Quarterly Commentary

What Goes Up Must Come Down – Isaac Newton

The turbulent start to 2018 in financial markets has finally brought an end to one of the longest ever global bull runs and there have been few places to hide.

After last year’s tranquility, investors have had it all thrown at them this quarter, from the biggest ever rise in stock volatility to rapidly escalating tensions over global trade, deepening turmoil in the White House and major tech sector wobbles.

Source: Trestle Asset Management Inc.

A melt-up that sent the MSCI’s world share index up 8% in January suddenly evaporated. Now the Dow Jones, S&P 500, FTSE, Nikkei and scores of other big markets are all down for the year.

U.S.A.

The market has been rattled over the past 2 months with uncertainty over how rising interest rates will affect stock prices, the ramifications of trade tariffs and doubts whether shares of tech companies can continue to lead major indexes higher. These fears dragged down the Dow and the S&P 500 2.5% and 1.2% respectively, for the first quarter. The Nasdaq rose 2.3% over the quarter, its weakest gain since the final 3 months of 2016.

Of the 11 primary S&P 500 sectors, 9 of them posted negative returns over the quarter. The 2 positive groups-technology and consumer discretionary – saw their gains come almost entirely from the Faang stocks (Facebook, Amazon, Apple, Netflix and Google). As a set, these stocks are still up nearly 10%, but recent privacy concerns and valuation have wiped $400 billion off their value, not exactly small change.

Source: Bespoke Investment Group

CANADA

Canada’s gross domestic product unexpectedly shrank by 0.1% in January, weighed down by sharp declines in oil production and real estate. Bank of Canada Governor Stephen Poloz recently summed it up by saying: “Uncertainty over U.S. trade policy is increasingly impacting business investment.” The loonie, meanwhile, is the worst-performing G-10 currency year-to-date (down approximately 3%), and the only one to weaken against the U.S. dollar. Canada’s S&P TSX has lost 7% YTD in $USD terms, the worst among global benchmarks that we follow.

Global Investors concerns regarding Canada can be placed into four buckets.

1. NAFTA and the possibility of trade wars.
2. Weakening home sales as a result of OSFI’s B-20 guidelines for the underwriting of residential mortgages which came into effect on January 1st.
3. Land-locked-oil whereby a new regulatory regime designed to speed up pipeline approvals is instead seen delaying projects while Alberta and British Columbia are fighting over one of the conduits the federal government has approved.
4. The prospects for ongoing currency weakness.

EUROPE

European shares posted their worst quarter in the last 2 years with the Stoxx 600 closing down 4.7%.

The quarter developed into a challenging one for stock markets with investors navigating a sharp spike in volatility, rumbling trade tensions and anxiety over the tech sector. In Europe, slowing macroeconomic indicators have become as a sell indicator for equities, which had enjoyed a lift most of last year on expectations of stronger economic growth.

JAPAN

Japanese stocks tumbled 5.8% in the quarter, undermined by worries about higher US interest rates, a stronger yen and growing fears of a global trade war.

COMMODITIES

Commodities posted mixed performance over the quarter, with crude oil rising and hitting its highest level in more than 2 years. Among precious metals, the rise in gold (1.8%), its third straight quarterly gain, was met with a pronounced decline in silver (-4.8%).

FIXED INCOME

Yields in the US were higher across the board in the first quarter, with short dated rates seeing the brunt of the rise. Concerns that a flare up in inflation would push the Federal Reserve to raise rates faster than expected led to the bearish action in the past 3 months.

The benchmark 10-year treasury note rose 33.2 basis points in the quarter, the largest quarterly rise since 2016.

Though inflation expectations have rolled over slightly, investors still expect the Fed to raise rates 3 to 4 times this year. The Fed is no longer being accommodating as they are lifting short-term rates due to the balanced US economy, and shrinking their balance sheet to be better prepared for the next financial crisis.

HOW DID WE FARE?

During the quarter, the Holdun Canadian Equity lost 2.0% (total return in local currency) on a relative basis, the portfolio outperformed the S&P TSX by approximately 2.5%. Stock selection within the portfolio was the largest source of added value this quarter. This outperformance was also driven by our sector overweight exposure to real estate.

With a loss of 0.8% (total return), the U.S. Equity market, as measured by the S&P 500 Index, decreased moderately during the quarter. The Consumer Staples and Energy were the main detractors. On a relative basis, the Holdun U.S. Equity underperformed its benchmark by 1.6%. Negative stock selection in Consumers detracted from relative performance.

International Equity ex North America lost 1.5% during the quarter and lagged its benchmark by 0.9%.

OUTLOOK AND STRATEGY

As we move into the second quarter of 2018 many issues remain unresolved, leaving room for higher volatility which we expect to be present in the near future. Market correction (10%) is not only healthy but also an opportunity for investors to catch their breath after an exceptional 2017 equity market rally generating more than 20% returns. Investors focus on a wall of worry which centres on US trade sanctions, higher Treasury yields and privacy issues around social media stocks which could potentially lead to new regulations. We believe markets are repricing equities based on these developments, but also believe that markets tend to overshoot. Though we don’t own any of the FAANG stocks, we are exposed to tech names that generate tons of cash and provide strong dividends, e.g. MSFT and CSCO. We remain positive on stock market valuations and believe concerns are overdone, despite the quarter’s rather disappointing performance. The portfolio is well positioned for such potentially adverse trends, thanks to our exposure to private equity, Holdun Income Fund, no FAANGs, sector diversification. We believe that a combination of strong company fundamentals within our North American portfolios and a constant focus on valuations, will not only reduce risk, but also give us the opportunity for long-term capital appreciation.