2018 was a difficult year for the TSX and global stock markets as volatility has returned with a vengeance. That the last few years have shown so little volatility, with such a temperamental President in the White House, has been nothing short of amazing - but it appears those days are gone. Certainly rhetoric, and indeed actions by the current US administration, have been a big contributor to the volatility with the prospect of a trade war between the world’s two most important economies and geopolitical instability (not to mention a US Government shutdown). Ultimately however, regardless of the catalyst, markets have had a strong run over the last many years and a pull-back was bound to happen eventually.
During 2018, Canadian stocks were challenged with trade uncertainty (NAFTA, steel tariffs) compounded by pipeline approval challenges in Western Canada, and a major auto plant closure in Oshawa by GM. An extreme measure taken by the Alberta government to force a reduction in oil production demonstrates just how difficult things have become. A handout from the federal government to Alberta does not seem to be appeasing those most affected. Despite all this, overall economic growth has held up for now - in part thanks to a weak Canadian dollar. Unemployment is low for the time being but the aforementioned challenges will bear watching.
To the south, the US saw euphoria in the first half of the year change to skepticism in the second half, and particularly the fourth quarter. Momentum stocks, which have dominated the S&P over the last few years, began to crack as investors started to shift their attention to quality, fundamentals and valuations. Policy uncertainty from Trump's White House appears to finally be weighing on stocks along with the prospect of higher rates. It is reasonable to assume that a full-out trade war with China will not be good for anyone, although as we saw with NAFTA negotiations, the bluster did not quite match the outcome. It is dangerous to attempt to predict which way the tweets will go, so we continue to focus on owning companies with reasonable valuations that are set to perform well over the next 5 to 10 years, in spite of the current administration's actions (or lack thereof).
European stocks have been buffeted about by fears on several fronts. Brexit continues to weigh and a major deadline looming in 2019 has many in the region on 'pins and needles'. Italy welcomed a new government made up of a populist coalition that are now facing the reality of managing the books. A major crisis seems to have been averted as the European Central Bank signed off on the budget put forth by this coalition in Italy. It is also worth noting the exit from politics of Angela Merkel. Her legacy of building coalitions in Germany and across Europe during very difficult economic and political times has been impressive. One of her legacies, however, has been strict austerity despite strong economic growth in Germany. A reversal of this policy could greatly benefit the entire continent.
Asian and emerging market stocks have been the most affected by global uncertainty as they are more dependent on global trade and indeed have been net beneficiaries of globalization over the last two decades. The populist movements evident across all continents are pushing back against this trend, often using xenophobia as a tool to gain power. As we have seen in the US, the promises of these populists may not actually meet reality as it is difficult to put the genie back in the bottle in terms of the global supply chain that has been created. Even if manufacturing plants were to move back to western countries, it is very unlikely they would offer the employment seen in the 60’s, 70’s and 80’s. In fact, one beneficiary of this trend is likely to be automation technology, and this is definitely an area we are keeping an eye on.
The overarching theme in all of this is where we sit in the economic and market cycles. Stocks have had a very impressive run since 2009, with a few pauses along the way. Economic growth has been strong, and unemployment in the US, Canada, and even moribund Europe, sits at low levels historically. Wage growth has not been as impressive but signs have emerged over the last few years that it is heating up as well. A big contributor to all of this economic success has been a very stimulative monetary policy globally. It is no surprise then that central bankers are eager to follow their Keynesian roots and unwind much of this stimulus, led by the Federal Reserve in the US. It makes perfect sense to tighten the screws when things are going so well but as in every cycle, the fear is there will be too much tightening.
Almost all cycles end with rates moving higher, even if the timing and catalysts are difficult to pinpoint in the moment. For investors with long memories, we have seen this act play out many different ways. The 1970’s brought an oil shock which led to hyper-inflation in the early 80’s. We had the tech bubble in the 90’s, and of course the financial crisis in 2008. All of these ‘events’ were catalysts for stocks to move into a bear market and, in some cases, crash. Predicting the timing of these events is difficult – especially given you would need to also predict when it was time to buy back in.
