December 2016

The Monthly


With this commentary, we plan to communicate with you every month about our thoughts on the markets, some snap-shots of metrics, a section on behavioural investing and finally an update on some of the people at MacNicol & Associates Asset Management.


We hope you enjoy this information, and it allows you to better understand what we see going on in the market place.


 “Uncertainty is the friend of a well-prepared investor”- Unknown

Market Commentary: Stocks Trump Bonds


A lot has happened within the markets in the weeks following the U.S. election. Despite initial volatility to the downside, markets have rallied strongly in anticipation of Donald Trump’s January 20th Inauguration. Speculation as to the reasons behind the market rallies have run the gamut, with the most dominating viewpoint being that Trump’s heavy focus on fiscal expenditure and protectionism will likely result in higher inflation figures in the long run. Thus, medium and long-term bond yields have spiked, causing the Bloomberg Barclays Global Aggregate Total Return Index to have its worst month of performance since 1990. Exhibit 1 below shows the historical performance of the index since 1990, exemplifying the magnificent run that the investment vehicle has had over the period. Some are beginning to believe this string of advances may have run its course.



This market reaction has been counter-intuitive to what many believed to be the most likely course of action following Trump’s surprise victory; many believed that Mr. Trump’s ‘outsider’ and cavalier status would project uncertainty, which is a trait heavily disliked by market participants. Initial stock market futures reacted in this way, but the rebound was swift, with the market opening higher on November 9th, and marching higher ever since. Gold was also expected to benefit from such uncertainty, due to a perceived demand for safe assets and a weaker dollar. However, most markets exhibit all-time highs, the USD has achieved its highest point in 14 years, and gold has weakened over the same period. Exhibit 2 below shows the performance of the ‘yellow metal’ since the date of the election.


The main query for market participants, then, seems to be: ‘what did we miss?’. There were very few professionals forecasting such a result, let alone a Trump Presidency, but we do have ad hoc commentary that has been layered onto the performance by most commentaries. The key take-a-ways are summarized below:


Spiking Interest Rates


  • Long term bond yields are meant to include a proxy estimate for future inflation, usually estimated as the difference between the 10-year bond yield and the yield on a similar-maturity inflation-protected bond yield. One of the textbook drivers of inflation is fiscal expenditure on top of ‘full’ employment. The US recently reported an unemployment rate of 4.6%, its lowest figure since 2007, and Trump has promised a fiscal expenditure program which could surpass $1 trillion. This has led to a spike in long-term interest rates, to account for higher future inflation estimates.
  • In the past, Trump has also indicated a potential desire to ‘renegotiate’ outstanding US debt. This decreases the confidence of capital return in US treasuries, resulting in higher interest rates being commanded.
  • Largely due to a strong third quarter GDP figure, market participants are now factoring in a 100% probability of a rate hike in December, which should shift the entire yield curve upwards moving forwards.


