Investing in the 2020s

High global debt levels appear to be exerting a growing influence on the financial markets. Despite volatility, equity markets have been largely range bound since early 2018. We continue to focus on potentially important longer-term trends and maintaining a balanced asset allocation in all market environments. Looking forward to the 2020s,  we highlight a focus on the following trends and resulting investment strategies:        

1. Interest rates have probably put in a generational low and may go substantially higher in the coming years. In reaction to equity market volatility, Central Banks have recently moved to a more “dovish” stance and they may lower short term rates in the coming months. In our opinion, higher interest rates will not be driven by Central Bank policy but by high global debt levels and the bond market’s demand to be paid more by indebted governments. The recent drastic change in policy demonstrates how dynamic the situation is becoming   We continue to focus on important, large capitalized, companies with good balance sheets. We are avoiding investments with longer duration risk and weak balance sheets.  
2. When looking at reasons for the large market decline in late 2018 it appears that that the prevalence of passive investing strategies led to a “crowded” positioning in a relatively small number of securities. We recognize the influence of passive capital flows and ETFs but focus on the fundamentals of individual companies when making investment decisions. Ideal situations are securities that have positive fundamentals, attractive valuation, and the potential to benefit from passive capital inflows.
3. The balance sheets of many Canadians are stressed, and this fact is receiving more and more media attention. Canadian real estate is beginning to weaken, and the banking sector may become more difficult especially in a higher interest rate environment. The Canadian equity market has a large weighting in banks, and this may be an issue for the index and many Canadian investors. Financials in Canada and globally have been poor performers over the past year and this may be foreshadowing some future issues.
4. The Canadian dollar may be challenged over the longer term (see Blog article May 2017). The “loonie” has been range bound for the past few years and it may be setting up for a move much lower in the future.  Any rally may be capped in the $0.80 (1.24) range and if any strength occurs it would be another opportunity to reduce exposure. Any move below $72.50 (1.38) would be a potential sign that the move lower has commenced. Having a balanced currency portfolio may protect wealth and add value in the coming years. Over the next decade this may be the most important investment theme for Canadians.  
5. The large global debt levels and the recent change in U.S. monetary policy are supportive to an increased attention to the gold sector. Gold has also been range bound and the market appears to be waiting for a break above $1360-$1400 to really gain momentum. The large mergers in the sector have been very interesting and constructive.  A recent Globe and Mail article correctly pointed out that Gold has nicely outperformed that U.S. Equity market over the past 20 Years.

Update on Volatility 

As reviewed in an earlier article in January 2018, the absence of volatility in 2017 was of concern and in early 2018 we recommended reducing equity exposure. We also recommended taking profits again in the Summer and early Fall of 2018 as the upside in markets appeared to be muted. These were not attempts to “time” markets but proactive rebalancing in order to protect capital in markets that did not seem to offer upside reward relative to potential downside risks. We did keep equity exposure at prudent levels (see The Most Important Paragraph About Investing Ever Written? March 2017). These tactical allocation changes along with GIC holdings and a precious metals weighting worked very well to protect portfolios through the extreme volatility in late 2018.

In last year’s article about volatility, we looked back at the 1998 market when there was a severe correction that led to the final rally of the 1990s bull market. The sharp correction in the S&P 500 in late 2018 was of similar magnitude to the 1998 market (more than 20%) and this may have produced a low of some significance.  The rebound in markets in early 2019 does offer the potential that 2019-2020 will produce substantially higher highs as was the case in the 1998-2000 market. We see it as more likely that equity markets began a mid-cycle correction in early 2018 and that there may be some additional weakness and volatility in the coming months. If stocks do move lower, we will recommend adding new quality equity for longer term investments. 

Chart of Canadian Dollar; Source Thomson One  

Chart of Gold in U.S. Dollars: Source Thomson One