Factors that could affect your portfolio in 2018
As the year comes to a close, investors for the most part have a lot to be grateful for, especially those fortunate enough to have had large allocations outside of Canada.
For example, those who bought into U.S. equity markets following the election of Donald Trump have fared very well with gains in excess of 20 per cent since the beginning of the year. Here in Canada, despite the rebounding economic picture, the S&P TSX returned a much more modest six per cent (excluding dividends).
For those wondering how to position heading into 2018, there are a couple of important factors to keep a very close eye on, any of which we think will have a material impact on future performance.
SHARE BUYBACKS
The primary driver of U.S. earnings growth and stock market performance has no doubt been share buybacks. This mechanism involves a company issuing debt — much of it at ultra-low cost — adding it to its cash flow and buying back a pile of its stock thereby decreasing the denominator in the EPS calculation and boosting per-share earnings.
In total, U.S. companies have spent a whopping $3.8 trillion on buybacks in the past eight years. According to a recent report by Artemis Capital Management, they calculate that buybacks have accounted for more than 40 per cent of total earning-pershare growth since the market lows in 2009 and over 72 per cent of earnings growth since 2012. For further perspective, if one removed the impact from the buybacks, U.S. companies would have grown earnings by only seven per cent since 2012, compared to the posted 24 per cent gain.
Despite the diminishing power of buybacks due to share prices setting new highs, debt markets are still eagerly willing to supply cheap capital and the upcoming tax cuts by the Trump administration could provide much needed ammunition for this financial engineered growth to continue — at least this is what the market is discounting at the moment.
RISING INTEREST RATES
As the U.S. Federal Reserve finally begins to enter into a tightening cycle, we wonder how aggressive they will be when it comes to unwinding their massive balance sheet. This question is very important as higher interest rates will have a pervasive impact not only on asset prices but also an already heavily levered consumer, corporation and government. Higher rates will also move the U.S. dollar, which could in turn influence the balance of trade and the ability international players who have borrowed in dollars to service their debt, among other effects.
TECHNOLOGY STOCKS
There is a huge buzz at the moment with everyone talking about autonomous vehicles, artificial intelligence and cryptocurrencies. While there has been a lot of money raised to fund these initiatives, the real power has been with the FANG stocks that now make up approximately 10 per cent of the S&P 500 but have contributed to roughly onequarter of the returns last year. The big question is how much more room is there for these stocks to move from here.
NAFTA
Looking closer to home, we believe the outcome from the ongoing NAFTA negotiations could have a material impact on our Canadian economy, equity market and currency given that more than three quarters of our exports are to the U.S. Combine this risk with higher taxes, minimum wage hikes and many companies are seriously considering a curtailment of capital reinvestment and hiring.
OIL & HOUSING
The Canadian economy has become a two-trick pony overly reliant on the benefits from a rising housing market and stronger oil prices.
While many have been trying to call a top, housing prices have persistently moved higher and continue to outperform expectations. This is a good thing as any moderation from previous years of growth could have a meaningful impact on all kinds of sectors from construction to banking. More worrisome is that we recently read about an emerging trend whereby ordinary Canadians are effectively turning themselves into “banks” by borrowing on their HELOCs and providing subprime loans at a higher rate and pocketing the spread.
Looking at oil prices, the current record-setting differential and low realized Canadian pricing, although likely temporary, isn’t providing a lot of confidence heading into 2018.
We are also concerned about a very crowded trade among the speculative longs with net positions hitting an all-time record high. We worry what will happen to the oil price when all of these specs start to hit the sell button as U.S. shale producers respond by flooding the market.
When it comes to our own predictions for 2018, one thing is for sure: There will be a few surprises. Having a well-diversified portfolio is key, especially if, in a reversal of last year, those surprises end up being more bad than good