Watching the Crisis Unfold in Real Time

Housing Crisis 2

The economic fallout of the pandemic has garnered many shocking headlines, from concerns over how many restaurants may fail to the sheer number of people seeking unemployment insurance. Some of this is economic rubber necking, basking in the shocking and outlandish statistics generated by the lockdown and pandemic. The real test is still in front of us, determining what is temporary and what is permanent.

From the New York Times

Concern that a number of restaurants may not reopen seems a reasonable fear, since lots of restaurants don’t survive normally. The impact to the airline industry will take years to work out, since you can’t just put all those planes back in the sky. It will take time to determine which routes should be brought back first, how many people want to fly and the planes themselves will need considerable maintenance before any of them roll down a runway.

But hope springs eternal. Eight weeks into the lockdown and efforts remain underway to gradually reopen the economy, and in time we will see which parts of our society (not economy, but society) need real help to get back on its feet.

I remain largely optimistic about the speed of the recovery once it’s safe to reopen, but remain cautious regarding existing problems within the Canadian economy that the pandemic will likely accelerate. Problems that were hidden just under the surface will find themselves in the cold light of day, and those problems will have repercussions, many of which will not be easy to predict.

As I wrote back in March (Will Covid-19 Make Real Estate Sick?)

“Problems rarely exist in isolation, and a problem’s ability to fester, grow and become malignant to the health of the wider body requires an interconnected set of resources to allow its most pernicious aspects to be deferred. In Canada the problem has been long known about, a high level of personal debt that has grown unabated since we missed the worst of 2008. What has allowed this problem to become wide ranging is a banking system more than happy to continue to finance home ownership, a real estate industry convinced that real estate can not fail, and a political class that has been prepared to look the other way on multiple issues including short term rental accommodation, in favour of rising property values to offset stagnant wages”

The issue of debt, real estate and short-term accommodations may be one issue undergoing a seismic shift in real time. The website MLS paints a surprisingly changed picture of the rental situation in downtown Toronto. Condominiums like the Ice Condos, located at the bottom of York Street were written about last year because so many of the units were being used for Airbnb. Today they offer hundreds of long-term rentals. The story is not limited to a few buildings either, much of the downtown condo scene, once reserved for Airbnb customers, has suddenly opened to long term accommodation.

Condo Rentals
A snapshot of available rental in May 2020 in downtown Toronto

For a city that only a few months ago was running perpetually short of rentals this change has been rapid, but its fair to assume that many of these landlords are hoping that the crisis will pass and that things will return to normal, with lucrative business in short term rentals resuming. The effect of all these new rentals is not happening in a vacuum. According to in their May 2020 report, the price of condo rentals in locations like the Ice Condos have dropped by 10%.

Rental Change in TO

The flip side of the real time change has been the sudden collapse in real estate sales. Reportedly year over year housing sales have dropped in Toronto by 67%, and new listing are down 64%. The selling and buying of houses has simply come to a grinding halt, and with it much of the city’s revenue from the land transfer tax, creating a secondary crisis within cities that have depended on the land transfer tax for revenue growth. In a cruel twist on a well-intentioned effort to get government finances under control, Toronto isn’t allowed to run a deficit, a constraint that has turned into a fatal weakness under the pandemic.

It is here that we should stop and consider a reality. In a few short weeks two major sectors of the Canadian economy within the city of Toronto (and Vancouver for that matter) have been radically altered. But this is also a period where we have seen the most government support and extensive economic intervention. Long term expectations have yet to shift. Airbnb hosts wish to remain Airbnb hosts. Homeowners hope to continue to use their houses to expand their financial footprint. But we should take a page from the city of Toronto reviewing its financial books, the real crisis has yet to truly unfold.

Our future contains, but has yet to have pass, the retreat of government financial support. It has yet to put people back to work, yet to reopen universities, yet to ramp up our manufacturing base, yet to know much of anything about moving past Covid-19. Clarity about what governments should or should not do are hindered by China’s resistance to openness and transparency, while other nations that have already faced the pandemic and seemed to recover are running into second waves. There is no clarity about the future.

iStock-518182156 (1) (1)Real estate remains at the heart of the Canadian economic story for the last 20 years. Appreciating housing prices are the chief source for growth in Canadian families’ net worth. Borrowing to buy houses and borrowing against home equity remain our chief sources of debt. Our politics revolves around the tension of needing more housing in certain highly desirable areas while preserving those areas from over development. That dynamic has revolved around a status quo that seemed to have no conceivable end. The pandemic may have radically altered the Canadian real estate landscape regardless of how people feel about it or what they want. Whether we can walk back changes of this magnitude remains very much unknowable. For now we can only watch the changes our society and economy are undergoing and hope that what we are witnessing will be for the best, those changes that have happened, and those yet to come.

