On The Potential Elastic Energy of Deceased Cats in Free-fall

Dead Cat

What is the “Dead Cat Bounce”? If you’ve been following the news you’ve probably heard the saying and it has become fairly common among financial professionals to describe the current market in such terms. So what is it?

The phrase has its origins on Wall Street, in that “even a dead cat, dropped from a sufficient height, will bounce.” Charming. But it describes the very real experience of stock markets having a brief but substantial recovery before resuming a fall. The effect is brought on by buyers reentering the market having assumed that a bottom has been reached and encourages others to begin piling in before another sell-off begins. The dead cat bounce is the shadow of hope over an otherwise dire situation that has not yet been fully realized.

As such many have called the current market rally a “dead cat bounce” based on previous experience of other bear markets. The expectation being that this is merely a brief respite before we head into even deeper losses. On March 30th, the website Market Watch asked “Is this a dead-cat bounce or the bottom investors have been waiting for?”. On April 15th Forbes reported “Don’t Be Fooled By The Markets 24% Dead Cat Bounce” and on April 20th the New York Times ran “Can Investors Trust the Stock Market Rally?”.

So what can you do with this new knowledge? Almost nothing.

As that Market Watch article points out, it is hindsight that indicates a “dead-cat” and it is not a predictive asset. Looking at the bear market of the early 2000s there were a number of rallies, some lasting for half a year. Some rallies were indistinguishable from the general volatility of the market and seemed like neither a correction or a rally. Similarly, in 2008 there were a number of rallies before the market finally bottomed and began its long march back (see charts below). Importantly these periods of rebound, while followed by another dip, didn’t hurt investors in the long run. Had you invested in any of the bounces none of the subsequent downturns proved permanent to the long-term investor.

2000 downturn

So if the “dead-cat” isn’t a useful predictor, either of time, recovery or depth of the next fall, why is it so ubiquitous? The answer is because it is a non-position, a place holder until something more tangible can be grasped and a way of saying that you don’t know what’s going to happen framed like you do. Just as most predictions at the beginning of the year were for a moderately positive year in market returns, today people are making a claim that markets that go up may also go down, a decidedly underwhelming statement about the nature of market performance.

If there is a benefit to the proclamations of a dead cat bounce it is to advice caution to investors, waving them off getting too excited about positive market volatility in periods of extreme danger. Would it be wise to rush into a market showing a tentative recovery, buying every highly risky investment on the chance we’d hit bottom? The answer is clearly no. The warning of the bounce provides a mental check on how fast we should proceed and reminds investors to reconsider worst case scenarios.

Lastly, the dead-cat reflects a bias towards how we understand current conditions. This form of bias isn’t isolated to the financial markets. In the business of predicting weather there is something called a “wet bias” by companies like Accuweather and The Weather Network. If there is a 5% chance of rain, weather forecasters are likely to say its 20%, hedging their prediction. If the chance of rain is 50%, they will likely round up to 60% since 50% is considered less accurate by the public. In other words, the accuracy of the prediction is less valuable than how accurate the prediction feels.

This makes sense. If someone goes on TV today to argue that the recovery will be swift, that the economy will be unscathed, and that we will put this whole ordeal behind us with little societal memory this sounds inaccurate, like a prediction completely detached from reality. Arguing that we are in a “dead cat” style rally is plausible, a sensible take on the current situation that gives the illusion that aspects of this unprecedented situation have precedent and can be known.

We can conclude that the dead-cat bounce is a kind of shorthand that serves as both a warning and an explanation. That doesn’t mean it doesn’t have value, but it is a little short on providing guidance. Instead I advise that people who wish to get back into the market consider the following things.

