The reality of the 21st century is that finding clarity in world events for investors is almost impossible. Take the recent price drop in oil, which has been hailed as both a good and bad thing. And as the new lower price of energy slowly becomes the norm, everyday news reports come in about its respective benefits and unintended negative consequences.
Those seeking to know what those events mean and what guidance headlines should give will only be frustrated by the almost endless supply of information that seeks to empower decisions but leaves many scratching their heads in wonder about the future.
A big reason for this is the sheer volume of information that we can now rely on. Since the advent of computers and the more recent rise of high-speed communication and networking we have found that the core truth of an event still isn’t apparent until after something has happened. In other words it’s almost impossible to predict corrections before they happen despite an almost inconceivable amount of data and endless ability to process it.
This is true no matter where we look in the world of investing. Consider Black Friday, the end all and be all day in shopping in the United States. This year Black Friday seemed to fizzle. Sales were down 11% year-over-year and that got people nervous. Yet Cyber Monday, the electronic version of Black Friday, sales were up 17% and topped $2 billion for the first time. Combined with the longer sales period leading up to the weekend, many suspect that total sales were actually higher.
All of this data conflicts with each other, which for investors means sometimes you will be wrong. Small things sometimes prove to be big things, and what initially appears simple turns out to be surprisingly complex, and much of it you simply won’t predict. This points investors back to some dull but surprising truths about investing.
1. Not much has changed when it comes to determining what makes a company worthwhile to invest in. Corporate health, sound governance and healthy cash flow still tell us more than loud hype about potential new markets, new products and new trends.
2. Time is a better arbiter than you about investing. The old line is time in the market, not timing the market, and that still appears true. Many Canadians are likely wringing their hands about the sudden drop of oil and the impact it is having on their portfolios. But the best course of action maybe not to abandon their investments, but make sure they are still sensibly invested and well diversified. The market still tends to correct in the long run and immediate volatility (both up and down) are smoothed out over time.
Not every sensible investment will work out, but a portfolio of sensible investments over time will. For investors now wondering about the future and their investments in Canada, the best thing to do is understand the logic behind their investments before choosing a course of action.
Vladimir Putin miscalculated however when he didn’t realize how precarious the Russian economy was. Sanctions were implemented and what followed was a largely hollow trade war that did more to identify Russia’s weakness than strength. But the most recent blow to Russia has been the change in the price of oil.
Now that the price of oil is under $80, Russia is suffering severely. Like many oil rich nations, oil exports substitute for taxes. This frees autocratic rulers to both pursue generous social programs while not having to answer to citizen complaints about high taxes. It’s how countries like Saudi Arabia and Iran get by with little democratic input and a relatively passive population with little to no public disobedience about democratic rights (mostly).
Combined with the falling rouble (now 30% lower than the beginning of the year) and the growth of corporate debt sector, Russia is now in a very precarious situation. I’m of the opinion that energy, and energy companies have been oversold and a rise in price would not be unexpected. But whether the price of energy will bounce back up to its earlier highs from this year seems remote.
Over the last few months I’ve been moving away from the Emerging Markets, and while the reasons are not specifically for those listed above, Russia’s problems are a good example of the choices investors face as other markets continue to improve their health. If you had a dollar today that could be invested in the either the United States or Russia, who would you choose? The adventurous might say Russia, believing they could outlast the risk. But with more Canadians approaching retirement the more sensible option is in markets like the US, where corporate health is improved, debt levels are lower and markets are not subject to the same kind of political, economic and social instability that plagues many emerging economies.
***This post will refer to both a mutual fund company and a particular fund. This post should not be construed as endorsing that fund. We always make sure that we cite our sources and in this instance our source is a fund company, and we are not suggesting in any way that you should invest in or purchase this fund. If you are interested in any fund, please consult with your financial advisor first for suitability, especially if that financial advisor is us!***
Since the price of oil dropped there have been lots of reasons to be excited. First the price of gas at the pumps is so low that I don’t hate going there anymore. Second, investments in energy have suffered since oil lost close to $30 in value.
