In the wake of the exceptional volatility experienced by markets over the last week we thought it appropriate to send you an update.
On Monday global markets dropped sharply as concern regarding global growth prospects quickly spread. Almost instantly many fund managers and strategists lined up to declare the selloff as temporary, and even compare it to the flash crash of 2010. In reality, this selloff was not a technical trading anomaly but a classic repricing of risk. There is nothing new about markets ignoring negative evidence for protracted periods only to suddenly recognize risk and price it in very quickly. A correction, while historically very common, hadn’t happened in the US for nearly four years – the third longest such stretch in history. Such major market swings are the result of shifting investor confidence and there are a number of broad themes contributing to that shift.
China – Since summer 2014 an equity bubble formed in China fueled by retail investors, leveraging and easy borrowing practices. Since June most of the 2015 gains were lost, which when combined with slower economic growth and the devaluation of the yuan has rattled global markets. Resource oriented economies see this as a signal that the Chinese appetite for commodities will remain subdued for the near term, while export & manufacturing based economies are concerned about losing Chinese market share due to higher import prices for Chinese buyers.
Commodities – Significant global growth concerns, waning Chinese demand and oversupply due to major capital investments over the past decade have clobbered commodities since 2011. While TSX investors have become intimately familiar with the slump, there is a sudden awareness that it is a symptom of global conditions that have been with us for several years, even if it is not the trigger for Monday’s equity selloff. We may be on the last legs of the rout but a strong recovery should not be expected to lead us to new market highs.
Monetary Policy – In their latest meeting the US Federal Reserve chose to maintain their accommodative policies, but stated that conditions were nearly met to move toward normalization. In other words, they reinforced the consensus view that an increase to overnight interest rates was imminent. That statement triggered a negative reaction from a stimulus addicted bond market. If this volatility continues it is likely that they will abandon their rate increase plans and may even eventually introduce further quantitative easing measures. Any such plans may face a number of complicating factors, like currency market turmoil, general stimulus exhaustion, and the fact that effective stabilization policies may need to come from emerging markets not the US.
Despite all of these legitimate macro concerns, it is crucial to remember that long-term performance is a product of corporate profitability and valuations. When viewed in that context and combined with a long-term investment time horizon, stock price volatility often presents opportunity.
According to many measures, U.S. and Canadian stock markets are generally a little overvalued. Our own research has also confirmed that bargains are hard to come by. For those reasons we are maintaining a level of caution going forward, but you can be assured that we have painstakingly done our best to focus on individual positions that are defensive and not overvalued, which helps insulate us from long-term or permanent losses.
It is impossible for anyone to predict if this turbulence is just getting started or is already over, but we do know that if we buy good companies at good prices we will be rewarded in the long-term. Our job continues to be to look for opportunities and seize them when we can. Market timing is a practice with a poor long-term record and while we make tactical shifts, we do not believe it prudent to move outside of the core parameters set out for our clients. Those on the sidelines waiting to buy stocks can view this as an opportunity to ease into the market. Long-term investors need to remain confident that the outlook for equities remains stronger than low-yielding fixed income. Conservative investors can rest easy during moments of volatility but forego some upside potential when markets rally. We strive to provide each of you a portfolio which matches your investment objectives within your risk tolerance.
If you have any questions, please do not hesitate to contact your advisor.
DiBrina Sure Wealth Team
IPC Securities Corporation