Stock markets began to roll over late in January and sold-off sharply Monday afternoon, February 5, 2018. Fast-paced market corrections can understandably cause anxiety, especially when news reports call out dramatic figures and facts. While not unusual, market corrections cause us all to re-check our facts and assumptions about our investments. So, we asked a few of GLC’s lead portfolio managers and Chief Investment Strategist to share their thoughts on the recent market sell-off and how they are responding to it. Here’s what they had to say:
Q: What are your views on this market sell-off?
Clayton Bittner, Vice-President Equities
This is long overdue, and headlines about the “plunging stock market” completely ignore the context that the market went a full year without a single negative month, not to mention January’s return was nearly enough for a whole year in a typical market. Having said that, other than taking some of the “froth” out of a market that has become somewhat parabolic, this means nothing regarding the overall health of the economy – which remains strong. Corporate earnings have been quite good as well, helped by the tax cuts. The thing is, markets run on fundamentals and sentiment, and the latter has gotten way ahead of itself. This has been evident for a while as witnessed in the volatility of Bitcoin, weed stocks, and retail market interest most recently. Even decent earnings have been shrugged off by the market, a classic sign of a market gone too far.
Janet Salter, Vice-President Fixed Income
Although the one day move lower in yields was impressive, it’s not uncommon for markets to have sizeable pullbacks after dramatic moves higher in yields, such as what we’ve seen over the last several weeks. Markets never move in a straight line. A pullback of some kind was expected, but what was difficult to anticipate was when it would occur, and what the catalyst would be. Specific to Monday afternoon’s sell-off, it was the risk-off tone that drove yields lower, with signs of a classic flight-to-quality trade as both US treasuries and gold rallied.
Dylan Fricker, Vice-President Equities
The bond market, specifically the rise in yields, was the impetus for the selloff. The sell-off was long overdue. Investor sentiment was running way too hot. In spite of valuations dropping with this sell-off, they are still high by almost every measure (except maybe by measure of the most recent past – but that’s the point…they were far too high to begin with!). Over the last several months, economic fundamentals and earnings have improved, while valuations have deteriorated. This put ‘risk’ at high levels, and accordingly we see this current correction as a healthy reset for company valuations.
Q: How are you responding within the portfolios you manage?
As far as positioning, we have been reducing cyclical risk as we have progressed through this late stage in the market cycle. Since the market weakness has been rate-driven, interest sensitive stocks such as dividend-paying stocks have been hardest hit – that is where we have been shopping. In particular, the utility stocks and REITs have been beat up, as have all bond-proxy type stocks. This could continue in the short-term as the Fed unwinds its balance sheet and increases rates, so we don’t feel the need to be hasty. Our expectation is that the dividend-paying stocks we own in the portfolio should regain favour as cyclical stocks retreat. Until then, we will be buying higher yield for the portfolio at a growing discount.
Unlike the equity market, Monday was the first day that we saw the bond market in Canada react to the risk-off tone (with rates dropping back). In our view, it’s too early to determine if any short-term adjustments need to be made to bond portfolios. One-day market moves don’t make a trend. As always, we are following the markets and staying focused. We remain nimble and poised to take advantage of market re-pricing opportunities in key areas that align with our longer-term strategy for the portfolio. What is that longer-term strategy? The portfolio is currently positioned with a shorter duration than the index with an overweight bias to short and mid-term corporate bonds.
Valuations are still high, and we are not in any rush. But are we “shopping”? Yes. We are actively looking for attractive entry points in our favoured stock names. This is a good reminder to check your risk profile, not a sign to throw your plan in the recycling bin.
Does this change GLC’s capital market outlook for 2018?
No. We acknowledged that easy monetary policy has been a significant catalyst for the bull market and as such rising rates are likely to be a headwind for equity returns moving forward. “While we could see change at the margin with respect to the absolute forecast figures, my overall comments around positioning and favouring of equities over bonds hasn’t changed. We see the current equity market weakness as a healthy and normal check-back and not all that surprising.” Brent Joyce, GLC’s Chief Investment Strategist.
Can you give some context around these market moves?
The stock markets had been booking stellar gains for quite some time now. This latest pullback erases days’ worth of gains, but not years’ worth. The S&P 500 is now back to levels last seen in early December 2017 and off 8% from its closing high on January 26th, 2018. The S&P/TSX Composite is back to levels last seen in mid-September 2017 and down 7% from its January 4th, 2018 high. It’s worth remembering that the current market levels were themselves record breaking levels not that long ago. A further point to recognize is that U.S markets had been moving up the fastest, and it was one of the markets that fell the hardest on Monday.
The U.S. S&P 500 lost 4.1% on Monday, February 5, 2018, more than erasing strong gains in January (bringing the YTD return to -0.9%). In contrast, the Canadian S&P/TSX Composite did not react as significantly during Monday’s sell off. The one-day downturn for the Canadian benchmark was limited to -1.7%, but YTD the index is down -5.4%.*
I’m hearing about the role ETFs (i.e. passive management) play in market corrections. What is that about?
A few media reports are raising the issue of ETFs and their role in accelerating the sell-off with algorithms and automated trading functions. We see more to it than that, but it is a good reminder about what ETFs are and what they aren’t. Unlike a portfolio that is actively managed, passive or index ETFs buy and sell the market as a whole, and these buy and sell actions are typically prompted by trigger points, rather than actual fundamentals. Hence an ETF may prompt an acceleration of market selling as it perpetuates a snowball reaction in which selling triggers more selling. This trigger response does not give consideration to the risk of the portfolio as a whole, nor does it offer the benefit of the active selection of holdings that can protect you on the downside and position you for better upside potential when markets recover.
What should investors do?
Market corrections are uncomfortable, but we caution investors against emotional reactions that take them away from their well-balanced and risk aligned investment plans. Likewise, GLC’s portfolio management and investment teams don’t abandon their well-thought-out investment strategies. Rather their value increases during times of market volatility in the ability to capitalize on market opportunities.
*Source: Bloomberg. All figures as of February 5, 2018
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This commentary represents GLC’s views at the date of publication, which are subject to change without notice. Furthermore, there can be no assurance that any trends described in this material will continue or that forecasts will occur; economic and market conditions change frequently. This commentary is intended as a general source of information and is not intended to be a solicitation to buy or sell specific investments, nor tax or legal advice. Before making any investment decision, prospective investors should carefully review the relevant offering documents and seek input from their advisor.