Market Insights: Fourth Quarter wrap-up

Fourth Quarter wrap-up

2016 was a great turnaround year for the Canadian stock market.  After the TSX Composite fell 11.1% in 2015, it roared back by advancing 17.5% this past year.  This is especially shocking, considering that it was down over 10% year-to-date in January alone as the steep correction that began in mid-2015 came to an end.  Including dividends, the Composite is now up 11% over the two-year period.  Although the TSX Composite hasn't yet reached a new high (set back in September 2014), the total return index has, showing again the power of the dividend when it comes to total return.  A year ago we had noted that the Canadian stock market hadn't underperformed the U.S. stock market for six straight calendar years (it had underperformed from 2011-2015), so it was nice to see this streak come to an end.  

The S&P 500 (U.S. market) hit new all-time highs many times in 2016 and finished the year on a strong note.  In Canadian dollar terms, the index advanced 6.4% on the year.  Globally, the MSCI World index (CAD) returned 1.7% or 3.8% on a total return basis.  It was a more difficult year for the Europe, Asia & Far East region, especially when factoring in the Loonie.  Our dollar appreciated against the Greenback and Euro by 3% and 6% respectively last year, which was a headwind for Canadian investors owning a globally diversified portfolio.

The Canadian bond market was hit very hard in the last two months of the year, as long-term rates quickly spiked fueled by the surprising Trump victory.  The FTSE TXM Canadian Bond Universe finished the year with a 1.7% gain, but that was after a 2.6% decline over November and December.  In the U.S., we witnessed the 10-year Treasury yield rise from an all-time low of 1.34% in July to as high as 2.62% in December.  For a low coupon, longer maturity bond portfolio, the harsh reality of interest rate risk for a conservative bond portfolio can quickly sink in.  The high yield bond market was a bright spot, returning equity-like returns last year.    

The biggest theme coming out of 2016 was no doubt the rapidly evolving political landscape and the global rise of populism.  Politically game-changing moves, from Brexit to the Trump victory, characterize 2016, for some, as 'the year that polls stopped working’.  One has to wonder if the results of polls, which in the past many have relied upon for short-term investment decisions, will be accorded less weight in the future.  And not only did the result of both of these votes catch most off guard, but the ultimate direction of the equity markets after these events likely did as well, with markets taking the results seemingly in stride.  The Trump victory follows a global trend that has seen populist leaders come to power in Latin America, Europe and Asia.  With more important elections forthcoming in Europe, we are likely to see continued volatility driven by political events.

Have markets gotten ahead of themselves following the Trump victory?  It is quite possible, and perhaps likely when taking into account that stocks are now more in the overbought territory and with much improved sentiment than recent past, however, it is our reasoning that the fundamental backdrop for equities remains favorable and thus warrants a constructive stance for our portfolios.  Our more near-term neutral outlook seems prudent as investors grapple with improved economic data, fear of higher interest rates, a less dovish Fed, and buying exhaustion.  

However, beyond just the near-term we remain optimistic that the transition from an interest-rate driven bull market to a fundamental earnings-driven one will take hold and prove successful.  That being said, as we likely move towards the back end of this cycle, a more active and tactical approach to asset allocation and sector weightings will become more important (see our Third Quarter wrap-up for more on this).  This could mean the return of value outperforming growth, and relative outperformance in more cyclical sectors and financials.  In summary, we would look to be buyers of any fear-based weakness as it develops because our fundamental core thesis remains in place, global economic data and earnings growth continue to improve (also beginning to see better numbers on leading indicators in Europe and Emerging Markets), and we still see no significant or meaningful deterioration in credit-based indicators.  The World Bank has just released their January 2017 Global Economic Prospects report, which indicates that global economic growth should accelerate modestly to 2.7% this year from a post-crisis low of 2.3% last year, with emerging markets leading the charge.  We are well aware that this outlook is clouded by uncertainty about political direction in major economies.  

Our Milestone Recession Risk (MRR) composite remains in the very low risk area.   However, we continue to closely monitor our leading indicators and overall positive market health and breadth as we begin a New Year with a glass half full mentality.

Lastly, we wanted to leave you with an interesting market occurrence for the S&P500 whereby last year was considered an 'outside year' (an 'outside year' is a technical chart pattern).  2016 was the first such occurrence since 1982, and only the third occurrence we can see on record.  All three resulted in a positive technical signal whereby the index's yearly range (2016 in this case) had a higher high and lower low than the previous year (2015) and closed above the previous year's high.  This is considered a bullish sign for the following year.  In fact, the two previous times were 1935 and 1982, where they were followed by 28% and 17% 'up' years respectively.  We will point to two caveats here, one that the years following 1936 were not particularly good years for the markets and that this is a very small sample size (now just three years) to base or extrapolate any trend to.  Although this very well could be meaningless and should form no part of any forecast, it is, nonetheless, an interesting occurrence and a positive one to set for the year.

Here is our Milestone Market Report on economic data, capital markets, commodities and currencies through December 31st, 2016: