Articles

Overview

At the end of December 2018, markets had just completed one of the worst quarters in several years.  The general view was very weak.

Today, many investors are much more positive after very strong returns in 2019.

Where that leaves us today is much more in the middle in terms of our outlook for 2020.

On the positive side, interest rates remain very low and the general trend is for them to remain at these levels for a while.  In addition, global growth is showing some signs of improvement after real slowdowns in 2019.

On the negative side, U.S. markets are now at the high end of their valuations, and there isn’t a lot of room to go higher unless corporate earnings pick up strongly.  Of interest, most other equity markets, including Canada, have much more reasonable valuations at the moment.

In Canadian Dollars – Total Stock Market Returns in 2019:

Other key 2019 Returns included:

What do we see for 2020 and why

We do not believe that a bear market is imminent.

Last quarter we said that historically, bear markets occur when at least two of the following four circumstances are found:

1. Economic Recession – Two consecutive quarters of negative growth.
2. Commodity Spike – A movement in oil prices of over 100% over an 18 month period.
3. Aggressive Fed Tightening – Unexpected and/or significant increases in the Fed funds rate.
4. Extreme Valuations – When S&P500 trailing 12 months price/earnings levels were approximately two standard deviations higher than the long term average.

As of the moment, we are seeing reasonable growth with expected real GDP growth of 1.8% in the U.S. and 1.6% in Canada, so no economic recession, although certainly not stunning growth either.

There was no major commodity spike in oil prices, even with the recent Iran conflict.

No meaningful increases in interest rates are envisioned.  We expect rates to remain flat or to be slightly down in 2020.

The only bear market risk at the moment is high stock market valuations, but even the overvaluation is not significantly large.  Focusing on the S&P500 in the U.S., the measure is a trailing 12 months Price/Earnings ratio two standard deviations higher than the long term average.  While not trailing, on a forward P/E basis, the S&P500 is at 18.5 vs. a 25 year average of 16.3.  This is 0.7 standard deviations higher than average. 

It is definitely something to be aware of, but not enough, especially in light of the other three criteria to put us in real concern of a bear market.

In addition, other global markets are valued more cheaply than the U.S.

This chart from J.P. Morgan highlights 25 years of the Forward P/E ratio of the S&P 500.

Interest rates fairly flat with slight downward pressure

On the interest rate side of things, the Central Banks in Canada and the U.S. are both signaling little movement for the time being, although the U.S. could lower rates again before Canada does. 

Strengthening of Canadian dollar vs. the U.S.

Our current view is that the CDN$ will strengthen further against the US$ this year.  The main reasons being that the U.S. Fed has lowered rates and may lower further, while Canada has not lowered rates and is less likely to lower them in 2020 vs. the U.S.  As a result, on the short end of the yield curve, Canada is now paying more than the U.S., and that is where much of the international money flow invests in (short term bonds).  The other driver is that there is more relative growth momentum in Canada than the U.S.  What we mean is that in 2018 U.S. growth was about 0.9% higher than Canada.  In 2019, it was only 0.7% higher.  This year, the U.S. GDP growth is forecast to be only 0.2% higher than Canada, despite a much higher Federal government deficit and more accommodative central bank.  We believe that this shift in growth momentum will be positive for the CDN$ vs U.S.$.

Trade Wars

It looks like we are finally seeing some warming on the trade wars.  As expected, the Trump White House is looking for some trade wins heading into the election.  With the imminent passing of the USMCA (what we will still call NAFTA), and the first phase of a China and U.S. agreement, there are signs of some confidence that may support global growth.

Corporate Earnings

Corporate earnings are expected to grow year over year by 16% according to Bloomberg, but the sentiment is for earnings growth to be lower than that.  This tells us two things.  The first is that strong earnings growth is not likely going to help ‘fix’ the high valuations in the U.S. market.  The second is that with reasonably modest earnings expectations, it is a little easier for companies to meet and exceed expectations.  Overall, we see corporate earnings numbers growing but not driving the markets higher.

Oil Prices

According to the U.S. Energy Information Administration, global demand for oil continues to increase.  In fact, the global demand chart below is remarkably steady for a commodity with a price that can be so volatile.  This is important to remember, because with all of the focus on alternative energy it can be easy to believe that Oil consumption is in decline.

Price expectations for oil are pretty flat, in the $55 to $60 per barrel range for West Texas Intermediate, although the general trend over the past 5 years has been higher.

For energy stocks, which have struggled for several years, this stability, and even the belief of stability, can lead to some modest gains for a depressed sector.

How does this impact your portfolio?

Based on this, we are starting to trim our U.S. stock weighting, and returning some of that back to Canada.  We will maintain our Global Stock weightings.  In addition, we see modest returns for bonds in 2020 and would look to be a little higher weighted in fixed rate preferred shares (with 5%+ dividend yields) as well as rate reset preferred shares, which should benefit from flattish interest rates.

Alternative investments remain an important part for our client portfolios and may be even more important given the more modest expectations from stocks.

On a sector basis, we will likely be lightening up on U.S. Health Care and looking for strong Canadian dividend growers.

Our fearless predictions for 2020:

Before we do our 2020 predictions, it is worth reviewing our 2019 predictions, which came in quite accurate overall:

1. Better than average stock market returns in most major markets including Canada and the U.S.
2. Interest rates being mostly flat with maybe one ¼% increase in both Canada and the U.S with a real possibility of an interest rate decline in Canada before the year is out.
3. The Canadian dollar being fairly flat, but being tied more to oil than we have seen in the recent past.
4. Oil rising but only slowly, and not a significant recovery.
5. Preferred Shares having a strong year, bouncing back from their late year steep declines.
6. Marijuana stocks will see a general decline overall as high valuations and uncertain revenues work their way through, but with increasing gaps between the winners and losers. In fact, we expect to see several bankruptcies in 2019 among the weak players in the market, and at least one major blow up of a more established firm (we just don’t know which one).
7. Cryptocurrencies – need we even comment?

For 2020, our predictions are:

1. Average stock market returns in most major markets including Canada and the U.S. – likely in the 5% to 10% return range but with more typical volatility.
2. Canada will outperform the U.S. market for the first time since 2016.
3. Interest rates will remain mostly flat to small decreases in both Canada and the U.S.
4. The Canadian dollar will see reasonable gains vs. the U.S. dollar.
5. Oil prices will mostly trade within a range of $60 +/- $5..
6. Preferred Shares will have a stronger year as more investors look for bond alternatives.

Based on these short term beliefs, we have a little higher than average  cash weightings in our stock funds, and will lower our weight on U.S. stocks, increasing the weighting in Canada.  We will also more actively use options to protect against downside risk.

In the Growth fund, which is more active in terms of adjusting industries, we will be adding to Canadian Financials and Utilities and reducing U.S. Health Care.

How Did TriDelta do in 2019?

Our 2019 returns were as follows:

TriDelta Private Funds

In mid-January the Private Fund 1 will do another cash distribution.  Over 9% of the remaining value of the TriDelta Private Fund 1 (Fixed Income Fund) will be distributed out as cash.  We expect to pay further distributions on the fund next quarter as more of the underlying investments mature or are sold.  On the TriDelta Private Fund 2 (High Income Balanced Fund), we didn’t pay a distribution this quarter, after distributing over 30% in the previous two quarters.   

Nine Quick Hits of news and items of interest

1. The TriDelta Alternative Performance Fund is launching later this month. It will provide a diversified mix of our top growth Alternative Investments in one fund that can be held in any account.  To learn more, please contact your Wealth Advisor.
2. A reminder that now is a great time to top up TFSA’s. There is another $6,000 per person in contribution room for 2020.  If you have never contributed to a TFSA, the lifetime limit is now likely $69,500 for you.  If you have the funds, January is also a good time to do 2020 contributions to RRSPs, RESPs and RDSPs, as appropriate, as it will help you to tax shelter for a full year.
3. If you like to save money on gas, a great website to look at is gasbuddy.com. The website shows gas prices at individual stations in your area, and includes prices for standard and high octane as well.
4. Since the S&P 500 market peak in October 2007, the Technology index is up 348.1%. During the same period the Energy index is up just 6.5%.
5. S. Household Debt Service Ratio is lower today at 9.7% that at any time in the past 30 years. In Canada it is at 13.3% and higher than it has been for many years.
6. According to the U.S. Census Bureau, average income for those whose highest education was a High School graduate or less was $38,900, Bachelor’s Degree was $71,200 and Advanced Degree was $99,900.
7. According to the U.S. Bureau of Economic Analysis, the US Trade Deficit stands at 2.3% of GDP. Despite all of the Buy American initiatives and Trade discussions, this level has been quite constant since 2013.  The Trade Deficit peaked around 2006 at 6%.
8. While it has come down meaningfully from the peak in mid-2019, there is still over US$11 trillion of debt globally that ‘pays out’ a negative yield, meaning the investor is paying the bond holder for the right to own the bond.
9. The current interest yield on the full Canadian Bond Index today is just 2.15%.

Summary

We expect a slightly lower than average year in stock markets overall, but do not believe that we are heading into a bear market, at least through the U.S. election.

This type of market can bring a relative premium to investments that pay decent dividends and other income returns, especially given the overall low return on cash and GICs.

Volatility is expected to be higher in 2020, and the reasons for volatility can crop up from anywhere, as we have seen with the Iranian conflict already this month.

Our goal for our clients is to build peace of mind through financial planning and developing portfolios that have much less volatility than stock indexes with a focus on income.  While stock markets are historically down three out of every ten years, we aim to have client portfolios that are rarely negative.  This is part of the reason for our Alternative Income weighting in portfolios.

At TriDelta we will continue to be nimble while focused on a long-term plan, a steady and diversified asset mix that is built appropriately for the goals of each client, and an eye on tax minimization.

Here is to a good investment year in 2020 for everyone.

Cameron Winser
CFA

Senior VP, Equities

Ted Rechtshaffen
MBA, CFP®, CIM®

President and CEO

Paul Simon
CFA, FRM

VP and Head of Fixed Income

Lorne Zeiler
CFA®, iMBA

Senior VP, Wealth Advisor and
Portfolio Manager

Overview

It is amazing how the day to day can seem very volatile, but when you step back far enough, returns have been fairly steady.  Q3 was one of those quarters.  July was good, August was bad, and September was good.  When you add it all up, the quarter was not great, but decent.

The TSX was up 2.5%, the S&P500 in Canadian dollars was up 1.5% and the MSCI world index was up 2.1%.  This was a rare quarter where Canada outperformed on the strength of Utilities, Consumer Staples and Financials.

The TriDelta Pension fund had a strong quarter, up 4.5%, while the Growth fund was still solid with a 2.3% gain.

The Canadian Bond Index was up 1.2% while preferred shares were up 0.5% on the strength of a rebound in September (after more weakness in July and August).

Despite these numbers, the recession chatter is as strong as ever.

Should we be worried?

How is TriDelta responding?

Where do we see things today and what are we doing about it?

We do not believe that a bear market is imminent.

Historically, bear markets occur when at least two of the following four circumstances are found:

1. Economic Recession – Two consecutive quarters of negative growth.
2. Commodity Spike – A movement in oil prices of over 100% over an 18 month period.
3. Aggressive Fed Tightening – Unexpected and/or significant increases in the Fed funds rate.
4. Extreme Valuations – When S&P500 trailing 12 months price/earnings levels were approximately two standard deviations higher than the long term average.

