We have turned the page on a difficult and turbulent 2020. However, there are signs that the current upward market trend can continue. Here are 20 of our favourite charts heading into 2021, organized into the following categories:

-2020 Index Returns
-Economy
-COVID and Sector Returns
-Market Analysis
-Central Banks and Inflation
-Asset allocation and Portfolio Construction

2020 Index Returns

Here are the major index returns for 2020. Most indexes were positive, though there was a large gap between the largest gainers (Nasdaq) and the more modest ones(TSX).

Economy

Report card: Here is an overview of recent positive and negative developments as we turn the page on 2020 and look to 2021. The “interesting” category (items of interest which may end up positive or negative) centers on the new U.S. government with President Biden and the potential of a soft U.S. dollar.

Business cycle “reset” due to COVID: Heading into 2020, this chart indicated the U.S. was most likely in a “late cycle” or “end of cycle” phase. COVID changed everything. The two most likely stages at this point are “early cycle” or “start of cycle”, with “recession” a distant 3rd.

Turning the corner toward recovery:

COVID and Sector Returns

Winners and losers: The two charts below give a quick view of the sector-based winners and losers from the COVID pullback.

The impact of technology on 2020 S&P 500 and TSX returns: The overnight creation of a “stay-at-home” economy was great news for tech stocks.

Strong year for green energy: Green energy continues to grow its market share and experienced strong returns last year.

Market Analysis

U.S. equity valuations to end 2020 increased year-over-year: As we see higher valuations, we should lower return expectations accordingly. Currently, U.S. forward P/E ratios are about 22.33 times earnings, compared to the 25-year average of about 16.3 times earnings. The forward P/E was 19.3 times earnings at the end of 2019.

The S&P 500 since 1900: Here we see the steady growth in the S&P 500 since 1900.

The S&P 500 and market volatility: Here, we see the major pullbacks the S&P 500 has experienced since 2010 and the subsequent recoveries.

U.S. bulls are longer and stronger than bears: Using data going back to The Great Depression, we see that the average S&P 500 bull market is 54 months, and the average total return is 166%, whereas the average bear market lasts 22 months but sees a 42% drop. Once again, the average bull market lasts longer and gains more than the preceding bear market lasts & drops. Note that the COVID-related recession lasted only 1 month and saw a 34% drop.

Intra-year declines happen every year, don’t panic! History has shown that a large majority of calendar years see at least one drawdown of 5% or more. Years like 2017, where markets truly head upward with no real speedbumps, are exceedingly rare. It is generally a good idea to ride out the volatility, as markets always rebound given time.

Weak outlook for fixed income: With central bank rates at emergency lows, bond yields have followed suit. Medium-term return projections for the fixed-income space are in the low single-digits:

Central Banks, Fiscal Stimulus, and Inflation

U.S. Fed made a series of emergency rate cuts: During the first wave, drastic action was taken by the U.S. Fed as they made a series of emergency rate cuts. Currently the Fed’s key rate is 0.25%, as is the Bank of Canada’s key overnight rate. The EU overnight is at 0%.

Inflation should be low in the near term but will rise in the long term: When so much money is injected into the overall money supply, rapid inflation becomes a long-term concern.

Inflation: Over the next 1-2 years, inflation should remain low but looking at a longer timeline, expect inflation to move upward.

Inflation’s impact on market returns: As we see below, the inflation environment has historically influenced where returns are best derived. We are currently in a low inflation environment, and as our previous charts show, we expect inflation to remain low in the near-term, followed by upward movement.

Asset Allocation & Portfolio Construction

Can you commit for 10 years? Why does the industry always talk about a “long-term mindset”? The historical worst-case for stocks over any 10-year period since 1950 is -1%.

Broad diversification is a great risk-mitigator: If there’s only one chart you want to look at, this is the one. Diversification is one of the best risk mitigation strategies one can undertake.

Sources: Capital Group, JP Morgan, RBC GAM

The post 20 Charts for 2021 appeared first on Smof Investment Manager, LLC.

1. 2020 Equity returns year-to-date

The first half the year saw a continuation of market increases until late-February, when COVID-related fears took hold of markets. After a steep decline – including the fastest 20% drawdown time of 19 business days in history – markets rallied from early-April to the present.

Here, we see market returns in domestic currency terms (YTD) and in Canadian Dollar terms (YTD C$), as of July 24, 2020. Note that “EAFE” stands for “Europe, Australasia and Far East”, and is a stock market index measuring equity performance of developed markets outside Canada & the U.S.

2 & 3: S&P 500 and international valuation measures

The chart below tracks various valuations methods for the S&P 500. Interestingly, the P/E ratio for the S&P 500 has actually increased from ~18.18 times earnings in December 2019 to ~21.72 times earnings as of June 30, 2020. This is due to declining earnings coupled with a rally in stock prices.

International equity markets remain cheaper relative to U.S. equities, though international P/E ratios have similarly risen – again due to reduced earnings & stock price rallies.

4: European COVID stimulus package

The screenshot below is as of mid-day on July 23, 2020. Commentary from Myles Zyblock, Chief Investment Strategist at Dynamic Funds, follows:

“Markets are green to start the day, particularly in Europe where many of those indexes are up by about 1%. This positive tone was set by a breakthrough agreement early Tuesday (July 21, 2020) morning between EU leaders on a 1.82 Trillion Euro ($2.1 Trillion USD) “European” budget and coronavirus recovery fund. In the details, we were told that 750 Billion Euros will be for coronavirus support (comprised of 390 Billion Euros in grants and 360 Billion Euros in loans) and 1.07 Trillion Euros will be placed towards a seven-year budget.

This is new. It is the first time the region is raising debt collectively to fund a response to a crisis. The debt issued will be in the form of a Eurobond. While the EU recovery fund disbursement is unlikely to start until 2021, national fiscal policy plus the ECB’s efforts will continue to provide the main avenues for support. Nevertheless, this is a big unifying policy step for the region and it is a large source of fresh fiscal stimulus for the year ahead”. (end of Myles Zyblock commentary)

5: Economic report card

From RBC Global Asset Management (RBC GAM), here is an overview of current positive, negative, and interesting market developments. The “interesting” category consists of items that may end up positive or negative when the dust settles.

6 & 7: Most countries are exhibiting recessionary market signals

Another RBC GAM chart. The majority of economic metrics (63%) indicate the U.S. is in a recessionary phase, with a small slice of metrics (17%) indicating the U.S. is in the “end of cycle” phase.

