December was a volatile month for investors, which given the way the year played out was a very appropriate ending. 2018 was the year that market volatility returned with a vengeance, taking investors on a roller coaster ride that hasn’t been seen in a few years. In December, the S&P 500 fell by more than 9% in U.S. dollar terms, while the S&P/TSX Composite was down by 5.4%. In the U.S. Large caps outperformed the small and mid-cap stocks as the Russell 2000 fell by nearly 12%. European and Asian markets outperformed the U.S., falling by 4.6% and 4.7% respectively.
As bad as the month end numbers were, the intra-month volatility was even more pronounced. Peak to trough, the S&P 500 fell nearly 16%, with many global markets falling into bear market territory. For Canadian investors, this volatility was somewhat muted, thanks to a stronger U.S. dollar, which gained ground on a flight to safety trade.
With volatility high, fixed income did what you would expect it to do in volatile markets – post positive returns and mute the overall equity market gyrations. The FTSE/TMX Canada Universe Index gained 1.35% as investor demand for safe haven investments pushed yields lower. Long-term bonds outpaced short-term issues, and the safe haven government issues outperformed corporate bonds.
Why markets were so volatile is anybody’s guess, but there were several factors that certainly played a role. One of the key reasons for the selloff is that higher interest rates have seen a very broad based repricing of risk assets. However, other worries such as fears that central banks have moved rates too high too fast was also cited, as was ongoing concern over trade and tariffs, slowing global growth, and tax loss selling heading into year end.
In this challenging return environment, the portfolios ended the month in negative territory, however all except for the Conservative Portfolio outperformed the benchmark. The Conservative Portfolio fell by 0.9%, while the benchmark was down 0.7%. The 60/40 Balanced Portfolio closed down 1.9%, compared to the benchmark which was lower by 2.4%. the most aggressive Growth Portfolio ended lower by 4.3%, compared to a nearly 5% decline in the 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, the largest source of outperformance came from the defensively positioned Fidelity Canadian Large Cap Fund. It ended the month basically flat, while the major equity markets were down substantially. Another defensive favourite, the Mackenzie Ivy Foreign Equity Fund was another key driver of outperformance, handily outpacing the index thanks to a focus on quality, combined with a high cash balance. The biggest headwinds in the portfolios was the Dynamic Advantage Bond Fund, and the Sentry Small Mid Cap Income Fund. The Dynamic Advantage Bond Fund trailed as the shorter duration position combined with high weighting to Corporate bonds weighed in a month that saw government bonds rally as investors sought a safe haven in volatile markets. Sentry trailed the broader equity markets as large caps outperformed small caps.
Looking ahead, we are seeing conflicted signs from the economy. Various sentiment indicators and other soft data points such as the ISM and PMI numbers have been extremely weak of late. However, the more tangible numbers such as job growth, industrial production, wage growth, and housing starts all remain positive, with some slowing noted. Where we go from here remains to be seen. If investors can continue to focus on the tangible numbers, the valuation levels of equity markets are considerably more attractive than they were a year ago and are at levels not seen since early 2015 and are now below the longer-term averages.
That said, valuation levels, at least in the short-term, have historically been terrible indicators for the direction of markets. However, over the long-term, they tend to be very good indicators. Where the markets go in the short term remains anyone’s guess. However, given the more attractive valuation levels today, compared to a year or so ago they indicate the longer-term expected returns for equities are better than they were this time last year. Regardless, higher levels of volatility across all asset classes is very much expected as much uncertainty remains.
In this environment, our managers’ focus on higher quality, value-focused names position the portfolios well. For equities, I continue to prefer high-quality, reasonably valued, and well-managed investments over more richly valued, higher growth investments. For fixed income, I continue to favour higher quality, shorter duration investments, but as yields move higher, I am more comfortable taking on some additional duration risk.
I continue to monitor the situation closely.