Today, we see none of the four circumstances in place.

Current growth rates in the U.S. are 2.0%, while Canada is at 1.6%.  These are not booming growth rates, but solidly better than a recession.

Oil prices did see a big drop from October 2018 to December 2018 and rebound, but it was well under 100%.  2019 has actually had more stable oil prices than we have seen in general.  As you can see below, there has been small positive trend for the past 3.5 years.

We are actually seeing Fed loosening of policy as the Fed Funds rate has been lowered twice this year.  As per the chart below, after four years of slowly raising rates, the tide has turned the other direction in 2019.

Valuations on the S&P500 are currently just slightly above their 25 year average based on a forward price/earnings basis, and in a reasonable space on a 12 month trailing basis.

When we take these factors along with our belief that Donald Trump will ease up on China trade demands and tariffs if stock markets are falling, we do not believe in an imminent bear market.

Despite this relative optimism, we do recognize some real risks that include:

• Slowing growth
• Few obvious catalysts for near-term market growth
• Fear that the Fed won’t lower rates as fast as the market expects
• Brexit dangers
• Trump….just saying
• Middle east hotspots in Syria, Iraq, Turkey.

When we net things out our view is slightly positive.  We did have a fairly defensive stance in the third quarter with both higher cash (10%) and a market hedge position in our funds (4%).  We are now slowly lowering our cash weighting, but will likely keep the small hedge in place for now.

Stocks

We are spending a little cash by adding to Emerging Market exposure.  We simply believe that Emerging Markets are undervalued and will benefit more than the rest of the world if the U.S. and China trade improves.  Year to date, Emerging Markets are up only 2.0% while the S&P500 in CDN dollars is up 18.8%, and we believe that gap should narrow.

We are also moving a little more towards Financials and Consumer Staples and a little away from Consumer Discretionary.

Interest Rates

U.S. – The Federal Reserve looks likely to lower rates another quarter percent in late October.  There may be a tougher case to be made for another cut in December as there are currently some Fed Governors clearly against further cuts.  Having said that, the market is still expecting further cuts after October.

Canada – The Bank of Canada is really standing alone as the only major economy that is not planning to lower interest rates any time soon.  Their view is that growth is reasonable and employment is strong while their biggest concern is consumer indebtedness.

Preferred Shares

We see more value in Preferred Shares than many Bonds at this point, in particular perpetual or straight preferred shares that have dividend yields in the 5% to 5.5% range.  While rate reset Preferred Shares provide the most value, and did see a big improvement in September, we still see more volatility on this side of the market.

Alternative Investments

We will soon be sharing information on a new offering from TriDelta that will represent some of our best thinking on the income focused Alternative Investment space along with better liquidity, better pricing, and full flexibility to be held in registered and non-registered accounts.  Stay tuned.

Canadian Dollar

We believe that there could be some strength in the Canadian dollar over the next year as U.S. interest rates fall below Canadian levels.  The very different view on interest rates between the two countries should provide a solid support for the Canadian dollar.  In fact, we have now put in place a 25% hedge on US$ in our funds when we often have no hedge in place.

TriDelta Private Funds

We paid another distribution in the first week of October.  Over 17% of the remaining value of the TriDelta Private Fund 2 (High Income Balanced Fund) was distributed out as cash.  Over 4% of the remaining value of the TriDelta Private Fund 1 (Fixed Income Fund) was distributed out as cash.  We expect to pay further distributions next quarter as more of the underlying investments mature or are sold.     

TriDelta Ranked one of the Top 10 Wealth Management Firms in Toronto by AdvisoryHQ

Here is what California-based Advisory HQ had to say about our firm:

“TriDelta’s holistic financial services approach ensures clients get personalized help from experts in a variety of financial specialty sectors. This provides additional value and ensures a client’s financial strategy is fully integrated.

With a deep bench of professionals, a wealth of financial education resources, and a talented team, TriDelta Financial earns 5-stars as one of the best financial advisors in Toronto….”

Summary

As we head into the final quarter of the year, 2019 continues to feel like a recovery year from the weaknesses of the second half of 2018.  Despite the fear that seems ever present, we do not see a particularly weak investing environment.  In the short term, anything can happen, but our slightly cautious approach should weather such storms and allow us to take advantage of opportunities.

At TriDelta we will continue to focus on being nimble in the short term, being a leader in the Alternative Income space, and helping clients plan for the long term.

Here is to a beautiful fall for everyone.

Cameron Winser

VP, Equities

Ted Rechtshaffen

President and CEO

Paul Simon

VP and Head of Fixed Income

Lorne Zeiler

VP, Portfolio Manager and
Wealth Advisor

The second quarter of 2019 has felt a little like Canada’s Wonderland. You climb the roller coaster, then you experience big ‘wind in your hair’ descent, then another climb. At TriDelta, we definitely work to smooth out your portfolio returns much more than the typical stock market, but I am sure that most of you still felt a bit of the roller coaster as you reviewed portfolios online or through monthly statements.

While the overall returns for equity markets were positive in the second quarter, volatility returned in May. After the stock market continued its strong year-to-date returns in April with the S&P500 (US) rising by 3.9%, the S&P/TSX Composite (Canada) increasing by 3% and Euro Stoxx 50 (Europe) up 4.9%, May saw the reversal of fortunes with the S&P500 declining 6.6%, TSX dropping 3.3% and Europe down 6.7%. June returns were positive again at +5% for the S&P500 (although only 1.8% in Canadian dollars due to a 3% increase in CAD during the month), +0.5% for the TSX and +3.7% for Europe.

