The rear view mirror – Chalten Q4 2015 Investment Review

Welcome to the Q4 2015 installment of the Chalten Investment Review.  Partway through January one can’t help but feel that Q4 was an investing lifetime away! The rearview mirror reflects a status quo very different to what we’re experiencing now.  For some, the recent volatility will feel like chaos and panic, for some it will feel like opportunity.  The important thing is not to abandon your plan.  Your plan should be designed to wring opportunity out of market situations like this – opportunities to rebalance, opportunities to buy low, opportunities to harvest tax losses and opportunities to prove to yourself that you are able to stay the course.  Do not abandon the plan.  Have faith that good process will lead to good outcomes but recognize that your faith will be rewarded over the long run, not every day, every month, or even every year.  The only way investors achieve long run average rates of return is to be in the market during all the moments of euphoria and all the moments of panic, all the while dispassionately executing a disciplined plan.  And remember, while the rearview mirror reveals all, it is very dangerous to try to infer correlations or causality between past events, even if it seems blindingly obvious. While the current market environment has probably sent most armchair quarterbacks and their rearview mirrors scrambling for cover for a few days, rest assured they’ll be back with robust explanations and forecasts.

But for now back to Q4.    

Q4 Market Review

Perhaps the most anticipated and debated economic event of the quarter was the US Federal Reserve policy-making meeting in December.  The Fed announced that it would be moving away from its seven year long accommodative policy of near zero interest rates.  Markets seemed to have already anticipated the increase, having born witness to the same data points the Fed uses – employment, economic growth, inflation and spending levels – which all pointed to an acceptable environment to begin the climb down from the prior policy stance.  While the Fed doesn’t respond to stock market movements per se, maybe the Q4 uptick in the US stock market gave them an extra boost of confidence.  In Europe, markets edged upward as bankers and speculators hoped that quantitative easing by that region’s monetary authority, the European Central Bank (ECB), would continue. However the early December ECB announcement left many disappointed.  Economic data in Brazil continued to disappoint in Q4.  In Asia, the Chinese equity market performed relatively well and the Chinese government continued to support the economy with interest rate and bank reserve requirement cuts.  Overall, however, emerging market stocks underperformed their developed market counterparts in Q4 and in 2015 as a whole.   Quality concerns seemed to govern returns in other asset classes also as local currency denominated emerging market debt and high yield debt underperformed on a relative basis. 

And we start the next paragraph the same way we started it after Q3 – “and then there’s Canada”.  As we have pointed out previously most investors tend to have a home country bias with respect to their investments.  Canadians especially tend to concentrate their investment positions in holdings of Canadian stocks and bonds.  Even investors holding a broadly diversified Canadian Equity fund are not nearly diversified enough as the Canadian stock market is heavily weighted towards the financial, energy and materials (mining) industries.  Likewise, our economy is weighted to those same industries so Canadian dollar concentration is a double whammy for Canadian investors when commodities and the companies that produce and finance them are underperforming.  For Canadians whose livelihoods are directly tied to the energy and materials sectors, it must feel like a triple whammy.  Spending by Canadian energy firms dropped by 30%, resulting in an estimated one percentage point decline in GDP for 2015.  Factory activity contracted for the fifth consecutive month in December.  Household indebtedness reached record levels.  On the other hand, Canadian house prices surged an average of 12% in 2015 according to the Canadian Real Estate Association – perhaps no surprise because for the marginal foreign buyer, it must look like our whole country is on sale.  The Loonie fell nearly 4% against the US dollar in the fourth quarter alone leaving it over 19% down relative to the Greenback for the year. 

Perhaps the stock market performance reflected some combination of the above, perhaps it’s foretelling of events yet to unfold.  In any case in Q4 the total return of the S&P/TSX Composite Index was -1.4% and -8.32% overall in 2015.   This compares to a Q4 and 2015 total return for the US market’s S&P500 of +11% and +21% respectively and for the MSCI EAFE Index of +8.6% and +18.8% respectively with much of the return differential clearly being due to Canadian dollar depreciation.

For Canadian investors, Q4 and indeed all of 2015 would have been a good time to be diversified internationally.  Of course it all may reverse going forward however it’s dangerous to chase the market and as we stated in our Q3 review, “a well diversified global portfolio allows you to capture positive returns when and where they occur and avoid concentrated specific industry and currency risks.” 

Financial Planning topics of interest

With a new government in power, change cometh and there is lots to consider from a financial planning perspective. 

  • For your taxes, you can expect a tax cut for taxable income in the range between $44,700 and $89,401 but a new 33% rate on income over $200,000.
  • The TFSA limit falls back to its prior annual contribution limit of $5,500 adjusting upward over time for inflation. For those who have never contributed to a TFSA and have been an adult resident in Canada every year since 2009 you’ll have $46,500 of unused contribution room from the beginning of 2016 – a good place to hide investment returns from those high tax rates. 
  • Family income tax splitting will also get the chop although pension splitting, spousal RRSPs, and spousal loans still offer the opportunity to utilize your family to lower your tax bill.
  • As the year unfolds look for more details on the new government’s plans to evolve CPP and OAS.

Warren Buffett said, “In the business world, the rearview mirror is always clearer than the windshield.” We humbly borrow from Mr. Buffett’s wisdom and remind you once again that while the rearview mirror might be helpful for you to make sense of the world after events unfold, beware of prognosticators who extrapolate history and forecast the future based on what they perceive to be clear correlations and trends. The world is complex.  We advise you to continue to believe that good process will yield good outcomes over the long run but that flip-flopping your approach in response to short term market movements will ultimately not serve your best interest. Plan well and look forward with confidence. 

Good luck in 2016!