This chart, from Fidelity, echoes the above chart and provides international context. Global activity shows early signs of improvement from extremely low levels. Near-term sequential progress is likely to continue as coronavirus-related restrictions on routine activities are lifted. China appears to be somewhat ahead of most major economies due to its earlier shutdown and reopening. While the worst of the recession appears to have passed for the U.S. and Europe as well, activity levels remain far below normal. In addition, “second wave” risks remain present.

8: Unemployment & wages

In January’s 20 Charts for 2020, we noted that unemployment in the U.S. hit a 50-year low. As we see here, the COVID-related economic shutdown led to 50-year high unemployment levels. Wage growth also moved downward toward its 50-year historical average.

9: Inflation has decreased from late-2019 to the present day

U.S. inflation, measured by the personal consumption deflator, was at 1.6% as of November 2019. The economic shutdown and unemployment spike had a predictable effect, as inflation dropped to 1.0% as of June 30, 2020. U.S. Fed Chairman Jerome Powell stated in June that the Fed is “not even thinking about thinking about raising rates”.

10: Mitigating risk through broad diversification

We consistently return to charts like this because this lesson never gets old. The best way to optimize risk-adjusted returns is to invest in a well-diversified portfolio, both from a regional and from a sector standpoint.

11: Intra-year declines happen every year

History tells us that the majority of calendar years see at least one market pullback of 5% or more. 2019 provided a great example of this, with a -7% decline during the year but a 29% return in the end. In 2020, the S&P declined as much as -34% and currently sits at -4% as of June 30, 2020.

12: Bear (declining) markets are historically shorter than bull (rising) markets

Using data going back to The Great Depression, we’ve seen that the average bear market is 22 months and sees a -42% decline, while the average bull market has seen a duration of 54 months and a return of 166%.

Sources: Dynamic Funds, Fidelity, JP Morgan, RBC GAM

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post First Half 2020 Market Update – Charts of Interest appeared first on Smof Investment Manager, LLC.

For the visual learners, next week’s entry will compliment this week’s FAQ with charts of interest summarizing the first half of 2020.

Could you provide an overview of the last quarter? (Answer from Myles Zyblock, Chief Investment Strategist, Dynamic Funds)

Unprecedented action by policymakers and moderation in COVID-19 caseloads helped ease lockdowns and initiate the early phases of the eagerly anticipated re-opening of the economy. These developments were well received by the market and beaten up riskier asset classes soared.

All major asset classes finished Q2 in positive territory. Global equities rallied by just over 19%, with the U.S. stock market having its best quarter in decades. Emerging market bonds also rebounded to produce robust gains while corporate bonds outpaced government bonds, as they benefited from stronger risk appetite. Despite the rally in riskier assets, gold bullion remained resilient with a 12.9% rise in Q2.

With the increasing number of cases in the “sunshine states” do you expect to see another trough similar to March? (Answer from Dan Bastastic, Portfolio Manager, IA Clarington)

He believes there is enough liquidity and support in the market (2.5 years of money supply injected in 3 months) for us to not re-test the lows

• Does anticipate there will be continued volatility
• The money support is being used to bide our time until we have a vaccine (reports indicate this could be in a matter of months)

How is the current vaccine timeline impacting markets? (Answer from Myles Zyblock)

Equity markets were supported in early trading by the news that Moderna’s vaccine had induced neutralizing antibodies in its Phase I trial. The biggest beneficiaries from this news have been those companies and industries which have felt the greatest negative impact from the pandemic (i.e., “Viral Outbreak” stocks). These include industries such as airlines, cruise lines, hotels, brick-and-mortar retailers, resorts and restaurants. Those companies which investors have sought for safety, termed the “Stay at Home” stocks like grocery stores, food producers, technology providers and online retailers, were significantly lagging the broad benchmarks at the time of writing.

Weeks like this one offer a potential window into what is to come. The announcement of a viable vaccine seems like the catalyst needed to lift many deep value stocks out of their performance malaise. This rotation might also place a number of the year’s leaders into the backseat for a while. The difficult part is to know when this vaccine is likely to be found or go into production. Most experts still believe it is many months away. Yet with over 100 vaccines being developed and tested around the world, the likelihood of some form of eventual success seems fairly high.

What are your thoughts on growth prospects for major regions – North America, Europe, Emerging Markets? Any potential growth divergence expected given relative progress on COVID-19? (Answer from Myles Zyblock)

Official activity indicators for May and June started to snap back in response to epic global policy stimulus, moderating caseload growth, and reduced mobility restrictions. Europe, U.S. and Chinese auto sales were up by 41% collectively over the past two months. U.S. retail sales rebounded by 17.7% month-over-month based on the latest reading for May. A similar sharp bounce was recorded for U.K. retail spending. Employment has jumped higher, and much earlier, than expected in countries as diverse as the U.S. and Korea. Housing activity looks to be reviving. Leading activity indicators for manufacturing are coming off the bottom all around the world.

While 2020 is likely to encompass one of the deepest global recessions in history, with GDP probably down by 5% for the year, the incoming data also tells us that it might be among the shortest in duration. Of course, a lot still depends on the evolution of the virus, and people’s reactions to it, but for now the lights are turning back on for the global economy.

What are your expectations for corporate earnings growth? (Answer from Myles Zyblock)

July kicks off the period when companies will begin to report their second quarter earnings and provide any guidance that they might have about their outlook for the future. It is probably going to be a very weak quarter, with U.S. earnings down by close to 40% and global earnings off by more than 25%. These results will mark the weakest reporting period since the depths of the last financial crisis in 2008.

Then, based on the current trajectory of economic activity, we are likely to see the downward pressure on corporate earnings begin to moderate. This is not to say that earnings will boom, but the year-over-year growth rates should start to look somewhat better in Q3 and Q4. For 2020, however, EPS is likely to be 15-20% lower than what was recorded in 2019.

How supportive do you expect policymakers to remain? (Answer from Myles Zyblock)

Policy makers are doing their utmost to mitigate the negative economic effects from the global health crisis. Central banks have used a combination of aggressive interest rate reductions and liquidity injections to help stimulate activity and keep financial markets functioning as normally as possible. Fiscal policy makers have been reducing taxes, offering loan guarantees, and providing counter-cyclical income support to bridge the economic gap. These policy efforts, amounting to about $24.5 trillion dollars or 28% of global GDP, are unprecedented in their size and scope.

Yet, despite this year’s gargantuan efforts there seems to be no end to the policy intervention in sight. In recent weeks, at least seven emerging market central banks lowered their interest rates. The Canadian government extended its emergency response benefit (CERB) program for two more months. The Bank of England upsized its quantitative easing campaign by £100 billion. And, the Federal Reserve increased the menu of options for its corporate bond purchase facility from ETFs to include individual issuers that met the criteria for purchase.

