Summary

  • The stock market in Canada had another good month in December, gaining 4.1%, which put the index up by 9.5% for the 4th quarter and 17.6% for the year.                                                                                                        
  • The Canadian bond market struggled again in December as mid-term bond yields continued to rise.  The index gained 0.16% on the month but fell by 0.71% for the 4th quarter and generated a total return of 6.74% for the full year.
  • Commodity markets continued their strength into year-end with oil prices rising 8.6% in December to over US$91 per barrel.  Copper and zinc each gained over 15%, lumber was up by almost 20% and the CRB Commodity Index gained 10.4%.
  • The Economic data remained positive and appears to be gaining more upside momentum, particularly in the US where employment had started to move higher and retail spending had a very strong finish to the year.
  • In terms of stock sectors, the resource sectors once again lead the pack with the Energy sector the top mover, gaining 8.6% in December.  The Telecom sector was the only decliner last month as investors increased risk by selling defensive groups.
  • Our Stock Market Outlook is still bullish over the medium-term as economic growth is recovering, profits continue to improve, interest rates remain low and stock valuations are reasonable.  Stocks have had strong gains since the market lows last August and are always at risk of a short-term correction, particularly since investor sentiment levels have gotten somewhat bullish lately, as often seen at short-term market highs.  But we view that only as a short-term risk.  The overall fundamental outlook argues for higher stock prices over the next few years.  Corporate profits are within 10% of their prior peak and there’s no reason to think that stock prices won’t do the same.

Account Review and Strategy

We had another month of exceptionally strong relative performance in your account in December as Asset Mix, Sector Rotation and Stock Selection all contributed to the gains.  We generated returns for the month, the 4th quarter and the full year which were all well ahead of the Benchmark Performance Measure for balanced funds. The Asset Mix in your account favoured stocks, which again did better than bonds last month.   Sector overweight positions in the resource stocks and underweight positions in financial stocks both added value during the month.  In terms of specific stocks, Manulife Financial (up 19.5% on the month), Suncor Energy (up 10.8%), Quadra FNX Mining (up 18.2%), Thompson Creek Metals (up 16.8%) and Gold Wheaton (up 14.7% on buyout offer from Franco-Nevada Mining) were the biggest contributors to the December advance in your portfolio.  Uranium Participation (down 4.5%) and Research in Motion (down 8.2%) were the biggest drags on the portfolio last month.

Going forward, we remain positive on the outlook for stocks over the next 2-3 year period and have positioned your portfolio accordingly, even though we are more wary about a short-term correction in the stock market given the sharp advances since last August.  In terms of the portfolio themes, the stocks still reflect an outlook for expanding global economic growth.  The only difference is that we think that growth will slow down to more normal rates in the Emerging Economies (particularly China) and will pick up somewhat in North America.  This should lead to better performance from domestic stock sectors such as retailing, autos, housing, rail, technology and even financials.  On the other side, we don’t expect commodity stocks to continue to dominate the gains the way they have in the past two years even though they may continue to rise.  The gains should come more from volume growth as opposed to price growth.  We will continue to monitor all economic developments though and shift the portfolios accordingly and in line with the opportunities presented by the market.

