Category: Monthly Reflections

Rising Short Rate Doesn’t Mean Bond Disaster

Interest rates have been on the rise in Canada since June 2017 and the general consensus is that they will continue to go up. What will this mean to the average client’s portfolio? Of course, everyone knows that rising interest rates are bad for bonds, right? In reality, history shows a different conclusion concerning the impact of rising interest rates on a broadly diversified bond portfolio.

When analyzing the past experience of bond investors under different interest rate scenarios it is clear that a bear market in bonds is quite different from a bear market in stocks. Unlike stocks, where the common definition of a bear market is a 20% decline in prices, to most investors a bear market in bonds is simply a period of negative returns. The past 49 years of return data shows that these periods are few and far between with only 5 calendar years of negative performance.

The chart below shows that increases in interest rates at the short end of the yield curve have not necessarily hurt most bond portfolios. Since 1970 there have been 22 years (including 2018 year-to-date; where bonds still managed to achieve a gain) when short-term or 91 day T-Bill yields have increased over the previous year. The chart shows the calendar year performance for the FTSE Universe Bond Index, the broadest and most widely used measure of government and corporate bonds in Canada, for the years when short-term rates increased. The first point of note is that there are only 2 years with negative results; 1974 and 1979, and the -4.5% return in 1974 was the worst annual bond performance of the last 40 years. The average annual performance over the 22 years was 7.0% which is only slightly less than the 8.7% average annual return over the last 5 decades.

Even when rates are rising across the maturity spectrum, it is unusual to suffer large losses in bonds. When both short-term and longer-term rates increase together it is more likely that bonds will see low or slightly negative performance.  As the data to the left illustrates, periods in which short-term rates increased between 1 and 3%  had a positive impact on bond results. Even during periods when short rates were rising at a rate of greater than 3% (which only occurred 3 times), bond investors still managed to realize positive returns on average.

Since the Bank of Canada’s priority is to keep inflation low, the likelihood of the Bank triggering a surge in interest rates is not very high. Most diversified, long term investors should not view weakness in the bond market with the same apprehension as an equity bear market. In general, investors should look to bonds for stable income and to protect against disaster, something which they did well during the financial crisis. Bonds are an asset class capable of storing value, providing liquidity and most importantly, providing positive returns in most economic environments.

Interest rates hikes don’t automatically spell disaster for bonds. Most investors own bonds in order to preserve capital and mitigate the volatility inherent in stocks or other risky assets. In a world where equities are becoming more expensive, maintaining exposure to bonds is a wise move. Ultimately, most bond investors are likely to be best served by sustaining their strategic allocation to fixed income. While short-term bond returns may not be overly impressive at the moment investors will be more than satisfied during the next equity bear market. Disaster? Unlikely.

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Reversing the Performance Difference

The performance difference between Canadian and U.S. stocks has been very pronounced over the past few years, but that could be about to change. Of course, the U.S. is a growth stock market and Canada is deep value, which as most investors know do very well during the late stages of an economic cycle. Since, Canada is relatively commodity price sensitive, which means the Canadian market is a much more effective hedge against inflationary pressures, which leads to Canada almost always outperforms the U.S. late in the investment cycle. Throw in the discrepancy in stock market valuations and equity risk premiums the case for choosing Canadian stocks is become quite compelling.

In fact, Canadian stocks frequently rise as the U.S. market declines or heads into recession as happened from August 2007 to August 2008 when the S&P/TSX index rose 3.5% while the S&P 500 sagged -10.7% (all figures in Canadian dollar terms). The reason for this can be summed up in one word: oil. Oil prices surged 56% which allowed the Canadian energy sector to advance 16%. The same thing happened in 2005, when the S&P 500 was only up 1.6% for the year, while the S&P/TSX rose more than 24.1%. Again, because of oil prices surged 37.7% and the Canadian energy space jumped 45%.

These are not isolated instances, but in fact highly correlated recurring events. Oil prices increase and Canadian stock markets out performance U.S. stocks; oil prices decline and Canadian stock markets lag behind U.S. stocks. This is not the case in most other stock markets, but none of them have currently have over 20% of there stock weighting in the energy sector and 30% in 2008 when oil prices reached its peak, like Canada does. For most of the rest of the worlds major stock markets the Energy sectors peaked out at 12% weighting versus a relatively meager 6% today.

The relationship between stocks markets and oil is volatile, with the correlation between the returns for stocks and oil prices swinging between positive and negative values depending upon the time period used. However, the correlation is very positive for Canadian stocks versus U.S. stocks over longer time periods.

