OB Report
January 2020
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Tempered Expectations

Murray Leith By Murray Leith CFA, Executive Vice President & Director, Investment Research

President Trump calls it the “best economy” in the history of the United States. Some might disagree. While the current U.S. expansion is the longest on record, it also has the distinction of being the weakest of the post-World War II expansions.

Indeed, the whole world is suffering from slower growth. In October, the International Monetary Fund made a fifth-straight cut to its 2019 global growth forecast, citing a broad deceleration across the world’s largest economies as trade tensions undermine commerce. At roughly 3%, 2019 global growth was the weakest since 2009, when the world economy shrank in the wake of the financial crisis.

Counterintuitively, slower growth didn’t hold stocks back last year. As of mid-December, the major North American equity benchmarks produced year-to-date total returns, including dividends, in excess of 20%. Moreover, the increase in stock prices occurred with only a marginal improvement in underlying corporate earnings.

Equity investors can thank the U.S. Federal Reserve and many of the world’s other central banks for their good fortune in 2019. In the face of slower growth, central bankers shifted into accommodation mode. They lowered interest rates and pumped money into the financial system, in turn making investors more optimistic regarding the outlook. Lower interest rates also rendered stocks relatively more appealing than bonds. 

The global economy should get a boost from last year’s significant, worldwide decline in interest rates, and as such we don’t see a recession on the horizon. Odds are good that stocks will continue to do well against a backdrop of slow growth and low interest rates.

Lower interest rates are helping to keep the economic expansion alive and drive stock valuations higher, but there are longer-term consequences and trade-offs involved. Investors should understand that the risk and reward attributes of the stock market have deteriorated. Stocks can’t keep appreciating faster than the underlying economy and corporate earnings. At some point, valuations will stretch beyond reason and stocks will correct. While we don’t believe we are at that juncture, it is time to temper return expectations and position portfolios more conservatively.

Higher returns today mean lower prospective returns. Think of it like a teeter-totter, with present returns on one end and future returns on the other. As present returns go up, future returns go down. We used to count on the major stock benchmarks returning 10% per year on average over the long term, but in today’s growth-challenged, low-interest-rate world, 6% is probably a more realistic expectation. 

We are also less optimistic that governments and central banks will be able to effectively stabilize and stimulate the global economy during the next inevitable economic pullback. With interest rates negative in Europe and Japan, and very low in North America and elsewhere, there is limited scope for authorities to use monetary policy to stimulate the economy. Governments will have to rely more on fiscal policy – running greater deficits to fund tax cuts and/or spending increases – to keep deflation at bay and support economic growth. That could be challenging, given that many governments already run big deficits and carry large debt. Moreover, social unrest and political division could hamper governments in building consensus and implementing fiscal change in a timely manner. Monetary policy is typically easier to conduct than fiscal policy as it is implemented by independent monetary authorities who can more easily make politically unpopular decisions.

Given the foregoing considerations, it’s quite likely that the world’s central banks will keep interest rates low in the near term. The path of least resistance for stocks against this backdrop is up, as prospective fixed income returns will remain unappealing.

Still, it’s important to remain mindful of the downside risks.  

The challenge in the market today is that the businesses we like most are popular and pricey. When we started buying high-quality blue chip U.S. stocks prior to the financial crisis, the biggest and best high-quality businesses were out of fashion and attractively priced. That’s no longer the case. Everyone wants to own high-quality businesses today; investors appreciate the uncertainties and risks in the world and are gravitating toward the businesses that are best positioned to thrive.

Over the last 20 years, the Odlum Brown Model Portfolio* has grown at a compound annual rate of 13.0%, much better than 6.5% and 5.5% for the Canadian and U.S. equity benchmarks over the same period. Our record is significantly better than these indices’ because we remained rational at two important junctures. We avoided expensive technology stocks and large U.S. companies at the turn of the century, and we didn’t get carried away paying high prices for Canadian resource stocks prior to the 2008/09 Financial Crisis. The difference today is that there aren’t attractively priced “high-quality” alternatives like there were in the previous periods.

modeltableNonetheless, we increased trading in the Model Portfolio in 2019 to achieve a more conservative posture, including establishing a 10% cash position. In the second half of the year, we trimmed our positions in some of our best-performing businesses, including Starbucks, Visa, Restaurant Brands International, Dollarama, Constellation Software Inc. and Amazon.com. We sold Air Products and CarMax outright, believing these cyclical businesses to be a little too popular and pricey. We sold homebuilder TRI Pointe Group and scaled back our holding in developer The Howard Hughes Corp. to further reduce our cyclical risk. We cut our losses on some of the loathed stocks in the portfolio by selling Peyto Exploration & Development Corp., Shawcor Ltd. and ING Groep NV, and used the proceeds to increase our position in Colfax Corp and buy The Charles Schwab Corporation. Finally, we added TC Energy and increased our positions in other dividend-paying stocks, including BCE Inc., Rogers Communications Inc., Enbridge Inc. and Weyerhaeuser.


In total, we made 45 trades in 2019, a significant increase from fewer than 10 in each of the prior two years, and the most since 2008. The value of our dispositions aggregated to approximately one-third of the portfolio, whereas the stocks we bought represented roughly one-quarter. With the more conservative positioning, we expect to modestly underperform during fast-rising markets and outperform during corrections and times of increased volatility. 

We believe it is wise to temper return expectations following a great year. However, owning high-quality businesses is still the best way to protect and grow wealth over the long term.


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*The Odlum Brown Model Portfolio is an all-equity portfolio that was established by the Odlum Brown Equity Research Department on December 15, 1994, with a hypothetical investment of $250,000. It showcases how we believe individual security recommendations may be used within the context of a client portfolio. The Model also provides a basis with which to measure the quality of our advice and the effectiveness of our disciplined investment strategy. Trades are made using the closing price on the day a change is announced. Performance figures do not include any allowance for fees. Past performance is not indicative of future performance.

Odlum Brown Limited is an independent, full-service investment firm focused on providing professional investment advice and objective research. We respect your right to be informed of relationships with the issuers or strategies referred to in this report which might reasonably be expected to indicate potential conflicts of interest with respect to the securities or any investment strategies discussed or recommended in this report. We do not act as a market maker in any securities and do not provide investment banking or advisory services to, or hold positions in, the issuers covered by our research. Analysts and their associates may, from time to time, hold securities of issuers discussed or recommended in this report because they personally have the conviction to follow their own research, but we have implemented internal policies that impose restrictions on when and how an Analyst may buy or sell securities they cover and any such interest will be disclosed in our report in accordance with regulatory policy. Our Analysts receive no direct compensation based on revenue from investment banking services. We describe our research policies in greater detail, including a description of our rating system and how we disseminate our research here.

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