  1. Do you need the money? If you were fortunate to have cash on hand when markets began falling, and can deploy that money today, do you need it? If you are hoping to invest money that is technically ear marked for spending in the near future, think twice about how you would fair without it.
  2. How risky is it? Let’s say you want to buy a blue-chip dividend paying company, a theoretically conservative investment, how well did it perform when markets fell? Did it perform better than the average market return, or was it relatively in line with it? The safety of stocks may be largely illusionary when markets sell off.
  3. Are you building on your financial plan, or abandoning it? Stocks at a discount may represent an opportunity to better round out your portfolio in aid of your financial goals, but if it weren’t for the sudden discount on the value of the company would it have still made sense for your portfolio?
  4. Will you be comfortable with a short-term loss? Just as you would hope that markets continue to recover, its important to consider the possibility that markets will indeed retreat and with it so will the value of your new investments. Can you live with an immediate drop between 10% to 20%? If this is early in the bear market, could you ride out multiple potential drops of up to 20% each time?

The dead-cat bounce is part of the lingua franca of the investing world, but it explains very little and doesn’t really provide advice. Whether you want to get back into the markets, or are fearful of doing so, the same due-diligence and questions about comfort of risk still apply. If you can answer those questions you should be able to benefit from the market volatility of bad markets.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

Recapping Last Week’s Market

A quick video looking at the sudden rise in markets last week and what conclusions we can draw from it.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

Why Can’t Markets Be Calmed?

A series of bad days, a moment of respite, and then more selling. This was the story of 2008, and it lasted for months. The rout lasted until finally investors felt that enough was going to be done to save the economy that people stopped selling. Massive quantitative easing, an interest rate at 0%, aggressive fund transfers, bailouts to whole industries, and the election of a president who seemed to embody the idea of “hyper competence”. That’s what it took to save the economy in 2008. Big money, an unconditional promise to save businesses and people, and the rejection of a political party that oversaw the bungled early handling of a crisis and had lost the public confidence.

I don’t think Donald Trump has never had been viewed as hyper competent. I doubt even his most ardent supporters see him as incredibly clever, but instead a thumb in the eye of “elites” who have never cared to take their concerns seriously, and to an establishment that seemed incapable of making politics work. Trump was a rejection of the status quo and a “disruptor in chief”. A TV game show host who played the role of America’s most sacrosanct character, the self made man, asked now to play the same role in politics.

There’s nothing I need to cover here you don’t already know. A history of bad business dealings, likely foreign collusion to win an election, surrounded by sycophants and yes men with little interest or understanding of the machines they have been put in charge of, and an endless supply of criminal charges. Like a dictator his closest advisors are members of his own family, and perhaps more shockingly he fawns over and publicly admires the dedications of respect other dictators get from their oppressed populations. Never has a person been so naked in their desires and shortfalls as Donald Trump.

Markets have played along with this charade because Trump seemed, if anything, largely harmless to them. Indifference to the larger operation of the government and the laser like focus on reduced regulations and tax cuts made Trump agreeable to the Wall Street set. If he could simply avoid a war and keep the economy humming, Trump was a liveable consequence of “good times”. Until the coronavirus issue, Trump had not done terribly. The economy wasn’t exactly humming. It had a bad limp due to a trade war with China. It had a chest cold because wealth inequality was continuing to worsen despite decreasing unemployment. And its general faculties were diminished as issues around health care, deficit spending, and other aspects of the society began to languish. But as far as unhealthy bodies go, the American economy still had its ever strong beating heart, the American consumer.

Whatever name you prefer; COVID-19, the coronavirus, SARS-CoV-2, or the #Chinesevirus (as Trump is now busy trying to get it renamed) has exposed the fault lines in the administration and the danger of such blinkered thinking by Wall Street. Having spent the last few weeks downplaying the severity of the outbreak and hoping China would be able to contain it, until finally, grudgingly, acknowledging its seriousness. Markets have suddenly come face to face with a problem that bluster and bravado can’t fix. Trump is a political liability for markets, and his leadership style, which is heavy on cashing in on good times with little management for rainy days, means that markets may not really have any faith that he can properly address these problems.

Other efforts to calm markets, largely through the federal reserve, have not reassured anyone. Two emergency rate cuts are not going to fix the economy but did spook investors globally (it did signal to banks that they should take loans to cover potential shortfalls). The promise of a massive set of repo loans to provide liquidity will keep markets open and lubricated, but again won’t save jobs and won’t prop up the physical economy. What will fix markets is an end to the pandemic, a problem with the very blunt solutions of “social distancing”, “self isolation” and the distant hope of a vaccine.