The chart the right and the data to the left, clearly show that on an annual basis, when oil prices increase the Canadian stock market does better that the U.S. market, in fact this outperforming correlation occurs 83% of the time. Over the past 18 years this relationship has only broken down 3 times: 2011, 2013 and last year, 2017. And other than, 2011 Canadian stocks gained on average 11.0% during the other two years, which are better than long term stock market performance. The problem has not been Canada, it has been the U.S. stock market producing abnormally large returns during 2013 and 2017, 27.9% on average.

When it comes to the relationship between oil and stock pricing, normally a moderate correlation does exist. However, when it comes to different markets and their underlying core components the price change in oil can have a highly cyclical and major impact on results. It is crucial to keep this relationship in perspective during this period of late cycle U.S. market conditions since traditionally the best place to hide is the Canadian energy sector and Canadian stocks in general.

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Uniquely Canadian

Around the world, particularly since the bottom of the stock market crash of 2008 (which occurred in February 2009), growth stocks have lead the recovery – but not in Canada. Global value stocks have traditionally produced greater gains during good quarters and bigger declines through bad quarters but Canada is different in this regard than the rest of the world. In this we are uniquely Canadian.

Growth indices include stocks with higher price-to-book ratios and faster than expected earnings growth rates. The value index includes stocks with lower price-to-book ratios and slower earnings growth rates. A quick glance at the three main sectors for Canada versus the U.S. and EAFE markets show exactly why our market marches to a different beat:

Canada – Financial Services (36.5%), Energy (19.4%) and Materials (11.7%)
U.S. – Information Technology (24.7%) Financial Services (17.4%) and Health Care (13.8%)
EAFE – Financial Services (23.6%), Industrials (14.6%) and Consumer Discretionary (12.6%)
Not only does Canada have one of the most concentrated stock markets in the world, it is also highly value stock orientated. Unfortunately for the past 10 years that has been a very bad combination.

By looking at the cumulative total return chart to the right (all values in U.S. dollar terms) investors might conclude that for the past 20 years Canadian value stocks (especially) and growth stocks would have been the place to be. And they would be absolutely correct except this timeframe can be divided into two distinct periods; before the 2008 market crash and after. As the data to the left shows, over the last 20 years we were world-beaters; after February 2009 (the market bottom of the crash) not so much. The U.S. stock market has absolutely dominated the rest of the world and growth stocks (everywhere but Canada) have ruled the roost.

Growth has normally been the better strategy in this bull market which could be coming to an end in the not too distant future. Bull markets have been greatly supported by the stimulative policies of the world’s central banks, which increased the money supply and kept interest rates at historically low levels for nearly a decade.

Value stocks do their job for the most part (everywhere but Canada) as a defensive play during the last cycle of rising interest rates. This time around, inflationary pressure, brought about by rising rates as demand for workers increases could force the central banks to be more aggressive. In Canada, we simply do not have many growth stocks so value stocks lead the way over most market cycles and distort the Canadian stock market relative to most other countries.

Despite the runaway success of growth stocks globally over recent years the reality of rising interest rates could mean a comeback for value stocks beginning this year as investors flock to defensive investments. During the last period of sustained interest rate increases Canadian value stocks have reeled off 10 straight quarters of outperformance. And for a country like Canada where value stocks are king and historically outperform the rest of the world, we might just be able to break the back of the sustained period of weak relative performance and once again become the world-beaters we used to be. In that way being uniquely Canadian may work in our favour once again.

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

The Downside of Market Timing – Missing Out!

Trying to avoid a bear market can come at a very steep price: missing out on further gains if you get it wrong. Market timing can be a costly mistake since correctly timing the market is virtually impossible. The potential mistakes are just as severe whether you are trying to time the market to sell high or buy low. Because of this, investors who are troubled by the current state of the stock market may want to take a long term view and hold tight.

A bear market is typically defined as a 20% drop from a market peak, or twice as severe as the threshold for a correction which is just a 10% decline. The last year of a rally is sometimes referred to as a “melt-up” or a move higher that is driven by investors being fearful of missing out on past gains. The final years of a bull market are usually the best years of the economic cycle and staging an early exit from stocks to avoid a coming downturn can be a damaging long term mistake. In particular, equities tend to see steep gains in the 12 months before the start of a bear market. Double digit gains have historically been seen in the year leading up to a bear market, as the gains in the last year of a bull market make for a much more pronounced rally than is seen earlier in the cycle. There have been nine significant market corrections since 1970 (using the Canadian stock market as the reference, see the dates of the market peak on the left). The chart to the right shows the asset class returns late in a bull market for various periods prior to the various security types reaching their apex.

