Market Brief - Staying the Course
Erica Stephenson - Jan 22, 2016
What started out as a happy new year is quickly turning into a frightful January in the global financial markets. North American markets are slumping putting us into bear market territory and in light of all the volatility we’ve seen over the past t
Staying the Course
What started out as a happy new year is quickly turning into a frightful January in the global financial markets. North American markets are slumping putting us into bear market territory and in light of all the volatility we’ve seen over the past three weeks, I thought it a great time to revisit some fundamentals and our ‘stay the course’ strategy.
While there have been some factors for the markets selling off, we remain positive on global equities for 2016 particularly as the fundamental backdrop remains constructive, profitability continues to grow and valuations are not particularly demanding. Typically markets that are driven by factors other than fundamentals are short lived. However, that does not mean that disciplined investment strategies are immune from short-term investment fluctuations.
As long-term investors, we focus on companies that can generate strong economic value and are priced at attractive valuations. While we can come up with many reasons for the volatility, which I touch on, it is important to see some positives based on economic indicators remaining intact. As history has shown, those who stay the course tend to outperform over the long-term; reacting to world events is not a good idea, and in times like these, we want to avoid the crowd in panic selling. Now is the time to remain patient while we wait for the best opportunity to buy or make changes.
Let’s look at some of the challenges causing the recent market volatility:
Early in the month, China’s currency devaluation efforts sent a shockwave through all markets, impacting oil, all commodities and causing a sell-off around the world. This contributed to the suspension of trading in their stock market and consequent intervention by the Government. Global markets responded seeing the sell-off as renewed confirmation of a low Chinese economic outlook. This topic remains important because China and Emerging Markets have accounted for approximately ¾ of global growth since the financial crisis. As it becomes clearer that Chinese GDP is decelerating from its highs, we should still count on a minimum of 4% growth going forward.
The unfortunate collapse in oil prices has lasted considerably longer than I think anyone had expected. The continued slide over the past several weeks is relative to the low response by producers to lighten up and the moderate mismatch of supply and demand. While some OPEC members are boosting their production and Iran is prepping to come back on line later this year, we may not see prices start to turn around for some time. Oil futures today are pointing to $40 oil by end of this year, but this can quickly change.
The US Fed raising interest rates for the first time in nine years, while Europe, Japan, Canada and several other countries have lowered rates has not helped financial markets. The strong US dollar has put downward pressure on US manufacturing and corporate profits. Typically, once the Fed starts tightening, stock markets go through some period of correction and rebalancing.
Today’s market challenges are not those of 2008, but it’s easy for us to draw parallels when faced with such market volatility. The collapse of Bear Stearns, eventual bankruptcy of Lehman Brothers and consolidation of the banking sector in the US would not happen today because of improved legislation and capital requirements. As well subprime mortgages and mortgage-backed securities are instruments of a financial market which is now more heavily monitored and regulated to limit defaults. Today’s markets should not be feared as any risks to growth are reasonably well understood and reflected in market prices. Moreover most equity market stocks continue to yield significantly more than most fixed income products.
Finally, it’s important to keep our emotions in check as the media tends to play on fear. Stocks are far more volatile than the real economy, which has proven so resilient throughout history in the face of countless challenges. Responding to fear when investing inevitably leads to poor outcomes, therefore it remains prudent to stay focused with a process of the long term in mind.
I will leave you with some thoughts from Howard Marks in one of his recent memo’s, Enormous Swings on Manic Depressive Markets, “Fear makes it hard to remain optimistic about holdings whose prices are plummeting, just as envy makes it hard to refrain from buying the appreciating assets that everyone else is enjoying owning. Confidence is one of the key emotions, and I attribute a lot of the market’s recent volatility to a swing from too much of it a short while ago, to too little more recently.”
As we continue to ride out the storm, I look forward to your feedback, and any questions or comments.