Stock market activity has a large impact on these cycles as well. Recall “Quant” funds which were in vogue prior to 2008 and which crashed spectacularly as they effectively were a bet on continued momentum. The late 90’s of course saw every manner of internet fund pop up. And for those with longer memories, there was the "nifty fifty" in the early 1970’s which effectively was showing blind faith in a basket of fifty stocks that everyone assumed would climb higher indefinitely. Interestingly we are seeing symptoms of all of these now. Investors have been chasing technology, crypto-currencies and cannabis stocks. “Smart-beta” funds and specialty ETFs are effectively quantitative funds repackaged. And of course, a basket of mostly internet-related stocks (FAANG) are reminiscent of the “nifty fifty” philosophy. All of these factors have led to the wild swings in security prices of late. One lesson from history is that these pullbacks presented opportunities for diligent investors, and markets did recover to move on to new highs.
2019 promises to bring some more bumps along the way. A looming Brexit deadline, interest rate increases, trade wars and geopolitical risks lie in wait. That said, we are more optimistic for the medium term than we have been in a while as valuations are looking more attractive. At Doherty, we do not spend a lot of energy trying to pick the tops and bottoms for markets as we have seen too many times investors get left on the sidelines trying to get the timing just right. The best course of action we believe is to remain vigilant at all points in the cycle. Over the last several years we have been continuously trimming positions where valuations have increased, and in some cases, we have exited positions altogether. Our style is unapologetically boring and will remain so because it is our discipline that has allowed us to be successful over these last 40 years since Peter Doherty first started the firm in 1979.
Markets can be humbling at times, and we won’t always get it perfect but we will always focus on delivering exactly what we promise – investment discipline and sustainable performance from a high quality portfolio of companies. 2018 was a reminder to investors that there is no reward without risk, but it is just as important to remember that these are often the times that the greatest opportunities present themselves. As Warren Buffet says: "Be fearful when others are greedy, and greedy when others are fearful."
We wish you and your families the very best in 2019, and look forward to any questions or feedback that you may have.
During 2018, Canadian stocks were challenged with trade uncertainty (NAFTA, steel tariffs) compounded by pipeline approval challenges in Western Canada, and a major auto plant closure in Oshawa by GM. An extreme measure taken by the Alberta government to force a reduction in oil production demonstrates just how difficult things have become. A handout from the federal government to Alberta does not seem to be appeasing those most affected. Despite all this, overall economic growth has held up for now - in part thanks to a weak Canadian dollar. Unemployment is low for the time being but the aforementioned challenges will bear watching.
To the south, the US saw euphoria in the first half of the year change to skepticism in the second half, and particularly the fourth quarter. Momentum stocks, which have dominated the S&P over the last few years, began to crack as investors started to shift their attention to quality, fundamentals and valuations. Policy uncertainty from Trump's White House appears to finally be weighing on stocks along with the prospect of higher rates. It is reasonable to assume that a full-out trade war with China will not be good for anyone, although as we saw with NAFTA negotiations, the bluster did not quite match the outcome. It is dangerous to attempt to predict which way the tweets will go, so we continue to focus on owning companies with reasonable valuations that are set to perform well over the next 5 to 10 years, in spite of the current administration's actions (or lack thereof).
European stocks have been buffeted about by fears on several fronts. Brexit continues to weigh and a major deadline looming in 2019 has many in the region on 'pins and needles'. Italy welcomed a new government made up of a populist coalition that are now facing the reality of managing the books. A major crisis seems to have been averted as the European Central Bank signed off on the budget put forth by this coalition in Italy. It is also worth noting the exit from politics of Angela Merkel. Her legacy of building coalitions in Germany and across Europe during very difficult economic and political times has been impressive. One of her legacies, however, has been strict austerity despite strong economic growth in Germany. A reversal of this policy could greatly benefit the entire continent.