What investors are facing are three big problems. First, that we don’t know when the virus will be contained. Optimistically it could be a month. Realistically it could be three. Pessimistically people are talking about the rest of the year. Even under the best conditions we are also likely facing a recession in most parts of the globe, and even then stimulus spending and financial help won’t be as effective until people can leave their homes and partake in the wider market (postponing tax filings and allowing deferrals on mortgages are good policies for right now, but at some point we need to spend money on things). But the last problem is one of politics. The Trump administration is uniquely incompetent, has shown little interest in the mechanisms of government, and in a particularly vicious form of having something come back to bite you, dismantled the CDC’s pandemic response team.

The best news came last week, when it seemed a switch had been flicked and the general population suddenly grasped the urgency of the situation and people began self isolating and limiting social engagements (I am now discounting Florida from this statement). Those measures have only been strengthened by government action over the last few days. Similarly, while I write this, Trudeau has announced a comprehensive financial package to come to the aid of small businesses and Canadian families. All this is welcome news, and I expect to see more like this over the coming weeks as Western governments take a more robust and wide ranging response to the crisis. So there is just one issue still unaddressed. The political mess in Washington.

I can’t say that markets will improve if Trump is voted out of office, but its hard to imagine that they could be made worse by his exit. Markets, and the investors that drive them, are emotional and it is confidence, the belief that things will be better tomorrow, that allow people to invest. Trump promised a return to “good times”, to Make America Great Again, and it is his unique failings that have left it, if anything, poorer.

Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI.

The Exciting New Field of Recession Prognostication

PsychicI wish to inform you about an exciting new profession, currently accepting applicants. Accurate recession prognostication and divination is an up and coming new business that is surging in these turbulent economic times! And now is your chance to get in on the ground floor of this amazing opportunity!

I am of course being facetious, but my satire is not without precedent. As 2018 has devolved into global market chaos, finally losing the US markets in October, experts have been marshalled to tell investors why they are wrong about markets and why they should be more bullish.

Specifically analysts and various other media friendly talking heads have been trying to convey to the general public that the negative market sentiment that has driven returns down is misplaced, and have pointed to various computer screens and certain charts as proof that the economy is quite healthy and that in this moment we are not facing an imminent recession. Market returns through the final quarter of 2018 indicate this message has yet to find fertile ground among the wider public.

Dow Jones Dec 31
The Dow Jones has had a wild ride this year, with significant declines in February, October and finally in December when the markets ended the year lower than they began.

While these experts, analysts and financial reporter types may not be wrong, indeed the data they point to has some real merit, I don’t think that investors are wrong to heavily discount their advice. For the wider investing audience, being right 100% of the time is not a useful benchmark to strive towards with investments ear-marked for retirement. Instead a smarter approach is to be mindful about risks that can be ill-afforded. Investment specific risk, like that of an individual stock may be up to an investor (how much do I wish to potentially lose?). On the other hand, a global recession that is indiscriminate in the assets that suffer may be more risk than an investor can stomach.

TSX Dec 31
The S&P TSX has had another dismal year, and is currently lower than it was in 2007, marking a lost decade. Making money in the Canadian markets has been a trading game, not a buy and hold strategy.

The experts have therefore made two critical errors. The first is assuming that what is undermining investor confidence is an insufficient understanding of economic data. The second is that there is a history, any history, of market analysts, economists and journalists making accurate predictions of recessions before they happen.

This last point is of particular importance. While I began this article with some weak humor on prognostication and divination, it’s worth noting that predicting recessions has a failure rate slightly higher than your local psychic and lottery numbers. That so many people can be brought forth on such short notice to offer confident predictions about the state of world with no shame is possibly the worst element of modern investment culture that has not been reformed by the events of 2008.

