Driving Around the Block

May 1, 2019

The first quarter of 2019 was all sunshine and rainbows from a market perspective as virtually every asset class was in the green and most major equity markets posted double digit returns. This was in stark contrast to the doom and gloom of the previous quarter (Q4 2018) which saw equity markets around the globe suffer steep double digit declines. The obvious question that arises is: what’s going on?

It seems that the biggest change between Q1 2019 and Q4 2018 was investor sentiment – the mood of the market swung from extreme pessimism to significant optimism. This is a recurring theme during periods of significant market volatility. The U.S. Federal Reserve and the Bank of Canada catalyzed this mood change as both central banks signaled that future interest rate increases would likely move at a slower pace than initially expected. In response, the market now expects no further interest rate increases in 2019 with some market participants speculating on potential interest rate decreases.

Despite this change in sentiment, many of the same underlying issues from last year remain:

  • Tariffs and trade war concerns (particularly the United States vs. China),
  • Uncertainty around the ratification of the United States-Mexico-Canada Agreement (USMCA),
  • Brexit, and
  • Slowing global growth concerns.

Expect continued volatility going forward as expectations regarding any of the above mentioned issues can change rapidly and ripple through the capital markets.

Q1 2019 Breakdown

The S&P/TSX Composite Index, representing Canadian large cap equities, returned 13.27% during the first quarter of 2019. Performance was broad based across all sectors with the Health Care and Information Technology sectors posting the highest returns (approximately +49% and +26%, respectively). Important to remember is that the Health Care sector in Canada is almost entirely composed of cannabis related companies, which have limited history and minimal (or zero) profits. Also contributing significantly to overall performance were the two heavy weight sectors of Energy and Financials, which combined make up approximately 50% of the Canadian equity market.

The S&P 500 Index, representing U.S. large cap equities, returned 13.65% in U.S. dollar terms during the first quarter of 2019. This translates to a return of 11.50% denominated in Canadian dollars (the U.S. dollar depreciated relative to the Canadian dollar). The Information Technology sector was the strongest performer – a sharp reversal from Q4 2018 in which the sector was one of the biggest losers. From a valuation perspective, the U.S. equity market continues to appear the most expensive on both an absolute basis (compared to historical averages) and a relative basis (compared to other major developed equity markets). The market correction at the end of 2018 had brought valuations down to a more reasonable level, but it proved to be short lived as the correction reversed itself in early 2019.

The MSCI EAFE Index, representing international large cap equities, returned 9.98% in U.S. dollars during the first quarter of 2019 (7.90% denominated in Canadian dollars). As with the North American equity markets, international equities rebounded from the lows seen at the end of 2018 and all sectors finished the quarter in positive territory. Despite the rebound, however, international equity markets remained approximately 14% below its Q1 2018 peak at the end of the quarter (the U.S. equity market finished approximately 3% below its all-time high and the Canadian equity market finished approximately 1% below its all-time high). The apparent disorder and uncertainty surrounding Brexit is one of the main factors weighing on the markets as businesses in the region may face significant challenges depending on how things play out. The most disruptive outcome would likely be a “no deal Brexit”, in which the United Kingdom leaves the European Union without any sort of deal regarding the future relationship of the regions.

The FTSE TMX Canada Bond Universe Index, representing the broad Canadian fixed income market, returned 3.91% during the first quarter of 2019. Bonds benefitted as interest rates declined following expectations for more accommodative monetary policy going forward (bond prices increase when interest rates fall). As previously mentioned, the U.S. Federal Reserve and the Bank of Canada were the main drivers behind this tone shift as the central banks signaled they will be taking a pause from hiking interest rates.

What’s Going On? – The Long Term Perspective

Let’s take a moment to re-visit the question near the beginning of this article: what’s going on?

The simple and general answer to that question is that this is how markets behave – unpredictable and volatile in the short term, anchored to fundamentals (economy, profitability, productivity, population growth) in the long term. The previous six months are reflective of how temperamental the markets and its participants can be at times. The two most recent quarters experienced major volatility (both negative and positive) and the net end result was essentially a “drive around the block”.

The past two quarters highlight the importance of remaining focused on a long term investment strategy. Of course, it’s easy to tell investors to just ignore short term volatility, but the reality is that life is lived in the short term – the long term is simply a linked chain of short term moments. Ignoring the short term in the markets would require investors to ignore their emotions, which is almost certainly impossible.

Instead of simply trying to “ignore the short term” during periods of heightened market volatility, perhaps the better approach is to take a step back and try to understand your emotions during these periods. Know that it is normal for people to be fearful and pessimistic when the market goes down (Q4 2018), and it is normal for people to feel good and optimistic when the market goes up (Q1 2019). Also know that it is typically unwise to make long term investment decisions based on either of these feelings.

A diversified, balanced portfolio with a systematic rebalancing policy will serve you well over time regardless of how the markets perform during short term time periods.



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Note: All returns and figures sourced from Bloomberg


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