Meanwhile, the Trump administration is said to be weighing a $1 trillion infrastructure program to help the beleaguered economy. China’s central bank has pledged faster credit growth. The U.K. has introduced a value-added tax cut. The International Monetary Fund (IMF) has built a $107 billion war chest to provide a potential safety net for struggling Latin American economies.

Global policy makers either do not see the recovery that is starting to take hold or have very little confidence in the strength of the recovery as it begins. Hence, they continue to pump the system full of stimulus.

Will the U.S. market outperformance vs. Canada continue? (Answer from Dan Bastastic)

• Given technology has been a major driver of the outperformance, do you expect the TSX will continue to underperform? Is it possible there will be a turnaround?
• U.S. is structurally advantaged vs. TSX
  • Look at weights among sectors
    • TSX is heavy energy, resource and financials
    • Any of these have an issue and the market as a whole struggles
• Does not mean you can blindly buy the U.S. market
  • Rather it is prudent to be selective in your sectors for both the TSX and U.S.
• This year alone:
  • Growth up over 11% and value down ~18%
  • Science related stocks up 19% and financials down 19%
  • In June the NASDAQ returned ~8% while the equal weighted S&P (normalizing for MEGA Tech stocks) is down ~11%
• For the TSX to recover we need to get through the virus and pandemic, have interest rates trend up, along with the US$ trending down
  • If/when this occurs we will see emerging markets will start to do much better
  • We link the TSX in with emerging Markets as it is the safest EM play globally
    • The TSX gives you the greatest upside with a lot less downside
• We expect the TSX to at least match the performance of the S&P when we see value come back and interest rates/inflation stabilize or increase

We are living in a world of Helicopter Money. Do you have any concerns about the inevitable inflation to pay for it? Also how does that effect the long-term GDP as it seems a lot of people are saving here rather than spending? (Answer from David Fingold, Portfolio Manager, Dynamic Funds)

• First part of the question asks about inflation & second says there is going to be deflation
• Nobody is going to pay for this debt, countries never repay their debt
• They grow their GDP which reduces debt-to-GDP ratio over time or they just default
  • Countries that can print own currency have never defaulted
• U.S. will not default, they’ve never repaid their debt, never unwound Quantitative Easing (QE), did QE from 1940-1952 and just let the bonds mature.
  • No one has ever unwound the central bank balance sheet as you do not need to, the bonds just mature.
• Can’t be any inflation as the velocity of money has gone to nearly zero
• If Fed proceeds with yield curve control which is quite possible in the next few meetings, that will lower velocity of money even more
• Inflation is an impossibility
• Bigger risk is deflation which is driven by several things
  • There’s a lot of worthless stuff out there, there’s no equity in shopping malls, office building, airlines, hotels
  • Don’t own any of these assets, as an active manager, don’t care for these asset classes
  • Don’t own any banks, so the fund is not exposed to mortgage or lease defaults

Does the U.S. election impact your investment decisions? (Answers from David Fingold and Dan Bastastic)

Fingold: The short answer to the question is no. We do not think anyone should be making investment decisions based upon elections. In the best-case scenario if the prediction you made for the election was correct, there is an interim election two years from then, and another Presidential election two years after that. It would be impossible to hold securities for the long-term if you have to take a view on politics, so we don’t do that. If we make an investment in a company, it needs to be a company that can do well regardless of who is in power. Our advice for investors who are trying to figure out who is going to win the election is don’t worry about that – just invest in good businesses.

Bastastic:

• One thing we know is it does not matter who holds the President’s seat if the executive branch and Congress are split
  • Markets and economy are not negatively impacted if you have a President who is Democrat or Republican and the Senate/Congress are opposite
  • Those are generally most market friendly types of market in the U.S.
• If you asked us three months ago if a Biden victory would be a risk to the markets, the answer would be no
  • That has now changed
  • If Democrats take Presidency, Congress and Senate you have to start discounting the tax increases, removal of regulation cuts implemented by current administration
    • These have been a huge factor in market returns and job creation over the past 4 yr
  • You need to start to accept that this may change
  • It would be prudent to be defensive heading into the fall if:
    • You think the markets are very overvalued
    • We get a Democratic sweep in the fall
    • The narrative of the final months of the election cycle has been that taxes and regulations are going up

What is your currency outlook? (Answer from Myles Zyblock)

The U.S. dollar has been softening in value since late-March. On a trade-weighted basis, it has lost about 5.5% of its value relative to the currencies of its main trading partners since March 23. It is probably no coincidence that the U.S. dollar peaked at the same time that global equity and credit markets bottomed. The dollar is considered a relatively safe-haven currency and when the desire for safety starts to wane, so too does the demand for US dollars.

The Canadian dollar is among the set of currency beneficiaries of global risk-on flows. It is considered a more cyclical currency and has therefore benefitted from improving global economic activity. More directly, the Loonie has also found support from a higher oil price and the expected improvement in the country’s terms of trade.

The Canadian dollar has strengthened by close to 7% since late March. More upside seems likely. While the pandemic has hit the country hard, the damage has been less severe than that experienced by many other countries. Fiscal and monetary support should therefore help lift Canada out of its recession relatively quickly. Meanwhile, further gains in commodity prices and a less skeptical investment mood could provide additional supports for the Canadian dollar.

How could the extreme concentration of some indices (ex: S&P 500 FAANGS) impact index returns? (Answer from Myles Zyblock)

Every so often, market capitalization weighted indexes find themselves in a situation where a relatively small number of constituents dominate the behavior of overall index performance. You don’t have to go too far back in time to remember when Nortel alone made up over a third of the S&P/TSX capitalization weighting.

Today, we find ourselves in a similar situation in some indexes, like the S&P 500, where the five largest companies now comprise about 20% of the index’s total market capitalization. Narrow breadth is always resolved in the same way. The relative outperformance of these market leaders eventually gives way to underperformance.

Timing the reconciliation is the hard part. In the U.S., there is plenty of precedent throughout the 1920s to the 1960s when weighting for the top 5 stocks hovered in the 25-30% range. Said differently, there is no iron law which says that the big cannot get even bigger.

How has market performance in 2020 differed from past years given that typically defensive sectors (e.g., real estate) have been underperforming?  (Answer from Myles Zyblock)

Naïvely adopting a low beta, or defensive, investment stance is often not as reliable in the next down-cycle as it appeared to be in prior periods. What is defensive today might not be defensive tomorrow. Today’s low beta stock or industry can morph into tomorrow’s high beta investment. This is because industry fundamentals change over time and the reasons behind each recession, or market dislocation, are almost never the same.

