Roberts Nash Advisory Group

December 20th, 2018: Where Are You Christmas?

The fourth quarter of 2018 is setting up to be the worst for equity markets since 2008. As of the close on December 19th, the S&P/TSX Composite Index was down 12.0% YTD. The Canadian market last suffered this way in 2015 when the index dropped 10.75% for the year.

The battle of words and opinions is upon us. Is this a correction to be bought? Or a crash waiting to happen? Is it different this time? Are drastic actions required? North America is now three months into what is proving to be a significant market correction.

Economic data (employment, GDP, inflation) and earnings reports do not appear to support the level of correction we are seeing. North America is near “full employment” and while growth is slowing, the economy continues to expand.

A market correction is defined as a decline of 10% or more. This current correction marks the 37th decline of 10% or more in U.S. markets since 1980. The average decline (including 1987 and 2008) was 15.6%. Ten of the corrections resulted in bear markets, the others transitioned back to bulls (source: Investopedia).

2018 YTD Returns as of December 19th:

 

% Change

 

S&P/ TSX Composite Index

-12.0

 

Dow Jones Industrial Average Index

-5.6

 

S&P500 Index

-6.2

 

NASDAQ Composite Index

-3.9

 

DAX Index (Germany)

-17.8

 

CSI 300 Index (China)

-23.9

 

Nikkei 225 Index (Japan)

-10.4

 

WTI (Oil)

-22.7

($60.42 to $46.65)

CDN Dollar (vs USD)

-6.5

(0.7955 to 0.7435)

Apple (APPL)

-4.9

 

National Bank of Canada (NA)

-8.5

 

Royal Bank of Canada (RY)

-9.7

 

Suncor Energy (SU)

-16.8

 

While there are figures that are more extreme, these indices and figures can have the greatest influence on Canadian portfolios.

Market corrections can come in different of forms. Everyone remembers and fears the "crashes." Examples include 1987 when the DJIA dropped 21% in a day, or the more recent September 2008 version that had markets fluctuating in excess of 5% per day, which is about 50% more than we are currently experiencing. Such movements are often preceded by what is later referred to as a “black swan event” – a dramatic change, which alters the way investors view the world. The current correction offers no such trigger.

The type of correction we are in now is more gradual. It feels very similar to the market action experienced from January to March 2009. Many investors had started 2009 buying into equities hoping that the issues of 2008 were behind. But in the last week of January, equities began to sell off again. They marched lower relentlessly for five weeks. There was no significant new information, and no equity holding was safe from the selling. The TSX dropped over 20% from high to low. On March 9th, it changed, and the TSX began to rise. The TSX went up almost every day. At the end of three weeks, it had risen 25%, recovering the entire drop.

Somewhere in the world, someone is going to call this market perfectly. They will identify the low for oil, an agreement with China, or simply state we have reached an end to panic selling. Of course, this prediction may simply be one of among many others they made. That person has the potential to be famous, so they will make extreme calls with the anticipation they will be one of the few to get it right, or it will be forgotten.

If you turn on CNBC or BNN right now, you will be bombarded with predictions, all founded on theory that the speaker believes to be sound. Always remember that these forms of media need you to watch. The more outlandish the claim being made, the more likely it is to draw in additional viewers, which helps them attract advertisers. Jim Cramer on CNBC has a history of making very bold (and sometimes very wrong) statements … yet he remains on the air and is often quoted for his views.

Here are a few of Cramer's comments to remember from 2008:

March 2008 – "Bear Stearns is Fine"

October 2008 – "Sell Everything and Go To Cash for 5 Years"

2018 has not been easy year for investors anywhere. The TSX has fallen 12% in 2018, and portfolio diversification hasn’t helped. As illustrated above, many global equity markets have had a significantly worse year than we have in North America. One of the hardest aspects was the decline in dividend growth stocks. As a group, they have experienced their second worst decline in 30 years (source: Blackrock). This is not what one expects, and it hits at the core of most investors’ portfolios.

