Opportunity or warning?
As you can see from the table below, the red numbers indicate that February was a volatile month that saw some retracement in equity market value both at home and abroad.
|February ’18||YTD||1 Year||3 year||5 year||10 year|
|S&P/TSX Composite||– 3.19%||– 4.73%||+ 0.28%||+ 0.45%/yr.||+ 3.79%/yr.||+ 1.29%/yr.|
|S&P 500 (C$)||– 0.03%||+ 3.81%||+ 10.79%||+ 9.72%/yr.||+ 17.40%/yr.||+ 10.30%/yr.|
|S&P 500 (U$)||– 3.89%||+ 1.50%||+ 14.82%||+ 8.85%/yr.||+ 12.37%/yr.||+ 7.39%/yr.|
|MSCI EAFE (C$)||– 0.88%||+ 2.32%||+ 12.93%||+ 3.67%/yr.||+ 8.89%/yr.||+ 2.62%/yr.|
* Source: Equity Index and Currency Data: Bloomberg. Data as of February 28, 2018
The period from November 2016 to the end of January 2018 was an unprecedented period for investors. Equities rose sharply and volatility was historically low. Not only was volatility low, but the S&P 500 gained more than 34% after going more than 18 months without even a 5% pullback, and a full 24 months without a 10% correction.
Then in February 2018, the law of averages caught up with the market, and the S&P 500 declined 10.1% from its January peak. There is little doubt the correction was overdue statistically, but it was also driven by a number of factors, including rising volatility expectations in a market that was hitting record highs, rising inflation expectations, excessive investor optimism, rising interest rates, concerns about Federal Reserve monetary policy and government shutdown concerns. While many of these signs had been present for several months, pinpointing the tipping point that sparks a correction is very difficult—thus many investors were caught off-guard.
Even diversified investors experience some losses in their portfolios when the market declines and volatility spikes, but are such spikes a warning sign of more trouble to come or can they be a sign of opportunity for investors seeking to put uninvested cash to work in the market?
Famous quotes you are likely aware of:
- British banker Baron Rothschild is credited with saying “the time to buy is when there’s blood in the streets.”
- Sir John Templeton is said to have used the philosophy of buying companies when they hit the “point of maximum pessimism.”
- The “Oracle of Omaha,” Warren Buffett, is known for saying, “Be fearful when others are greedy and greedy when others are fearful.”
All three of these highly successful investors had one thing in common: They were all contrarians.
However, these investing philosophies are not just about buying market pullbacks or corrections, but of capitalizing on, rather than succumbing to, the fear of others. Of course buying when others are fearful and being a contrarian investor is easier when you have the kind of investing capital and extremely long time horizons these three gentlemen had. Can it also be effective for regular investors with shorter-term outlooks?
I see the current weakness as transient, set against a strong medium-term outlook for market fundamentals. In particular, economic growth momentum remains solid with economic data continuing to beat economists’ forecasts, leading to growth forecast upgrades for this year and next. This has fed into corporate earnings growth estimates running at double-digit rates for 2018, supporting equity valuations. Combined with a gradual pick-up in inflation and interest rates over the coming year, Scotia Wealth Management’s Global Advisory Group continue to expect a cyclically-biased investment strategy (equity over bonds; industrials, financials, resources over utilities, real estate, consumer staples; corporate bonds over government bonds) to outperform at this stage of the business cycle. With valuations having returned to more attractive levels, we see the recent pullback in equity markets as an attractive opportunity to put any large cash allocations to work.
In summary I view the recent equity market pullback, despite its speed, as a healthy development. Investors that are overweight cash or fixed income have a chance to increase their equity exposure. I am doubtful that equity volatility will return to the low levels experienced in late 2017. Fasten your seatbelts for more turbulence as the year unfolds but expect a well-diversified actively managed portfolio to provide reasonably attractive returns over the next twelve months.
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Senior Wealth Advisor
Director, Wealth Management
Mailey Rogers Group