In the 2000 bear market, for example, Technology was one of the hardest hit sectors. It was the subject of over-investment and extreme valuations. Today, this same sector benefits from rock-solid balance sheets, is not nearly as overvalued as it once was, and has caught the tailwinds of accelerated technology adoption.

Through today’s current health crisis, we are concerned about empty hotels, empty casinos, and empty retail stores. Real estate companies, many of which have highly leveraged balance sheets, are vulnerable to an extended period of high vacancy rates. So the last few years of apparent safety that these companies have offered seems to have disappeared through the pandemic.

The benefit of owning equities has been their long-term rewarding returns. But we must not forget that they are also a relatively risky asset class. Given that the future is highly uncertain, a well-diversified equity portfolio typically offers the most reliable defense.

The market is not the economy and the economy is not the market. Why is it important for investors to recognize that? (Answer from David Fingold)

I understand the confusion because I think that the media is often telling people that the stock market is an indication of the economy, yet the stock market does not look remotely like the economy. The stock market, for instance, has a significant exposure to technology and healthcare, and the economy is very different. The economy has broader exposures to industries that simply are not publicly traded businesses.

People get confused when they see the unemployment numbers rising and the market going up. What they miss is that the market is going up because of resilient, high quality, profitable global businesses that consumers and businesses need to work with and need to do business with.

The other thing that I think confuses people is that they want to look at the market as an absolute indicator of the state of the economy and I think that is wrong. The stock market does not know good or bad, it only knows better or worse. Things were getting worse in late-February and throughout the month of March, and things have been getting better since late-March. In fact, if you were to overlay jobless claims versus the stock market, you will see that as the number of people who are claiming unemployment has fallen, the stock market has moved up. Again, that confuses people because they see a growing number of people who are unemployed, but they do not understand that we actually see green shoots. We see something that is less bad when several hundred thousand people claim unemployment this week than claimed last week. If less people are making claims, we see that as better, but it is clearly not good; however, that doesn’t matter – the stock market only likes better.

The post Q2 2020 – Frequently Asked Questions (FAQ) appeared first on Smof Investment Manager, LLC.

Further downside risks include the U.S. elections, global trade tensions, aging demographics, and technological disruption. 

However, no two economic cycles follow the exact same path. For example, despite weaker corporate earnings, global equity markets showed renewed strength last year, and with several central banks cutting rates in recent months to encourage business activity, this may be a longer than usual “late-stage”.   

We compiled 20 charts that summarize the economic and financial picture for 2019 and 2020:

1: 2019 Equity returns were strong, more than recovering from the 2018 pullback 
After a turbulent finish in 2018, markets rebounded across the board in 2019 to end the decade on a strong note.  Here are the 1, 5, and 10 year returns for the major indexes:

2 & 3: TSX (Canadian Market) and S&P 500 (U.S. Market) sector returns
Last year, the top-performing Canadian sectors were Information Technology, Utilities, Industrials, Materials and Financials. Overall, returns for the 11 S&P/TSX sectors were strong, except for Health Care. This sector declined 10.9%, led by the “return to earth” performance of many of the previous year’s “high-flying” cannabis stocks.  One of the common themes across the best-performing sectors was the market favouring stocks that look like bonds (high-yielding sectors such as Utilities and Financials).   

For the S&P 500, the strongest returns in 2019 were in the Information Technology, Utilities, Industrials, Materials and Financials sectors. The wide gap (75% for the TSX and 40% for the S&P 500) between the best and worst performing sector makes a strong case for diversification.  

4: U.S. equity valuations to end 2019 were slightly above the historical average
The chart below tracks various valuations methods for the S&P 500. You can read more about the P/E ratio and expected market returns in Anthony’s article, New Decade, New Expecations.

5: Economic Report Card
From RBC Global Asset Management (RBC GAM), here is an overview of recent positive and negative developments as 2019 wound down, as well as some “interesting” items that may end up in positive or negative territory when the dust settles.

6 & 7:  Most countries are exhibiting late–stage market signals
Another chart from RBC GAM. A gauge of various economic metrics suggest the U.S. is most likely in a “late cycle” phase. 

Fidelity’s chart below presents a similar case. Most countries are firmly in-between the expansion and contraction phases. 

8 & 9: Global GDP growth slowed as expected in 2019
Last year, we speculated a reversion to about 2.0% in 2019 was a likely outcome. Actual Q3 year-over-year growth was 2.1%. Looking to 2020, the U.S. economy could see a bump if any of the economic headwinds (for instance, the U.S.-China trade dispute) were removed, with additional Quantitative Easing (QE) or with a continued “lower for longer” rate strategy at the Fed.

The Purchasing Manager’s Index (PMI – measure of manufacturing strength) data shows that only a handful of global economies continue to operate in expansion mode. 

10: U.S. unemployment hit lowest level since the late-60s
Unemployment hit a 50-year low in 2019. Persistent factors limiting labour force growth (baby boomers retiring, tight immigration policy, etc.) remain. Wage growth also ticked upward from 3.2% in November 2018 to 3.7% in November 2019. 

11: Inflation was stable 2019, but expect an uptick in 2020
U.S. inflation, measured by the personal consumption deflator, dropped from 2018 levels (1.9%) and sat at 1.6% as of November 2019. Rising wages and lowering unemployment have not impacted inflation as one might expect. The U.S. Federal Reserve (the Fed) will likely continue its “lower for longer” rate strategy to stimulate inflation up toward the Fed’s 2.0% target.

12: U.S. Central Bank changes course, lowering key rate 
After slowly raising rates the last few years, the Fed and other central banks around the world made an abrupt 180 in 2019 and cut their key rates. Global Central Bank activity could be described as “over-reactionary” in 2018, as tightening effects helped lead markets downward to end the year. 2019 saw a reverse, with nearly 40% of central banks easing throughout 2019. 

13: Volatility during U.S. election primaries is often followed by strong returns
Historically speaking, whether a Democrat or Republican is elected President has had little bearing on market results. However, investors who chose to ride out the volatility experienced during primary season tend to be rewarded in the following 12 months.

14: Brexit will hurt the United Kingdom’s GDP…
Note that this chart was as of October 31, 2019. As expected, Boris Johnson was elected Prime Minister of the United Kingdom. The most likeliest Brexit outcome is Johnson’s “Soft” Brexit*, which would still negatively impact the U.K.’s GDP. However, this outcome would still be superior to the “Middling” or the “Hard” Brexit scenarios.

*Editor’s Note: This week, parliament voted Boris Johnson’s “Withdrawal Agreement Act” into U.K. law. The U.K. is now set to leave the European Economic Union on January 31st.