Bonds performed well with the FTSE TSX Bond Universe index rising by 2.55%. during the quarter with much lower volatility than the stock market (bonds have sold off a bit so far in July). Preferred shares continued to struggle, with the BMO 50 Preferred Share index declining by 2.4% in the quarter, but have performed well recently with a 0.5% rise in June and so far +1.5% in July. Preferred shares continue to offer high tax-efficient dividend yields, especially relative to other income investments. If bonds prices stabilize, preferred shares could also enjoy some capital gain. For more information on the Preferred Shares market, the reason for its decline, and the opportunity for positive future returns, please click here.

While declines can be stressful, even during periods of overall rising equity markets, it is worth remembering that equity markets have typically provided higher returns than most other asset classes, particularly bonds, but with much higher volatility. Even though equity markets (as represented by the S&P500 in the US) have generated positive calendar year returns roughly 70% of the time, in a typical calendar year, equity markets experience declines of 5% or more 3 times and one decline of 10% or more.

TriDelta clients on average were up between 0.25% and 1.5% during the quarter with the biggest difference being the percentage exposure to Preferred Shares. Our basket of alternative investments continued to perform in line with expectations, with private debt funds up approx. 2%, mortgage investment funds up 1%-2% and real estate up 2.5%, outperforming stocks.

So the key question for most investors is why the strength in April and June vs. declines in May? And more importantly, are we in for weak equity markets like we experienced in Q4 2018 when the S&P500 fell 20% from its peak before recovering? Or can we expect strong market conditions, like Q1 2019 when nearly all major markets were up at least 10%?

Earnings, valuations, cash flows and growth rates should ultimately dictate long-term returns for investors. In fact, most classic equity and market valuation models are based on trying to forecast future earnings and cash flows from an investment based on growth rates, but also bond yields. Sometimes, short-term declines are the result of seasonal factors, or major headlines, such as the continued trade discussions between US and China and in May the threat of US tariffs on Mexico. Often though there may be no clear reason for short-term declines. But in recent years, accommodative monetary policy has definitely been a factor in the strength of (and sometimes weakness in) the equity markets.

Why Central Banks Matter?

Central Banks main goal is to use monetary policy (primarily by setting government interest rates, but also by buying and selling government or related bonds in the market) to keep inflation at stable, predictable levels (price stability). The US central bank, the Federal Reserve, actually has two mandates of price stability and full employment.

Since 2008, central banks lowered interest rates to unprecedented levels and even engaged in quantitative easing, buying long dated bonds, to lower longer-term interest rates. The actions of central banks influence money supply, bond yields and even overall economic growth as more flexible monetary conditions can help protect companies and investors. Companies with higher levels of debt can more easily pay and finance credit. Lower borrowing costs can increase profits for corporations and can be used for dividend increases or share buybacks. Lower rates also encourage individuals and endowments to invest in riskier assets when holding cash that offers only meager returns. Higher dividend paying equities appear more attractive in a low yield environment as they offer higher yields than bonds with the potential for upside (they also have the potential for downside if prices drop). Higher valuations seem more reasonable in an environment of low rates, so stock prices go up and investors seeking higher returns bid up growth stocks.

The Q4 2018 sell-off was impacted by fears of slowing growth, a breakdown in US-China trade discussions, but also due to more hawkish central banks. In fact, when the US Federal Reserve (the ‘Fed’) raised rates in December, then commented that it expected future interest rate increases AND expected further reductions in its bond holdings, this threw fire on an already nervous equity market, accelerating declines in stocks, before recovery began just after Christmas.

Presently, US President Trump is demanding that the Federal Reserve reduce rates, Wall Street is anticipating a rate cut later this month AND at least two more rate cuts within twelve months. If this were to occur, the Bank of Canada, which has been neutral, would have to lower rates as well or see the Canadian dollar rise significantly due to the higher yield of Canadian bonds vs. US bonds. The problem is that while yes the world’s growth rate is slowing and lowering rates would help spur growth, most US economists do not see the need for rate cuts. They still anticipate GDP growth of over 2% in both 2019 and 2020, slower, but still a good growth rate for an advanced economy ten years into a recovery. They expect the unemployment rate, already near historical lows, to decline even further, and for inflation to be slightly above 2% (the Fed’s target rate), so these economists do not see a need for near-term rate cuts. (Source: Blomberg Economics, July 8, 2019). Most members of the Federal Reserve are economists. So who will win? Wall Street and the President or the more conservative economists? Much like the Kawhi Leonard watch to determine which basketball team he signed with, the Fed’s decision will also be followed and analyzed throughout the summer.

US Federal Reserve Interest Rate Expectations

The green line reflects the projected Federal Funds Rate (interest rates) per members of the Federal Reserve at July 12, 2019. The yellow line reflected those projections at December 31, 2018. For example, at the end of 2018, the Fed expected rates to stay at approximately 2.4% in one year’s time and now expect rates to be closer to 1.5% over that period.

At TriDelta, we think the result is likely to be somewhere in the middle. We will get at least one rate cut in 2019, but possibly later than July and we may see only 1-2 additional cuts within the next 12 months. If this is the case, Wall Street is likely to be disappointed and we could be in for a few months of volatility.

As a result, we have focused equally on capital preservation as well as growth. The stocks currently in the equity portfolios have higher yields than the overall market, as well as lower volatility (Beta) and cheaper valuations (as measured by Price / Earnings ratios). We also presently hold higher levels of cash in our equity funds. Our bond portfolios hold shorter terms to maturity than the Canadian bond universe and has improved its credit quality. We also continue to believe that investing a portion of clients’ portfolios in income-focused alternative investments should provide less volatility and a higher level of income than a typical stock and bond only balanced portfolio.

