Manager commentary - December 31, 2018

Despite an exceptional rise in U.S. business profits, the decision by the U.S. Federal Reserve (Fed) to continue normalizing its monetary policy and the escalation of U.S.‐China trade tensions have created a highly volatile environment on Wall Street. This resulted in the S&P 500 Index posting a drop of nearly 15% in the fourth quarter of 2018, its worst quarterly performance in a decade. The last month of the year was particularly painful, recording a drop of 9.2% – the worst December since the 1930s.

The most important factor affecting global financial markets over the year was probably the Fed’s monetary policy tightening. The correction in the fourth quarter is a reminder of the impact that tightening liquidity conditions in financial markets can have on portfolio returns.

When the Fed raises its key rate, two phenomena are usually observed: 1) increased volatility in the markets and 2) stock market value, measured by the ratio of price to profit, contracts; that is, investors are willing to pay less to invest in markets despite an increase in corporate profits.

Further adding to uncertainty, trade tensions created by President Trump were omnipresent throughout the year. The renegotiation of the North American Free Trade Agreement (NAFTA) and, more recently, U.S.-China negotiations, took center-stage. At year-end, a truce seemed to have been achieved between the two superpowers, which agreed to speed up negotiations during the first quarter of 2019.

Moreover, several geopolitical risks made headlines throughout 2018, with North Korea, Iran, Brexit and Italian politics topping the list.

Brexit was the centre of attention in the fourth quarter. The U.K. House of Commons vote on the deal reached between Theresa May and the European Union was postponed to January 2019 due to a lack of support in December. We are now navigating in complete uncertainty about what is to come.

In Canada, a factor that probably contributed to the slowdown was weakness in Canadian oil prices. In fact, not only have oil prices been under severe pressure across the world in the fourth quarter (the price per barrel for American crude fell from $75 to $45 at the beginning of October), but the price per barrel of Western Canadian Select slid to around $13 in mid-November. The reason for this major price difference was the difficulty in transporting heavy Canadian crude to export destinations (mainly the U.S.) because pipeline capacity and rail transportation were lacking, leading to a stockpile in Alberta.

As for the bond market, yields started the fourth quarter higher after news broke of a new NAFTA deal, the United States-Mexico-Canada Agreement (USMCA). Rapidly, fear of deterioration in U.S.-China trade negotiations, concerns surrounding Brexit and fear of overtightening by the Fed resulted in equity volatility. The Fed continued to maintain a restrictive tone on its monetary policy at the start of October. This triggered the first decline for risk assets. The central bank’s December release, perceived as accommodative, was not accommodative enough considering the market's state of mind at that time. This volatility led to a safe-haven bid in the bond market, mostly in the 10-year sector. Oil prices also started to fall early in the quarter and continued through to quarter-end. Prices dropped significantly on supply concerns. Although the strong decline in oil prices knocked down Canadian yields the most, these lower rates were not specific to Canada, as 10-year yields also closed the quarter lower in the U.S., Europe and Japan.

The equity sell-off in the fourth quarter impacted the fixed-income markets on both sides of the border. Canadian outperformance in yields last quarter was due to the outsized effect of lower global oil prices on the domestic economy. Also, overall financial conditions worsened, reducing the probability of Fed and Bank of Canada rate hikes expected by the markets.

During the period, the Canadian bond market, measured by the FTSE Canada Universe Bond Index, posted a gain of 1.7% (1.4% in 2018). The FTSE Canada Short Term Bond Index posted a return of 1.4% (1.9% in 2018). Finally, the FTSE Canada Long Term Bond Index rose to 1.9% (0.3% in 2018).

The Fund has a clear focus on capital preservation. It invests primarily in money market instruments that mature in less than 365 days. At quarter-end, the Fund was invested essentially in Treasury bills. The fund manager continues to focus on high-quality issuers and maintaining a high degree of liquidity in the Fund. The fund manager does not take any unnecessary credit risk in the selection of securities, as the main investment objective of the Fund is capital preservation and liquidity.


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