2008 Predictions vs reality
These are the economist predictions for economic growth at both the start of Q3 and Q4 in 2008. Even as the collapse got worse, economists were not gifted with any extra insight. 

This doesn’t mean that investors should automatically flee the market, listen to their first doubt or react to their gut instincts. Instead this is a reminder that for the media to be useful it must think about what investors need (guidance and smart advice) and not more promotion of headline grabbing prognostication. The markets ARE down, and this reflects many realities, including economic concerns, geopolitical concerns and a host of other factors outside of an individual’s control. It is not a question of whether markets are right or wrong in this assessment, but whether good paths remain open to those depending on market returns.

Beware the Rally

*At the time that I wrote this markets had just finished several positive sessions, however by the time it was ready markets had once again changed directions!

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I’m going to potentially embarrass myself and go on the record as saying we shouldn’t place too much trust in the current market rally, though the upturn is welcomed.

Rallies present opportunities for potential short-term gain, and with markets having shed roughly 10% over the month of October, there is certainly money to be made if you’re feeling sufficiently opportunistic and have a plan. For the rest of us, the rally is a welcome break the punishment the market has been delivering, and an opportunity to see portfolios stabilize and regain some ground.

S&P 500 Rally

The long-term viability of a rally, its ability to transition from opportunistic buying to sustained growth, very much depends on the fundamentals of that rally. Are markets sound, but oversold? Or are fundamentals deteriorating and represents more hopefulness than anything else?

Readers of this blog will not be surprised to find out I have no set answer to this question. As always, “it depends”. But as I look over the news that has supposedly rekindled the fire in the markets much of it seems at best temporary, perhaps even fanciful. Up against the wall of risk that investors are currently starring down, the best news currently available is that Trump had a phone call with Xi Jinping and has asked for a draft to be prepared to settle the trade disputes between the two countries.

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I’m of the opinion that a recession isn’t imminent, but it should be obvious that recessions happen and the longer we go without one, the more likely one becomes. That seems especially true in a world that is undergoing a seminal shift when it comes to international trade and multilateral deals. To take one example, in the last year U.S. soybean exports to China have dropped by 97%, with no exports for the last quarter. This is a trade war still in its infancy. Other market data is mixed. Even as job growth exceeds expectations it will also keep the Fed raising rates. Housing starts have dropped significantly below expectations, driven in part by rising costs.

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All this is to say that market rallies like the one we’ve just seen should be treated with trepidation. Investors should be cautious that a bottom has been reached and that this is a good time to rush into the market looking for deals, and we should keep an eye on the fundamentals. Rallies falter precisely because they can be based more on hope than on reality.

So what should investors do if they want to invest but are unsure about when to get into the markets? Come talk to us! Give us a call and help get a plan together that makes sense for your needs! Check out our new website: www.walkerwealthmgmt.com or give us a call at 416-960-5995!

The Deceptive Nature of Indices

Index

An essential part of the business of investing involves figuring out how well you are doing. In some respects, the best benchmark for how well you are doing should be personalized to you. How conservative are you? What kind of income needs do you have? How old are you? While the case remains strong for everyone to have a personal benchmark to compare against their investment portfolios, in practice many people simply default to market indexes.

I’ve talked a little about market indexes before. They are poorly understood products, designed to give an impression about the overall health and direction of the economy and can serve as a guide to investment decisions. Large benchmarks, like the S&P 500, the TSX, or the FTSE 100, can tell us a great deal about the sentiment of investors (large and small) and what the expected direction of an economy may be.

But because these tools are usually poorly understood, they can contribute to as much confusion as they do clarity. For instance, the Dow Jones uses a highly confusing set of maths to determine performance. Last year General Electric lost about 50% of its market capitalization, while at the same time Boeing increased its market capitalization by 50%, but their impact on the Dow Jones was dramatically different. Boeing had an outsized positive contribution while General Electric had a much smaller negative impact.

