At the end of December we pointed out the themes of 2015 were unlikely to disappear into 2016. It’s just that in 2016 we would be more likely to think of those themes as established rather than new. And while that’s certainly the case I didn’t expect 2016 to so openly embraced that principle.
So what to do? Eternal optimist might be excited by the prospect of discounted markets, but given the nature and severity of the problems that we currently face, it is difficult to endorse the idea of simply jumping into last year’s losers. Consider China as an example. There have been expectations that China would face serious economic consequences for its boundless growth for a long time. Optimists that predicted that China’s top-down economy was more clever and more sound than our own have clearly now been proven wrong. With so much to unravel does it make sense to invest in China right now? The answer is possibly, but not without taking on considerable risk.
The same can be said for Canada. Over the last six months the TSX has returned in excess of -12%. Are things cheaper than they were before? Certainly. Is the Canadian economy so healthy and discounted that it presents an irresistible opportunity to invest? Even the optimist would have to concede that’s unlikely. Falling oil, weakening banks, and declining manufacturing all speak for longer term problems that are yet to be resolved.
In a past life when I worked for a mutual fund company I heard some smart advice about these types of situations. It involved corporate mergers, but is useful here. A particular fund would buy into companies that were merging but only after the merger was announced. Mergers are preceded by rumours which pump up share prices, and those gains can be huge. But it’s not until a merger has been announced and the plan outlined that the likelihood of the deal can be understood. The big jump in share prices represent opportunity but all the risk. They’d have missed the big money, but rather than gamble with money on the rumour of a merger that could be successful, they instead chose to bank the guaranteed gain between the time of the deal was announced and when it closed.
This advice is good for investors generally as well, and is useful guidance when looking at distressed markets like we see today. Lots of markets have had significant sell offs. From the emerging markets to Europe and Canada returns over the past year have all been negative. But as people approach retirement it would make sense to not be to anticipatory of recoveries, and ensure that when we see market recoveries they are built on solid ground, that economic growth has secular reasons for occurring before running in and investing in discounted markets. It will not hurt investors to miss some of a gain in favour of a more certain perspective.
Let’s not squander this new year’s pessimism! Resist the temptation to chase last year’s losers, and be content to be a little pessimistic as our year takes shape.