Financial Markets: Monthly Review and Outlook

Stocks carried the momentum from the rally that started in August right into the end of 2010 as improving economic data, strong earnings growth, increased corporate activity and falling bond prices all motivated investors who were either out of the stock market or holding too many bonds to shift funds into the equities on a more upbeat outlook for 2011.  In Canada, the S&P/TSX Composite Index followed up the 3rd quarter gain of 10.2% with a 4th quarter increase of 9.5% to push the index to an annual return of 17.6%. This followed the 35.0% return generated by the index in 2009.  The strength in the 4th quarter of 2010 followed the pattern of the entire 2-year rally with the resource sectors leading the advance.  The Basic Materials lead the 4th quarter advancers with a gain of 14.1%, despite a lack of help from the gold stocks which only advanced 5.0% for the quarter.  Energy stocks were a close 2nd for the quarter with a gain of 13.5% while Financials lagged with a gain of only 4.0% and the Telecom sector fell by 1.1%.  It was the same story for the annual returns where the largest positive impact on the index was the 35.8% gain for the Basic Materials sector.  The Consumer Discretionary and Health Care sectors were the only other ones to beat the index last year, and that was driven primarily by the performance of 2 stocks, Magna in the Consumer group and Biovail (now Valeant Pharmaceutical) in Health Care.  Laggard groups in 2010 included Financials, Energy and Technology with gains, respectively, of 4.4%, 8.7% and 4.7%.  Interesting as well was the difference in returns for the smaller stocks versus the large cap group.  The TSX60, which is made up of the largest 60 stocks in the index including all the major banks, the larger energy companies and RIM, gained just 10.9% in 2010 while the TSX Completion Index (total index less the TSX60) gained 26.5% for the year! Clearly good stock selection was able to deliver superior investment results for the year.  When we looked at our strongest gainers for the past year they were almost all smaller names, including Grand Cache Coal (up 106%), Uranium One (up 75%), Farallon Mining (up 45%), Magna International (up 44%) and Gold Wheaton (up 43%).  Laggards in 2010 included the larger financial names (Royal Bank down 7.5% and Manulife down 11.3%) and RIM (down 18%).

Outside of Canada the rally continued as well, leading to strong annual gains for most global stock markets.  In the US, the S&P500 saw almost all of its gains come in the 4th quarter with an advance of 10.2%, which lead to an annual gain of 12.8%. Strength in US technology stocks (particularly Apple and Google) helped push the Nasdaq Index to a 16.9% annual gain.  The MSCI World Index gained 9.6% in 2010, driven in large part by the 4th quarter gain of 8.6%.  Germany lead the European markets with a gain of 16.1% in 2010 as that economy benefited from weakness in the Euro currency and strength in the manufacturing sector.  Emerging Markets as a group were also strong last year with the MSCI index up 16.4%.  A notable exception to the global stock market gains was in China, where the Shanghai index fell by 14.5% in 2010, despite the fact that China was probably the biggest source of economic strength in the global economy and clearly the leader in driving the strength in the Basic Materials (commodity) sector.

While stocks were rallying into year-end, bonds were headed in the other direction despite the best efforts of the US Federal Reserve to add support to long-term Treasury prices by the announcement in early November that they would be buying over US$600 billion worth of Treasury securities over a six-month time frame (the much bally-hoed “QE2” program).  Bond prices were also hurt by more indicators of economic strength coming in North America and Europe, which had been laggards thus far in the recovery.  This is one of the key themes we have focused on for our outlook for 2011.   Although we remain positive on the outlook for global economic growth as well as global stock markets in general, we believe that the nature of this advance will be changing somewhat. The Emerging Markets of the world had been the stalwarts of growth following the collapse in 2008 as their lighter government and consumer debt burdens and inherent secular shift into industrial versus agricultural economies.  China had been the leader over the past two years with the real annual growth rate surpassing12% early last year.  But as we enter 2011, the spread between economic growth rates in the US and Emerging markets will narrow, with US growth picking up and China in particular slowing down a bit.  This will still push global growth higher but it won’t be as strongly focused on the commodity sectors that generally gain when Emerging economies dominate global growth.  We expect that consumer goods and services, technology, autos and even housing will start to grow again this year but that it will be a bit tougher on commodity trade, which suddenly won’t be the ‘only game in town.’

One of the big reasons why we see a stronger recovery taking hold in the US is that here are two big sectors that have effectively been ‘running at zero’ but which are now starting to show some signs of recovery.  For both of these sectors, just a return to ‘trend’ growth will lead to some huge gains.  The first is autos. The US industry is clawing its way back from selling 8-9 million units of production to 11-12 million annually.  But 10 million to 12 million units, against a fleet of 220 million units, just barely replaces the autos that are literally dying each year. So there has really been no discretionary spending there. Housing, which has yet to show any recovery, is in a similar condition. Housing starts are running at 500,000 to 600,000 units a year. The ongoing trend demand in housing is roughly 1.4 million units a year; that’s a combination of household formation growth of 1.1 million, and 300,000 houses fall down each year. So, again, the US has been under-producing and living off excess inventory, but that can only go on so long.

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