a boost to consumers but also keeps inflation low, allowing central banks to keep monetary policy highly stimulative. We’re expecting world growth of around 3.3% in 2016. One downside risk to that outlook, however, is the potential for corporate debt to sour. The sizable amount of USD-denominated debt issued outside of the US has become harder to service after the greenback’s historic surge.
- While the US economy is on a solid footing, not all is rosy. Hammered by the strong dollar, trade will continue to subtract from growth in 2016. Domestic demand is also set to decelerate as a softer labour market ─ after the prior year’s employment surge ─ takes some steam out of consumption and housing. Benefits of low pump prices will also fade for consumers. We remain comfortable with our forecast of 2.3% for 2016 US GDP growth (or 2.2% Q4/Q4). The latter is softer than the median estimate of the Fed’s economic projections, and consistent with our view that there won’t be as many interest rate hikes as expected by most FOMC participants.
- With oil prices in the basement, it’s tough to be optimistic about Canada these days. Trade is the economy’s best hope, although lost market share will make it an uphill battle for exporters even with the help of a much-depreciated loonie. Domestic demand will remain under pressure as the investment slump continues while housing and consumption are likely to soften after the prior years’ heroics. A rare positive, however, is that fiscal policy should be more accommodative under the new government. If we’re correct about the extent of the investment slump that would equate not only to weak growth in 2016 but in subsequent years as well. With a declining stock of capital, the economy’s potential for growth is indeed severely curtailed.
- Ontario and BC will once again be Canada’s star performers in 2016. Those provinces are blessed with strong employment and positive immigration flows which are fueling domestic demand, while a much-depreciated Canadian dollar coupled with sustained vigour of the US economy is giving a boost to exporters. However, those two provinces remain at risk of a housing correction after hefty price gains over the past several years. Alberta, Saskatchewan and Newfoundland & Labrador will again be laggards in terms of growth in 2016 due to the oil shock. In Quebec, trade will be the major driver of growth while domestic demand will be restrained by tight public sector spending and a stagnant housing market. Manitoba should be able to replicate the prior year’s growth performance in 2016 thanks to hydroelectric projects and better exports courtesy of a more competitive loonie. In contrast, poor demographics will restrain Atlantic Provinces yet again. Our base case scenario shows a degree of recovery in oil-levered provinces in 2017. However, the persistence of low oil prices constitute a material downside risk to that call.
NBFM Forex (January 2016) – USD surge raises risks of market turmoil
- The trade-weighted USD looks stretched after gaining about 20% over the last two years. The last time the greenback saw a similar surge was in 1997, and that didn’t end up well for the global economy. The Fed will take note of risks, both domestic and global, associated with its policies and is therefore likely to move very slowly on interest rates. The unwinding of the massive speculative long USD positions could help bring the dollar back to earth.
- There are encouraging signs that the European Central Bank’s aggressive policies are starting to bear fruit. Credit channels in the Eurozone are slowly being unblocked as evidenced by improving household credit and business loans, the latter even managing to grow on a year-on-year basis for the first time since 2012. So, unless inflation disappoints, the ECB may want to adopt a wait and see approach. The common currency could slip over the near term on unfavourable yields, but we remain of the view it will recover later in the year particularly if the USD gives back some of its outsized gains of the past couple of years.
- While the Canadian dollar has sunk faster than we had anticipated due to a further slide in oil prices, we continue to expect it to stabilize in 2016. Besides an expected Fed-induced weakening of the USD, the loonie could also benefit from commodities which arguably have more upside than downside following the recent collapse. We expect USDCAD to come close to the lower end of the 1.30-1.40 trading range in 2016. The major downside risk to that call, besides oil prices, is Bank of Canada policy which could potentially be loosened further, particularly if the employment outlook sours.
Week At a Glance
See Week At a Glance Report.
Reads of the Week
- “Statement changes will provide clarity for investors” (Globe and Mail)
- “Be Smart. Don’t Try to Time the Market.” (Bloomberg)
- “Saudi Aramco’s Fire Sale” (Bloomberg) and “Saudi Arabia is considering an IPO of Aramco, probably the world’s most valuable company” (Economist)
- Crumbling preferred share market sees some light (Financial Post)
- “My Chart of the Year, Hands Down” (Reformed Broker)
- “2015 The Year in Money” (Bloomberg)
- “These Malls Didn’t get the Memo They’re Dying” (Bloomberg)
Monday January 11th – Canadian Housing Starts
Tuesday January 12th – None
Wednesday January 13th – U.S. Federal Reserve Releases Beige Book
Thursday January 14th – Canadian New Housing Price Index, U.S. Initial Jobless Claims
Friday January 15th – Canadian Existing Home Sales, U.S. Retail Sales Advance, U.S. PPI Final Demand, U.S. Industrial Production, U.S. Manufacturing Production
Monday January 11th – None
Tuesday January 12th – CSX
Wednesday January 13th – Cogeco Cable
Thursday January 14th – Intel, JP Morgan, Shaw Communications
Friday January 15th – Citigroup, Wells Fargo & Co
Have a good weekend!