The penultimate year of a bull market has seen a 31.3% gain for Canadian stocks on average, which on its own would more than compensate for the pending market correction. More importantly this level of return confirms the fact that typically Canadian stocks are very much late cycle stocks and their performance dwarfs what is achieved elsewhere. For example, U.S. stocks “only” averaged 16.1% in the year before the stock market correction occurred, while bonds eked out 7.3% over the same time span. Comparatively, in the year before that and the two years before the peaks (meaning the period that is between 24 and 36 months before the start of the bear market), U.S. stocks were clearly the better overall investment. This sounds very familiar to what has been occurring over the much of this economic cycle. Should this 40-plus year pattern continue and if the current market uptrend is winding itself closer to a market correction or a bear market, it is possible that Canadian stocks could make up much of their relative underperformance versus U.S. stocks over the past few years.

Certainly, the concerns that stock markets could be looking at weak future results, if not necessarily a bear market, have been growing. However, stocks are not seen as overly expensive right now and the first quarter earnings season has been strong, although the market’s reaction to them suggests investors have not been impressed. The final stages of a bull market can be lucrative for investors and an early exit can be detrimental to an investor’s long term results. Current economic data supports the case for continued economic recovery and further stock market gains. Despite what could happen in the coming years, the best course for most investors is to stay put, getting the benefit of compound growth and not making short term trading decisions.

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market data imageThis report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Closing The Gap

Dividend paying stocks have been very popular with investors in recent years due to weak returns in the bond market. That picture appears to be shifting in Canada for the first time in almost a decade. As the Bank of Canada has slowly tightened monetary policy, bond yields have naturally risen, yet still remain well below the levels seen before the financial crisis. As bond yields rise, investors may cut their exposure to equities. Historically bull markets tend to end once interest rates have risen too much, too fast. The current long-lasting uptrend is beginning to show signs of entering the euphoria stage. If dividend yields drop below bond yields it could be another indication that the high-flying stock market is headed for a correction.

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The ‘Yield Gap’ is the difference between the S&P / TSX Stock Index dividend yield and the 10 year Government of Canada bond yield. The yield differential between stocks and bonds has historically been one of the more attractive signals for many investors. It has signaled when equities were good value relative to bonds. However in the last few months that spread is becoming less favorable to equities and is giving many investors pause for thought. Higher bond yields could make stocks look more expensive. Additionally, higher borrowing costs could have an impact on corporate earnings as it becomes more expensive for companies to finance projects. Lower profits could result which would boost the price-to-earnings ratio and raise equity valuation concerns.

Before the 2008 financial crisis the yield on 10 year bonds was markedly higher than equities, before abruptly changing course during the depths of the crisis. In fact, for most of history, dividend yields have stayed below 10 year bond yields. During the 2008 financial crisis bond yields started oscillating around dividend yields for several years but have spent significant time below dividend yields since June 2011, as economic growth recovered and inflation concerns faded. As the chart above and data to the left illustrates, the dividend yield of the S&P / TSX has remained steady at around the 3% mark throughout the post-2008 crisis recovery period as companies have grown their dividends to keep up with increasing share prices.

For the past decade, investors have flocked to the stock market for higher yields as government bond yields have hovered at historic lows. The increase in asset prices can be partly attributed to low yielding debt instruments. Still dividend paying stocks tend to be a poor defense when rates are rising and stocks could be facing yield competition from bonds for the first time since the financial crisis. If and when the S&P / TSX yield falls below bonds it will not necessarily be bad news as most equity investors generally buy stocks for capital appreciation and not for steady income.

At this juncture, the case for stocks still appears to be favourable compared to owning bonds so yield seekers currently invested in stocks do not necessarily need to jump ship yet. As with all market measures, the consequences of the narrowing yield gap are hard to predict. While some risk averse investors might switch to bonds, for most investors dividend yield is simply one factor contributing to the total performance of owning stocks.

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Great Expectations?

Asset allocation is one of the most important decisions investors will likely make. There are a number of risk factors related to the type of investments used as well as their mix which makes determining the appropriate capital market assumptions necessary. There are many firms which provide investment assumptions to investors with each making their own risk and return calculations so that clients can evaluate their investment decisions. Of course, these assumptions are not permanent and need to be changed over time.

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Empirical evidence has not been favourable to market forecasters. Studies have shown that the vast majority of financial gurus do not do better in their predictions than simply flipping a coin. So, on the face of it, being able to accurately forecast markets 10 years out is extremely difficult. In a world of seemingly random events, all of which could affect assumptions, it is hard to figure out where to turn. Fortunately, in Canada, there is one semi-independent organization that touches upon almost every adult’s life to varying degrees; the Canada Pension Plan (CPP). The CPP operates throughout Canada (except in Quebec, where the Québec Pension Plan serves the same function) to provide pension benefits to Canadians. It is the responsibility of the Chief Actuary of CPP to form the capital markets assumptions used in the modeling that serves as foundation for their strategic asset allocation. So, it makes sense that their primary projections should be the bedrock of the return on investments for most investors. Fortunately, these are updated periodically and publicly available.