There has been nowhere to hide in 2018. Equity, bonds, commodities, all have suffered declines. Canadian banks are held in almost every portfolio and are a good example of the magnitude of the selling currently going on.

 

 All Time High   

As of Dec 19 close 

 Drop %

Current Yield %

Bank of Montreal

 $109.00

$89.03

-18.3

4.51

Bank of Nova Scotia 

 $83.73

$69.64

-16.8 

4.87

CIBC 

 $125.21

$104.26 

-16.7 

5.23

National Bank of Canada 

 $65.95

$57.36 

-13.0 

4.55

Royal Bank of Canada 

 $108.52

$92.68 

-14.6 

4.23

Toronto Dominion Bank

 $80.05

$67.58 

-15.6 

3.96

In the 2009 correction, Royal Bank of Canada (RY) and Bank of Montreal (BMO) had dropped over 50% from their all time highs[i] and were trading around $25.

On Thursday, December 20th, five of the six major Canadian banks traded at new 52 week lows.

There are two things investors should take from the charts above. The first is that this correction is very broad based. ALL investors should expect December to be a negative month and 2018 to be a negative year.

The second is that there is tremendous opportunity in the market. Equities are on sale! No major Canadian bank has ever cut its dividend and, as the chart shows, over half of them are now offering yields of over 4.5%. More on the Canadian banks in the Q&A below.

We believe the markets are now in an oversold position. This does not mean they will turn quickly, but in the long run those buying at current levels should be well rewarded.

Q&A:

Where is the bottom? This is always the number one question, and it’s impossible to answer. We believe that the current market is being driven by emotion, and that markets of this type don’t require a specific event to turn them around. Further, we believe that the widespread use of exchange traded funds (ETFs) has reduced investor’s attachment to their portfolio holdings and made them more likely to sell into market weakness. When an ETF is sold back to the issuer, all the underlying holdings must be sold in the market. This has the potential to increase volatility in the overall market.

When will the Loonie stop falling? The easy answer here is that it will likely happen when the price of oil finds a floor and turns higher. The loonie has held up well against global currencies, but it is lagging the USD due to its strength as a global reserve currency. The current trend for the dollar is lower and without a turn in resource prices, it could go lower still. If one subscribes to the concept of purchasing power parity (stats.oecd.org) then the Canadian dollar should be trading around $0.80 versus the USD. Currency movements can be viewed like a pendulum. They swing one direction and then another. Once past center, you know the pendulum will swing back, but you don’t always know from what extreme.

Why are the Canadian Banks doing so badly? Canadian Banks are one of the most widely held equity assets for Canadian investors, and they have a heavy weighting in our indices. During market pullbacks, they can experience larger than average downward pressure as investors liquidate equity, mutual funds, and exchange traded funds. Such movements have historically been an ideal time to add to positions. Given their history of stability, few Canadians worry about their holdings in Canadian banks during volatile times. However, their price movements do influence portfolio values and returns. In 2018, the impact has been quite negative.

Should I be buying? The long-term answer is yes, but short term one must be prepared to experience more downside in this market. The S&P/TSX Composite Index is now over 14% below the high it reached in July 2018. The current level is also below the 15,154 reached in June 2008. One could rightly say that it is “on sale”. However, there could be more downside before this market climbs and investors need to be prepared. 

[i] RY hit $61.08 in May 2007 and $25.52 in February 2009. BMO hit $72.75 in April 2007 and $24.05 in February 2009. (Source: Thomson Reuters)

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** I have prepared this commentary to give you my thoughts on various investment alternatives and considerations which may be relevant to your portfolio. This commentary reflects my opinions alone, and may not reflect the views of National Bank Financial Group. In expressing these opinions, I bring my best judgment and professional experience from the perspective of someone who surveys a broad range of investments. Therefore, this report should be viewed as a reflection of my informed opinions rather than analyses produced by the Research Department of National Bank Financial **

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