By looking back on the performance of the markets in the last quarter of 2018, we can learn a few things about the current market conditions: one, investors are nervous; two, central banks are nervous; and three, no one knows what 2019 will really look like. So, what should investors do under these conditions? In order to answer this question, we need to examine the underlying forces in the markets.
September of last year began a slide in most global market indices that led not only to the evaporation of the previous three fiscal quarters’ gains, but a significant loss for the year. The TSX faired far worse than the American indices ending down more than 11.5%, erasing the gains of the previous three years. Between US tariffs on metals, slumping fuel prices, and an economy that just can’t seem to get its motor running, it’s no wonder Canadian investors are looking for alternatives.
Since the election of Donald Trump and the execution of some of his policies, the US markets have generally faired much better, at least until US and Chinese representatives began trying to untangle the trade war that Mr. Trump began. By this point, however, many stock valuations had grown to an unrealistic level that could not be supported under any challenge to market conditions. As optimism in a resolution on the trade wars faded, so did the US indices, and quickly. Although US markets didn’t fall precipitously, the downward slope was significant enough to speak truth to the underlying jitters and investors’ decreasing appetite for risk.
In the past, this has often led to a retreat to fixed income products such as bonds, GICs, and T-bills, however, given the fluctuating yields, these have not proven to be attractive alternatives. As such, many investors have retreated to cash, which prompted some banks to offer rates in High Interest Savings Accounts (HISAs) comparable to GICs. While these rates are better than a standard chequing or savings account, they are still below the average rate inflation and thus yield negative real rates of return under growth conditions.
“…this bull still has legs, but he is getting tired.”
Q1 2019 has shown good signs of recovery with the TSX, the Dow Jones, and the NSDAQ, almost back to their 2018 high-water-marks with market volatility in general decline. That said, most analysts are still signalling caution in their 2019 forecasts, with some going so far as to say that we are on a highspeed train to recession. The truth is, no one knows, but the markets still lack any real signs of pushing to new highs as no one sector is charging forward with any confidence.
This means we can expect more volatility over the course of the year and with US stock valuations in the popular sectors stretched, we can say with a modicum of confidence that this bull market is nearing its end. That does not mean that it is all going to come crashing down tomorrow. In fact, the more positive experts are now suggesting that this bull still has legs, but he is getting tired. Some say we will see another couple of years of growth, while others suggest 2019 could be the end of it.
Domestically, we haven’t seen the over valuation as in the US, so there may yet be some room for growth, but the energy and financial sectors, two of the biggest driving forces of the TSX, have been lagging and are expected to continue along this path, at least for now.
“…now may be a good time to look to products with guarantees and tax advantages.”
One thing we do know is that the latest jobs data are showing an increasing cost of labour and this could be very bad news. Canadian average household debt is at a record high which means that most households require two salaries to make ends meet and there are few savings set aside to weather any storms. If the next recession hits the labour market hard, it will in turn hit the housing market like a wrecking ball. Since the housing market has been a big driving force in the Canadian economy for the last few years and the central bank rate has not fully recovered since the financial crisis, the next recession could be deep and long.
So, what does all this mean for investors? At this point, they should be reducing the equities portion of their portfolios and shifting some of those equities from growth to value funds and/or stocks. There is value to be found in the consumer staples and utilities sectors, and it is advisable to focus on small to mid capitalization companies and funds.
Fixed income assets have been a bit harder to call of late. Corporate bonds funds, high-yield bond funds and government bond funds have all been trading places on the performance ladder. I would suggest that diversification in this area is key, and now may be a good time to look to products with guarantees and tax advantages to reduce down-market risk and increase yield potential.
Segregated Funds (essentially Mutual Funds wrapped in insurance contracts) with annual resets, Universal Life Insurance, and Whole Life Insurance all offer features that may augment and/or protect returns over time. The reset option on a Segregated Fund will lock in any gains by resetting the minimum guaranteed amount on an annual basis. Universal Life Insurance allows policy holders to select the types of investments held within the policy and provides some tax advantage, but one must keep a watchful eye on these investments as excess gains could trigger a taxable event.
Whole Life Insurance also has an investment component, but in the form of dividends which are paid annually and are therefore vested (i.e. they cannot be lost in a market correction). These dividends can be used in a couple of ways: one, they can build the cash value within the policy, which can be extracted at a future date (the retirement planning option); or two, they can be used to increase the mortality component for tax-efficient wealth transfer (the estate planning option).
The use of any of these products requires careful configuration, so it is best to consult a financial planner or advisor for advice. Just be sure that the advisor is licensed to sell all products, or you may be getting biased advice.