We will continue to monitor market conditions, particularly leading indicators, developments in trade discussions and their impact on the world economy, as well as technical factors that may give indications of potential market movements and which sectors to favour.

Update on Private Investments

At the end of Q2, both TriDelta Fixed Income and High Income Balanced Funds made additional distributions based on investments being sold or maturing. Distributions for the Fixed Income Fund were roughly 0.5% and just over 13% for the High Income Balanced Fund. Additional distributions are expected near the end of Q3 as certain bonds mature and others are sold.

Summary:

We continue to search for value in under covered areas of the market, such as a promissory note issued by a leader in the litigation finance field that pays our clients a 10% yield, as well as stocks, preferred shares and bonds trading below historical averages or offering higher levels of growth than are priced in by the market. We are also focused on capital preservation, income and reducing overall risk through prudent management and diversification.

We hope that you have a chance to enjoy the sunshine and good weather that we are presently experiencing. Summers in Canada are too short, so they must be savoured.

Cameron Winser VP, Equities

Ted Rechtshaffen President and CEO

Anton Tucker Exec VP and Portfolio Manager

Lorne Zeiler VP, Portfolio Manager and Wealth Advisor

After double digit declines in Q4 2018, Q1 2019 saw a significant bounce back.

We saw double digit increases in the TSX at 12.4% and in Canadian dollar terms, the S&P500 at 10.8%, with a 7.1% gain in the Euro Stoxx 50 and 2.8% in Japan.

Leading the way in gains in Canada was the ‘Health’ sector which is primarily Cannabis names, which were up 45.9%!! I.T. was up 27.3% in Canada and 20.5% in the broad U.S. market. While the gains were fairly broad, not surprisingly, many of the biggest gains came from more volatile sectors that saw the biggest declines in the fourth quarter of 2018.

The key question is where does this leave us?

Can we relax and look for another 5% to 10% gain in stocks through the rest of the year?

Are we headed for a third straight quarter of extreme volatility?

The last couple of quarters, we have focused on 5 factors moving markets. If we review them as of April 2019, they are now telling us the following:

• Interest rates/bond yields – after meaningful increases in the first half of 2018 on both the overnight rates and longer term rates, the mood has definitely shifted with long term rates declining meaningfully, and short term rates seemingly on hold for a while. A stable interest rate environment gives investors the confidence to take advantage of cheap borrowing costs and increase allocations to equities, pushing the stock market higher.
• Fears of higher inflation – in part due to lower growth expectations globally and in part due to lower wage growth in the U.S., the fear of higher inflation has meaningfully pulled back. One more fear that has eased and allowed stocks to pull forward.
• U.S.-China Trade Wars (and broader trade conflicts globally) – The stock market has responded well to confident statements from Trump and more frequent high level meetings between the countries on trade. While there remains real uncertainty, we believe that there will be tangible improvement on this front, including an announced agreement with small ‘victories’ for both sides.
• High US stock market valuations and earnings expectations – Today, with higher valuations and mixed earnings reports, equity valuations are becoming a little more expensive again. Forward earnings are trading about 4% higher than the long term average multiples.
• Global Growth – Investor concerns about continued slow global growth have resurfaced, particularly after the IMF (International Monetary Fund) cut its 2019 global growth forecast this week to a mere 3.3%. Growth rates were closer to 4% just 2 years ago. The IMF stated that the world economy faces downside risks brought by potential uncertainties in the ongoing global trade tensions, as well as other country- and sector-specific factors.

So if we look at this little scorecard, three of the five are pointing more positively for stock market returns, and the last two are more negative.

Where that leaves TriDelta after the very good returns in the first quarter, is that we have become a little more cautious. In early January, we went from higher cash levels in our funds to being fully invested in stocks. Today we are holding some cash taking a small amount off the table from Canadian and global stocks. We are not overly negative; just a little more cautious than early in the year. We are also monitoring technical indicators to see if further defensive measures should be taken.

We are also lowering our small exposure to energy after a strong increase in oil prices this quarter.

U.S. – The Federal Reserve is not likely to lower rates unless we see a significant slowdown in growth. This is in part because they don’t see a strong case for lowering rates at this point, and they don’t want to send a negative signal to the marketplace. Medium and long-term rates have already come down meaningfully. We see this likely coming to an end, although medium and longer-terms yields are not necessarily rising back up for the time being.

Canada – There is a little more concern about slowing growth in Canada and the need for the Bank of Canada or the government to provide some form of stimulus. We don’t see short term rates falling in the near term, but there could be a drop later in 2019. The mid and long-term rates have already fallen meaningfully and we don’t believe there is room for much more of a decline unless the economy slows down dramatically.

We are currently leaning a little more towards straight, fixed rate preferred shares, as they offer dividend yields of over 5%, should benefit from the lower long-term bond yields and are much less volatile. Rate reset preferred shares continue to be undervalued with yields often over 5.5%, but they have shown greater volatility for longer periods than would be expected, and this could continue.

As this sector grows, it becomes even more important to understand the managers and those that have a longer track record of success. At TriDelta, we are sticking pretty close to the few managers that have delivered very steady returns and who we believe will be best able to adjust to a low interest rate environment, while strategically adding additional managers that we think can enhance portfolio returns, add stability to a portfolio or reduce volatility.

There has been a lot of talk about inverted yield curves and that it is a precursor to a recession.

An Inverted Yield Curve is one where short term yields are higher than long term yields.

Traditionally if you put money into a 5 year government bond you would expect a higher return than in a 30 day T Bill. This is due to a couple of main reasons. The first is that you will not have use of your money for 5 years vs 30 days, so there is a premium paid for locking in your funds. The second is that there is a bit of an uncertainty premium. If you invest for 5 years and interest rates go up, you are missing out on participating in those higher potential yields.