The S&P 500 currently is one of the best preforming markets in 2018. Compared to most global indexes, the S&P 500 is ahead of Germany’s DAX, Britain’s FTSE 100 and FTSE 250, Japan’s Nikkei and Canada’s TSX. Yet if you are looking at your US focused investments, you might be surprised to see your own mutual funds lagging the index this year. If you were to ask an ETF provider or discount financial advisor why that is they would likely default to the answer “fees”, but they’d be wrong.

YTD FTSE S&P500 TSX
While the S&P 500 isn’t exactly “running away” it is doing considerably better than the TSX and the UK’s FTSE 100

This year is an excellent example of the old joke about Bill Gates walking into a bar and making each patron, on average, a millionaire. While the overall index has been performing quite well, the deeper story is about how a handful of companies are actually driving those returns, while the broader market has begun to languish. Of the 11 sectors in the S&P 500, only two are up, technology and consumer discretionary, while a further 6 were down for the year. In fact the companies driving most of the gains are: Facebook, Amazon, Apple, Alphabet (Google), Netflix and Microsoft. The 80 stocks in the consumer discretionary space not in that list have done almost nothing at all.

What does this portend for the future? There is a lot to be concerned about. The narrowing of market returns is not a good sign (although there have been some good results in terms of earnings), and it tends to warp investment goals. Investors demand that mutual fund returns keep up with their index, often forcing portfolio managers to buy more of a stock that they may not wish to have. In the world of Exchange Traded Funds (or ETFs), they participate in a positive feedback loop, pulling in money and buying more of the same stocks that are already driving the performance.

In all, indexes remain a useful tool to gage relative performance, but like with all things a little knowledge can be deceptive. The S&P 500 remains a strong performing index this year, but its health isn’t good. Healthy markets need broad based growth, and investors would be wise to know the details behind the stories of market growth before they excitedly commit money to superficially good performance.  

Did that make you worried? Don’t be scared, call us to set up a review of your portfolio to better understand the risks!

The Market is Rallying – Why Again?

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Markets have begun to rally around the globe, perhaps signalling an end to the volatile beginning of the year. The mood has definitely lightened and there seems to be some broad support for a return of some positive numbers across the board.

But if we stop to ask ourselves why, we may be left scratching our heads at the answer. The current list of issues affecting the global economy is pretty long. China’s slowdown, the demand destruction for oil, problems across multiple oil and commodity producing nations, financial instability and an almost unbelievable amount of debt. In fact the the market turmoil has a lot of justification, far more than some of the previous sudden corrections over the last two years.

So what’s changed? Three things. First, central bankers have recommitted themselves to doing whatever it takes to put the economy back on a path to growth. Second, a deal has been announced with Russia and Saudi Arabia to cap oil production. Third, a growing concern about the financial assets of Deutsche Bank have been “put to rest” as it were by the German government.

As a list of reasons to be excited, I’m left somewhat underwhelmed. Take the deal between Russia and Saudi Arabia. The larger promise of this deal is that is spells out potential future moves to get oil prices back to a level of sustainability. For right now it simply outlines capping oil production at January levels, but will be largely meaningless if Iraq and Iran can’t be brought into the deal. Iraq and Iran for their part aren’t really interested. Iran, who isn’t exactly friendly with Saudi Arabia, has just got back into the global oil market and is looking to ramp up production. Iraq is also increasing it’s oil production, helping bring much needed funds to a country that is still looking to stabiles and legitimize itself. Neither are particularly interested in following Saudi Arabia’s lead.

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It would at least mean more however if the January production numbers reflected some kind of wide ranging reduction in oil output, but among OPEC nations, as well as the United States and even Canada, oil production has continued to increase despite the price drop.

What about the central bankers promising to use all their muscle (and some that we didn’t know they had) to save the economies of the planet and return economic growth? Having spent the last eight years with emergency level key interest rates and very little to show for it the only solution is to go to a negative interest rate. Earlier in 2015, Stephen Poloz suggested that negative interest rates were a possibility for Canada. Much of Europe already has negative interest rates. Japan surprised markets a few weeks ago by making their key interest rate negative. Last week Janet Yellen, head of the Federal Reserve, also said that negative rates were not “off the table.” Disturbingly, having interest rates as close to zero as possible hasn’t encouraged wide ranging inflation across developed economies. Obviously the only solution is more of the same but SAID LOUDER AND MORE CLEARLY.

