October 2018 Model Portfolio Review

Posted by on Nov 13, 2018 in Paterson Portfolio Review | 0 comments

I will just come right out and say it. I hate October. Sure, the changing leaves make it a beautiful time of year to pack up the family and take a relaxing drive through the country, the NHL and NBA seasons kick off in earnest, and the Thanksgiving holiday gives us time to pause and reflect with friends and family about how grateful we are for all that we have. But, there is a dark side to the month. It is a forebearer of the impending cold and dark winter months that will soon be upon us. It is also the month where the investment markets are likely to take us on a wild ride.

I’m not sure why market volatility seems to pick up in October, but it does, and this year was no exception. Equity markets sold off harder than they have in many years, with European and Asian markets bearing the brunt of the selloff. The MSCI EAFE Index ended the monthly nearly 8% lower after being down nearly 10% in the month. In the U.S., the bellwether S&P 500 was down 6.8%. However, small, and mid-cap stocks, and tech names were hit even harder, with the tech heavy NASDAQ dropping 8.7% and the Russell 2000 losing nearly 11% in the month. Closer to home, the S&P/TSX Composite fell 6.3% with energy and cannabis names leading the way down.

While these numbers are jarring compared to anything we’ve seen in the past few years, it pales in comparison to where we’ve seen in some October’s past. In October 2008, both the S&P/TSX Composite and the S&P 500 were down by nearly 17%, while the Russell 2000 was down 21%. Now to be fair, markets don’t sell off every October. In fact, they tend to rise more often than they fall in October, but it seems that if something bad is going to happen, it happens in October.

Historically, when stocks sell off, bonds rally. That didn’t happen this time around as rising bond yields put pressure on bond prices. For the month, the FTSE/TMX Canada Universe Bond Index fell by 0.8%, with the long-term bonds taking most of the pain. According to some experts, it was this rise in bond yields that was a key reason for the equity market selloff. With yields rising here and, in the U.S., traders are in the process of “repricing risk” for their holdings. With the benchmark U.S. ten-year Treasury Note yielding well north of 3%, the premium needed to hold risk assets has been moving higher.

There are also other headwinds including the ongoing trade skirmish between the U.S. and China, rising worries over consumer, business, and government debt levels in the face of rising bond yields, and concerns that the robust earnings growth we’ve seen in the past few quarters has peaked.

While the markets were volatile, these are the type of markets for which our model portfolios are positioned. Each of the portfolios ended the month in negative territory, but each significantly outperformed their respective benchmark, protecting investors capital. Our most defensive Conservative Portfolio was down 1.2% compared with its benchmark which was down 2%. Our Balanced Portfolio was lower by 2.3% while its benchmark lost 3.9%. Our most aggressive Growth Portfolio was lower by 3.9% handily outpacing the 6.1% fall in its benchmark.

For a more thorough review of the portfolios’ performance and risk reward metrics, you can download our standard monthly portfolio report here. More detail can be found in these reports generated by Morningstar. A summary report can be downloaded here, while the more detailed report can be downloaded here.

Digging deeper into the portfolios, most of the outperformance was the result of the defensive positioning of the core equity positions, namely the Fidelity Canadian Large Cap Fund, and the Mackenzie Ivy Foreign Equity Fund. In both cases, the Managers were carrying higher levels of cash, and had the portfolios focused on higher quality, more reasonably valued companies, rather than some of the high flyers that have been pushing markets higher for the past few quarters. The Managers have noted in recent commentaries that they have been using the recent market volatility to pick away at attractive opportunities at more favourable prices and valuation levels.

Many risks remain, and I expect that we will continue to see higher levels of market volatility heading into the end of the year. In this environment, I continue to favour high-quality equities that are trading at reasonable valuation levels. I still slightly favour the U.S. over Canada, but that may begin to change in the coming weeks as we monitor the pace of economic activity. In fixed income, I continue to favour lower-duration, higher quality issues. I am also watching the credit markets for signs of erosion, as historically, the credit markets have been a leading indicator for the equity markets.

The portfolios are well positioned for a more volatile environment and I am monitoring things closely.

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