15: …But international equities continue to offer long-term opportunities
Structural issues in Europe have resulted in lower valuations for European equities relative to the U.S. Historically, the U.S. and Europe have had alternating periods of outperformance.

16: Climate change’s first “corporate casualty”
2018 saw California wildfires run out of control, culminating with the so-called “Camp Fire” which caused ≈ $7 Billion in property damages, including the complete destruction of over 14,000 homes in November. Lawsuits ensued. The Pacific Gas & Electric Corporation (PG&E), under extreme financial duress due to the incoming lawsuits, filed for Chapter 11 Bankruptcy protection on January 29, 2019. PG&E is now widely cited as the first corporate casualty of climate change.

17: Broad diversification is a great risk-mitigator
2019 returns exceeded most analysts’ expectations and there is reason to be cautiously optimistic as we look ahead to 2020. With valuations for many assets near record highs, a well-diversified investment portfolio can help to maximize returns and mitigate risks as they occur.  

18: Intra-year declines happen every year, don’t panic!
History has shown that a large majority of calendar years see at least one market pullback of 5% or more. Last year was a perfect example of this, with the S&P 500 finishing up 29%, but declining 7% in May. It is generally a good idea to ride out the volatility, as markets always rebound over time.

19 & 20: Bull (rising) markets are longer and stronger and last longer than bear (declining) markets
Going back to the mid-1950s, the average bull market gain has seen the TSX gain 129% with an average length of 54 months, while the average bear market sees the TSX drop by 28% while lasting only 9 months. As we can see, bull markets last longer and more than make up for their preceding bears. 

Using data going back to The Great Depression, we see that the average S&P 500 bull market is also 54 months and the average total return is 164%, whereas the average bear market lasts 22 months but sees a 42% drop. Once again, the average bull market lasts longer and gains more than the preceding bear market lasts & drops.  

Sources: Capital Group, Fidelity, JP Morgan, RBC GAM, NEI Investments, Mackenzie, Forbes.com, CI Investments, Sky News 

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post 20 Charts for 2020 appeared first on Smof Investment Manager, LLC.

Trump Tweetstorm – Following New Chinese Tariffs on Imported US Goods – Pushes Markets Lower to End Week

Investors flocked to safe-haven assets on Friday following President Trump’s tweetstorm in response to the Chinese Commerce Ministry’s decision to impose 5% – 10% tariffs, or roughly $75 Billion, in import tariffs on US-made products, starting September 1st. These tariffs will target soybeans, coffee, oil, seafood and whiskey.

Additionally, beginning December 15th, tariffs on imports of US automobiles (25%) and parts (5%) will resume.

President Trump responded, as usual, via tweet, to say “American companies are hereby ordered to immediately start looking for an alternative to China”. It should be noted that the President’s statement here is not binding, and companies are not required to adhere to his “order”.

Trump next tweeted that the Fed can “show their stuff”, and soon after that tweet, attacked Fed Chair Jerome Powell, tweeting “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?”.

Next, Trump tweeted that he will respond to the new Chinese tariffs accordingly.

In response to Trump’s series of tweets, markets almost instantly dropped across the board. The Dow Jones Industrial Average (DJIA) fell by 2.37% (622.19 points) to finish at 25,630.05, the Nasdaq dropped 3% (239.62 points) to finish at 7,751.77, and the S&P 500 dropped 75.7 points (2.59%) to close at 2,847.25. The S&P/TSX New York Exchange shed 215.88 points (1.33%) to close at 16,037.58.

After markets closed, Trump announced, again via Twitter, an increase on imported Chinese products from a 25% tariff (roughly $250 Billion) to a 30% tariff, taking effect October 1st. Lastly, he increased the tariff measures taking place on September 1st from 10% (roughly $300 Billion) to 15%.

It is worth reiterating that it is not countries who pay these tariffs; rather, it is the end users. Costs are always passed on to the customer. Thus, tariffs will drive inflation upward over time.

What Does This All Mean?

As we wrote about extensively recently in our Mid-Year Outlook, continuing trade tensions could push long-term bond yields downward and lead to an inverted yield curve. If an inverted curve persists for a couple of months, the risk of a recession could become more crystalized.

The US Fed’s 10-Year Minus 2-Year Curve has briefly inverted a couple of times now in the past 2 weeks and is currently at a razor-thin margin of 0.01%, as you can see in the chart below:

What Should I Do?

In our 2019 Mid-Year Outlook, we outlined a few key strategies to deal with volatile markets – many of which you will have already undertaken:

• Update Your Equity Portfolio – more growth-oriented equities (for example, technology companies) have different properties from defensive, dividend-paying equities (for example, banks). The more growth-oriented the company, the more exposed to market volatility. Thus, re-balancing the equities sleeve of your portfolio to include some defensive holdings is prudent.
• Keep Your Emotions In Check – investor psychology can lead to poor decisions in times of market volatility. Risk aversion (in this case, the bias of loss aversion) can lead people to cash out entirely. This attempt to time markets may “feel” like the right move; however, history has shown us that staying the course over the long term has proven to be the superior strategy.
• Ignore Market Forecasts – the ability to predict future market movements, be it equities or fixed income, is very, very difficult to successfully accomplish on a consistent basis. We do not have a crystal ball to rely upon, so we believe in the time-tested strategy of setting a long-term allocation, weathering pullbacks and investing in quality companies.

Sources: Globe Advisor, CNN Business

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post Weekly Update – August 23, 2019 appeared first on Smof Investment Manager, LLC.

Tempered Fed Cut Hike Speculation Leads Indexes Lower

Major U.S. indices dipped to end the Friday trading session after a strong opening. The Wall Street Journal reported the coming Fed Cut would be 25 basis points; however, comments on Thursday by Fed officials inferred a larger rate cut.

New York Federal Reserve President John Williams gave a lengthy speech on Thursday – which he later walked back from to an extent – that appeared to favour aggressive rate cuts, Mr. Williams pointed to too-low inflation and the need for stimulus. Fed Board of Governors Vice Chair Richard Clarida also made his case for aggressive rate cuts.

Williams’ accommodative-sounding speech and Clarida’s comments led markets upward on Thursday, but the Wall Street Journal’s report dampened investors’ spirits as Friday wore on.

The extent to which U.S. markets are dependent on accommodative monetary policy is significant. Dennis Dick, head of markets structure at Bright Trading LLC in Las Vegas opined “this market has been dependent on cheap money and it is going to continue to be”.

Rate cut expectations, heavily expected to be 50 basis points or more until Friday, now are lowered to a 25-basis point expectation.

The refocused rate cut expectation does not preclude further easing going forward; thus, further rate cut announcements would likely fuel additional equities growth.

