Year-to-date to December 31, the Ninepoint Focused US Dividend Class generated a total return of -5.33% compared to the S&P 500 Index, which generated a total return of 3.82%. Returns in the month of December were disappointing on an absolute and relative basis, with the Fund generating a total return of -8.30% while the benchmark generated a total return of -6.55%. Currency hedging detracted significantly from our returns relative to the benchmark in 2018, as we were partially hedged into the USMCA trade agreement. However, the USD strengthened dramatically in the fourth quarter of the year on a flight-to-safety trade during the broad market correction.
To say that 2018 was a challenging year for investors is an understatement. By now you have probably seen the some of the stats from 2018. It was the worst year for the stock market since 2008, it was the worst December since 1931 and it was the worst Christmas Eve ever. Nearly every asset class (developed & emerging market stocks, high yield & investment grade corporate bonds and various commodities) generated a negative return on the year.
To put it simply, investors had become terrified that a Trump-induced trade war with China and an overly-hawkish US Federal Reserve would trigger a recession in the near-term. Although none of the incoming economic data supported this view, investors panicked. Obviously, it will be important to watch future developments closely, looking for any signs of policy error that would force us to change our more optimistic outlook. But note that Federal Reserve Chairman, Jerome Powell, seems to have already pivoted to a more dovish stance during a speech in early 2019, which triggered a powerful reflex rally in the markets and a selloff in the USD (immediately improving our relative performance due to our USD/CAD hedges).
Performance anxiety likely exacerbated the selloff into December and valuations disconnected from fundamentals (earnings growth for the S&P 500 is expected to come in around 24% in 2018 according to data from Refinitiv). The market is forward-looking and yes, estimates for 2019 have been coming down (from approximately $178 to $173, or a reduction of just under 3% according to data from Refinitiv) but this still implies 8% earnings growth. With the IMF calling for global growth of 3.7% in 2019 (including the US at 2.5%, the Eurozone at 1.9%, Canada at 2.0% and China at 6.2%), investors appear to have confused a slowdown with a recession.
Despite the 6% draw down for the S&P 500 in calendar 2018, history suggests that 2019 should be a decent year in the stock market. It would be very unusual to see two back to back negative years in a row, since down years have been followed by up years 74% of the time, with a median gain of 15% and an average gain of 13%, according to market data back to 1931. In fact, the 20% peak to trough drawdown for the S&P 500 over last few months of 2018 was almost as severe as the median recessionary decline of 24%, essentially pricing in a significant growth scare. Further, after last six corrections that have occurred since 1984 during a period of economic expansion (with an average decline of 19%), the market has generated an average return of 25% over the next six months.
Finally, although we are making the argument that this selloff is overdone, and valuations have become too attractive to ignore, we are cognizant that we are relatively later in the economic cycle. As the market rallies back toward more realistic valuation levels, we plan to focus even more intently on businesses with stable revenue and earnings growth, clean balance sheets and the ability to consistently grow dividends through the cycle, reducing the beta and increasing the yield across the funds.
Our modelling indicates that the Canadian dollar is slightly undervalued. However, the equity market selloff, oil price collapse and trade war rhetoric have introduced a new level of complexity to our FX analysis as prior correlations have become less statistically significant. We have therefore maintained hedges on half of our USD exposure to reduce volatility in the Fund, but we may collapse the hedges should the CAD overshoot fair value in 2019.
Top contributors to the year-to-date performance of the Ninepoint Focused US Dividend Class included Mastercard (+118 bps), Microsoft (+110 bps) and Visa (+90 bps). Top detractors year-to-date included Marathon Petroleum (-77 bps), Brookfield Asset Management (-61 bps) and Comcast (-54 bps). Top contributors by sector included Information Technology (+309 bps), Healthcare (+139 bps) and Industrials (+71 bps) while top detractors by sector included Energy (-234 bps), Consumer Discretionary (-162 bps) and Financials (-36 bps).
Our underweight positioning in the Information Technology (especially the non-dividend paying, high growth names) and Healthcare sectors and overweight positioning in the Industrials sector detracted from our overall relative performance for the year but, once recession fears subside, we expect to regain some lost ground. Again, our currency hedges detracted significantly from performance in the fourth quarter of 2018, but the USD has since reversed dramatically on Powell’s more-dovish comments and the hedges are now working to our advantage in early 2019.
The Ninepoint Focused US Dividend Class was concentrated in 25 positions as at December 31, 2018 with the top 10 holdings accounting for approximately 42.7% of the fund. Over the prior fiscal year, 21 out of our 25 holdings have announced a dividend increase, with an average hike of 9.0%. We will continue to apply a disciplined investment process, balancing various quality and valuation metrics, in an effort to generate solid risk-adjusted returns.
Jeffrey Sayer, CFA