In an inverted yield curve, you have a situation where you are getting paid more for a short term investment than a long term one. This is not that common, and it is often caused by concerns about future growth, disinflation and expectations of future interest rate declines.

What creates the situation is when the market believes that interest rates will be moving lower, i.e. an expectation of future interest rate cuts by the central bankers, and there is demand to lock in longer term rates at higher yields before they decline. As more long bonds are bought, it pushes the yield down and continues until the market decides that these lower yields are no longer appealing. The end result can be an inverted yield curve. One other action that creates an inverted yield curve is when the Federal Reserve raises short term rates at a fairly fast pace and longer term rates don’t keep up.

The chart below lists the last 9 Yield Inversions in the US and duration until the subsequent recession. The average time lapse before a recession starts is 14 months in the 7 cases where there was a recession following a yield curve inversion.

If we keep in mind that there will always be a recession at some point in the future, and that there was not a recession for at least a year in 7 of the past 9 instances of inverted yield curves, we do not believe a recession is imminent in the U.S. If the Federal Reserve or US government react to declining growth rates, the economy can continue to grow in 2020 as well. Economists forecast that the U.S. grew at about a 1.5% pace in the first quarter of 2019 but expect 2.4% for the full year.

In Canada the current growth forecast for 2019 is down to 1.5% and could see further downside if there are negative developments on trade, housing or the energy industry. We will continue to monitor the data, but continued growth, albeit at a slow rate is our current expectation.

Overall, an inverted yield curve does not meaningfully concern us for the rest of 2019.

Overall, most clients had returns in the 4% to 7.5% range on the quarter depending on their individual asset mix.

Our 2019 Q1 returns were as follows:

Other news and items of interest:

• Taxes – if you or your Accountant have any questions, please don’t hesitate to ask.
• Tax Refunds – if you are receiving a tax refund it can be a good source of funds for doing 2019 contributions to RRSPs, RESPs, RDSPs and other savings vehicles.
• World Trade – in January 2019 trade was down 0.4% year over year. It has averaged a year over year gain of 5.1% over the past 25 years.
• Growth of Middle Class in Emerging Markets – Today India’s middle class represents 14% of the population (up from 1% in 1995). This is expected to grow to 79% by 2030 according to the Brookings Institute.
• Retirement Savings Gap – According to a U.S. study from 2017 by the Employment Benefits Research Institute, 64% believe that they need over $500,000 for retirement. Actual savings for the average 65 to 74 year old was $126,000.

Q4 2018 was much worse than it should have been in markets, and Q1 2019 was much better than it should have been.

This leaves us at the moment with lower interest rates, low unemployment, a little lower growth, continued trade issues and slightly elevated market valuations. Overall, that puts us in a ‘not too hot and not too cold’ place where we are fairly comfortable. We don’t believe that a U.S. recession will happen this year, and expect low to middle of the range stock market returns for the near future.

At TriDelta we will continue to be nimble while focused on the client’s long-term plans. Portfolios are designed to provide a diversified asset mix that is built appropriately for the goals of each client, with an eye on tax minimization.

Here is to a beautiful spring for everyone.

Cameron Winser VP, Equities

Ted Rechtshaffen President and CEO

Anton Tucker Exec VP and Portfolio Manager

Lorne Zeiler VP, Portfolio Manager and Wealth Advisor

Q4 and in particular December, was a period to forget from an investment perspective.

An example of the damage includes the following quarterly returns in their home currency:

Fortunately, TriDelta clients were cushioned somewhat from the damage by three main factors:

1. A diversified portfolio that is not close to 100% in stocks.
2. Exposure to our select group of Alternative Investments that were mostly up in the range of 1% to 2.5% on the quarter.
3. The Canadian dollar decline helped to boost the return of foreign investments.

Most TriDelta clients ended the quarter down in the range of 3% to 5% depending on their exposure to stocks and overall asset mix.

As mentioned last quarter, the recent pullback has been caused by:

• Rising interest rates – which lead to higher borrowing costs for companies, and higher returns on lower risk investment alternatives like GICs (although they remain low historically)
• U.S.-China Trade Wars (and broader trade conflicts globally)
• Fears of higher inflation
• Declining earnings growth in the U.S. following the one time benefit of a new lower tax policy.

We are now fairly positive on stocks for the short term – and the rationale goes back to the four points above.

1. We see interest rates in a stable range in 2019 with few if any rate hikes. While this is somewhat a comment on the general economy, we believe that stock markets will mostly react positively to news of slow to no rate hikes.
2. While the U.S.- China Trade war is the hardest to predict for a variety of reasons, we do believe that there is a good chance of a “deal” taking place in the next few months and the stock market reacting positively on a global basis. The Chinese stock market fell 24% in 2018. U.S. markets were negative. Both countries are looking for a way to show investment growth in 2019 and the one area they can control is the negotiations and substantive agreements.
3. As Oil prices fell 40% in the quarter, this has had a meaningful impact on inflation. Central banks in Canada and the U.S. like to keep inflation in the 2% range. Canadian inflation dropped to 1.7% in November, and U.S. inflation rate was at 2.2%. These rates ease some fears of higher inflation.
4. The 20 year average of stock market valuations in the U.S. as measured by price/earnings, is 15.8. On December 31st it stood at 14.4 times earnings, almost 10% below its average. The TSX has a forward price earnings ratio of only 13 times earnings, compared to its 10 year average of closer to 15 times earnings. For the first time in several years, stock markets are ‘undervalued’ with Europe, Japan and Emerging Markets trading at even lower multiples.

