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PETER DOLEZAL: Equity markets – stumbles and challenges

Peter Dolezal is the author of three books, including his recent Third Edition of The Smart Canadian Wealth-Builder.
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Peter Dolezal

Over past decades. equity markets world-wide have often wobbled in October, at times quite drastically. October 2018 saw this trend continue, in almost all major markets. The Canadian S&P TSX Composite Index for example, fell by 6.5% during the month, for a cumulative year-to date loss of 8%.

Canada’s dismal year-to-date market performance is certainly not unique. Broad U.S., European, and broader Global Markets have all recorded corrections. What is unusual however is that, despite trade tensions spearheaded by a new protectionist U.S. policy, these corrections are occurring at a time when GDP growth in most countries continues to be healthy.

In the U.S., the Administration injected a major stimulus during the year, with massive tax cuts and huge deficit increases. Even that accelerant however, could not prevent an October correction that almost nullified earlier advances in 2018. Despite the October correction, U.S. equities, having increased by an average annual total return of 13.9% over the past decade, remained hugely overvalued relative to most markets - by any historical Price/Earnings or other measures of value. As rising deficits, debt levels, and interest rates take hold, the U.S. economy, and hence its equity markets, are set for a significant correction – possibly a “Bear” market. The only question is when it will occur.

Canada’s sluggish market performance is particularly surprising. Despite delivering a respectable 5.8% average annual total return over the past decade, the TSX Index has lagged the performance of almost all major world markets since 2009. Yet, we weathered the financial crisis of 2008/09 more successfully than any developed nation. Our Price/Earnings market valuations are far healthier than those of the U.S. Although our national deficit and debt-levels need more government focus and discipline, Canada’s, as a percentage of GDP, remain among the lowest of the world’s industrialized countries.

The renegotiation of NAFTA, amounting to not much more than a tweaking of the former Pact, has been successfully settled. Our unemployment levels are not only historically low, but also dropping; corporate profits continue to grow at a healthy pace. Even the softwood lumber tariffs imposed on Canada have not taken a significant toll on our forestry sector, with U.S. demand for our products resulting in price increases which largely offset the additional duties.

On the negative side of Canada’s ledger is the continuing struggle of our Western Canadian oil industry, forced to absorb a discount to world prices of as much as $50 a barrel, due to its inability to deliver product to markets beyond the U.S. – to the great benefit of the U.S., and to Canada’s disadvantage. This economic drag amounts to as much as $80 million daily. With the energy industry still a major economic driver in Canada, this is a serious issue, unlikely to see early resolution, even should the Trans Mountain Pipeline receive approval to proceed in 2019.

History tells us that market performance is cyclical. While Canada’s equity markets have largely underperformed world markets in the last decade, they are probably better-positioned than most to outperform in the next decade.

Continuing trade tensions and rising interest rates, particularly in North America, are likely to be a drag on future GDP growth. At some point, a recession will materialize - interest rates will then begin their cyclical downward trend, and economic performance and equity markets will resume their long-term upward trend.

How is the average investor to cope not only with these visible issues, but also those that have yet to emerge? How do we make appropriate long-term investment decisions? The only way to overcome shorter-term market reversals, such as this past October’s, or even occasional “Bear Markets”, is to outlast these corrections with a solid long-term portfolio strategy.

The key is to maintain a laser-like focus on managing downside risk on each investment decision over which the investor has control. This includes selecting a suitably-tailored Equity/Fixed asset allocation, minimizing portfolio holding costs, optimizing dividend/interest income streams (yield), ensuring broad sector and geographic diversification, and utilizing currency-hedging where possible for foreign holdings.

Has this investment strategy proven itself historically? Look no further than Canada’s TSX Index. Despite lagging most world markets over the past decade, it still delivered a respectable average annual total return of 5.8%. The U.S. delivered a sizzling 13.9%; the Asia/Pacific region 8.5%; Emerging markets 7%; and Europe 6.7%. The prudent investor who split the Equity portion of his/her portfolio equally among Canada, U.S., and beyond North America, had little reason to complain about long-term portfolio performance.

The worst-possible strategy is to attempt to time market entry or exit points of an economic cycle. These cycles are inevitable; they occur periodically, but with unpredictable timing. Even acknowledged market experts such as Warren Buffet cannot predict the ups and downs and turning points of markets. It is instructive that he makes no attempt to do so. Every investor should take note.

A retired corporate executive, enjoying post-retirement as an independent financial consultant, Peter Dolezal is the author of three books, including his recent Third Edition of The Smart Canadian Wealth-Builder.