What will 2019 bring?


A Very Tough Q4

Global markets closed a turbulent 2018 with one of the worst Decembers ever, and with most equity indices and asset classes negative for the year. After the steep selloff on Christmas Eve, December was on track to become the market’s worst month in nearly 90 years. The four consecutive days of 1.5%+ declines going into Christmas Eve occurred five times during the Great Depression and only twice thereafter, during October 1987 and July 2002.

After out-pacing global markets for the first nine months of the year, US equity market performance came back to the rest of the world in the fourth quarter. The weakness that began in October continued throughout the majority of November and December, barring a brief rally after the Christmas holiday. There were few places to hide, furthermore, with over 90% of asset classes exhibiting a negative total return in USD for 2018 (see figure on the next page). All told, all three major US indices and the TSX Composite were negative for the year

Table 1: Percentage Return Figures


S&P 500

Dow Jones

Nasdaq 100


Q4 Price Return





2018 Calendar Price Return






Looking Ahead- What Does 2019 Have in Store? Two Key Areas May Hold the Answer

We published a piece at the start of November following the weakness in October that laid out our views around recessionary risks in the market. Since that piece, which we have attached along with this report, most of the economic data, and thus our overall view, has remained intact.

So, what has changed since the end of October? The answer to that is very little. We still view the two main drivers of this market weakness to be the US/China trade war and the Federal Reserve of the United States, with the latter continuing to raise interest rates and reducing the size of their balance sheet as they unwind years of Quantitative Easing.

1) US/China Trade War

While there has been no resolution to this war, it is worth mentioning that following the G20 summit further escalation of tariffs between the two countries has been shelved until March to allow for further discussion and negotiations. Any meaningful developments need to be monitored, because a resolution to this conflict will reduce many uncertainties and concerns – including those about global growth, global trade, and how supply chains will adjust to a new global trade paradigm.

2) The Federal Reserve

The other key driver of the US markets is the Federal Reserve. Most sustained market sell-offs and recessions have started with a Fed policy mistake. The speech on October 3, 2018 by Jerome Powell, Chair of the Federal Reserve, might well have been the key catalyst for the drawdown in the final quarter of 2018. During this speech, Mr. Powell indicated that not only was the Fed going to keep hiking rates, but likely well above the neutral rate.

The Fed raised rates again at its December meeting, as expected. However, markets reacted negatively to comments from Chairman Powell after the announcement, where he noted the Fed expected rates to continue to increase over the course of 2019, and Quantitative Tightening (QT) was going to continue unabated (with little acknowledgement that the market had tanked during the quarter). More recently the Fed has commented on market weakness and the equity markets rallied. It follows that how the Fed approaches 2019 will have a substantial impact on the markets. Indeed, some of the markets’ headwinds could abate drastically should interest rates be put on hold and/or QT is reduced.

We know that the markets do not like uncertainty. Uncertainty means that a higher discount rate will be applied in the valuation of markets, sectors, and companies - resulting in a lower fundamental fair value. Add the fact that market participants are human, and exhibit emotional responses and behavioral biases, and the market is likely to overreact on the downside when uncertainty spreads.

We continue to maintain the view that the US is not at risk of an earnings recession over the next 6-9 months, and that we could accordingly witness one more leg in this bull market. How some of the foregoing situations play out over the course of the first half of 2019 will go a long way to determining how long that final leg can last.

Over the course of the first half of the year, we will look to strategically reduce some equity exposure on strength, particularly in sectors and companies that are more cyclical in nature. We will also look to move to a more neutral allocation to fixed income from the relatively underweight exposure we have maintained over the last few years; both the Federal Reserve and the Bank of Canada are coming to the end of the rate-hiking cycle. We will also be looking to strategically increase our allocation to alternatives, with the view of allocation to strategies and assets that can provide steady income and/or diversification and capital preservation benefits.

Emotion and Volatility- A Revised Framework to Consider

While listening to a presentation from a CFA conference recently on behavioral biases in investing and finance, the presenter put forth an alternative way to look at volatility and risk in the context of behavior and emotion in a way that resonated. Where traditional finance theory equates volatility in the markets and assets as the “risk” of the asset, the presenter challenged us to come at risk from a different perspective. He posited that volatility, instead of measuring risk, was a measure of emotion, and that when volatility is higher, so is the emotional response. As such, an investor holding a portfolio that consisted of 100% equities versus a portfolio of 50% equities and 50% government bonds would exhibit a higher probability of emotional responses due to volatility in their portfolio, both on the upside and the downside, all else being equal.