The last reason that we are more positive about stocks is captured in the chart below. The chart looks at the S&P500 since 1940, focused on the seven worst quarters it has experienced. It then looks at the market performance in the one year, three year and five year periods after that terrible quarter.

Most investors would have been happy with the one year return in six of those seven scenarios, and happy with seven of seven scenarios for three year and five year returns.

Essentially, the stock market tends to go up in the long term. When it has a particularly bad period, it tends to bounce back, based in part on simply catching up to fair value.

Our positive outlook is not blind to some of the prevailing risks, which include:

• higher U.S. borrowing costs
• increasingly high debt levels (both government and consumer)
• political gridlock
• unwinding of previous stimulus

Nevertheless, we are looking to see decent stock market growth in 2019.

1. Better than average stock market returns in most major markets including Canada and the U.S., barring a breakdown on global trade.
2. Interest rates being mostly flat with maybe one ¼% increase in both Canada and the U.S with a real possibility of an interest rate decline in Canada before the year is out.
3. The Canadian dollar being fairly flat vs. USD, but being tied more to oil than we have seen in the recent past.
4. Oil prices rising, but only slowly.
5. Preferred Shares having a strong year, bouncing back from their late year steep declines.
6. Marijuana stocks will see a general decline overall as high valuations and uncertain revenues work their way through, but with increasing gaps between the winners and losers. In fact, we expect to see several bankruptcies in 2019 among the weak players in the market, and at least one major blow up of a more established firm (we just don’t know which one).
7. Corporate bonds outperforming Government bonds.

Based on these short term beliefs, we have reduced our cash weightings in our stock funds down to essentially fully invested in both our Pension and Growth funds.

In the Growth fund, which is more active in terms of adjusting industries, we will be adding to Energy and Industrials, while reducing Telecoms and Utilities.

In the Fixed Income world we are looking to add some High Yield Debt and Preferred Shares to the fund.

Overall, most clients had returns in the 0% to -5% range on the year depending on their individual asset mix. Given the major stock market declines, most of our clients did much better than the average Canadian investor for the year.

Our 2018 returns were as follows:

1. The 2019 Edition of our TriDelta Retirement Income Guide has just been released. It contains a wide range of tips and information on the different sources of retirement income, and how best to draw that income. Ask a TriDelta Wealth Advisor for a copy.
2. A reminder that now is a great time to top up TFSA’s. They have added $6,000 per person to contribution room in 2019. If you have the funds, January is also a good time to do 2019 contributions to RRSPs, RESPs and RDSPs, as appropriate, as it will help you to have tax sheltering for a full year.
3. U.S. consumer debt payments as a percentage of disposable income were 9.9% in 2018. That is the lowest rate in over 30 years.
4. For a 65 year old couple (male and female), there is a 22% chance that a male will reach age 90, a 33% chance that a female will live to age 90, and a 48% chance that at least one person in the couple will live to at least age 90, so investors need to plan for the long term.
5. According to studies by the U.S. research firm Dalbar, in the 20 year period from 1998 to 2017, the S&P 500 averaged a 7.2% annual return, the U.S. bond market averaged a 5.0% return, yet the average U.S. investor only averaged a 2.6% annualized return. The reason for this underperformance is primarily attributable to too much trading and shifting of portfolios, particularly moving away from risk after stock markets have declined, and too heavily to stocks when markets are peaking.

As long term investors know, down markets eventually recover and great markets don’t last forever. Right now we believe that we are in the ‘down markets recover’ stage and are acting accordingly.

In the very short term, anything can happen (all it takes is one Tweet). Having said that, most stock markets historically go up 7 years out of 10, and are more likely to go up in the year after having declined. Even for our older clients, there is usually lots of time to recover. There is an old adage that says “Investing is about time in the market, not market timing.”

At TriDelta we will continue to be nimble while focusing on the long-term plan. This would include a steady and diversified asset mix that is built appropriately for the goals of each client, and an eye on tax minimization.

Here is to a better investment year in 2019.

Cameron Winser VP, Equities	Ted Rechtshaffen President and CEO
Anton Tucker Exec VP and Portfolio Manager	Lorne Zeiler VP, Portfolio Manager and Wealth Advisor

We wanted to kick off the fourth quarter with some TriDelta news, by announcing the opening of TriDelta’s Edmonton office.

The office is led by Arlene Pelley, an industry veteran who is joining the firm and planting the TriDelta flag in Western Canada. Click here to learn more about Arlene’s background.

Turning from TriDelta growth to the markets, we see reason for some caution after a meaningful pullback to start October and negative returns for most equity and fixed income indices in September. Through this period, we have been holding higher levels of cash at approximately 10%-15% in the equity funds, and while we see more short term volatility this month, we will be lowering our cash position shortly as the pullback is bringing with it lower valuations and opportunities to buy good companies at cheaper prices.

Looking at things from a purely 2018 point of view, the recent pullback has been caused by:

• Rising interest rates – which lead to higher borrowing costs for companies, and higher returns on lower risk investment alternatives like GICs (although they remain low historically)
• U.S.-China Trade Wars (and broader trade conflicts globally)
• Fears of higher inflation
• High US stock market valuations and difficulty in companies beating high earnings expectations

Of interest, the reason it is so hard to predict the exact timing of a pullback is that the factors listed above are not new. Interestingly, on the trade front, the signing of the new NAFTA deal (USMCA) should have somewhat lowered trade concerns in Canada, US and Mexico, but all of those equity markets are down since September 30. These have all been issues of concern for many months, yet for some reason early October has been the time for a meaningful pullback. It is worth noting that in a typical calendar year, equity markets experience at least two drops of 5% and one drop of 10%+, yet in the vast majority of cases, equity markets still return highly positive returns year over year.

