It's a scary time for investors, but they need to find the courage to face their fears
Martin Pelletier: Those who face their fears when things are at their scariest always end up with the most candy
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It was just a matter of time, 14 years to be precise, before the doomsayers finally got another kick at the can and that time appears to be now given all the ghouls and goblins warning us about the end of the world — Halloween has indeed come early.
This time, the fear factor has to do with the surge of inflation caused by the tremendous pent-up demand of locking us all down for a year or two combined with what in hindsight was an unnecessarily prolonged economic stimulus package.
We’ve all been infected with YOLO, or “you only live once,” with the initial focus on consuming goods now followed by a transition to services where there just isn’t enough labour to keep up with demand.
Bring in the bears, who tell us this is a permanent situation fuelled by excess monetary and fiscal stimulus and the only way to end it is by going full nuclear or (Paul) Volcker on our economy. Suddenly, everyone has become familiar with what the “terminal rate” of inflation is.
Not surprisingly, given their defensive nature, bond managers had been giving this a lot more attention than equity investors until the capitulation over the past two weeks.
There hasn’t been a place to hide. The cross-asset correlation from stocks to bonds to commodities, as tracked by Barclays PLC, shows readings that rank among the highest since 1981. Consequently, the United States bond market is on pace for its worst year in history, with a loss of near 14 per cent, while U.S. investment-grade bond yields are the highest since 2009 at 5.6 per cent, more than double where they were at the end of last year, according to Bloomberg.
As of Sept. 27, Charlie Bilello, chief executive of Compound Capital Advisors LLC, noted the S&P 500 this year has experienced 30 daily declines of between one and two per cent, which is the most since 2008 (which had 34).
So far, the S&P 500 has finished in the red on 56 per cent of the 184 year-to-date U.S. trading days and is on track to have the second-highest annual proportion of loss-producing trading days since 1957, when such data was first recorded, according to S&P Dow Jones Indices.
Bespoke Investment Group LLC pointed out that the S&P 500’s 10-day advance/decline line has dropped to a record low, with the underlying breadth over the past 10 trading days being the weakest it has ever been in the past 32 years.
A recent Bank of America Corp. survey shows investor sentiment is “unquestionably” the worst it has been since the global financial crisis. And almost 25 per cent of Canadians have no confidence in the stock market and plan to cash out this year, according to a new survey by personal finance site Finder. Put another way, that’s 7.5 million Canadians ready to cut their losses.
Talk about a lack of conviction on the potential for a recovery.
This type of behaviour isn’t uncommon during the depths of a market correction and is known as loss aversion: market losses simply become too much to bear, so investors start selling at the worst possible time.
Fund manager cash positions are now at their highest level since 2001, with US$30.3 billion of cash inflows, while global equity funds had outflows of US$7.8 billion in the week through Sept. 21, according to Bloomberg.
Investors have accumulated US$4.6 trillion in U.S. money-market mutual funds, with another US$18 trillion in deposits at U.S. commercial banks, according to U.S Federal Reserve data reported by Yahoo Finance. In total, U.S. banks are now sitting on about US$6.4 trillion of surplus liquidity (excess deposits relative to loans), up from about US$250 billion in 2008.
Investors are also buying expensive put protection, and speculative futures positions are heavily net short. Only three per cent of stocks in the S&P 500 at the end of September closed above their 50-day moving average, a reading more oversold than 99 per cent of historical data points, according to Bilello.
During such times, it really helps to stick to a process and not let emotion take over. This means having the right balance between being defensive to survive what could be a prolonged downturn and being brave enough to find your inner contrarian and selectively go on the offence to benefit from the ultimate recovery.
Keep in mind that Halloween is only one day out of 365, and those who face their fears when things are at their scariest always end up with the most candy.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.
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