Rallying Stocks

  • One of the key pillars of Trump’s campaign has been the idea that the US tax code and relatively high corporate tax rate is hamstringing business and lessening the country’s ability to compete for business. This translates into strong rhetoric to reduce corporate tax burdens, which is positive for future forecasts and profit margins. It should be noted that very few companies pay the actual 35% corporate tax rate, due to deductions, capital expenditures and accounting schemes, but perception is everything when it comes to the stock market.
  • A massive fiscal expenditure program would ostensibly result in massive new contracts for some of America’s key businesses across the Infrastructure, Development, Information Technology and Defense sectors. Many of these companies serve as constituents to bellwether Stock Indices, such as the Dow Jones, and have rallied strongly since the election.
  • Remember, we started the year in pretty scary times, with the average S&P 500 and Russell 2000 stock down 23% and 38% from 52-week highs, respectively, at the February lows. Outside of a major bear market, that is usually about as bad as it gets. And while the overall market has largely improved since then, it hasn’t been a straight-up shot, and it certainly feels like each individual sector has taken its turn leading and lagging along the way.
  • Also, keep in mind that the Dow Jones Industrial Average and the S&P 500 aren’t necessarily representative of your portfolio, especially the Dow, which is only 30 stocks. Moreover, the Dow happens to be price weighted, meaning that the higher price stocks have more of an impact on the performance of the index which has allowed just three stocks to account for half of its big rally over the last month. We bring this up just in case your portfolio has not kept up with the Dow since the election and you are wondering why. Well, depending on your asset and investment mix, you could very well be doing better or worse than the major averages (they are averages, after all), so it is important to look under the surface into your holdings to really draw conclusions.
  • Banking and Financial stocks have been some of the biggest laggards during the post-recession Bull Market, but have rallied strongly following Trump’s victory. Part of this strength can be attributed to the spike in longer-term interest rates and ‘steepening’ of the yield curve. This benefits banks’ profitability, as they borrow short term and lend long term funds. Another factor is Trump’s vocal opposition to key financial reforms such as Dodd Frank, and his willingness to repeal them.
  • Providers of health insurance, many of whom have suffered recently due to a sicker-than-expected patient database caused by Obamacare, have also seen strong gains. Trump has often voiced his disapproval of Obamacare and his desire to repeal the system. Key market players such as Humana, Aetna, Anthem and UnitedHealth have all rallied near 20%.
  • Energy stocks have also performed well, partly due to Trump’s favourable attitude towards fossil fuels and coal, and partly due to a rally in oil prices, which is largely unrelated to Trump’s election.
  • Basic materials have also benefitted, likely from Trump’s protectionist view on manufacturing and exporting, coupled with his desire to impose harsh tariffs on outside materials being brought into the country. Steel producers, in particular, have seen very strong moves.


It is important to outline that many of these statements are narratives that have been fit to the market performance after-the-fact; they make sense at the moment, but this does not mean that everything will play out as outlined here. The binding factor for most of these comments are their reliance on future actions or policies, and as such, constant monitoring of the key areas of interest is pertinent. The purpose of providing the prior bullet points was to outline the currently-held view as to why the market has performed this way, particularly when we consider how few participants forecasted it correctly.



The Art of the Deal: OPEC


After several failures to come to an agreement, the Organization of Petroleum Exporting Countries (OPEC) has finally come to a tentative agreement with regards to a production cut, reducing up to 1.2 million barrels of per-day production by January. The brunt of the production cuts is expected to be contributed by Saudi Arabia, Iraq, and Kuwait, all of whom are the largest producers of the group. In conjunction, the group is also relying on non-OPEC member Russia to cut production by a significant amount. Iran and Nigeria, who have both been producing at below-historical levels due to their own idiosyncratic issues, are not required to cut production.


The prominent goal of the production cut is to stabilize (or boost) the price of oil, as many of these countries rely on oil exports to contribute a massive portion of their fiscal funds. Reluctance to cut production has mainly been driven by the idea that, if one country reduces production while another does not, the country which pulled back may have lost market share which they could be unable to regain in the future. General agreement of production cuts across all members of the group is the best way for OPEC to boost the oil price, while also protecting their share of the market. Exhibit 3 below shows the exact production cuts agreed to by each constituent of OPEC.

One of the key after-thoughts of the announcement is regarding US oil producers. As mentioned, OPEC members cutting production presents a potential opportunity for US producers to gain market share if they so choose, because they have not agreed to reduce their production. If US producers were to increase production to capitalize on this opportunity, it would also undermine the overall goal of reducing global supply to support the price of oil. As you can see, this is a complex issue which is hardly ‘solved’ by the recent announcement by OPEC.


Here in Canada, Prime Minister Trudeau also took further steps to increase Canada’s ability to export oil. Two out of the three proposed pipeline projects have been approved; the Trans Mountain pipeline, from Alberta to BC, which is expected to increase our ability to export oil to China, and ‘Line 3’, which increases our capacity to export to the US. The contentious Northern Gateway pipeline was dismissed. As a net result, these decisions will undoubtedly enhance Canada’s capacity to export oil and increase supply in the long run.


Behavioral Investing: The Prisoner’s Dilemma


Given the recent OPEC announcement and prior discussion in this commentary, we thought that it would be of interest to touch on the famous ‘Prisoner’s Dilemma’, to properly justify why we believe that the OPEC announcement is not an immediate saving grace for the oil market.