Looking at things beyond 2018 and from more of a long term seasonal perspective, the timing of the pullback and heightened volatility is not unexpected. Also from this same seasonal perspective, the weeks ahead may bring solid investment returns.

The chart below is the VIX index, which looks at volatility in the U.S. markets. The chart shows that over the past 27 years, volatility has definitely peaked in October. Studies of the S&P/TSX in Canada have demonstrated similar high volatility levels in October.

Source: www.cboe.com/products/vix-index-volatility/vix-options-and-futures/vix-index

Of interest, high volatility does not necessarily translate into poor overall returns. In fact, for the S&P500 index in the U.S., since 1950, October has had an average monthly return of +0.78%. Historically, the two best months of the year are November +1.39% and December +1.53%. Over the past twenty years, the TSX has had the following returns over the same three months: 0.7%, 0.9% and 1.8%.

The chart below comes from equityclock.com. It looks at the TSX over the past 20 years from a seasonality perspective, meaning, when is the most and least productive times of the year to invest. Of interest, it suggests that one of the best times for new investment is around mid-October.

From a purely seasonal standpoint, it suggests that it is worth hanging on through the October volatility as there is often a strong payoff during the fourth quarter.

In addition, in both Canada and the U.S., the third quarter has historically been the worst quarter for returns while the fourth quarter has been the best.

Interest rates: one of the most talked about concerns for the stock market is the fear of rising interest rates. Over the past 30 years, there have been six periods of meaningfully rising bond yields as measured by the U.S. 10 year Treasury yield. During those periods of rising rates, the stock market actually performed very well – as the following two charts from a study for CNBC show.

The market rose big during five of those instances and only fell slightly during the one lagging period.

As the chart above shows, the S&P 500 rallied 23 percent on average in those time periods and the Dow Jones Index was up in all six periods.

The message is that rising bond yields often do not correlate directly with declines in stock market returns. It also should be noted that bond yields in the past week have been flat to declining.

When we factor in the reasons for the pullback, our expectations on earnings growth (which remain reasonably good), the history of similar pullbacks and seasonality effects, we think there are more reasons for optimism than pessimism.

In terms of TriDelta’s direction from here, we have been a little cautious on stock markets but we are feeling a little more comfortable in deploying more capital following the early to mid-October declines. We have reduced our weighting in non-North American and Emerging Market stocks in our Pension fund, and will be using some of that cash to soon add to Canadian and to a lesser extent, U.S. names.

We have been adding some money to Preferred Shares. There are many good quality preferred share issuers yielding over 5% in tax preferred income. In some cases, we even see the potential for some small capital gains opportunities to add to the 5%+ yields.

In the bond market, we have been adding to some names in the “belly of the curve”, the 5 year to 10 year maturity range. We have added recently-issued bonds from BMO and TD maturing in five and ten years respectively and currently paying in the mid-3% range. We also added a bond from first-time issuer Sysco Canada (a U.S. based food services company), with a seven-year maturity, paying 3.7%.

One of our beliefs is that there is a real possibility that the projected interest rate hikes from the Bank of Canada may not fully play out. The market is currently anticipating approximately four interest rate hikes by the Bank of Canada over the next 12 months. While we do expect a hike at the end of this month, we think additional hikes are less certain due to slowing housing activity and moderating inflation pressures. As a result, we are seeing some signs to be a little more bullish on bonds for the first time in a while.

In terms of currency, it was informative to see that the Canadian dollar climbed for only a very brief time and a relatively small amount upon the approval of the USMCA (or NAFTA for those of us who are resistant to change). We are fairly neutral on the dollar at this point, but would look to be more exposed to the Canadian dollar (i.e. sell some US$ back to CDN$) if we see our dollar get down under 76 cents.

Overall, most clients had returns in the 0% to 1% range on the quarter, with more growth oriented clients having a weaker quarter based on the Growth fund’s negative return.
Looking specifically at the third quarter of 2018:

By comparison almost every equity and fixed income market outside of U.S. stock markets had a weak quarter – especially in Canadian dollar terms.

The TSX was down 1.3%.
Euro Stoxx was down 2.1% in Canadian dollars.
The UK Based FTSE was down 4.4% in Canadian dollars.
Hong Kong based Hang Seng was down 5.0% in Canadian dollars.
The Canadian Bond Universe was down 1.3%.
On the other end, the U.S. S&P500 was up over 5% in Canadian dollar terms.
The Canadian Preferred Share index was up 1.5%

These numbers do speak to the value of a portfolio that is diversified globally and by asset class. At TriDelta we talk a great deal about lowering volatility, and the third quarter of 2018 was a good example. While most of our clients were flat to slightly up on the quarter, the major individual stock markets saw returns ranging from up 5% to down 5%. By limiting the downside, we are better able to maintain our long term investment focus, and reduce the temptations to change course after markets decline.
Even with a fairly flat last quarter, most TriDelta clients are up around 5% over the past 12 months to the end of September.

By planning long term and adjusting a well-positioned investment mix a little along the way, we can avoid the pull towards major changes when people are most nervous. There is a lot of reason to believe that there are some good returns ahead between now and February, and you don’t want to miss them. This doesn’t mean that all is fine in the world and things will only go straight up. What it means is that your investment portfolios already have some pretty good shock absorbers. This should help you to avoid getting too aggressive in good times and too nervous in bad times.

We hope that you get to enjoy some spectacular fall foliage whether in Ontario, Alberta or other parts of the country, and we thank you for your continued trust.

Cameron Winser VP, Equities	Ted Rechtshaffen President and CEO
Anton Tucker Exec VP and Portfolio Manager	Lorne Zeiler VP, Portfolio Manager and Wealth Advisor