- - MARKET COMMENTARY By Rob Edel, CFA HIGHLIGHTS THIS MONTH Economists’ Crystal Ball: A Prediction for 2018. The domestic economy and why growth stocks remain hot. The risks associated with an inverted yield curve. The Fed carefully navigates markets as they move to regulate monetary policy. The U.S. Tax Reform: How does it impact the markets? Are fast-growing “disruptive” companies the new norm or a fad? Let’s talk Bitcoin and Blockchain. Is this a Bitcoin bubble? THE NICOLA WEALTH MANAGEMENT PORTFOLIO Returns for the NWM Core Portfolio Fund were up 1.2% for the month of November. This fund is managed using similar weights as our model portfolio and is comprised entirely of NWM Pooled Funds and Limited Partnerships. Actual client returns will vary depending on specific client situations and asset mixes. Both the Canadian and U.S. yield curves continued their year-long flattening trends last month, with the spread between 2 and 10-year Canada’s narrowing nine basis points to 0.45% and 2 and 10-year U.S. treasury spreads declining five basis points to 0.63%. Short rates in both Canada and the U.S. continue to drift higher but long rates remain stubbornly low. For the month, the NWM Bond Fund was up 0.4%, a good result in a tough interest rate environment. The NWM High Yield Bond Fund was flat in November, compared to -0.3% for the Bank of America Merrill Lynch U.S. High Yield Index. The high yield market was down over 2% at mid-month, but post-U.S. Thanksgiving inflows supported the market by the end of the month. The fund’s defensive posturing outperformed during this brief sell-off, and we remain patient and ready for any volatility that may return to high yield. Despite a flat Canadian dollar, global bond returns were strong again last month, with the NWM Global Bond Fund returning 0.7%. The mortgage pools continued to deliver consistent returns, with the NWM Primary Mortgage Fund and the NWM Balanced Mortgage Fund returning both +0.4%. Current yields, which are what the funds would return if all mortgages presently in the fund were held to maturity, all interest and principal were repaid and in no way is a predictor of future performance, are 4.4% for the NWM Primary Mortgage Fund and 5.3% for the NWM Balanced Mortgage Fund. The NWM Primary Mortgage Fund ended the month with negative cash of $1.2 million or -0.7%. The NWM Balanced Mortgage Fund ended the month with $54.8 million in cash or 11.1%. The NWM Preferred Share Fund returned 0.6% for the month while the BMO Laddered Preferred Share Index ETF returned 0.5%. The move higher felt quiet as the 5-year Bank of Canada’s were effectively unchanged while 10-year yields moved lower. Fund flow continues to be strong as ETF’s grew almost $170 million for the month, creating buying pressure for high rate reset spreads. Canadian equities were stronger in November, with S&P/TSX +0.5% (total return, including dividends). The NWM Canadian Equity Income Fund returned +1.1%, while the NWM Canadian Tactical High Income Fund was +0.4%. Our underweight position in the materials sector helped performance last month, as did our consumer staples holdings. The NWM Canadian Equity Income Fund exited its position in CGI Group and WestJet in favor of Roger’s Sugar and Air Canada. In the NWM Canadian Tactical High Income Fund, strong performance from Aritzia and Intertape Polymer helped performance while Sleep Country and Guardian Capital detracted from returns. The fund still maintains a low net equity exposure (current delta adjusted exposure is 41%), which helps the fund’s relative return in a down market, but hurts relative returns when the S&P/TSX is strong. Foreign equities were also higher last month, with the NWM Global Equity Fund up 2.1% compared to a 2.3% increase in the MSCI All World Index and a 3.1% increase in the S&P 500 (all in Canadian dollar terms). Results for our external managers were all higher last month, with Pier 21 Value Invest +4.2%, BMO Asia Growth & Income +2.4%, Edgepoint Global Portfolio +2.2%, Lazard Global +2.0%, Pier 21 C WorldWide +1.7%, and our new internal EAFE Quantitative Fund returned an index-like +0.8% (the iShares MSCI EAFE ETF was +0.7%). The NWM U.S. Equity Income Fund increased 3.1% in U.S. dollar terms, and the NWM U.S. Tactical High Income Fund increased 2.1% versus a 3.1% increase in the S&P 500 (all in U.S. dollar terms). In the NWM U.S. Equity Income Fund, relative performance was helped by strong performance in Costco, Estee