Uncertainty remains a theme in 2017
By Alfred Lam, CFA, Senior Vice-President and Portfolio Manager, Multi-Asset Management
Last year was full of surprises – Britain’s decision to leave the European Union, OPEC’s decision to cut oil production, Donald Trump winning the U.S. presidential election and the subsequent sell-off of sovereign bonds on higher inflation expectations, to name a few. All of these events led to changes in asset prices. Some benefited our portfolios while some did not. We invested diversely and generally defensively, and our portfolios finished the year with positive returns and low volatility, especially when compared to the changes in individual asset classes in response to these events.
The Canadian stock market was the world’s best-performing developed equity market in 2016, partly because of the strong rebound in energy and other resource sectors. We did not fully participate in the downside of the market in previous years when commodity prices were correcting aggressively and in 2016, we did not fully capture the upside. We continue to benefit from not owning Valeant Pharmaceuticals, a former top-performing company in the Canadian market whose share price has fallen consistently for another year. Our balanced and equity-centric portfolios reached new highs at year-end while the income-centric portfolios were moderately lower compared to the peak values reached during the fall of 2016.
Going into 2017, we remain defensive as stock valuations are above fair value and the “Trump effect,” which has pushed valuations higher since the election, is still largely an unknown. We recognize that change can lead to a positive or negative outcome, but the markets seem to be putting too much weight on the bright side. No one knows whether new governments and their policies will result in inflation or deflation, or economic growth or contraction. Furthermore, holding cash may not offer the best protection in a world filled with uncertainties. For example, U.K. residents who held cash to protect against uncertainty from Brexit did not achieve their intended result. While the face value of the cash (sterling) has not changed, its purchasing power has decreased as a result of the depreciation of the currency.
We expect only modest growth from the stock markets, and some downside pressure if Trump fails to deliver on his growth promise. The good news is that the opposite outcome – lower-than-expected growth – likely will lead to lower inflation expectations and higher bond prices. Investors should pay equal attention to both asset classes and consider the upside and downside of “Trumponomics.” News headlines may convince investors to favour the upside but the risk of under-delivery should not be ignored. Until there is more clarity and valuations become compelling, our portfolio positioning will be “boring” based on our decision to protect capital, backed by our process aimed at buying low and selling high.