Tricia Leadbeater’s Market Updates

January 2016: Q4 2015 market review and year ahead












S&P/TSX Venture (small cap)





S&P/TSX Materials





S&P/TSX Capped Energy (XEG)










S&P/TSX Financials







S&P 500





Euro Stoxx 50





England (FTSE)





MSCI Emerging Markets





TMX Universe Bond










Natural Gas (NYMEX)





WTI Crude



















2-yr Gov Cda




5-yr Gov Cda




10-yr Gov Cda




2-yr Treasury US




5-yr Treasury US




10-yr Treasury US




US/CAD spot




Source: Richardson GMP,, Thomson


Investment theme of the year: deflation

The spectre of deflation loomed over markets in 2015. It was the overriding factor that impacted returns in 2015, notwithstanding universal government efforts to achieve 1.5%-2% inflation targets through money printing and asset purchases. Their hope is that by flushing capital markes with low return cash, investors will buy and bid up other asset classes, businesses will invest and consumers will spend. But still we are living in a world where very few assets or consumer goods are going up in value (think cars and computers, and what you paid five years ago, versus the vast improvements you get for the same purchase price today). The big exception to the downward trend, is taxation and government obligations.

We think the deflation theme will dominate 2016 as well. Taxes and debt have the effect of compounding deflation in terms of consumers having less money to spend, and business have less to invest. Technology is driving large long term structural changes in consumption. For example, more efficient cars, improving efficiency of alternative energy, ability for teams to work effectively without plane travel, roboticization of jobs are all contributing factors in lower consumption of energy. Another major factor in declining energy consumption is continuously improving (cheaper) methods of commodity extraction (also contributing to fewer workers and equipment required). We are in a cycle of commodity prices moving downward in part because the marginal cost of production keeps moving downward just as fast – so no supply is being taken off yet. An example of how much more efficient rigs and drilling techniques are can be seen below:


In 2011, one rig drilling one new well in the Eagle Ford play would add 200 new barrels of oil production. Today, one rig adds 800 barrels per day of production. Rig counts haven’t been indicators of future production levels for years now because of drilling efficiency. However, we are this year starting to see modest production declines in basins like the Bakken, Eagle Ford and Permian begin to fall back because of the massive drop in investment. But it will take much greater pull backs than what are occurring to get global markets balanced again.

As we examine a variety of investment classes, we see the forces of deflation pushing down value broadly. The TSX was down 11% last year, reflecting the dramatic decline in commodity prices that began in summer of 2014. While the more diverse U.S. market seemed resilient, a further look at the numbers is warranted. The U.S. markets have outperformed since the 2008 crisis, but this past year started to wane. If you strip out the “FANG” stocks of Facebook, Amazon, Netflix, and Google (add Starbucks, Salesforce, Microsoft, eBay, Priceline to round out “the nifty nine”) U.S. stocks were generally weak. The equal weighted S&P 500 return was -4.1% (versus the market cap weighted that emphasizes those very large companies). One commentator noted in December that the top 10 performing stocks in the S&P 500 were up 13.9% on the year, but the other 490 down on average 5.8% (, Peter Atwater of Financial Insyghts). Within the S&P 500 index, money was chasing a very small group of momentum stocks.


Cash returns zero in the US; and around 0.75% in Canada, perhaps less soon in Canada if the bond markets’ assumption of a rate cut is accurate. Achieving decent returns on savings is difficult. The unexpected rate cuts earlier in 2015 helped to boost Canadian domestic bond prices out of the gate in early 2015, but bonds were weak the last half of the year. The High Yield sector performed very poorly, as measured by the ETF “JNK”, down 12%. Commodities almost universally had a poor showing; REITs pulled back: the S&P Global REIT index in USD were down -3.37%; along with utilities, as measured by the S&P 500 utilities index was down -8.39% ( On the positive return side, outside of the small group of the “nifty nine” the U.S. dollar was one of the bigger stars of last year, moving up against all its trading partners. The USD rose 9% against its basket of trading partners (DXY index).

