Time to Panic

In case you missed the humour, it’s obviously not time to panic, although you may not feel like laughing if you’ve been watching the investment markets over the past few days. Specifically I am speaking about the whipsaw session we experienced on August 24. When the Dow Jones opened that day, at one point it fell 1089.43 points, recovered over 900 points and finished the day -588.40 points. That’s what we in the business call volatile.

Joking aside, there are several reasons for what lead us to this point:

1. China: Their economy is slowing from 9.3% growth in 2011 to 7.4% in 2014. As a result their government is devaluing the yuan. This will make Chinese exports cheaper to buyers and in turn will make our products more expensive by comparison.
2. Prospect of Fed Tightening: Given the gradual improvement in the US economy the Fed has signaled its intent to raise interest rates in the coming months. Recent remarks from the Fed have indicated a possible rate hike date in September. This uncertainty has weighed on investor sentiment, but now we believe, given the sell-off, that the future hike date has been pushed out, possibly to December or 2016.
3. No 10% correction since mid-2011: The S&P 500 has gone on one of its longest streaks without a 10% correction and therefore was overdue for a correction. Based on our analysis, the S&P 500 endures three 5% pullbacks and one 10% correction every year, on average.
4. Summer: Finally, June to September is historically the worst period of the calendar year for equities. However, seasonality turns positive in Q4, with October through May being the strongest seasonal period of equities.

The question we have to ask as investors is, if this is a “normal” pullback/correction or the start of a new cyclical bear market? Ryan Lewenza, private client strategist at Raymond James, believes it is the former and I agree.

From his market update on August 24 he says “In the short-term we believe the equity markets are oversold and due for a bounce. The S&P/TSX RSI indicator is at 21 (below 30 indicates oversold), while the percentage of S&P/TSX stocks below their 50-day moving averages is at 19 (below 30 indicates oversold).” Our Raymond James research team also believes we should see a bottom to the market over the next couple of months and they don’t believe we are headed into a global recession.

Here are some facts to back up this hypothesis:

• India has seen growth in Q1/15 of 7.5%.
• S. job growth is strong with 2.9 million jobs added over the last year with an unemployment rate of 5.3%.
• S. auto sales are hitting a new cycle high of 17.5 million units sold annualized in July.
• S. manufacturing is rebounding and in Europe, GDP and industrial production is slowly improving.
• Stocks are not materially expensive in our view. The S&P 500 is trading at 17.2x trailing earnings (4% premium to long-term average) and 16.4x forward earnings.
• Market cycles tend to be bullish in election cycles. In 2012 I wrote a piece with the historical figures of election cycles.

So things are not as bad as they may seem, even though you feel the only thing to buy is Pepto-Bismol. What does that mean for you? Here is how we see positioning in general:

• The S&P/TSX will bottom soon; consolidate through September/October, before rallying into year-end.
• We continue to overweight the consumer discretionary, information technology and industrials sectors.
• From a geographic perspective we remain bullish on US and Europe over Canada and emerging markets.
• From an asset allocation perspective we remain overweight stocks relative to bonds.

Don’t forget Warren Buffet’s advice to be greedy when others are fearful (and vice versa). Generally people are counter intuitive with respect to their investments and to how they purchase other things. No one offers to buy a car for $50,000 when it’s listed for $40,000, but that is exactly how most invest their money. And don’t forget, it is never time to panic.