EQUITIES COMMENT: "It Was a Very Good Year"
Global stocks surged over 20% in 2019. The TSX Composite was ahead 23% including dividends. In Canadian dollar terms, the S&P 500 clocked in a gain of 25% and EAFE (Europe, Asia and the Far East) returned 17%.
Stocks demonstrated resilience against a background of a synchronized global slowdown in manufacturing and trade. This weakness had a lot to do with U.S. China trade negotiations and increased tariffs on Chinese goods. Actions by central bankers saved the day. Three rate cuts by the influential U.S. Federal Reserve helped to calm fears of a recession and support the economy. Many other central banks also reduced rates or added liquidity to keep growth expanding. News of a Phase 1 U.S. China trade deal buoyed markets in the fourth quarter.
The standout sector in both Canada and the U.S. for the year was Information Technology. In Canada, Technology stocks rose 64% and, in the U.S., they gained 48%. These stocks benefitted from strong sales growth, in some cases boosted by acquisitions. As well, investors were willing to pay more for these growth stocks so valuations increased. Shopify was the star Technology stock in Canada with a 174% return.
The only sector with negative results was Canadian Health Care. Marijuana stocks suffered from disappointing financial reports, production problems, executive turnover, funding shortages and regulatory issues.
What about 2020? Will it be a very good year? We expect 2020 to be a good year with returns between 7% and 10% including dividends. This is in line with the long-term average return of stocks.
Our optimism is based on continued low interest rates which will support economic growth. As well, low bond yields increase the attractiveness of dividends. In Canada, the TSX has a dividend yield of 3% compared to a 10-year Canada bond yield of 1.7%. In the U.S., the S&P 500 dividend yield is 1.8% compared to the 10-year treasury bond yield of 1.85%. Prior to the financial crisis, bond yields were normally much higher than dividend yields.
The price to earnings multiple or p/e (a key valuation measure for stocks) also benefits from low bond yields. The lower the bond yield, the higher the p/e that can be justified. Using the December 31st TSX Composite value of 17063 and our 2020 earnings forecast of 1100, the p/e multiple for the TSX is 15.5. Using a value of 3231 for the S&P 500 and a 2020 earnings estimate of 175, the p/e is 18.5. These levels are slightly above long-term averages. Our view is that p/e multiples should be higher given the level of bond yields.
Other positive factors for stocks include:
Phase 1 U.S. China trade deal--Reaching this agreement meant no additional tariffs were implemented in December and some tariffs that were set earlier are likely to be rolled back. This is constructive for trade and business investment.
Conservative election win in the U.K.--The level of uncertainty associated with Brexit has diminished somewhat and this is benefitting confidence. The U.K. will be leaving the EU however, the terms of the new trade relationship still need to be negotiated.
An expanding economy is virtually a requirement if Trump wants to win the U.S. election.
On the negative side, geopolitical risks have increased:
Tensions between the U.S. and Iran have escalated. A large spike in oil prices could cause a global recession.
In Eastern Asia, unrest in Hong Kong and potentially Taiwan as well as further testing of nuclear weapons by North Korea could damage confidence and weaken growth.