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.

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.

A Broken Clock That’s Right Only Once

Ray Dalio: ‘We’re disappointed because we should have made money rather than lost money in this move the way we did in 2008’ © Reuters

In 2009 I was working for a large mutual fund company in Western Canada. It was the peak of the financial crisis and I was given the opportunity to take a promotion but had to move to Alberta. I was eager to move up (I was only 28) and jumped at the chance though I had no great desire to live in Edmonton. It was a difficult time. It was lonely in Alberta, and people weren’t eager to speak to a wet behind the ear’s wholesaler right after the biggest rout in modern financial history.

One particularly vivid memory for me was back in 2009, walking into an office at the tail end of conference call being given by Christine Hughes, a portfolio manager of some note during the crisis. Hughes was at the top of her game. She had outperformed much of the market by holding 50% cash weighting and had correctly predicted the financial crash. In later appearances she would complain that the company she worked for had prevented her from holding more and would have had been allowed to. But at this moment, in 2009, it was late summer, and markets had been rebounding for several months, having hit bottom in early March. Hughes was adamant that “the other shoe was going to drop” and that’s when things would really go wrong.

For much of my time in 2009 Hughes, and her fund, was the story that challenged me. Having made the correct call in 2008, advisors were eager to listen to what she had to say and believed that her correct prediction in 2008 meant she knew what was coming next. Many people followed Hughes and her advice, which led primarily nowhere.

Hughes’ time subsequent to 2008 was not nearly as exciting or as successful as you might have guessed. She left AGF, where she had made it big, and went on to another firm before finally starting her own company, Otterwood Capital. The last time I saw Hughes it was in 2013 and she was giving a presentation about how close we were to a near and total collapse of the global financial system. Her message hadn’t changed in the preceding four years, and to my knowledge never did.

Hughes may not have prospered as much as she hoped following her winning year, but others who made similar predictions did. One such person is Ray Dalio, the founder and manager of Bridgewater Associates. Dalio is a different creature, one with a long history on Wall Street who had built a successful business long before 2008. But 2008 was a moment that launched Dalio into the stratosphere with his “Alpha Fund” largely sidestepping the worst of that market and by 2009 his hedge fund was named the largest in the US. Since then Dalio has grown a dedicated following beyond his institutional investors, with a well watched YouTube video (How the Economic Machine Works – 13 million views) and a series of books including one on his leadership principles and a study on navigating debt crises (I, of course, own a copy!). Yet when the corona virus rolled through Dalio’s funds faired no better than many other products (I’m sorry, this is behind a paywall, but I recommend everyone have a subscription to the Financial Times). Once again past success was no indication of future returns.

I’m not trying to compare myself to a hedge fund manager like Dalio, a person undoubtably smarter than myself. However its important to remember that being right in one instance, even extreme and unpredictable events, seems to offer little insight into when they will be right again.

If you’ve read many of these posts you may know that I am a fan of Nassim Taleb, the author of The Black Swan and Antifragile. Early in the book Black Swan, Taleb makes the case that “Black Swan logic makes what you don’t know far more relevant than what you do know. Consider that many Black Swans can be caused and exacerbated by their being unexpected.” This is an important idea that I think can be extended to our portfolio mangers that gained notoriety for getting something right and then getting much else wrong.

A complaint I have long held about experts within the financial industry is both their desire to position themselves as outsiders while being likely to share many of the same views. Having a real contrarian opinion is more dangerous than being part of the herd, after all if things go wrong for you as a contrarian, they are likely to be going right for the herd. On the other hand, if things go wrong for the herd, the herd can use its size as a defense: “We were all wrong together.”

Some of this group think can be applied to the failure of governments to get a jump on the coronavirus situation. Far from not listening to experts, governments took the safest bet which was also the most conservative view, that the virus posed a low risk to the population of countries outside China. People who thought the virus was a large risk were taking a more extreme view; that the virus posed a serious risk and required extreme measures such as travel restrictions, aggressive testing, encouraging people to wear face masks and socially distance. As a politician which choice would you make?

The point for investors should be to treat the advice of financial experts who rise to prominence during outlier events as no more special than those that got big financial events wrong. This is not because their advice isn’t good, just that the thing they got right may not indicate wide ranging knowledge, but a moment when they understood something very well that other people did not. Investors should avoid personality cults and maintain a principle of uncertainty and scepticism to prophets of profit. The rise of COVID-19 and the global pandemic response, including the rapid change in the market, will produce a number of books and talking heads who will parlay their status as hedgehogs into that of a foxes! (If you don’t know what I’m referring to, please read this from 2016).

Dalio remains a very successful manager, but his correct reading of 2008 did not prepare him for 2020. In his own words: “We did not know how to navigate the virus and chose not to because we didn’t think we had an edge in trading it. So, we stayed in our positions and in retrospect we should have cut all risk.” Christine Hughes on the other hand seems to have disappeared, her fund gone and she in an early retirement. I know of no financial advisers eager to hear her views.

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.

What To Do When You Need To Sell in Bad Markets?


Following up from a previous video (Why investors are told to stay invested in bad markets), we must recognize that we can’t always pick and choose when we need money from our savings. So how should we pick what investments to sell in a poorly performing market? Here’s one strategy to consider and help guide you!

As always, I’m available to talk any time and can be reached on my cell phone, through our office number or via email!


Adrian Walker


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.

All Eyes Are On China

People in China

China, the first hit by the coronavirus and the first to emerge from its enforced hibernation, is the global centre of attention as people watch to see how fast its economy can recover from the from the pandemic chaos unleashed in January. If China is able to bounce back quickly it will be good news for other countries and should raise spirits of investors, businesses, and governments that a global shut down may not lead to the worst of all worlds.

Early economic data is both more and less reassuring than one might expect. The impact of the lockdown in China took a sizeable bite out of the economy. The one year change in the value of exports is -15.9% (down already since the trade war began), industrial production was -13.5%, the fastest contraction in 30 years, while retail sales in China were down -20.5%.

China Data

But as things return to normal in the shadow of the pandemic, numbers may also be improving faster than we thought. Reported in the Financial Times on March 20, of the 80% of restaurants that had been closed in February, less than 40% are closed now. That’s good news for small businesses watching from across the Pacific. There is good news in manufacturing as well. The Purchasing Manager’s Index (PMI) has been officially reported at 52.0, which indicates that manufacturing is growing and not contracting. In February the PMI for China was 35.7, a record low for the country. That positive PMI result is helping extend gains today (March 31st) and giving hope to governments and markets that the worst of this pandemic may be shaken off faster than economists have predicted.

PMI China March

But economic activity is still well below 2019 levels and have a way to recover. In addition, China is one nation, the Western economy is made up of many, and the countries worst hit by the COVID-19 outbreaks have yet to peek and plateau. Italy, Spain and the United States are all fairing poorly, with Italy and Spain perhaps just finally reaching peak of cases now. The United States on the other hand now has more officially recorded cases than any other country, while New York, Catalonia, and Madrid are on track to pass Lombardia as the worst affected cities both in infections and mortalities.

Ft Capture Countries

The coronavirus remains the central unknown in this story. If tamed, can it be permanently subdued? If not, can new cases be dealt with on a case by case basis, or will we have to revert to aggressive forms of social distancing? Concerns remain about whether there will be a second wave of infections in Asia, while China has maintained that all new cases are being imported and can be dealt with proactive screening and testing.

FT Corona City Mortality

In Europe and North America the best news has been to see production of ventilators, masks and the deployment of field hospitals ramp up to deal with the threat. In the wider Asian region, wide testing and a willingness to follow government dictates and a focus on personal protection through the adoption of wide mask usage has had a direct impact on taming the virus in Taiwan, South Korea and Japan (the exception here might be Japan, which seems to have relaxed prematurely and now is considering shutting down Tokyo). But the best news may still be from China and a sudden and rapid improvement in their economy as restrictions are lifted. If prolonged the early rally than began last week, and has continued yesterday and through overnight trading may become the foundation for a more sustained recovery. If not markets may be thrown back into turmoil.*(Please note, markets seem to be in turmoil again.)

Covid-19 CHina Economy

Today, at the end of March, I think the potential for a slower recovery remains possible. Huge stimulus packages have been put in place by governments to help ease the worst of the economic fallout. Governments and their citizens seem to be facing the challenge head on, even if they have been late to the game. America’s enormous manufacturing capacity is being used usefully to deal with the pandemic (better late than never) and early economic news from China is encouraging, but should be treated with caution.

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.

COVID-19 is a Black Swan, What Does That Mean?

disease epidemic New coronavirus “2019-nCoV”, handwritten text.

Late last week markets began to take the novel corona virus very seriously, and returns started to walk back from the all time highs earlier in the month. That retreat accelerated this week as COVID-19 virus fears exploded and the potential of a wide ranging global pandemic seemed possible despite the enormous efforts of the Chinese to quarantine and contain the virus. In South Korea, Italy, Iran, Japan, Canada and the United States the virus has appeared in varying states of severity, and are sparking varying degrees of public health responses.

COVID-19 strikes me as a black swan event, an unpredictable outlier that can’t really be planned for. An “unknown unknown”. Governments have plans in place to deal with epidemics, and learn from past outbreaks, but can’t plan for a virus they don’t know about and proves to be better than the precautionary measures already established to contain such events. In the instance of COVID-19, the virus seems very virulent, spreading rapidly but also having a long incubation time. You may not show any signs of the virus, and, in a cruel twist, many people with the disease may only have mild symptoms, making it easily confused with the common cold and less likely for an infected person to seek treatment while being an effective transmitter.

Dow Jones Industrial Average
The Dow Jones Industrial Average over the last month. 

Markets have capitulated to the fear that this virus is dangerous and will have an outsized impact on the global economy, already in a much weaker state than market returns suggested. But like all black swans what happens next will determine how serious it becomes. For my own part I believe the virus is serious, but that the 2% mortality rate may only apply to China, and that it is likely lower with a much larger pool of diagnosed people obscuring the data. This is backed up somewhat by the much smaller number of fatalities in other countries, including Japan and South Korea. What black swans really do is expose a society’s resiliency.

Resiliency is something I’ve discussed before, and it comes into play here. Iran is proving to be one of the more virulent places for the disease, with underreporting of people who have contracted it, a number of government officials who now test positive for it, and a number of cases in foreign countries linking back to Iran, the reality is that Iran’s problem is one of resiliency planning compared to richer countries that have well established protocols for dealing with public health emergencies and the money to dedicate to them. By comparison Iran faces long standing economic sanctions while simultaneously engaging in expensive (and somewhat successful) proxy wars for hegemony in the middle east, ignoring wider investment in public infrastructure.

But resiliency covers a wider range of issues. From an investment standpoint diversified portfolios containing a wide selection of asset classes and geographic allocations are safer because they tend to be more resilient, and not through any confusing magic. Debt, both long term and short term, erode resiliency as they eat away at your ability to respond to new problems while shackling you to existing commitments. In terms of managing the economy, interest rates are also a form of resiliency, and the ability to cut rates or raise them speaks to the strength of an economy. A cursory glance at these issues might give one pause, since Canadians have all time records of debt, and an attempt in 2018 to raise interest rates for the wider health of the economy led to a rapid sell off at the end of the year, while in 2019 central banks cut rates almost everywhere to prop up a softening global economy.

COVID-19 is a significant challenge that I believe the world is up for, but as a black swan I suspect its impact will be felt more in its economic fallout. As we move into the second quarter of the year a clearer picture will emerge at just how serious the economic impact of the virus, and efforts to contain it, really have been. Given some of the existing issues within the economy, as well as those currently being stressed by the fraying of international trade, the corona virus has the potential to push economies into recession. At which point all citizens should ask, just how resilient is my country, and just how resilient am I?

Have questions about the resiliency of your portfolio? Please feel free to give me a call or send an email.

Our office: 416-960-5995

My email:

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.

The Mystery of Market Volatility

GTY 460643338 A FIN MAX USA NY

This past week markets had a sudden and sustained sell off that lasted for two days, and though they bounced back a little on Friday, US markets had several negative sessions. The selloff in US markets, which began on Wednesday and extended into Thursday, roiled global markets as well, with extensive selling through Asia and Europe on Wednesday evening/Thursday morning. At the end of the week Asian, European and Emerging markets looked worse than they already were for the year, and US markets had been badly rattled. This week has seen an extension of that volatility.

Explanations for sudden downturns bloom like flowers in the sun. Investors and business journalists are quick to latch onto an explanation that grounds the unexpected and shocking in rational sensibility. In this instance blame was handed to the Federal Reserve, where members had been quoted recently talking about higher than expected inflation forcing up lending rates at an accelerated pace. This account was so widely accepted that Donald Trump was quoted as saying that “The Fed has gone crazy”, a less than surprising outburst.

TSX year to date performance is currently just over -4.3%

I tend to discount such explanations about market volatility. For one, it seeks to neuter the truth of markets as large complex institutions that are subject to multiple forces of which many are simply invisible. Second, by pretending that the risk in markets is far more understandable than it really is, investors are encouraged to take up riskier positions and strategies than they rightly should and ignore advice that has proven effective in managing risk. Finally, I have a personal dislike for the façade of “all-knowingness” that comes along after the fact by people who have parlayed luck into “expertise”. Markets are risky and complex, and it would be better if we treated them like a vicious animal that’s only partially domesticated.

The Dow Jones performance has been quite good this year, but in the past week lost just over 5%, bringing year to date returns to 2.94%

In fact, as markets continue to grow with technology and various new products, complexity continues to expand. At any given time markets are subject to small investors, professional brokers, pension funds, algorithm driven trading programs, mutual fund managers, exchange traded funds and even governments, all of whom are trying to derive profits.

So what does that tell us about markets, and what should we take from the recent spike in volatility? One way to think about markets is that they operate on two levels, a tangible level based on real data and expectations set by analysts, and another that trades on sentiment. On the first level we tend to find people who advocate for “bottom up investing”, or the idea that corporate fundamentals should be the sole governor of stock’s price. If you’ve ever heard someone discuss a stock that’s “under-performing,” “undervalued,” “out of favor,” or that they are investing on the “principles of value” this is what they are referring to. People who invest like this believe that the market will eventually come around to realizing that a company hasn’t been priced correctly and tend to set valuations that tell them when to buy and sell.

Germany, the strongest economy in EUrope has already struggled this year under the burden of the EU fight with Italy’s populist government and ongoing BREXIT negotiations. YTD performance is -10.56%

The second level of investing is based on sentiment, informed by the daily influx of headlines, rumour and conspiracy that clogs our news, email inboxes and youtube videos. This is where most investors tend to hang their hat because its where the world they know meets their investments. Most people aren’t analyzing a specific bank, but they may be worried a housing bubble in Canada, or the state of car loans, or the benefits of a recent tax cut or trade war. The sentiment might be best thought of as the fight between good and bad news informing optimism and pessimism. If a bottom up investor cares about a company they may ignore general worry that might overwhelm a sector. So if there is a change in in the price of oil, a value investor may continue to own a stock while the universe of sentiment sees a widespread selling of oil futures, oil companies, refining firms and downstream products.

Shanghai Comp YTD
China is the world’s second largest economy and the biggest market among the emerging markets. Having struggled with Trump’s tariffs, YTD performance is a whopping -22.8%

As you are reading this you may believe you’ve heard it before. Indeed you have, as our advice has remained consistent over the years. Diversification protects investors and retirement nest eggs better than advice that seeks to “beat the market” or chases returns. However, it seems to me that the market sentiment is undoubtedly a stronger force now than its ever been before. As more investors come to participate in the market and passive investments have grown faster than other more value focused products, sentiment easily trumps valuations. Since we’re always sitting atop a mountain of conflicting information, some good and some bad, whichever news happens to dominate quickly sets the sentiment of the markets.

You don’t have to take my word for it either. There is some very interesting data to back this up. Value investing, arguably the earliest form of standardized profit seeking from the market, has remained out of favor for more than a decade. Meanwhile the growth of ETFs has continued to pump money into the fastest growing parts of the market, boosting their returns and attracting more ETF dollars. When the market suddenly changed direction on Wednesday, the largest ETF very quickly went from taking in new dollars to a mass exodus of money, pushing down its value and the value of the underlying assets. At the same time some of the worst performing companies went to being some of the best performing in a day.