Here is Christian Bale yelling at you to spend some of your money!

But possibly the least exciting of the exciting news is surrounding Deutsche Bank. Last week Deutsche Bank seemed to be cruising towards the unenviable title of “the next Lehman Brothers”, before the German government “encouraged” the the market with some supportive words around the stability of the bank; a coded signal that Deutsche Bank is both “too big to fail” and that the German taxpayer would be on the hook.

Deutsche Bank’s problems have been extensively catalogued. Between massive fines, massive losses, massive layoffs, and a massive derivative position currently in excess of $50 Trillion (yes, with a “t”) the potential for the world’s fourth biggest bank to implode and set of some kind of financial (and given it’s position within Europe, political) cascade effect is very real, even if they do get a bailout.

On top of all that is the regular bad news that we haven’t addressed. China’s liability is still unknown, and as it hemorrhages foreign currency reserves threatens yet another line of attack against markets. Venezuela may, or may not, default on it’s debt. Here at home provinces like Ontario would have at least been hoped that a combined falling dollar and oil price would start bringing new manufacturing within our borders, instead they must brace for the disappointing news that of three new auto plants for North America, we will get none.

Some people may be excited about the most recent rally, but I’m afraid I’m not one of them.

What “The Big Short” Can Tell Us About Market Risk

I81wBzBcSclL‘ve just had a chance to watch the movie The Big Short, based on the book of the same name by Michael Lewis. Michael Lewis has made a name for himself as a writer for being able to explain complex issues, often involving sophisticated math that befuddles the general population but is responsible for much of the financial chaos that has defined the last decade.

The principle of our story is Dr. Michael Burry, a shrewd investor whose unique personal qualities gives him the patience to tear apart one of the most complicated financial structures in modern finance. Having done that he creates a new market for a few people who had the foresight to see the US housing bubble and how far the crash might reach. The story is captivating and the tension builds to what we know is the inevitable conclusion of the worlds biggest crash, but there is a problem with the story.

No matter what they do in the movie, we know how it all ends. That hindsight undercuts the real tension in the film, the risk that these few traders and hedge fund managers took with other people’s money to bet against what were largely considered to be safe investments. In some ways, the US housing crash is unique because of how much institutionalized corruption had seeped into the system. The ratings agencies who sold their AAA ratings for the business, the mortgage brokers who pushed through unfit candidates into subprime adjustable rate mortgages, the analysts and financial specialists that repackaged low grade mortgages into AAA rated bonds; it took all of them and more to create the biggest market bubble since the South Sea.

Their smart move seems like lock, but if you look past the drama the heroic brokers of our story were taking a huge gamble with other people’s money. From Dr. Michael Burry down through the rest of the characters, hundreds of millions, billions even, were tied up in investments that few understood but carried incredible potential for losses. The confidence that our heroes show in demanding “half a billion more” as they come to understand the scope of the problem seem smart in hindsight, but they were making big bets. Bets that could have easily ruined people’s lives and finances.

This is the true nature of risk. Things are only certain in hindsight. At the moment we need to make decisions rarely do we possess the kind of clarity that we believe we should have when dealing with markets. If we look to current markets what can we honestly say we know about tomorrow? Markets are chaotic, oil prices are in the tank, central bankers are talking about negative interest rates (while some have gone and done it), and then we will have 2 or 3 days of market rallies. What picture should we draw from this? What certainty do we have about tomorrow’s performance?

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From Bloomberg

Our problem is that when we are inclined towards certainty we are also inclined towards fantastic risk. In fact we won’t even believe there is risk if we are certain of an outcome. And we are prone to lionizing people who risk it all and are proved to be right, while forgetting all those people who made similar gambles and lost everything, leading us to repeat a mistake that has undone many.

