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 Mystery of Market Volatility

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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 YTD
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.

Dow YTD
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.

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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.

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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.

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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.

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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.

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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.

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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.

 

Let’s Undo Brexit! (Here’s How)

Brexit-2If there was ever going to be a moment to gain some clarity about what the Brexit would truly and ultimately mean, Friday was the day. Following the win by the leave camp, markets were sent reeling on the uncertainty stirred up by the referendum, and by the day’s end Britain had gone from being the 5th largest economy to the 6th, $2 trillion in value had been wiped from the markets, Scotland wants another referendum as Northern Ireland is proposing a unified Ireland, and embarrassingly the top google result in the UK following the referendum was “What is the EU?”

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The buyers remorse now swirling around the UK seems to have ignited a renewed “Remain” campaign. Already there is a petition to have another referendum, citing the quite reasonable objections that a 52-48 split does not indicate the kind of definitive turnout to, in good conscience, topple the British economy and break up the UK. In other corners some of the bloom has quickly come off the rose.

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Nigel Farage, the UKIP leader who has been championing the leave vote while Boris Johnson (BoJo for short) has parading across the country with a bus emblazoned with the phrase “we give the EU £350 million a week, let’s fund the NHS instead” has said that was a poor choice of campaign phrase. In other words the NHS will not be getting an additional £350 million per week. JoJo on the other hand has said that there is no urgency in triggering Article 50 of the Lisbon treaty, and instead there should be preliminary discussions before actually starting the leaving process.

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Liars! Lying Liars!

In Cornwall, the picturesque seaside county with a crumbling and weak economy, it has suddenly dawned on the residents that they are hugely dependent on cash transfers from Brussels, an idea that had apparently not occurred to them when they overwhelmingly voted in favour of leaving.

It is worth taking some time to consider some underlying facts. The referendum is non-binding, merely advisory to the government. As the impact of a leave vote starts to set in and people begin to reject the emotional tenor of the campaign in favour of some hard truths, the next government will have time to try and potentially weasel out of the deal. The current front-runner for the next Prime Minister is BoJo himself, a man who had said that he sided with Leave (and became its very public face) because he didn’t think Brussels would really negotiate with the UK unless they knew the Britain might seriously leave.

So I’m going to go out on a limb here and say that Brexit will not happen, at least not like the worst case scenarios have made it out to be. David Cameron has said triggering Article 50 will fall to the next Prime Minister, which is months away. The chief proponents of Brexit don’t seem eager to start the clock on an official leave at all. Despite calls from within the EU to get the ball rolling on leaving, the real appetite to lock down a time table for a permanent withdrawal from the eurozone isn’t there. Instead it seems the winners are happier to let everyone know that they’ve got the gun, and that it’s loaded.

There are months to still screw this up, but the leave camp has had its outburst and now its time to look in the mirror and see the outburst for what it is; and ugly distortion of what the future could be. Nigel Farage and UKIP have had their moment, letting everyone know they are a serious force that needs to be addressed. But the stakes are far higher than I think many believed or thought could come to pass. The GBP fell dramatically, markets convulsed, Scotland and Northern Ireland might leave and starting Monday many financial jobs will start being cut in London. Now is the time to calm markets not with more interest rate cuts but with some measured language that could open the door to another referendum, or at least avoid the worst outcomes of an isolated and petulant Britain.

* this article had initially incorrectly identified Boris Johnson’s nickname as JoJo

The Blind Men & The Elephant

1280px-Blind_monks_examining_an_elephantMarkets have reached six or seven week highs, (HIGHS I say!) and questions are arising as to whether this represents a sustained recovery.

The crystal ball is decidedly opaque on that question, not simply because there is an abundance of conflicting data, but because more of it is produced everyday. Add to that the fact that the “mood” often dictates much of the day’s trading, plus the often counter-intuitive reality that sometimes sufficiently bad news is considered good news in its own right.

Take for example China’s financial woes. China’s economy is definitely slowing, and the tools used in the past to spur Chinese growth are no longer useful in the same way. To summarize, the Chinese economy got big by building big things; cities, ports, factories, and other big infrastructure to facilitate its role as a manufacturer to the world. In turn the world sold China many of the resources needed to do that. Now the Chinese are up their eyeballs in highways and empty cities they must “transition” to a service economy, essentially an economy that now serves its people rather than the rest of the planet.

Such a transition is no easy thing, and to the best of my knowledge there is no law that says the Chinese government is somehow more adept at managing such a transition. But every bit of bad news may either make investors nervous, or give them hope that the Chinese government may be encouraged to do more economic stimulus. Moody’s, the ratings agency, recently downgraded their outlook on Chinese debt from stable to negative, and downgraded their credit rating. The market’s response?

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That big jump is after they received the downgrade! We see similar patterns out of Europe and the United States. Raising US interest rates has been widely decried by various financial types and talking heads, urging the Federal reserve chairman Janet Yellen to either reverse, stop or even consider negative rates to help the economy. Why such panicked response? Because it has become a common thought that raising rates is now more damaging that the requirement of lowering them!

This has less to do though with distortions in the market and more to do with people trying to accurately read and project from various data points, even when many of those reports conflict. In the short term the abundance of conflicting news creates a blind men and the elephant relationship between investors and economies. Everybody is feeling their way around but all coming back with wildly different descriptions of what is happening.

Janet Yellen
Janet Yellen has raised interest rates and has said she expects to raise rates four more times this year. She has met serious opposition on this matter from many within the financial sector.

What we do know is that there are some big problems in the markets and economies, and the threat of a global recession is very real. What day traders and analysts are looking for is confirmation on whether this threat is easing or not. So, if we suddenly read that managers see a contraction in oil production we might see a sudden rise in the value of crude oil. That news has to be weighed against that fact that global oil supply is still growing, and whether it still makes sense to price oil by its available supply, or against its expected future reduced production.

And that is the challenge. Big problems take time to sort out, and in the intervening period as they are addressed the blind men of the markets make lots of little moves trying to bet on early outcomes, attempting to assess the correct value of a thing often before a clear picture is actually there. For investors the message is to be cautious, both in making large bets or by trying to avoid risk all together. It is a mantra here in our office on the benefits of diversification and risk management, precisely because it reminds us to hold positions even when the mood has soured greatly, and shy away from investments that have become too popular. The goal of investors should to not be one of the blind men, guessing about what they touch, but to make irrelevant that shape of the markets altogether.

 

 

In Praise of Investor Optimism

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My industry is awash in optimism. This makes intuitive sense, for the entire process of investing assumes that the companies you invest in will go up in value. Regardless of how conservative and cautious a portfolio manager is, underlying his dour outlook is an optimist that runs a portfolio of various stocks, each one intended to make money.

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For this reason it is incredibly rare to hear outright negativity from professionals, which I suspect contributes to a subtle sense of unease by the average Canadian who must both trust a portfolio manager to look after his money while scratching their heads at a market that can decline significantly in value with no perceivable change to the asset mix they are invested it.

This is Bill Gross. Until 2011 he was a very successful manager with PIMCO, where he headed up their largest fund. Then he made a contrarian prediction about the markets, lost a lot of money and was fired from his fund.
This is Bill Gross. Until 2011 he was a very successful manager with PIMCO, where he headed up their largest fund. Then he made a contrarian prediction about the markets, lost a lot of money and was fired from his fund.

Even when we do get very negative views from portfolio managers, the subtext is still optimism, just for THEIR investment choices. There is never a contrarian market call that doesn’t seem to serve double duty as a marketing plan as well. When Bill Gross famously said that the US was going to tank back in 2011, he was also claiming that his investments wouldn’t and took a contrarian stance that proved to be very costly for his investors. The same is true for Eric Sprott, whose own doubt about the future of stock markets had prompted some very optimistic numbers about the value of gold and junior mining companies.

For the average investor much of this can be quite exasperating as investing shies away from the ways we attempt to establish certainty. Investing is all about educated guesses, and despite many different tweaks the rules for investing remain surprisingly limited: “buy low, sell high” and “diversify”. Professionals have attempted to improve and refine how these two things are done, seeking out the best ways to analyse companies, markets and whole countries, but in the end these two rules still provide the best advice to investment success.

I wish to write to you about a mistake on your billboard...
I wish to write to you about a mistake on your billboard…

But as investment guides go, reveling in the uncertainty of the investments is something that many people don’t want. Instead they would much prefer to hear about what is going to happen in a matter-of-fact manner from an “expert”. This is why there is always a market for doomsayers and contrarian predictions, because of the certainty they seem to offer. It feeds our innate sense that there must be a right and knowable answer about the future that can be revealed to us.

sandwich-board-man-warns-us-of-impending-doomAnd yet like their biblical equivalents, contrarian predictions have all failed to live up to their hype. Just as every “end is nigh” doomsday cult has disappointedly had to move the calendar date for the end of the world, the number of people who have proclaimed loudly the end of traditional investment world is both numerous and filled with failure.

And so, frustratingly, investors are faced with the assuredness of doom-saying predictioners (who are almost certainty wrong), and the cheerfully faced optimistic portfolio managers who routinely remind investors that there is no bad time to invest, that bad markets are “corrections” or “set backs” and that significant price drops are “buying opportunities”.

And yet I doubt we would have it any other way. If we could be absolutely certain about what stocks were going up or down and when there would be no money to make in the markets as companies would always be priced correctly. And whether we realize it or not, it is hugely helpful to remember that there exists no accurate way to divine the future, no Ouija board that can contact the dead, no equation or computer that can process the world’s data to tell us what is happening tomorrow, next week or a decade from now.

I derive great comfort in this, because the optimism that drives the investing world is also a wider optimism about the future. Experts predicted famines wiping out millions in 1970s and 1980s, environmentalists predict the end of all things, and political talking heads bombard us with a daily diet that everything is awful, but our world is healthier, wealthier and kinder than ever before. And unbelievably investors believe in that world, even when they don’t know it.

Crimean Crisis Reminds Everybody Why Investing is a Long Game

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Kiev Square, before and during the protests.

You might have been forgiven if you hadn’t been paying close attention to the Ukrainian Revolution two months ago when it was a long and violent standoff between the Ukrainian government and its people. Kiev square looked like a war zone and reports, while increasingly dire, were not necessarily front page news. But since the toppling of the pro-Russian Ukrainian President Victor Yanukovych it has been impossible to not pay attention to the exploding diplomatic mess of the Crimea.

As of this morning it appears that Vladimir Putin is going to annex the Crimea, much to Ukraine’s dismay, Europe’s frustrations and America’s exhaustion. The crisis is also far from over. The Ukrainian government (now mostly pro-western Europe) is saying that that will not allow such a loss of territory, EU and US sanctions are targeting Russian oligarchs. France is promising to cancel an order of military ships to Russia if Britain punishes Russian billionaire’s living in London. Russia seems relatively unfazed by any of this and seems to know that regardless of what legal reasons may exist that could start a war, few seem interested in shedding blood for the Ukraine.

All of this is obviously upsetting markets. Over the last month the global markets, and especially European markets have taken significant hits over concerns that some kind of conflict is about to breakout.

Bloomberg's Global Index looks at European, Middle Eastern and African Markets
Bloomberg’s Global Index looks at European, Middle Eastern and African Markets
This is the UK stock market (FTSE) over the last month. Performance has clearly suffered as the Crimean situation has worsened.
This is the UK stock market (FTSE) over the last month. Performance has clearly suffered as the Crimean situation has worsened.

This creates the kind of immediate volatility that is both temporary and is difficult to counter. It’s a reminder that investing is different from day trading. There are people who are willing to try and make profits from the day to day fluctuations of this (most recent) crisis. They will be jumping in and out of the markets, trying to grab the slight differences over each day and profiting from nervous investors. But being an investor means riding out this volatility with the knowledge that while it is uncomfortable, it is ultimately temporary and that real growth comes from long term success, not day to day jitters.

That being said, it would be nice if we didn’t accidentally end the world!

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