The Prisoner’s Dilemma is a popular example of Game Theory, which deals in forecasting interactions and outcomes of situations with multiple rational decision-makers. You may recognize the topic, as it is heavily associated with the famed John Nash (played by Russell Crowe in the movie A Beautiful Mind).


The dilemma puts forth a hypothetical scenario with two criminals, both convicted of a crime. While being separately interrogated, they are told that if they implicate their partner, and their partner remains quiet, they will go free and their partner will serve 3 years in prison. On the flip side, if they remain silent and their partner implicates them, they will serve three years. If they both attempt to implicate each other, they will both serve two years in prison, and if they both remain quiet, they will both serve only one year in prison. Exhibit 4 below shows the matrix summarizing these potential outcomes, with the black figures representing the cumulative prison time of each scenario.

As you can see, the best scenario for the group is for both to cooperate and stay quiet. However, without knowing with certainty the other’s actions, it is in each individual’s best interest to implicate their partner. If they defect and implicate their partner, who stays quiet, they go free; if they defect, along with their partner, they serve 2 years. If they remain quiet, they risk serving 3 years, because they can’t fully trust their partner.


The upshot here is that, in a group scenario that relies on the cooperation of all parties, there are large incentives to not comply. With the OPEC deal, specifically, there are large incentives for each country who has agreed to cut production to not follow through, so that they can gain market share from their competitors.  This may be viewed as a pessimistic viewpoint, but we also view it as being very realistic and a reason for cautious optimism. As Canadians, we are always rooting for higher oil prices, but we also believe in approaching scenarios such as this with a guarded and diligent approach.




Diane and I were fortunate to be in sunny Florida for the US Election.  The days leading up to the election were quite surprising as I took my own “polls” asking who people would vote for.  We had service people coming through the house we were staying at so it was fairly easy to ask what their thoughts were on the election.  I can see how the census polls got it so wrong as people were hesitant to say who they were voting for.  I even had a man cleaning the pool look over both of his shoulders before answering that his wife would kill him if she knew who he was voting for.


We spent election night with three American friends at a Sports Bar converted into a CNN political bar.  Our friends were from Washington, California and Florida so we had the country covered.  As the evening progressed it became increasingly clear that Donald Trump’s Republicans were going to win.  Our friend from Florida had been publicly calling this from 8 months prior and was beside himself with the prospect of change he saw coming.  My friend from Washington and I stayed up until 3:30 am to witness the results confirmed and see the acceptance speech and Hilary Clinton’s concession speech.  Hard to believe that a person who coined the phrase, “You’re fired!” has been “hired” by the US Electoral College voting system.  November 8th, 2016 will be a date that I will never forget.  Let’s just hope that all of this political change will positively affect the US economy and there will be a spill over affect to our country.


We are looking forward to spending time with our family over the holidays.  Time seems to race by with both David Jr and Sarah (our two oldest) living with friends now.  Sarah recently moved into a condo tower just steps to her job downtown.  That area of Toronto has really changed over the years where Millennials want to live close to where they work.  What a pleasure being able to walk to work!  They are both working hard in their new careers.  Our youngest, Ben, is in his 4th year of five in a dual degree at Western.  Ben has been working diligently towards his Ivey Business and Urban Planning Degrees.  He spent the summer on an exchange program at Bond University on the Gold Coast in Australia near Brisbane.  Every day is 70 degrees Fahrenheit, surfing and getting from A to B on a scooter.  What a life!  Ben recently was initiated at my Fraternity, Sigma Chi.  I was able to attend the event and was very proud to see 23 young men get involved in a fraternal system that is very important to me.



I look forward to watching some World Junior hockey over the holidays – Go Canada Go!


Here’s hoping everyone has a Merry Christmas, Happy Hanukkah and Happy New Year!



MacNicol & Associates Asset Management Inc.

David A. MacNicol, B.Eng.Sci., CIM, FCSI

President, Portfolio Manager
December 2016