Bank of Canada Lowers Stress Test Qualifying Rate

The Bank of Canada reduced its five-year benchmark rate from 5.34% to 5.14%, a drop of 20 basis points. The BoC’s five-year benchmark is also used by lenders as the qualifying rate for would-be home buyers.

Initially only for high-ratio (less than 20% down payment, requiring CMHC default creditor insurance) mortgages, the qualifying rate now impacts both high-ratio and conventional (20% down or more, not requiring CMHC insurance) mortgages.

The goal of the stress test is, generally speaking, to ensure that a would-be borrower could weather a higher interest rate and/or a lower income level at mortgage renewal.

As a reminder, the stress test for insured mortgages stipulates the buyer(s) must be able to meet the servicing hurdle using the BoC’s posted five-year rate (now 5.14%).

For uninsured mortgages, the stress test calculation is measured as the greater of the lender’s rate + 200 basis points OR the Bank of Canada’s Posted Five Year Fixed Rate.

Sources: Globe Investor, Advisor.ca

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post Weekly Update – July 19, 2019 appeared first on Smof Investment Manager, LLC.

CMHC Updates Canada’s Housing Market Risk Levels

The Canada Mortgage and Housing Corporation (CMHC) has lowered the country’s housing market from “highly vulnerable” to “moderately vulnerable” in a statement this week. The Crown Corporation reported on Thursday that an “overall easing” of price acceleration led to the lowered risk rating, which had been rated as highly vulnerable for the previous 10 quarters.

CMHC Chief Economist Bob Dugann: “Even though moderate evidence of overvaluation continues for Canada as a whole, there has been improved alignment overall between house prices and housing market fundamentals in 2018.”

Mortgage stress-tests, introduced in 2018, were a major factor in the risk rating change.

It is important to note that while the national rating dropped to moderately vulnerable, there is continued high-level vulnerability in New York, Victoria, New York, and Hamilton. These four cities did see a move toward more sustainable levels, CMHC said.

Bank of Canada Rate Update

Last week, the Bank of Canada set its key rate at 1.75% for the fourth consecutive rate announcement, on the heels of five rate hikes between mid-2017 and fall-2018.

BoC head Stephen Poloz was also quiet about future hikes, no doubt with an eye on the sudden economic slowdown in the last half of 2018 (which led to worldwide market pullbacks from July through December).

The moratorium on rate hikes helped to steady the ship, resulting in the rebound we’re currently experiencing.

While the BoC made no mention of future hikes, and indeed inferred a continuing accommodative policy in the near-future, there is a differing opinion out there. Scotiabank VP and Head of Capital Markets Economics, Derek Holt, feels strongly that a hike before year-end is likely. “We still think the [BoC] is not done with its hike cycle, and our current view is a hike by year-end”.

Time will tell if the Bank of Canada ultimately continues with its rate-hold strategy or will look to mitigate recent positive inflation reports via a rate hike later in 2019.

Weekly Update – By The Numbers

North America

• The TSX closed at 16,494, down -120 points or -0.72% over the past week. YTD the TSX is up 15.16%.
• The DOW closed at 26,505, down -38 points or -0.14% over the past week. YTD the DOW is up 13.62%.
• The S&P closed at 2,946, up 6 points or 0.20% over the past week. YTD the S&P is up 17.51%.
• The NASDAQ closed at 8,164, up 18 points or 0.22% over the past week. YTD the NASDAQ is up 23.04%.
• Gold closed at 1,280, down 11.00 points or -0.62% over the past week. YTD gold is down -0.39%.
• Oil closed at 61.87, down -1.00 points or -1.59% over the past week. YTD oil is up 35.00%.
• The USD/CAD closed at 0.745, up 0.0023 points or 0.31% over the past week. YTD the USD/CAD is up 1.66%.

Europe/Asia

• The MSCI closed at 2,154, changed 0 points or 0.00% over the past week. YTD the MSCI is up 14.27%.
• The Euro Stoxx 50 closed at 3,503, up 3 points or 0.09% over the past week. YTD the Euro Stoxx 50 is up 16.73%.
• The FTSE closed at 7,381, down -47 points or -0.63% over the past week. YTD the FTSE is up 9.71%.
• The CAC closed at 5,549, down -20 points or -0.36% over the past week. YTD the CAC is up 17.29%.
• DAX closed at 12,413, up 98.00 points or 0.80% over the past week. YTD DAX is up 17.56%.
• Nikkei closed at 22,259, changed 0.00 points or 0.00% over the past week. YTD Nikkei is up 11.21%.
• The Shanghai closed at 3,078, down -8.0000 points or -0.26% over the past week. YTD the Shanghai is up 23.42%.

Fixed Income

• The 10-Yr Bond Yield closed at 2.53, up 0.0200 points or 0.80% over the past week. YTD the 10-Yr Bond Yield is down -5.95%.

Sources: Advisor.ca, Dynamic

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post Weekly Update – May 3, 2019 appeared first on Smof Investment Manager, LLC.

Here are 10 charts providing a case for optimism in 2019:

1: The U.S. economy heated up in 2018, but should resume a slow and steady pace in 2019

Growth accelerated in 2018, with real GDP growth reaching 3.0% year-over-year by the third quarter, reflecting a pickup in inventories, government spending, and fiscal stimulus through tax reform. However, 2019 growth is likely to slow without any new tax cuts or stimulus, reverting to the roughly 2% pace that it averaged between 2010 and 2016.

2: Unemployment continues to fall and wage growth has moved modestly

Unemployment has reached a multi-decade low, and factors that limit labour force growth, such as retiring baby boomers and tighter immigration, should continue to push the unemployment rate down. Finally, we have also seen a modest response from wages; however, many companies continue to resist raising wages. Still, difficulty finding qualified workers may force companies to make some concessions, causing wage growth to edge up, but not surge, in 2019.

3: Corporate profits have continued to be strong, but will slow  

Profit growth was strong in 2018, with the operating earnings per share of S&P 500 companies rising by over 30% year-over-year in the third quarter. Revenues have been boosted by a surge in oil prices and above-trend GDP growth. Margins have also risen thanks to corporate tax cuts and persistently low inflation and interest rates. Share buybacks – a product of excess cash – have also modestly boosted earnings per share.

In 2019 and beyond, however, many of these factors will fade. As a result, earnings growth should return to a mid-single-digit pace. However, the combination of healthy profits and a correction in stock prices have brought equity valuations down to near their long-term averages.

4: Inflation should remain stable

Almost 10 years of monetary stimulus, economic growth, and falling unemployment have succeeded in boosting home prices, bond prices, and stock prices. However, they have not had a meaningful impact on consumer prices. Although oil surged and then retreated in 2018, it should stabilize in 2019, sustaining steady inflation.