As the USD rises, commodities, which are priced in USD, fall. If we continue to see strength in the USD this year, we can expect weak commodity prices. But perhaps the more significant factor in commodity price weakness is the abundance of supply in a slow growth world. The commodities that Canada specializes in exporting: oil, gas, coal, base metals, are not growing in demand that matches the inventory buildups that have occurred since 2011. We expect the global economy at this point to stay on track for modest growth, but not the level of growth that will chew through the oversupply of commodities, especially not while heavily indebted countries like Venezuela or Brazil a driven to continue to produce as their key source of revenues. The World Bank expects overall global growth of 2.9%, U.S. GDP growth of 2.5%, and Europe to grow at 1.7% (a modest improvement from last year).

WTI crude price as of January 11, 2016:

Global supply and consumption trends,, January 2016:

The U.S. Energy Information Administration, among other industry analysts, expect that oil will be oversupplied into 2017.

We are investing assuming broad deflationary pressure continues. Much of corporate North America has been showing slowing earnings growth or even earnings decline over the last year. And it has been tough for the multinational U.S. domiciled companies that may have had steady overseas sales, but have to translate their global earnings back into the very strong USD. Johnson and Johnson is an example. The company had modest 1% sales increase over last year, but once they translated earnings into constant USD, sales in USD fell 7.4%. Within the U.S. economy, the trend of slowing earnings by domestic focused companies was masked the last few years by the zero interest rate policy of the Federal Reserve.

Some companies showed earnings per share growth by taking advantage extremely abundant and cheap capital to borrow to buy back shares, increase dividend payouts, and acquire growth through merger and acquisition activity. The year 2015 was in fact the best year ever for M&A activity at $3.8 trillion spent on deals, surpassing even 2007. Spending was concentrated in mega-deals in healthcare, but the mega merger of Anheuser-Bush InBev closed out the year, which is about to raise a record $46 billion in the bond markets to close the transaction. In a low interest rate and risk averse environment, money is seeking the comfort of relatively safe high grade corporate debt. This issue is priced to yield around 3.69% for 10 years and was reportedly oversubscribed with more than $110 billion in demand. This past week also saw record participation in a $21 billion U.S. offering of 10 year treasury notes.

As reflected by this deal, bond returns are expected to be low in the investment grade space, and the high yield (“junk”) spectrum of the bond market is still very risky, especially given its overall weighting to resource producers. The rising interest rate environment in the U.S., and the rising aversion to risk makes us especially cautious of the high yield space or going very long in duration. To provide examples of what to expect from the bond markets, current Canadian corporate bond yields are: 3 year Manulife: 1.83%; 5 year Royal Bank of Canada: 1.94%; 7 year Telus: 2.88%.


Here in Calgary and Alberta generally, it feels like ground zero for deflation. And what happens in Calgary does affect the rest of the national economy, as oil and gas spending was a major driver of growth in other areas, like manufacturing, technology R&D, financial services, construction, and not the least, provincial transfer payments. (A whole other discussion but consider that there is likely only one “have” province today, BC). It is astonishing how complacent the rest of Canada is about the demise of the Alberta economy, especially because of the transfer payments that have been happily received, pulling up the average standard of living across Canada. Ironically, due to the three year rolling average calculation that is used, Alberta has to continue making these distributions for the year ahead, and now may have to borrow to meet this obligation.

