As summer slowly shifts into fall and kids are going back to school, we’re here with our analysis of market behavior in the month of August. We also have an update on some upcoming communication tools we’re excited to bring out in September!
How are the markets doing right now?
If we’re taking news headlines as our only source of market information, then it’s gloom and doom everywhere we look. Between Brexit (exacerbated by a now-pending parliamentary shutdown), Sino-American trade war expansion, election-induced volatility here in Canada and all sorts of other ‘irrational’ influences on the markets, it’s becoming harder and harder for portfolio managers to make short-term decisions about where capital should be invested.
“We’re one headline or one tweet away from triumph or tragedy almost every single day right now,” Arthur Hogan, chief market strategist at National Securities Corp., told Bloomberg TV. “We’re really on a knife’s edge. And that’s what makes trading really difficult.1 ”
In Canada and the US, we saw August bring a slight dip after a relatively strong July with the S&P TSX Composite down -0.5% and the S&P 500 down -2.2% since the 1st of the month. While not catastrophic by any measure (compare that to October 2018 bringing -6.7% and -6.9% respectively), it’s still not fun watching this much volatility. With banks starting to invoke creative strategies to inject stability into their markets, such as Denmark’s new negative interest rate mortgage, we’re seeing governments around the world struggle with how to manage a late-business cycle economy in the face of political instability. The simple fact remains that companies that have benefited from extremely low-cost access to capital since the 2008 recession are now holding back on investing that capital back into the economy because of that instability.
All that being said, not everything is falling apart: energy prices bounced up slightly (WTI up 1.2% over the month) and other sectors such as Consumer Staples (think toothpaste and toilet paper) also showing positive growth of ~2.0% over the month.2 Diversification is a valuable tool in a volatile market and holding small portions of many types of company is a great way to make sure you don’t capture all of the downside.
1: Energy Rally Leads Advance in US Equity Markets.
2: Bar Charts – Consumer Staples
What is being done to protect and grow my assets?
In advance of what our Q3 update next month (when our asset management partners tend to put out more detailed commentary), we’ll focus this section on a key aspect of investment management: Diversification.
One of my favorite articles about the power and drawbacks of diversification is written by Brian Portnoy at Forbes: “Diversification Means Always Having to Say You’re Sorry“. In the article he emphasizes the obvious logic behind a well diversified portfolio – namely not putting all your eggs in one basket. If you could look into a crystal ball and determine that, for instance, Canadian markets would tumble 15%+ in the next month, chances are pretty good you would hold as few Canadian equities as possible. The question would then be whether you knew where to invest instead – unfortunately, the crystal ball doesn’t provide that information. So, in the interest of hopefully capturing some positive returns, you invest a little bit of your capital into a lot of other baskets. This is the nature of diversification: a well built portfolio will spread out your capital so that no one iceberg strike can sink the whole ship.
Unfortunately, as Portnoy mentions, this has a drawback: when you’re properly and well diversified you must by definition have pieces of the portfolio that will be down when others are up. That’s the nature of diversification – you cannot be all up all the time otherwise you’re not diversified. This phenomenon is called correlation and to reap the benefits of diversification you need some investments that have low-to-negative correlation to others so that when the high fliers start to tumble, the under-performing holdings will instead climb and keep your portfolio stable for their inclusion.
The challenge is in confronting the psychology of loss – the tendency to overweight the value of a loss compared to an equivalent gain.
Diversification is absolutely an art form and there are many approaches, but it is increasingly well understood; one of the key aspects of management style we look at in our partners is how well they diversify their mandates to help achieve a better risk-adjusted return.