And while energy stocks have recovered somewhat from their low points, they are still way off where they were earlier in the year. I’m not going to get into the finer points about the nuances of energy producers and the various types of oil and costs of production. It’s a worthwhile article, but will take up too much time here. Instead I wanted to focus on a different way that Canadians can participate in the energy sector.
Commodities can be volatile but also a valuable element of a portfolio. So how can Canadians play the energy sector while being mindful of the risks associated with it?
The answer may be by investing in what is called “Midstream MLPs”. Midstream MLPs (Master Limited Partnerships) are American operators that transport energy from the producers to the consumers. It’s a capital intensive business that is federally regulated but traded on the stock market. It therefore provides consistent cash flow while offering liquidity to investors. But Canadians already have opportunities for energy infrastructure, so why should they care about this in the United States?The answer has everything to do with the rising levels of oil production in the United States combined with what federal regulators are willing to do to encourage new growth.
That brings us to the growth of the shale revolution in the United States. Newly discovered reserves (of significant size), improved technology and a dropping costs of production have set the US on a course to be the largest global energy provider in the coming years. This combination of efficiencies means that the United States is going to continue to increase its oil production over the next decade, while dropping the cost of extraction for each additional barrel. But each barrel produced has to go somewhere.
In the United States, Midstream MLPs are responsible for moving that oil. But it’s a sector that also must grow. Infrastructure to move oil efficiently from shale producers doesn’t exist yet, and regulators are eager to get MPLs in place with new development. New infrastructure is costly, and while the business model for an MLP doesn’t require a high price for energy to be profitable, it does need assurances about the consistency of the volume of oil to be moved. To encourage that growth regulators are allowing the price that MLPs charge to rise at a rate faster than inflation. Why are they doing that? Much of the shale oil is having to be shipped via rail to get to its right home. This causes price disparities that reduces producer margins and rankles federal governments.
Currently there is only one fund option in Canada that we are aware of for investing in MLPs. We had an opportunity earlier this week to meet the managers of this fund and were greatly impressed by what they had to show us. I am already a big believer in the growing Shale Revolution, and am particularly pleased by the arrival of new opportunities for investment. Growth in the Canadian and American energy sectors is good news for not just investors, but also citizens. Russia, Saudi Arabia, Venezuela and a host of other despotic and semi-despotic regimes have been able to get by on the high price of oil. Now they are feeling the pinch of a decreasing price that has the benefit of bringing jobs back to North America while weakening their influence. In all, this is a good story for everyone.
If 2008 was the financial apocalypse it is often written about, it is a zombie apocalypse for sure. It’s victims don’t die, they are merely resurrected as an infected horde threatening to infect the other survivors. And no matter how many times you think the enemy has been slain, it turns out there is always one more in a dark corner ready to jump out and bite you.
This past month has seen the return of the zombie of deflation, a menacing creature that has spread from the worst ravaged economies in Europe into the healthier economies of the Eurozone. Deflation is like the unspoken evil twin that lives in the attic. I’ve yet to meet an analyst, portfolio manager or other financial professional that wants to take the threat seriously and doesn’t insist that inflation, and with it higher interest rates are just around a corner.
The eagerness to shrug-off concerns about deflation may have more to do with the reality that few know what to do when deflation strikes. Keeping deflation away is challenging, but not impossible, and it has been the chief job of the central banks around the world for the last few years. But like any good zombie movie, eventually the defences are overrun and suddenly we are scrambling again against the zombie horde.
In the late 1990s, Japan was hit with deflation, and it stayed in a deflationary funk until recently. That’s nearly 20 years in which the Japanese economy didn’t grow and little could be done to change its fate. The next victim could be Europe, whose official inflation numbers showed a five year low in September of 0.3%. That’s across the Eurozone as a whole. In reality countries like Greece, Spain and Portugal all have negative inflation rates and there is little that can be done about it. Pressure is mounting on Germany to “do more”, but while the German economy has slowed over the past few months it is still a long way from a recession and there is little appetite to boost government spending in Germany to help weaker economies in the EU.