The story we need isn’t the one about the people who bet big and won. We need the story about the people who bet smart and navigated confusing and risky markets and came out fine. That story sadly won’t have the kind of impact or drama that we long for in a movie, but it’s the story that each and every investor should want to be part of.

Pessimism is in! You Can Keep Your 2016

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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.

On our first day of business in 2016 the Chinese stock market had tumbled so steeply that market trading had to be shut down. Canadian manufacturing data also showed that Canada had hit its lowest manufacturing point in years and that manufacturing was continuing to decline. Meanwhile Saudi Arabia looks almost poised for war with Iran as tensions continue to heat up over flagrant human rights abuses that finally seemed to cross the line for someone. At the very least we might assume that oil prices would have risen on the growing tensions of the Middle East, but even that has yet to be the case. And while the Canadian dollar continues to tumble, even the United States is starting to show signs of wear on its economy.
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.
FT China
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.
TSX last year highlight
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.

BRICs Trouble
There’s a lot of sadness underlying this photo…

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.

America Is In Great Shape; Be Afraid!

markets_1980043cAll year people have been expecting a correction in the US Markets. For most of the year I have listened to portfolio managers discuss their “concern” about the high valuations of American companies. I have also listened to them point out that America remains the strongest economy and the most likely to see significant growth in the coming year.

Flash forward to late-September, early October and the markets have finally had their corrections. At the bottom every market was negative, including the TSX which had given up all of its YTD high of 15%. That was the bottom. The recovery was swift, money flowed back into the markets, and hedge fund managers managed to make a mockery of some otherwise nervous DIY investors. Now the markets look strong again, with the S&P 500 reaching new highs. Nobody is happy.

All of this comes on the news that US GDP was up 3.9% in the third quarter, a full .5% above analyst expectations (that sounds small, but it’s worth billions) while energy prices continue to decline, manufacturing is highly competitive and US consumers look poised for a significant Christmas bonanza. So what’s wrong with this picture? Why are both the Globe and Mail and the Financial Times worried about the US stock market?

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The answer is a combination of fear, data, and the insatiable need for stories to populate the media everyday. First is the fear. Stocks are at all time highs. The problem is that “all time high” isn’t some automatic death sentence for a stock market. The stock market always hits new highs all the time, and a by-product of that is that corrections can really only happen after a high is reached. Look at the history of the S&P 500 since 1960:

Screen Shot 2014-11-26 at 11.02.50 AMAs you can probably tell, there are a lot of “new highs” that had occurred over the last 40 years, but each new high did not automatically translate into some automatic correction. There were legitimate reasons why the economy could continue to grow, and in the process make those companies in the stock market more valuable. That isn’t to say that the stock market can’t be “frothy” or that their aren’t problems in the stock market today. It merely means that setting a new market high isn’t proof of an impending collapse.

The second issue is data. We live in an age of Big Data. Data is everywhere and there is so much it can be hard to separate the useful data from the useless. Some of the data is concrete, but much of it takes time to understand or even become clear. The first analysis of the higher than expected GDP numbers seemed great (more economy, Yay!) but upon closer inspection, there are reasons to be cautious. While the GDP was higher than expected, it was largely due to growth in government spending, not consumer spending. In fact consumer spending was lower quarter over quarter. In addition there are a number of concerns about how corporations are spending their profits and whether that is sustainable. Many of these concerns, when taken in context, seem to be the same from earlier in the year.

The third factor is the insatiable need to write something. Content is king in the news world and providing insight (read: opinion) means that you must constantly produce new stories to publish. That means that there is a need to be constantly suggesting that things are about to go wrong (or more wrong than they already have) to create a compelling story. It isn’t that these stories are wrong, just that constantly saying the stock market is going to go down isn’t insightful, since at some point we can expect the stock market to correct for one of a number of reasons.

So is America frothy? Are we poised an some kind of financial collapse? I don’t know, and nobody else does either. We are no more likely to correctly know when the market might correct again than we are to guess the future price of gas. The best response is to diversify, and remember some core elements of investing. Buy low and sell high. With that in mind sturdy investors should probably start giving the beat-up and maligned Europe a second look…