Information technology continues to make consumer markets more competitive and this, along with only modest wage growth, suggests that CPI inflation will hover at just over 2% year-over-year over the next 12 months, with inflation as measured by the personal consumption deflator, staying very close to the Federal Reserve’s 2% target.

5: The global economy has slowed but remains in expansion mode

After experiencing synchronous global growth coming into 2018, many developed countries lost momentum, and emerging markets faced headwinds from a strong U.S. dollar and tightening U.S. monetary policy. Concerns over trade fed fears of slowing global growth. Nonetheless, PMI data show that most global economies are still in expansion mode, with a few notable exceptions such as Italy, Taiwan and Korea.

6: The Fed should feel comfortable about raising interest rates

The global economy is generating fewer worries than in recent years and the U.S. is at or near many long-term targets, like unemployment and inflation, making it clear that interest rates are still too low. Moreover, inappropriately expansionary fiscal policy and the desire for future flexibility of monetary policy in the event of a recession has made the need to normalize policy more immediate. Barring any significant negative shocks, the Fed is expected to raise rates by 0.25%, potentially twice in the first half of 2019.

7: Careful fixed income positioning is necessary in a rising interest rate environment

Long-term interest rates remain low, especially compared to historical averages. As the Fed continues to raise interest rates in a low-inflation environment, there is the possibility of a yield curve inversion. While this has historically been a reliable signal of an impending recession, recent unprecedented central bank policy may mean that the yield curve has been distorted. As a result, a yield curve inversion may not mean what it used to.

As rates rise, and the economy continues to grow, credit risk, rather than duration risk, is more appropriate in fixed income investing. That said, as interest rates continue to rise and bonds approach normal valuations, flexibility will become increasingly important.

8: U.S. equity valuations are near long-term averages

Market volatility in the fourth quarter of 2018 brought equity valuations closer to their long-run averages, quelling fears that the equity market is overvalued. This was not only due to market corrections, but also to healthy profits. The earnings yield on stocks is still higher than the yield on BAA corporate bonds, making stocks cheap relative to bonds.

9: International stocks offer long term opportunities

For most of the last three decades, both U.S. and international markets moved sideways. However, come 2011, U.S. markets took off while international markets remained stuck. In 2017, international markets started to outperform, but 2018 was a year of U.S. outperformance, leaving many to wonder if international strength was short-lived. However, international equities remain attractive over the long run thanks to strong economic growth and a downward trajectory for the U.S. dollar. Moreover, valuation measures suggest that international stocks are cheap relative to both the U.S. and their long-term histories.

10: Broad diversification and careful portfolio management are required in volatile markets

Despite market volatility at the end of the year and slowing economic growth ahead, equity markets and the economy still have room to run. However, an older expansion and bull market call for a more disciplined approach, with smaller over-weights and under-weights relative to a normal portfolio. It will be even more important for investors to maintain well-diversified portfolios and be willing to adjust as late-cycle risks gradually rise.

Bonus: Higher education leads to higher income

Don’t forget those RESPs! The higher the educational attainment reached, the higher the average expected annual income.

Remember: the less debt-load a student has as they enter the job market, the better off they are. Avoiding student loan debt in an environment of rising post-secondary tuition requires a greater education savings nest-egg.

Sources: J.P. Morgan, Fidelity Investments

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post Optimism in 10 Charts appeared first on Smof Investment Manager, LLC.

TSX Finishes Positive for Sixth Straight Day, Wall Street Winning Streak Snapped

Don’t look now, but the S&P/TSX Composite is on a Six-Day winning streak and is up 1,100 points (over 8%) since its recent bottom on Christmas Eve. The TSX unofficially closed Friday at 14,939.18. When the markets closed on Christmas Eve, the TSX sat at 13,780.20.

On Wall Street, all of the NASDAQ, Dow Jones Industrial Average (DJIA), and S&P 500 edged lower on Friday, snapping Five-Day winning streaks.

Since Christmas Eve, the NASDAQ has rebounded by around 12%, the Dow Jones has jumped around 9%, and the S&P 500 has increased by around 10%.

Nearly all of the December losses on Wall Street and Bay Street have been recovered since market close on Christmas Eve. Much of the positive momentum this week was driven by hopes of a US-China trade deal.

This recent turn of events serves as an important reminder just how difficult trying to time the market can be when emotion and narratives are at play. The investor who read the negative news in December (and into January) and decided to sell off at or around Christmas Eve – rather than patiently waiting out the storm – has now missed out on nearly gains of nearly 10% or more.

Bank of Canada Holds Key Rate at 1.75%

On Wednesday, the Bank of Canada head Stephen Poloz opted to hold the BoC’s key rate steady at 1.75%. Though there had been the possibility of an additional hike, soft oil prices forced the BoC to temper its economic outlook for the next several months.

Indeed, the BoC now projects only a 1.7% growth in the Canadian economy in 2019, where previously the bank had forecasted growth at 2.1%. Despite this, the bank remains optimistic that 2019’s second quarter will see the economy strengthen, at which point further rate hikes might come into play.

The BoC did stress that more rate hikes would be necessary over time, potentially into the 2.5% – 3.5% range.

As always, there is a fine line to be walked when dealing with the potential economic impact of rate increases. Inflation needs to be factored in (one key reason why rate hikes happen), but raising the key rate tends to take some wind out of the economy’s sails.

Weekly Update – By The Numbers

North America

• The TSX closed at 14,939, up 512 points or 3.55% over the past week. YTD the TSX is up 4.30%.
• The DOW closed at 23,996, up 563 points or 2.40% over the past week. YTD the DOW is up 2.86%.
• The S&P closed at 2,596, up 64 points or 2.53% over the past week. YTD the S&P is up 3.55%.
• The NASDAQ closed at 6,972, up 233 points or 3.46% over the past week. YTD the NASDAQ is up 5.08%.
• Gold closed at 1,288, up 2.00 points or 0.08% over the past week. YTD gold is up 0.23%.
• Oil closed at 51.7, up 3.42 points or 7.08% over the past week. YTD oil is up 12.81%.
• The USD/CAD closed at 0.7543, up 0.0066 points or 0.88% over the past week.YTD the USD/CAD is up 2.93%.