Lauder, and Walmart, while Newell, AIG and Boston Scientific hurt performance. We initiated a new position in Crown Castle and added to our existing positions in Vulcan Materials. As for the NWM U.S. Tactical High Income Fund, we were called away on our Aptar and GGP Inc. positions and we added new naked put positions in Lowes, Disney, and Federal Express. The net equity exposure (delta) in the NWM U.S. Tactical High Income Fund is down to a very defensive 15%. In real estate, the NWM Real Estate Fund was up 0.9% in November versus the iShares REIT Index +2.0%. We report our internal hard asset real estate limited partnerships in this report with a one month lag. As of November 30th, performance for the SPIRE Real Estate LP was +1.2%, SPIRE U.S. LP +0.9% (in U.S.D), and SPIRE Value Add LP +2.4%. The NWM Alternative Strategies Fund was up +0.3% in November (these are estimates and can’t be confirmed until later in the month), with Winton +0.6%, Citadel +0.1% (this position is being redeemed at the request of the manager at the end of the year), and Millenium -0.1%. Of our other alternative managers, all had positive performance with RP Debt Opportunities +0.2%, Polar North Pole Multi-Strategy +0.4% and RBC Multi- Strategy Trust +0.6%. Precious metals stocks were slightly up last month with the NWM Precious Metals Fund -0.1% while gold bullion increased 0.4% in Canadian dollar terms. NOVEMBER IN REVIEW Markets were strong again last month, with the S&P/TSX up 0.5% and the S&P 500 +3.1% (in Canadian dollar terms). Year-to-date, the S&P/TSX is up a respectable 7.8% but the S&P 500 has soared +15.6%. Not only have U.S. large-cap stocks done well, but they have done consistently well all year long. Throughout 2017, the S&P 500 has been setting new record closes while avoiding even a single down month. On a total return basis, in fact, the S&P 500 has recorded 13 consecutive months of positive returns stretching back to 2016. As a consequence of this strong run in performance, volatility has fallen to multi-decade lows. This month, we are going to take a closer look at what’s driving this performance and what it might indicate for returns next year. After taking a macro look at performance, we’ll also dig a little deeper into some of the micro trends in the markets by taking a closer look at perhaps the biggest price bubble the world has ever seen, Bitcoin. Most asset classes are in positive territory this year, and while big-cap U.S. stocks do not have the highest absolute returns, when volatility is included, the S&P 500 has been hard to beat on a risk-adjusted basis in 2017. While most forecasters were predicting positive returns for 2017, year-to-date performance has outstripped even the most optimistic targets. Next year doesn’t look any easier to call. Valuations for stocks look high, but so do valuations for all asset classes, especially bonds. Economists have had a poor track record predicting the direction of interest rates and bond yields since the financial crisis, typically predicting rising rates, only to see yields generally fall or tread water. For their part, Wall Street strategists nearly always forecast a rising market so at least they get the direction right some of the time. Rarely, however, do they get both magnitude of the move in the S&P 500 as well. In order to help forecast what going to happen next year, it is useful to take a closer look at the market year-to-date beyond just the top-line return numbers. Not only has volatility for the market as a whole been low but the inter-sector correlation has plunged to levels not seen since the tech bubble of the late 1990s. Sectors and industries have been trading independently from each other, resulting in definite winners and losers. Doing well were technology stocks, particularly the disruptive FANG names, Facebook, Apple, Netflix, and Google (now called Alphabet). Growth stocks, in general, outperformed their value counterparts, and international companies fared better than those with more than 50% of their revenue generated domestically. Slow domestic economic growth explains most of these trends. First, growth stocks do well when growth is scarce. If the economy is struggling to expand, investors are willing to pay a premium for companies who are still able to grow. Alternatively, with a strong economy, a rising tide lifts all boats, meaning even a company with a struggling business model could see its prospects improve if the economy is strong.