Donald Nesbitt & Mikhail Alkhazov – Ziegler Capital Management
The U.S. economy expanded 2.0% in the third quarter, a significant slowing from the second quarter’s 3.9% increase, and setting up for another mediocre year of growth. Third quarter growth reflected healthy increases in personal consumption, investment and government spending, but was offset by weakness abroad.
Markets remained volatile in the fourth quarter. Movements in developed market government bond yields were mixed in the fourth quarter; while yields in the US, UK and Australia rose – in large part driven by the US Federal Reserve’s decision to raise interest rates for the first time in almost 10 years – yields in other markets generally moved lower, reflecting investor concerns over further declines in commodity prices and the state of the Chinese economy. Changes in credit spreads were varied, with movements depending on quality, sector and maturity. Developed market equities rose sharply, rebounding from the selloff experienced in the third quarter. The US dollar rallied against most major currencies, with the Canadian dollar declining further.
Joseph Sirdevan & Scott Connell – Galibier Capital Management Ltd.
The 4th quarter of 2015 was mixed for investors as concerns about the pace of the economic recovery in the western world were intensified by continued evidence of a significant slowdown in China as well as acts of terrorism in Europe. The Federal Reserve was finally able to engineer a “lift off” in rates in the U.S. which, along with continued supply and demand imbalances, put additional downward pressure on commodity prices. These developments in turn had a further damaging effect on resource intensive markets such as Canada’s. With equity prices falling, our investment team was doubly busy applying the Galibier process to identify companies that meet our criteria and to identify new investment opportunities. To this end, we did make several changes to the portfolios during the quarter.
The year 2015 was certainly eventful as Greece, weakness in crude oil prices, a strong U.S. dollar, China, emerging markets, and the endless banter on when the Federal Reserve (Fed) would finally raise interest rates dominated the headlines. While the year was difficult, there were areas of the market that have done quite well, particularly in the consumer discretionary and health care sectors. Investors who have made contrarian calls on the energy and materials sectors have yet to be rewarded. There was a defensive tone in the markets as large-cap stocks represented by the S&P 500 Index finished 2015 with a slight gain of 1.4%* due to dividends outperforming the Russell 2000 Index, which lost -4.4%*.
The fourth quarter of 2015 saw continued divergence between the Canadian and US equity markets, especially when viewed from a Canadian dollar perspective. Canadian government bonds, corporate bonds, and preferred shares performed better than the broader Canadian equity index while equity income securities lagged. In our view, the three main drivers of broad capital market movements during the quarter were the US Federal Reserve’s increase in the Federal Funds rate, movement in the CAD / USD exchange rate, and the ongoing weakness of the energy and commodity complex.
Note: All returns are in Canadian dollars
Source: Bloomberg, NGAM Canada LP
EXHIBIT 2: MONTHLY MARKET PERFORMANCE
Equity markets started the quarter off with relatively strong performance in both Canada and the US but tapered off rather sharply going into December as energy markets continued their slide, global economic data disappointed and US economic data began to reflect the headwinds of a strong US dollar. Incrementally better US labour and inflation data translated into higher market expectations for a rate increase from the US Federal Reserve which arrived in the form of a 25 basis point increase in December. The divergence in monetary policy between Canada and the US helped Canadian investors holding US equities as the US dollar appreciated +3% versus the Canadian dollar over the quarter.
Source: Bloomberg, NGAM Canada LP
EXHIBIT 3: GOVERNMENT BOND YIELDS DIVERGED
During the quarter, fixed income markets responded largely as one would expect, with Canadian government bond yields declining due to increasing economic weakness while US government bond yields moved up as the US Federal Reserve raised the Federal Funds rate for the first time since the Global Financial Crisis. Credit spreads continued to tick up as a result of increasing economic stresses globally, which contributed to the tepid corporate bond returns achieved by investors.
EXHIBIT 4: EQUITY SECTOR PERFORMANCE
In Canadian equities, we saw strength in companies exposed to secular growth drivers and those seen representing relative safety as investors rewarded Information Technology, Financial, and Consumer Staples companies. Notably, despite the weakness in precious metal prices themselves, gold equities staged a rally which helped the Materials sector put up positive fourth quarter returns. Investor concerns around the Canadian consumer grew over the quarter which sent the Consumer Discretionary sub-index down by 5%. The further collapse in Valeant Pharmaceuticals (VRX) drove down the very concentrated Health Care sector.
In the US, all sectors were positive, however, secular and cyclical growth beneficiaries were particularly strong as Health Care, Information Technology, Industrials, and Materials performed well. Across both Canada and the US, Utilities paused ahead of the Fed rate hike and anything related to the energy market continued to perform poorly.
After a two-quarter pause, the US dollar reasserted its uptrend and helped to keep the pressure firmly on the commodity complex. While the US Dollar Index briefly crossed through 100 in March, it reasserted its trend in November and crossed back above 100; a level it has not seen since 2003. In contrast, WTI crude oil dropped below $35 per barrel in December, a level it has not seen since the 2009 crisis, and 2004 prior to that. Natural gas crossed below $2 per mmbtu, a level it has not seen since 2012.