Across the world we see the spectre of zombie deflation. Much has been made of China’s slowing growth numbers, but perhaps more attention should be paid to its official inflation numbers, which now sit below 2% and well below their target of 4%. The United States, the UK, the Eurozone and even Canada are all below their desired rates of inflation and things have gotten worse in this field over the summer.
For investors this is all very frustrating. The desire to return to normalcy (and fondly remembering the past) is both the hallmark of most zombie films and the wish of almost every person with money in the market. But as The Walking Dead has taught us, this is the new normal, and investing must take that into account. Deflation, which many have assumed just won’t happen, must be treated as a very likely possibility, and that will change the dynamics of opportunities for investment. It leads to lower costs for oil and different pressures for different economies. It will also mean different things for how people use their savings for retirement and how they will seek income in retirement. In short, the next zombie apocalypse can likely be defeated by paying attention and not keeping our fingers in our ears.
A correction is typically defined as a drop of roughly 10% in the markets over a very short period of time. It’s often “welcomed” by investment professionals because it creates opportunities for new investments into liked companies that were previously trading above valuations considered appealing. Corrections are talked about as being necessary, beneficial and part of a normal and healthy market cycle, which all makes it sound somewhat medical. But in medical terms it falls under the category of being told your are about to receive 5 injections in short order and they are all going to hurt.
For investors the past couple of weeks in the market has felt like many such injections. The US markets have had a significant sell off, as have the global, emerging, and Canadian markets. All of it very quickly. The sudden drop has erased many of the gains in an already slow year and eaten dramatically into the TSX’s return which had been one of the best.
For many investors any sudden change in the direction of the markets can immediately give the sense that we are heading into another 2008. As Canadian (and American) investors are now 6 years older and closer to retirement the stakes also seem much higher. So here are some reasons why you shouldn’t be concerned about the most recent market volatility, and what you can do to make them work to your advantage.
1. Everyone is nervous.
For several months people have been calling for a correction. Investor sentiment is neutral and consumer confidence has dipped, meaning that overall atmosphere is somewhat negative for the markets. But that can be a good thing. Market crashes and bust cycles typically show up when people are exuberant and feel euphoric about markets. Bad news is swept aside and the four most dangerous words in investing “This time it’s different” become the hallmark of the new bubble. It’s rare that negativity breeds an over exuberant market.
Remember when oil was more than $100 a barrel? High energy prices, and the expectation of future high energy prices can really put the kibosh on future returns and throw cold water all over the market. As we’ve previously said, energy is the lifeblood of civilizations and a steady supply of affordable energy is what separates great economies from poor ones. (Look, we tweeted this earlier! See, twitter is useful. Follow us @Walker_Report)
The arrival and growth of American gas production combined with changing technologies and increasing efficiencies on existing energy use means that global demand is slowing, while global supply is increasing. In fact in March of last year, the head analyst for energy at Citigroup published a paper describing exactly this trend of improved efficiency with new sources as a mix for lower energy prices in the long term. Whether this proves true over the next two decades is hard to say, but what is true is that cheap energy helps economies while expensive energy hinders it. Since economies have already adjusted to the higher price over the last few years, a declining price is a tailwind for growth.
Does this mean that there aren’t any risks in the market? Absolutely not. Europe is having a terrible year as a result of persistent economic problems and Russian intransience, and many Emerging Markets are showing the strain of continued growth, either through corruption or exceeding optimism about the future. Those pose real risks, but taken in the grand scheme of things our outlook remains positive for the markets.
How can I make this all work for me?
