After finishing 2018 with the worst December performance since the Great Depression, the S&P 500 started 2019 with the best performance in 23 years, despite slowing global growth and concerns over US Fed tightening. Investors shrugged this off and allocated to undervalued equities after the correction in December.
EPFR, (the Financial Intelligence Division of Informa), reported that for the last week of January, $15.0 billion was pulled out of equities and $9.4 billion was allocated to bonds. Bank of America’s Michael Hartnett reported in his Flow Show for the end of January, fund flows out of equites occurred in 10 of the last 11 weeks. Flows out of ETFs amounted to $12.1 billion and mutual funds was $2.9 billion. Over the last three months, US equities lost a record $82.2 billion in value. Based on fund flows, it would normally be expected for the market to decline, however it was speculated that the market was being supported by short sellers closing out their positions. Discussion with long and short managers confirmed this as they also closed out their shorts and took advantage of the December rout by adding to existing long positions and new names as valuations became more attractive.1
While the market rallied strongly in January on somewhat thin volumes, fears that earnings would disappoint became a major overhang in the market or at least a headwind for future market advances. Remarks from the US Fed confirmed investors fear that the economy was weakening. Fear of economic weakness and earnings concerns is not isolated to North America. Deutsche Bank reported that earnings growth for European stocks is just over 1% for 2019. China’s growth rate for 2018 came in at 6.6%, the slowest growth rate in over 27 years and estimates are that 2019 will be lower at 6.2%. The IMF revised global growth estimates down to 3.5% for 2019 and 3.6% for 2020. Trade frictions and increased tariffs along with high consumer debt levels contributed to the growth rate reductions. All this negative news should have spooked investors, but once it was ignored by the market.
Compared to other developed country markets, Canadian equities (up 8.74%) faired quite well, fueled by energy, healthcare and cannabis sectors. The US S&P 500 managed a strong positive month in domestic terms (8.01%) however in CDN terms, a strong Canadian dollar resulted in a 4% gain for the month. Mid-cap and small-cap names led the advance with growth outperforming value in US quality and low risk names. Bond markets rallied as well as the BofA ML Canadian Broad Market gained over 1.20% during the month as investors shifted allocations to safe haven fixed income. With the Canadian 10-year Benchmark Bond at 1.88% compared to the US 10-year at 2.63%, it is hard to think the Canadian dollar will remain strong against the US dollar for any length of time, if rates continue their divergence.
While we think equities will outpace bonds from current levels, in the short term, recessionary fears, slowing growth, rising debt levels and increased taxation will require a cautionary stance throughout the balance of 2019.