This chart shows that actively managed mutual funds have hemorrhaged money oer the past few years, while passive ETFs have been the chief beneficiaries, radically altering the investment landscape.

So what’s been going on? The markets have turned negative and become much more volatile because there is a lot of negative news at play, not because interest rates are set to go up too quickly. Sentiment, that had been positive on tech stocks like Amazon and Google gave way to concern about valuations, and with it opened the flood gates to all the other negative news that was being suppressed. Brexit, the Italian election, the rise of populism, currency problems in Turkey, a trade war with China and rising costs everywhere came to define that sentiment. As investors begin to feel that no where was safe, markets reflected that view.

Our advice remains steadfast. Smart investing is less about picking the best winner than it is about having the smartest diversification. A range of solutions across different sectors and styles will weather a storm better, and investors should be wary of simplistic answers to market volatility. Markets always have the potential to be volatile, and investors should always be prepared.

Vexed by the VIX

This past week a number of articles spilled forth regarding the VIX index being at record lows. If you aren’t familiar with the VIX, that’s quite okay; the VIX is an index that tracks the nervousness of investors. The lower the VIX is the more confident investors are. The higher the VIX, the greater the concern.

At first glance the VIX seems to clearly tell us…something. At least it seems like it should. The index is really a measure of volatility using an aggregate of prices of options traded on the S&P 500, estimating how volatile those options will be between the current date and when they mature. The mechanics aren’t so important for our purposes, just that this index has become the benchmark for the assumed fear or comfort investors have with the market.

So what does it mean when the VIX is supposedly at its lowest point in nearly a quarter of a century?

Historic VIX
This is the historic performance of the VIX. Data provided by CBOE.

Because we live in the 21st century, and not some other more primitive time, we have the best technology and research to look to when it comes to discerning the meaning of such emotionally driven statistics. Its here that the the area of study of behavioural economics and investing supposedly cross paths and that we might be able to yield some useful insight from the VIX.

Motorola RAZR V3_1
What is this, 2007? Might as well be the stone age!

Or not.

The holy grail of investing would presumably be something that allowed you to accurately predict changes in the market based on investor sentiment. Though over time stock markets are meant to be an accurate reflection of the health and wealth of an economy, in the short term the market more closely tracks a series of more micro events. Investor sentiment, political news, potential scandals as well as outside influences like high frequency trading and professional traders pushing stocks up and down all make up daily activity.

The VIX seems like an ideally suited index to then tell us something about the market, and yet it probably isn’t. The problem with research into behavioural economics (and its other partner, big data) is that it is great at telling us about things that have already happened. The goal, that we could use this information to change or alter human behaviour, is still a long way off (if it exists at all). Similarly the VIX is basically great at telling us stuff that we already know. When markets are bad the VIX is high. When markets are good its generally low.

Skiing in pants
Bad forecasting can lead to terrible outcomes.

Thus, the VIX represents a terrible forecasting device but an excellent reminder about investor complacency. When markets are “good” (read: going up) there is a tendency for investors to ask for more exposure to those markets to maximize returns. If you feel uncertain about the future, investors and financial advisors are less likely to “drift” in terms of their investing style, but if people feel very good about the future their far more likely to take their foot off the breaks.

Screen Shot 2017-05-18 at 2.00.19 PM
Yesterday’s selloff followed news that Trump’s Russia problem wasn’t going to go away, but remain a permanent feature of his administration.

Real market panics and crashes tend to be triggered by actual structural problems. 2008 wasn’t the result of too much confidence about the future from investors, but because the market itself was sitting on a bubble. That the VIX was low only tells us what we already knew, that we weren’t expecting a financial crisis.

We can hope.

With markets down sharply yesterday its tempting to see that this level of investor complacency/confidence harbingered the most recent sell off. But that’s not the case. Trump is, and remains, a kind of nuclear bomb of unpredictability that must be factored into anyone’s expectations about the markets. But what we should do is consider the VIX a mirror to judge our willingness and preparedness to deal with unexpected events and market downturns. If you’ve started to assume that you can afford growing concentration in your portfolio of high performing equity or that you don’t need as many conservative positions, you should take a long hard look at why you feel that way. Maybe its just because you feel a little too confident.

Like everyone else.