While the current environment for commodities looks especially dire, looking forward, it’s important to remember that commodities are driven by supply and demand. At current strip pricing, the bulk of global production is uneconomic. Therefore, producers are losing money and have no incentive to drill additional wells, beyond generating enough cash flow to service their debts. Ultimately fewer wells implies lower production and it is our belief that future global oil demand is highly unlikely to dip below 95 million barrels a day on a sustained basis. Thus, it is from this condition that higher commodity prices and the next energy bull market will emerge. With that said, the time it takes for the market to clear remains uncertain and could be substantial. We do not think it’s wise to commit large amounts of capital too far ahead of actual improvement in the supply and demand outlook.
NEXGEN FUNDS & INVESTMENT OUTLOOK
2015 was clearly a difficult year for Canadian focused investors. While we were not overly enthused by our Fund returns for 2015 we were able to outperform the markets largely as a result of underweighting exposure to Materials and Energy stocks, although a zero weight would have been the optimal positioning. With the benefit of hindsight, we did not fully anticipate how broadly the commodity weakness would impact stocks outside of the Energy and Materials sectors. Investor concerns around second order effects hurt our holdings in companies such as WestJet Airlines, Auto Canada, and Canadian Western Bank which detracted from overall performance. Conversely, exposure to strong sectors and US growth stocks such as Microsoft, CVS Health, and Abbott Laboratories were a significant contributor to returns, as were well-timed sells of positions in Goldcorp, West Fraser Timber, and Disney.
In accordance with our view of increasing market volatility, a view that we have highlighted in 2015’s second and third quarter commentaries, we generally have not been adding risk to the portfolios over the past several months although we continue to hold some smaller market capitalization companies that we feel are undervalued relative to their long term prospects. As of the writing of this commentary, our cash position is in the high single digits as a percent of both the Canadian Dividend Fund and the equity sleeve of the Canadian Diversified Income Fund. This partially reflects some current caution, but also our desire to have deployable cash as the correction runs its course.
As we look into 2016, we continue to view equity market weakness as transitory and expect to put our cash to work as valuations improve. Despite the negative headlines that global growth is slowing, it is not contracting, and as long as growth remains positive, then aggregate corporate earnings can grow. Ultimately, a growing earnings stream results in higher future stock prices, although the less predictable movements in multiples can certainly delay this for a time. Valuations on many companies have come down substantially in the past few quarters, and we believe that many stock prices reflect an overly pessimistic view of the future.
We certainly acknowledge that the news feels pretty bleak these days and that there is no shortage of things to worry about. That said, there are always things to be concerned about and from an investment perspective, better returns follow those periods where investors are focused on worry, rather than those periods where they are focused on greed.
Regardless of the news of the day, it’s critical to remember that the key to long term investing success doesn’t really change that much. Investing in dividend paying companies with good long term growth opportunities, strong management, and good competitive positioning, typically pays off over time.
We do not expect this to change and will continue to invest accordingly.
For more information about NexGen Canadian Dividend Fundsor NexGen Canadian Diversified Income Funds, please contact your financial advisor.
All performance data is as of December 31, 2015.
Performance for the NexGen Canadian Dividend Tax Managed Fund, Capital Gains Class, Front End Load Regular Series – 1 month: -3.6%; 3 months: 0.4%; 6 months: -6.7%; 1 year: -6.0%; 3 years: 5.1%; 5 years: 4.7% and Since Inception*: 2.9%. Performance for the NexGen Canadian Dividend Registered Fund, Front End Load, Regular Series – 1 month: -3.6%; 3 months: 0.4%; 6 months: -6.7%; 1 year: -6.0%; 3 years: 5.1%; 5 years: 4.6% and Since Inception*: 2.8%. *Inception Date: Sept. 5, 2006
Performance for the NexGen Canadian Diversified Income Tax Managed Fund, Capital Gains Class, Front End Load Regular Series – 1 month: -2.2%; 3 months: 0.6%; 6 months: -4.3%; 1 year: -3.7%; 3 years: 3.8%; 5 years: 3.9% and Since Inception*: -0.2%. Performance for the NexGen Canadian Diversified Income Registered Fund, Front End Load, Regular Series – 1 month: -2.2%; 3 months: 0.6%; 6 months: -4.3%; 1 year: -3.6%; 3 years: 3.7%; 5 years: 3.9% and Since Inception*: -0.1%. *Inception Date: Sept. 5, 2006
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. The indicated rates of return are the historical annual compounded total returns including changes in share value and reinvestment of all dividends and distributions and do not take into account sales, redemptions, distributions or optional charges or income taxes payable by any securityholder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Mutual fund securities are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer.
Invest better: Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not
be repeated. Mutual fund securities are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer.