August 2017 (click here for full commentary)
“Buy on the cannons, sell on the trumpets.”. Rothschild
Last month we looked at the concept of risk but we didn’t include the risk of war or natural disasters on your investments. The phrase above assumes the market falls at the prospect of war which creates a buying opportunity. Once the war is over there is euphoria and a good time to sell. We have threats and counter threats with only minor impacts on the market. Could it be that investors believe the prospect of cannons is miniscule? Let’s hope we do not actually have to get to the point of cannons. A few years ago a neighbouring country to Israel fired missiles that were deflected by the Iron Dome defence. The Israeli market declined 10% and recovered shortly thereafter. I hope the only buying opportunity was the decline caused by the President’s threatening tweet.
If a country has an improving GDP growth it is assumed that corporate profits should rise in line with the growth. Since you purchase a company to benefit from rising prices that are a result of rising profit per share, then a rising GDP is good for the stock market. Both the Canadian and US economies showed excellent rates of growth in the second quarter. The Canadian economy grew at an annualized rate of 4.5%. One problem with fast growth is the central banks try to ensure the economy does not grow too fast to cause inflation. The recent rise in the Canadian dollar was caused by the prospect of higher interest rates due to a strong economy. Unfortunately a 10% increase in our dollar may lead to slower exports and cheaper imports which could mean lower profits. At the moment I can’t tell you if the high GDP growth will be a positive or a negative for company earnings over the next couple of years. We continue to like less volatile dividend paying stocks.
July 2017 (click here for full commentary)
“Using volatility as a measure of risk is nuts. Risk to us is 1) the risk of a permanent loss of capital or 2) the risk of inadequate return.”. Charlie Munger – Warren Buffett’s business partner
How do you define risk? When you invest do you worry when the markets go down? The pundits on TV often soften the blow of a weak market by calling it a “correction”. Conversely you never hear a movement up as a mistake that needs to be corrected. I had a chat with an investor who indicated they could accept above average risk to get better returns, after a quarter of a market decline they called and asked, “what happened?”. When I suggested they are not truly an investor who could handle high risks and they should reduce the amount they have in the market they replied they wanted to stay in the market. This, in my view, is someone who cannot tolerate the risks related to the markets. Maybe he is correct as risk is only if the loss is permanent. In the end, you have to decide what risks you are willing to take. Back in 1987 the stock market fell more than 20% in a day but recovered in 3 months. I don’t think investors are prepared for those kinds of days.
Currency movements replaced market volatility. Over the past two months the US dollar has fallen almost 10% relative to other major currencies. The same factors that caused the US dollar to weaken have been ignored by the equity markets. Investors no longer believe Trump will turn the US economy’s growth up to 3%. This change in attitude led to lower interest rates and a change in view on the US dollar. You might expect lower growth rates to lead to lower earnings for US companies and then lower prices for stocks. Or a weaker dollar could lead to improved earnings from foreign affiliates when converted to US dollars. US goods became 10% cheaper in Canada and Canadian goods became more expensive to Americans. The US trade balance might correct itself without renegotiating NAFTA as the relative costs changed between the two countries. There are many factors that cause the market to gyrate and the significant move in the currency does not seem to have changed investors’ outlooks, at least for now.
“High valuations entail high risks”. Benjamin Graham
It is almost impossible to pick the top or the bottom of any market. One quote I like is that they do not ring a bell at the top of the market. The quote is warning you that there is no one indicator of a market top. I will tell you they ring a bell to open the market every morning. The stock market, like the housing market, is driven by the interactions of buyers and sellers. I hear that the housing market in Toronto has recently had unsustainable price increases, yet even the capital of Iceland has experienced more than a 20% price increase in the last year. On the other hand, many cities in Scotland, the entire country’s population is smaller than the population of London, have price declines of 45% from their peak in 2007. In hindsight there was a bubble in Scotland. Current prices in Toronto can be justified by the ability of the average person to carry their mortgage. The average price of a semi-detached house in London is 70% higher than a house in Toronto yet the average wage in the UK is $45,000. Since house prices are much more highly valued that previous years we could say they entail high risks.
In a month with few market moving announcements the markets meandered. Contrary to expectations the Canadian dollar soared despite falling oil prices. The Canadian dollar rose based on unexpected announcements from the central bank that rates would likely rise in July. Many students of equity markets believe the market reflects all known facts so it is impossible to beat the market. The banks announcement was a surprise and caused a significant movement in the Canadian dollar. I cannot tell you if the market will rise tomorrow, the next day or next month. I can tell you that getting a portion of your returns from dividends lessens some of the pressure of day-to-day movements in your portfolio. Buying companies with a history of dividend increases should mean increased income in the future as you benefit from higher dividend payments. Many of the stocks in our clients’ portfolios may lag in raging bull markets but provide stability by generating dividend income.
“ Bubbles are best identified by credit excesses, not valuation excesses.. James Chanos
Last month we dealt with concerns the equity markets were ready to crash and this month we took the opportunity to look at what could trigger a decline in house prices. The most important item to note is that I am not a real estate expert. I have a few contacts that warned me to avoid Toronto real estate as it is overvalued; these contacts have made this caution for more than 3 years. Housing prices are up considerably over the past 3 years. Prices do not decline on their own, there has to be a catalyst. Some believe the new regulations included in the provincial budget might lead to a decline but similar policies in Vancouver only stabilized the market 6 months later. As the quote above highlights, it is the availability of credit and not the price of an item that creates and ends bubbles. The recent run on Home Capital has raised concerns about the ability of mortgage lenders to source capital. So far, some have found several billions of dollars of credit life lines. The story has not ended but if you are worried about housing and the impact on the economy keep your eyes on the Home Capital Group saga.
Markets have trouble dealing with uncertainty. Donald Trump’s comments have raised the stakes in uncertainty. This month he commented on how Canada had taken advantage of US farmers and foresters. He threatened to rip up the NAFT Agreement. The Canadian stock market and the Canadian dollar fell. It is interesting in this period of uncertainty that the price of Gold, often viewed as a safe haven, has barely budged. The VIX, a gauge of expected market volatility, hit a 52 week low. We are concerned about near term market fluctuations but believe that dividend paying companies with solid balance sheets should provide relative stability and upside over the next year and beyond.