Europe/Asia

• The MSCI closed at 1,957, up 53 points or 2.78% over the past week. YTD the MSCI is up 3.82%.
• The Euro Stoxx 50 closed at 3,070, up 28 points or 0.92% over the past week. YTD the Euro Stoxx 50 is up 2.30%.
• The FTSE closed at 6,918, up 81 points or 1.18% over the past week. YTD the FTSE is up 2.82%.
• The CAC closed at 4,781, up 44 points or 0.93% over the past week. YTD the CAC is up 1.06%.
• DAX closed at 10,887, up 119.00 points or 1.11% over the past week. YTD DAX is up 3.11%.
• Nikkei closed at 20,360, up 798.00 points or 4.08% over the past week. YTD Nikkei is up 1.72%.
• The Shanghai closed at 2,554, up 39.0000 points or 1.55% over the past week. YTD the Shanghai is up 2.41%.

Fixed Income

• The 10-Yr Bond Yield closed at 2.7, up 0.0400 points or 1.50% over the past week.YTD the 10-Yr Bond Yield is up 0.37%.

Sources: Globe Advisor, Advisor.ca, Dynamic Funds, CIBC

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post Weekly Update – January 11, 2019 appeared first on Smof Investment Manager, LLC.

We’ve now experienced nearly 10 years of expansion with few speedbumps along the way. When listening to commentary by economists, fund managers and analysts, the only thing everyone agrees on is that a market correction is inevitable; however, when the correction will happen is a matter of wide debate.

Here, we will look at some potential evidence of a future market volatility. We will also look at strategies to help minimize porfolio impact.

What’s Happening in the Markets – Potential Indicators

Interest Rates

In the last 18 months, both the Bank of Canada and the U.S. Federal Reserve have hiked their key rate multiple times. The Fed has hinted at up to six more rate increases through 2020.

Rising interest rates make it more difficult for households and businesses alike to borrow money, and increases the servicing cost on existing variable-rate debts. On a business level, more difficulty in borrowing money and increased servicing costs mean less growth and lower earnings. Over time, rising rates act as a headwind to economic growth. The chart shown below bears out:

Price/Earnings Ratios

The price/earnings (P/E) ratio is calculated by dividing the company’s stock price by its earnings per share (EPS). P/E ratio tells us what an investor is willing to pay for $1 of earnings. Because a company’s stock price depends not only on earnings but also on the number of shares outstanding, the company’s P/E ratio is a better indicator of a company’s value than its stock price and allows for apples-to-apples comparison between companies in a particular industry.

Depending on the index, historical P/E ratios have been between 15 and 25 on average. For example, the S&P 500’s historical average P/E ratio is about 17. The S&P’s 12-month trailing P/E ratio stands at 24.40, 44 per cent higher than its historical average.

Higher than average P/E ratios indicate investors are paying more for a dollar of earnings than they have on average, so that dollar of earnings is more and more expensive as P/E rises.

P/E ratios running higher than historical average can hint at future market volatility.

Yield Curves

In a normal economy, the yield for long-term debt instruments is higher than the yield on short-term instruments. Investors expect to be compensated for lending money with a longer duration to maturity, because they are exposed to various risks that are less prevalent in short-term debt instruments. Thus, a normal yield curve will curve upwards. As market expansion continues and central banks raise rates, the yield curves will flatten out and even become inverted.

The inverted yield curve is considered a leading indicator of market corrections. A widely-used comparison when looking at yield comparisons is the spread between 2-year vs 10-year yields. Historically, 2-year yields greater than 10-year yields have shown to correlate with recession and its the accompanying market instability. See the below chart:

While we are not currently experiencing an inverted yield curve, the chart shows that the difference between a 10-year yield and a 2-year yield is declining. The black line (a differential of 0 per cent) represents a flat yield curve and a negative differential indicates an inverted curve. You will notice that recessionary periods (the grey areas) tend to follow inverted yield curve instances within a short time frame.

Now, let’s look at some strategies to deal with increased market volatility.

The Late-Stage Investing Playbook

Defensive Equities Versus Cyclical Equities

Firstly, investors can increase their defensive equity weighting and reduce their cyclical equity weighting.

As the name implies, defensive (or “non-cyclical”) equities tend to be less volatile than the index, so as markets pull back, defensive equities theoretically do not pull back as much as the index. For example, the index drops by 10 per cent, but a defensive equity only drops by 6 per cent.

On the other hand, cyclical equities’ valuations are affected by the ups and downs of the overall market, rising and falling with the business cycle. Cyclical equities are more volatile than defensive equities and tend to rise and fall as much as (or more than) their index. For example, the index drops by 10 per cent, and a cyclical equity drops by 12 per cent.

Examples of defensive equities include companies that produce stable, predictable earnings, dividend providers, utilities companies, consumer staples, health care, and real estate investment trusts (REITs). These kinds of companies are perceived as defensive because consumer demand for these products and services persists, regardless of market conditions.

Tech Weighting

Related to the Defensive vs Cyclical balance is the influence of the tech sector on overall growth. The Tech sector is generally more cyclical and has driven the majority of growth in 2018. See the below chart, showing the TSX Composite’s 2018 by-sector growth figures as of September 14th.

As we can see here, Technology is the main growth driver, at a Year-to-Date (YTD) increase of 24 per cent. The second leading sector is Health Care, at just over 15 per cent. YTD, the TSX is at -1.2 per cent.

A portfolio rebalancing to reduce tech weighting locks in some profits and allows the investor to re-position their portfolio into more defensive assets.

The Case for Holding More Cash

In an expanding economy, holding (or hoarding) too much cash presents the disadvantage of opportunity cost, since that cash is subject to inflation but very little growth. This means that hoarding cash will erode your purchasing power over time.

A key benefit of holding cash, especially when markets cycles are near their highs, is that cash acts as a portfolio buffer, protecting you from the full brunt of a market downturn. So, tactically increasing a portfolio’s cash position is a great way to take some downside risk off the table.

Many fund managers, especially those managers with more defensive mandates, actively tweak their funds’ weightings already.

In Summary

It’s important to keep in mind that any one indicator or piece of evidence is not necessarily reliable on its own; however, we can see how increasing bank rates, climbing P/E ratios and a flattening yield curve are all pointing in the same direction.

Reading these tea leaves, we can formulate a strategy to reduce the downside risk to portfolios through a mix of re-balancing within equities from cyclical to defensive, trimming positions in the most growth-oriented sectors/funds, and tweaking the cash weighting within portfolios.

If you have any questions about your portfolio’s asset allocation or cash weighting, please contact our office.

Sources: Fidelity Investments, Federal Reserve Bank of St. Louis, Advisor’s Edge, Bank of Canada, TD Asset Management

This information is provided for general information purposes only. It does not constitute professional advice. Please contact a professional about your specific needs before taking any action.

The post Late-Stage Investing – Protecting Against A Pullback appeared first on Smof Investment Manager, LLC.