Downtown office vacancy is at 18% and expected to go over 20% over the next two years, as several new developments add an additional 3.8 MM square feet of space to the existing 44 million square feet. Parking rates are going down, with special discounts on Fridays and Mondays, reflecting the new work week reality at many firms. We are hearing of multi-year commercial leases in the core being offered for the price of covering operating costs. Residential vacancy is moving up as well, to about 5% in Calgary (which is arguably a more sustainable rental market from what we had). Still, landlords are starting to offer incentives to entice apartment renters. Home buyers seem to be waiting to see if they can get cheaper prices in the future, with the volume of sales down 26% from 2015. Housing starts are now slowing. Some areas in Canada escaped the forces of housing deflation last year, like Toronto and Vancouver, which saw their best years for their housing markets yet. But the demand for housing in these cities may not be reflective of real strength in their local economies. Canadian Mortgage and Housing Corp. (CMHC) estimates that the share of foreign ownership of condos in Toronto and Vancouver grew by 22 and 51 percent respectively in 2015 (globeandmail; CMHC). The estimates of foreign condo ownership are still small, around 3.3% in Toronto and 3.5% in Vancouver. Still, they were the drivers of demand and price increases in 2015. The boom in condo building has helped to keep the overall national jobs picture look resilient, but we expect that the rate of new construction must slow down at some point, likely this year. Demand from domestic buyers is expected to slow given the extremely leveraged state of the Canadian consumer – which also means loan growth at the banks will likely slow and delinquencies will rise in the especially vulnerable provinces of Alberta and Saskatchewan.

Broadly speaking, Canada’s core industries are not growth sectors: banking; resource extraction, pipelines and related infrastructure and services. You can see the loss of value of these sectors in how the mix of the TSX has changed over the last 3 years. In 2012, Energy and Materials constituted over 40% of the TSX index; today Energy represents 18.5%; Materials 9.5%, totaling now less than 30% ( The stalwart investment for Canadians, the financial sector, was down 6.8% last year. Institutional investors are looking past 2015’s strong earnings at the banks to what lies ahead: a slowing economy, over-leveraged consumers, over leveraged oil and gas sector, and a weak domestic currency.

Canada has been a tough market to be reliant on for investment returns for years now, tracking the turning point in commodity prices very closely. The 3, 5 and 10-year index returns are now: 1.52%; -0.65%; 1.44%. 2015 was the biggest single year drop in the value of our currency (down 18% against the USD); making absolute returns on the TSX even gloomier. The TSX provided exceptional investment returns during the years of exceptional Chinese demand for commodities, but this demand has declined dramatically, perhaps permanently. We think investors need to continue to look for growth outside Canada.

So where do we go from here?

Deflation is a force that makes it very difficult to achieve exciting investment returns broadly, especially when a key factor in the compounding of long term returns is going up: taxes. But we can find exceptions and individual investments that have tailwinds in their favour. Stock and asset selection will be paramount; income from dividends will be a significant component of investment return in many cases. Bonds will provide modest returns and we need to orient to the low yielding, shorter term, high quality bonds in this risk-averse environment, which as demonstrated above, may only yield 2-3% this year. Certain alternative funds that specialize in arbitrage and market neutral strategies are also in a sweet spot with tailwinds, being that they can benefit from market volatility and fewer dollars chasing the same trades with restrictions on proprietary trading within banks. In some cases, we are hearing that spreads are wider and positions are easier to put in place, an advantage for nimble traders.

Canadian investors need to care about absolute returns when the CAD looks set to stay weaker than we have been used to, and weak for the foreseeable future. The CAD is back to where it was in 2003, and looks to stay in a low 70 range, even lower, for at least the next year. Even if you are not a traveler to the U.S., Canadians need to be concerned as we rely heavily on purchasing imported finished goods and groceries from the U.S. The average Canadian’s lifestyle could be ground down over the coming years owing to the weak currency, along with higher taxes and debt burdens if they don’t have a way of defeating deflation on investment returns. We may see the “brain drain” again of our accomplished Canadian University grads leaving for higher wages and standards of living in the U.S.

For the year ahead there are key factors we are considering:

  • Currency of your investments

    • Expected stock market volatility from factors such as:

    • Federal rates rising while world monetary policy diverges, and working through the great distortion of years of abnormal borrowing rates. We may have several US hikes next year getting us to a 1.75% short term rate or higher. There is a re-pricing of assets and risk that comes with rate hikes. The first two weeks of January, post first hike, we are experiencing market volatility much like the “taper tantrum” of years past.