So what can you do as an investor to make a correction benefit you? The first piece of advice is always the same. Sit tight. Dramatic changes to your investments when they are down tends to lead to permanent losses. Secondly, rebalance your account periodically as the market declines. On the whole equity funds will lose a greater proportion of their value than fixed income, leaving a balanced portfolio heavier in conservative than growth investments. Rebalancing gives you a chance to buy more units of growth funds at a lower price while adding greater potential for upside as the market recovers. Lastly, if you have money sitting on the sidelines, down markets are great opportunities to begin Dollar-Cost-Averaging. For nervous investors this is a great way to ease into the markets even as markets look unstable. You can read about it here, but I recommend watching the movie below for a nice visual explanation. Now, take your medicine.
Whether this proves to be a false start, or if Russia is going to become more open in its military involvement it’s hard to say. What is clear is that this war in Ukraine is far from over.
Meanwhile this week also saw some evidence about the rising cost of food in Russia as a result of the retaliatory trade restrictions directed at nations like the United States, Canada and most of Europe. Reported in Slate and Vox.com, this graph of rising food costs is actually quite surprising. Potato prices have risen by 73%!
Since I first wrote about the Ukraine much has happened. Russia has been unmasked as a bizarre cartoon villain seemingly hellbent on destabilizing the Ukrainian government, assisting “rebels” and being indirectly responsible for the murder of a plane full of people. All of which came to a head last week when it appeared that Russia might have just started a war with the Ukraine (still somewhat indeterminate).
Russia’s moves with the Ukraine may have more to do with challenging the West, and some of the other recent militaristic actions show that may be its real intent. Russia announced in July that it would be reopening both an arctic naval base and a listening post in Cuba built back in the 1960s. Combined with many heavy handed tactics at home including essentially banning homosexuality, Putin is making a brazen attempt to assert its regional dominance and stem the growth of Europe’s influence in the most aggressive way it can. To some extent this seems to be working with his own population, but it isn’t making him popular globally.
Europe’s response to Russia has been to hurt it with economic sanctions, which since the Ukrainian situation first began have been escalating in severity. Two weeks ago Russia responded in kind. How? By banning food imports from sanctioning nations.
If you don’t know much about the Russian or European economies this may seem like potent response from one of the BRIC countries and major global economies. But Europe is a big economy, and agricultural exports don’t make up a significant part of GDP, with the same being true for the United States. And while sanctions targeted at farms can be politically dangerous (farmers are typically a well organized and vocal lobby) the most interesting thing about these sanctions is what it tells us about the Russian and European economies respectively.
First, Russia imports a great deal of food, mostly from Denmark, Germany, the United States and Canada. So sanctions imposed by Russia are really going to hurt the Russians as food prices begin to rise and new food suppliers (expected to be from Latin America) have to ship food farther. But more interesting is the sanctions Russia chose not to impose. Europe is heavily dependant on oil & gas for its energy needs. So why not really make Europe feel the pinch and create an energy crisis? Because Russia needs oil revenue.
16% of Russia’s GDP is made up from the oil and gas sector. Beyond that oil and gas make up more than half of Russia’s tax revenues and 70% of it’s exports. In other words Russia can’t stop selling its oil without creating an economic crisis at home every bit as severe as in Europe. Banning imports of food and raising the cost of living may not be the ideal outcome from sanctions you impose, but it is mild in comparison to creating a full on catastrophe.
By comparison Europe starts to look very good, and it’s a reason that investors shouldn’t be quick to write off Europe and all its recent economic troubles. It’s a large and dynamic economy, filled with multi-national companies that do business the world over. It is backed by stable democracies and a relatively prosperous citizenry. By comparison Russia is a very narrow economy, dependent on one sector for its economic strength run by a (in all but name) dictator with an incredibly poor populace. A few years ago it was quite trendy in the business news to write off Europe as a top heavy financial mess, and while I wouldn’t want to dismiss Europe’s problems (some of which are quite serious) it’s important to have some perspective about how economies can rebound and which ones have the flexibility to recover.