Asian and emerging market stocks have been the most affected by global uncertainty as they are more dependent on global trade and indeed have been net beneficiaries of globalization over the last two decades. The populist movements evident across all continents are pushing back against this trend, often using xenophobia as a tool to gain power. As we have seen in the US, the promises of these populists may not actually meet reality as it is difficult to put the genie back in the bottle in terms of the global supply chain that has been created. Even if manufacturing plants were to move back to western countries, it is very unlikely they would offer the employment seen in the 60’s, 70’s and 80’s. In fact, one beneficiary of this trend is likely to be automation technology, and this is definitely an area we are keeping an eye on.
The overarching theme in all of this is where we sit in the economic and market cycles. Stocks have had a very impressive run since 2009, with a few pauses along the way. Economic growth has been strong, and unemployment in the US, Canada, and even moribund Europe, sits at low levels historically. Wage growth has not been as impressive but signs have emerged over the last few years that it is heating up as well. A big contributor to all of this economic success has been a very stimulative monetary policy globally. It is no surprise then that central bankers are eager to follow their Keynesian roots and unwind much of this stimulus, led by the Federal Reserve in the US. It makes perfect sense to tighten the screws when things are going so well but as in every cycle, the fear is there will be too much tightening.
Almost all cycles end with rates moving higher, even if the timing and catalysts are difficult to pinpoint in the moment. For investors with long memories, we have seen this act play out many different ways. The 1970’s brought an oil shock which led to hyper-inflation in the early 80’s. We had the tech bubble in the 90’s, and of course the financial crisis in 2008. All of these ‘events’ were catalysts for stocks to move into a bear market and, in some cases, crash. Predicting the timing of these events is difficult – especially given you would need to also predict when it was time to buy back in.
Stock market activity has a large impact on these cycles as well. Recall “Quant” funds which were in vogue prior to 2008 and which crashed spectacularly as they effectively were a bet on continued momentum. The late 90’s of course saw every manner of internet fund pop up. And for those with longer memories, there was the "nifty fifty" in the early 1970’s which effectively was showing blind faith in a basket of fifty stocks that everyone assumed would climb higher indefinitely. Interestingly we are seeing symptoms of all of these now. Investors have been chasing technology, crypto-currencies and cannabis stocks. “Smart-beta” funds and specialty ETFs are effectively quantitative funds repackaged. And of course, a basket of mostly internet-related stocks (FAANG) are reminiscent of the “nifty fifty” philosophy. All of these factors have led to the wild swings in security prices of late. One lesson from history is that these pullbacks presented opportunities for diligent investors, and markets did recover to move on to new highs.
2019 promises to bring some more bumps along the way. A looming Brexit deadline, interest rate increases, trade wars and geopolitical risks lie in wait. That said, we are more optimistic for the medium term than we have been in a while as valuations are looking more attractive. At Doherty, we do not spend a lot of energy trying to pick the tops and bottoms for markets as we have seen too many times investors get left on the sidelines trying to get the timing just right. The best course of action we believe is to remain vigilant at all points in the cycle. Over the last several years we have been continuously trimming positions where valuations have increased, and in some cases, we have exited positions altogether. Our style is unapologetically boring and will remain so because it is our discipline that has allowed us to be successful over these last 40 years since Peter Doherty first started the firm in 1979.
Markets can be humbling at times, and we won’t always get it perfect but we will always focus on delivering exactly what we promise – investment discipline and sustainable performance from a high quality portfolio of companies. 2018 was a reminder to investors that there is no reward without risk, but it is just as important to remember that these are often the times that the greatest opportunities present themselves. As Warren Buffet says: "Be fearful when others are greedy, and greedy when others are fearful."
We wish you and your families the very best in 2019, and look forward to any questions or feedback that you may have.