The second leg of this theory, around risk, is that the actual risk to an investor comes from foregoing the gains associated with long term equity exposure. It is widely acknowledged that over the long term, investing in developed market equities is proven to be a profitable endeavor. Looking at the long-term chart of major indices attests to this. Therefore, the “risk” to an investor is that emotionally, they are not able to handle the shorter-term swings that equities can exemplify. This past quarter being a very recent example of the swings equities can endure over a short time horizon. As such, due to emotional responses and biases, investors tend to settle on a sub-optimal asset allocation to avoid some of these emotional responses inherent in equities, to the risk of their longer-term wealth creation.

To that point, the following chart shows the real returns after inflation of varying asset classes, assuming no taxes, all dividends and interest reinvested, and no fees. The conclusion the presenter draws from this chart is that the risk to investors is foregone profits by having less exposure to equities then they should.

Source: InvestorsFriend, http://www.investorsfriend.com/asset-performance/

This intuitively makes sense, and we at McCulloch & Partners believe that the emotional management and behavioral coaching components of our service are among our most valuable to clients. A large component of this can be in the setting of a long-term asset allocation that can acknowledge the emotional side of investing and marry that with the long-term goals of the capital being invested.

The presenter subsequently put forth a framework for the top down view of setting an asset allocation that can help acknowledge and mitigate some of the emotional constraints we put on ourselves as investors that we feel is worth sharing with you to consider. The presenter called it the Needs Based Portfolio approach, and it consists of three buckets, liquidity, income, and growth.

The first bucket is the liquidity bucket. How much cash do you need in the bank/GICs/money market to feel comfortable? This will vary based on stage of life, risk tolerance, and personal circumstances but is an important first step in the mitigation of some of the emotional risk in an asset allocation, as no matter what happens to the market that capital is there.

The next bucket is the income bucket. Do you need income from your portfolio? Let’s design this bucket of capital to meet your income needs for the medium term. This can be constructed through dividend paying equities, fixed income products, and alternative income sources.

Finally, the third bucket, after the cash and liquidity needs are met, and the income component of the portfolio is built, is the growth bucket. Here, the focus is on expected returns into the future, and attempting to generate as much wealth as we can, with a long-time horizon and viewpoint. The presenter’s goal with an approach such as this is that by compartmentalizing capital and satisfying liquidity and income needs first, investors may be better able to emotionally handle shorter-term equity market fluctuations.

We would be happy to expand upon an approach like this more at a more personal level, but we wanted to share with you an alternative way to approach asset allocation that attempts to mitigate as much as possible the emotional and behavioral biases we all exhibit. In this example, if an investor can view their capital from the lens of having liquid capital available outside of the market, having a strong bucket of capital invested in income generating assets if needed, then the remainder is the growth capital. This growth capital bucket may be more volatile and therefore more emotional, by conceptualizing this bucket as earmarked for the future and its purpose being to maximize future value, we as investors can look to stomach the ride in that growth bucket more effectively.

In times like this when sentiment is extremely low, how we as investors respond makes a large difference in the long run. Many of Warren Buffet’s most profitable investments were made in times when buying equities was seen to be too risky and investors were selling into downturns as a herd. True to his word, we know from Berkshire Hathaway filings and statements that Mr. Buffet has been an active buyer of American equities over the last quarter, true to his word. To that end, we continue to look for what we deem to be market mispricing opportunities, where a company/sector/theme that is exhibiting strong fundamentals, growing cash flows, and a clear investment thesis gets excessively sold along with everything else.

We know, understand, and share the feelings and anxieties that are brought forth when the markets go through difficult times. We hope that these pieces, along with sharing our views about the global environment and where to best position portfolios, helps to also bring a little perspective, and some helpful food for thought. We are all in this journey together, and we are here if you have any questions or concerns, through the good and bad times.

McCulloch & Partners Investment Counsel

Garry McCulloch, CIM 

Director, Portfolio Manager

Tel.: 403.355.6070



Brenden Soley, CFA   

Portfolio Manager

Tel.: 403.260.8486



Rosa Golanowski


Tel.: 403.776.6225



Richardson GMP Limited

525 8th Ave SW, Suite 4700

Calgary, AB  T2P 1G1







All data and/or charts are sourced to Thompson Reuters Eikon unless otherwise noted.

The opinions expressed in this report are the opinions of the author and readers should not assume they reflect the opinions or recommendations of Richardson GMP Limited or its affiliates. Assumptions, opinions and estimates constitute the author’s judgment as of the date of this material and are subject to change without notice. We do not warrant the completeness or accuracy of this material, and it should not be relied upon as such. Before acting on any recommendation, you should consider whether it is suitable for your particular circumstances and, if necessary, seek professional advice. Past performance is not indicative of future results. Richardson GMP Limited is a member of Canadian Investor Protection Fund. Richardson is a trade-mark of James Richardson & Sons, Limited. GMP is a registered trade-mark of GMP Securities L.P. Both used under license by Richardson GMP Limited.