Chalten Investment Review – Q4 2017

Welcome to the Chalten Investment Review for Q4 2017.   The fourth quarter of 2017 capped another strong year for risky asset investment returns, especially equity returns.  While the CAD/USD exchange rate remained relatively stable during Q4, the Canadian dollar gained 7% against the USD during 2017.  Even with Canadian dollar strength, however, Canadian investors benefited from diversification outside of Canada in Q4 and in 2017 overall. 

Investors scratched their heads as equity markets surpassed “all time highs” several times during the year despite what many viewed as an increasingly fragile geopolitical landscape.  Of course the market pundits were as loud as ever with forecasts of impending doom.  While pundits should generally be ignored, it’s understandable that investors are nervous about the future.  Concerns and questions aren’t surprising:

  • “The market has been on a strong run for a long time now – don’t you think we’re due for a correction?”
  • “The market is at an all time high – are we reaching the limits of what is reasonable?”
  • “Given what we’ve seen in the stock market, can’t we expect returns to be much worse in coming years?”

These are all fair questions to which we’d respond with a resounding “maybe!”  As we’ve written in past quarterly reviews, successful investing is not about market timing, it’s about having the discipline to ride through the market’s ups and downs in order to capture the great long-term investment returns that stock markets deliver.  This is a cornerstone of any sound investment philosophy and essential to the success of a good long-term investment experience.  Peter Lynch said it well:

  • “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.”

Bonds, on the other hand, had fairly muted performance in Q4 and 2017 in general.  Over the past two or three decades investors have grown to expect the bond side of their portfolio to be a return-driver in its own right and are therefore disappointed with the lackluster returns delivered by investment grade bonds globally (with perhaps the exception of emerging market bonds). 

  • “Shouldn’t we be seeking higher yielding bond investments?”
  • “With interest rates so low, why would we hold bonds?”

It is important to recognize the role that bonds play in a properly diversified portfolio.  They should not be relied upon as a return generator but rather the ballast that will save your portfolio from volatility that is beyond your comfort zone.  Any attempts to drive higher yield on the bond side of the portfolio will simply increase risk and likely leave your portfolio looking and behaving more like a 100% equity portfolio in a market downturn. 

Are equity markets going to collapse?  Yes, they always do at some point, we just don’t know if it’s going to be this year, next year or later.  Neither does anyone else.   Are bond returns low and will they continue to be low?  Yes and probably, but you likely won’t mind a 0% bond return if equities are returning -10%, -20% or -30%! 

When we hear these questions and concerns we reiterate the importance of having a portfolio that is allocated in a way that is suitable for your risk tolerance and financial situation, one that you can comfortably stick with during times of market volatility and one that has the best chance of delivering what you need to achieve your long-term financial goals. 

Global diversification is one of the best tools we have to manage risk yet to borrow and repeat another unattributed phrase, “Diversification means always hating something in your portfolio.”  “De-worse-ification” is another term we’ve seen used to describe the same idea – often used by those touting their stock-picking or investment timing skills.  Over the long run diversification is a critical ingredient to giving you the best chance of having a great investment experience. 

In Q4 we wrote about some of the above client concerns.  To begin with, investors needn’t be concerned that markets are hitting all time highs – it happens all the time!  Furthermore, investors should be reminded that trying to time the markets is difficult because it doesn’t just involve one decision (when to sell) but a second decision (when to buy back in!).  Rules of thumb like sell in May and go away aren’t helpful.   

Q4 Market Review

In local currency terms, global equity markets experienced their strongest quarter of the year in Q4.  The Canadian dollar remained relatively flat against the US dollar over the quarter and Canadian investors experienced strong returns for their US stock investments.  Economic indicators were robust in Canada and globally and investors shouldn’t be surprised to see further signs of inflation which sway central bankers to consider increases in interest rates.  In the US, we did see legislation enacted to change corporate and personal taxes and the market seemed to react positively.  Stock markets outside of North America also continued to move up in local and CAD terms. 

  • The total return on the Canadian stock market was 4.5% for Q4 2017 and 9.1% for the year.
  • In the US, the total net return of the S&P500 in Canadian dollar terms was 7.4% for Q4 and 13.5% for the whole of 2017.
  • The total net return for the S&P Global ex-US BMI Index of stocks outside of the US (in Canadian dollar terms) was 4.6% for Q4 and 18.0% for the year, the strongest performing region between the three geographic regions we track.
  • The Canadian dollar gained just over 7% against the US dollar over 2017 despite losing 0.5% against the USD in Q4.
  • Total return for Canadian bonds rebounded 1.87% over the quarter and returned 2.3% for all of 2017, well ahead of US and Global bond returns in CAD terms.   

Financial Planning topics of interest

While 2017 saw stock market indices hit several new all time highs some other metrics reached peak levels also, like the amount of household debt as a % of income being carried by the average Canadian.  We encourage people to be comfortable that the amount of mortgage and other debt they carry makes sense within the context of their financial plan and broader goals, workable even if interest rates go up.

A new year brings new TFSA and RRSP contribution room and an opportunity to make 2017 RRSP contributions through until March 1.  You may also wish to make new contributions to RESP and RDSP accounts to take advantage of various government grant programs. 

Since our last quarterly review we have a little more clarity on changes to the taxation of Canadian Controlled Private Corporations, specifically with respect to income sprinkling.  We’ll have to wait longer for the government to conclude on how it will tax passive investment income within a corporation.  The new laws and transition provisions will likely be complex and worth discussing in detail with your accountant/tax advisor as they evolve and before you make any corporate investment decisions. 

In closing we hope for continued strong equity performance in 2018 but know that markets can turn at any time and the way to give yourself the best chance of having a great long-term investment experience is to maintain a portfolio that is one you can stick with through a variety of market conditions, is suitable for your risk profile and aligned with your financial goals.