    • Effects of strong USD on emerging markets; and the Chinese RMB becoming a factor in global markets.

    • Geopolitical tensions running high.

    • The U.S. is still among the strongest economies – with continued jobs growth, a recession seems unlikely; however we could eventually see wage growth, which pressures margins.

    • Fragility of U.S. economy in the slow growth state and high currency value

    • Liquidity in the markets has not been strong – and stresses in Middle East economies due to the low oil price has led to equity sales.

    • Middle East sovereign wealth funds have been liquidating stock market holdings. At least $19 billion was drawn out of markets in the third quarter of 2015 by sovereign wealth funds. Morgan Stanley estimates that Blackrock alone, which does not disclose dealings with sovereign wealth funds, suffered redemptions of $31 billion during the second and third quarters. The main Saudi wealth fund, with $672bn in assets, has withdrawn $70 billion from external managers over the last year to support its economy. Four of the five largest sovereign wealth funds in the world are based in oil-rich countries. ( Expect more mass selling if oil prices stay depressed.

  • Corporate earnings growth slowing in many cases; buying at the right valuation key.

  • Canada still has huge headwinds, making growth companies here harder to find

  • We are still not confident buying oil stocks, even here: oil and gas companies will still struggle to make money or even stay in business. Very few, if any in Canada, unless integrated like Suncor, are economic today.

    • Fundamentals do not support real growth: demand is not keeping up with supply growth

    • The market is now a real competitive market, not artificially constrained by a monopoly regime. The marginal cost of production, which keeps going down on shale oil, will govern the price. Oil sands will struggle to be economic.

    • Cuts are still happening in the industry – BP announced this past week they are laying off 4,000 globally. Budget cuts are expected to be in the 15%-25% range.

    • WTI average 2015 price expectations low. The EIA is using an average of $38 WTI price for 2016, and $48 for 2017, with expected ranges between $25 and $46/barrel WTI.

    • Risks are still running high as very few producers globally, never mind North America, are running economic businesses at current price levels in the low $30’s. Many are not even fully covering costs here, and debt levels are high, especially for Canadian producers that tapped U.S. high yield markets over the last three years. There will be both solvency issues and opportunity in this space.

We are finding some areas that still have pricing power and growth for their products: the key component in our investment process is striving not to pay too much for those companies.

  • The Internet of Things: increased demand for connectivity of our lives to the Internet and data gathering (think Fitbit; connected vehicles; Nest thermometers; evolving uses of smartphones; Google and Facebook as data collector via everyday activity)

  • Security needs driven by increased interconnectivity and sensitive data being stored digitally.

  • Changing demands of China: materials consumption has slowed, but consumer spending in some areas has increased, like global tourism.

  • Healthcare costs and demands: we see this as a long term trend for long term care needs, drugs and medical devices.

  • Changing consumer goods consumption owing to technology developments: newspapers and cable subscriptions on the decline; on-demand online content consumption and advertising increasing.

  • Evolving uses of energy: more efficient vehicles, government policy and consumer demand for renewables

  • U.S. domestic consumer demand growth

We aim to use stock market volatility to our advantage: we buy target companies in the windows where we believe the market misprices them because of broad weakness. We like exposure to companies outside of Canada that can use cheap energy, cheap local currencies to their benefit, and whose economies are strengthening.

Hedge funds generally had a disappointing year last year, down 3% on average according to research firm HRF Inc. Many high profile US managers had a very negative year (, however the managers we used provided positive returns with less volatility than the stock market, and we plan to keep investments allocated to them in the year ahead.

Bonds, short term and high quality, may provide modest growth, but we expect 2-4% from this asset class this year. Cash yields less than 1%.

In conclusion, it is probable that making money will continue to be challenging this year, as it was last year. In a world where investors are generally risk averse, having some cash and low risk/return investments will be helpful for preserving capital, but we are still looking to the stock market for opportunity.

Please feel free to contact me with your comments.


Tricia Leadbeater
Director, Wealth Management


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