The data to the left illustrates the most current forecasted long term nominal returns for capital markets in Canadian dollar terms (i.e. returns before the impact of inflation). The chart to the right shows the historical evolution of those previous projections from the past 8 years. Clearly, the prospects for cash and/or other short term investments has been deteriorating over the years; as has the expectation for bonds since the significant tightening of credit spreads have lowered yields, thereby reducing the potential for future returns. These conditions could be made worse if the yield curve inverts as is broadly expected. Still not all bonds are created equal with government bonds expected to return just 3.0%, corporates 3.5% and high yield instruments 5.25%.

Similarly, assumptions for equities in general have trended lower; falling behind what history would suggest. Interestingly, Canadian stocks are no longer considered the shining light for forecasted performance. Increases in expected earnings growth and corporate profit margins outside of Canada has seen the expected returns for both major foreign and emerging market stocks jump, such that investors should be relatively indifferent as to which markets to invest for the best results. Although, the returns investors do actually receive will be ultimately determined by the crucial impact of dividends and buybacks going forward. Of course, most investors are not looking to just match the market but exceed it. Unfortunately, that then becomes a question of determining those that have the necessary skills to add value. However, that is a question for another day.

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Stock Sectors After Rate Hikes

Last year the Bank of Canada (BOC) implemented its first interest rate hike since 2010 and many investors reached for their crystal balls to try and forecast the future. While rising rates tend to signal stronger economic conditions and inflationary pressures, they can also have a meaningful impact on stock market sector returns. Changing the overnight interest rate, which is the cost that depository institutions pay to borrow money, is how the BOC attempts to control inflation. When the BOC increases the overnight rate, it does not directly affect the stock market but it does have a ripple effect that can rock the market. However some sectors benefit from interest rate hikes and others do not.

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A review of equity performance following previous BOC tightening cycles over the past 20 years shows that in five of the past six periods of hiking overnight interest rates; October 1997, November 1999, May 2002, October 2004 and June 2010 (July 2017 excluded), there was some deviation from normal results which provided excellent opportunities but there are grounds for concern. The conventional way of thinking is that cyclical sectors like Industrials, Materials, Energy, Information Technology and Financials do well in a rising interest rate environment. A healthy economy has more investment activity, increased profit margins for financial entities, improved employment and a healthy housing market; all of which allow consumers to splurge. Meanwhile, defensive sectors like Utilities, Telecom, Consumer Staples and Healthcare (which tend to be proxies for bonds and do poorly as interest rates climb) generally show weaker results when the world’s central banks take away the cookie jar.

At times Canada dances to a different beat and over the past 20 years our stocks have for the most part have done the opposite of what economic theory would forecast. Perhaps it is a weak Canadian dollar, the near term glut in crude oil or weak commodity prices, but whatever the cause, the unexpected has occurred. The chart on the right shows the net difference between the average annual calendar returns for the 10 Canadian stock sectors since 1998 relative to the average 12 month return for the same sectors after the BOC implemented its first rate hike. The data to the left shows the individual averages for both occurrences.

These performance numbers do not include the impact of dividends. These five sectors: Energy; Consumer Staples; Financials; Telecom and Utilities, have outperformed their long term averages after interest rates started rising, leaving the other five; Materials, Consumer Discretionary, Health Care, Industrials and Information Technology lagging. The degree of variance in some cases is quite glaring and the reverse of what was expectedValue stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

 

While a rising interest rate environment may not be detrimental to equity market returns in general, historically there have been clear winners and losers. Canadian investors who invest in our very unique stock market have been doing things differently for quite some time as conventional wisdom (at least with regard to domestic rate hikes) is thrown out the window. Perhaps rather than focusing on our own situation, many Canadians may be overly fixated on what is happening elsewhere; say to the south of us perhaps

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Shifting Importance

Eventually this bull market will break its long winning streak but that does not mean you should be abandoning everything and running for the hills. What it does mean is that you should consider shifting your portfolio’s emphasis. Not all stocks react equally during good and bad times so the secret is to rearrange the deck chairs to ensure smoother sailing.

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History never repeats itself exactly but similarities do exist, particularly in the timing of economic events or cycles. These recurring ups and downs in economic activity (or market/business cycles) are made up of several years of peaks, recessions, troughs and eventually a recovery phase. The peak is when business activity has reached its maximum level followed by a slowdown or recession during which business activity reaches its lowest level. The final phase or recovery is when the economy again expands towards maximum output. The movements of the markets are closely linked to the business cycle. Stocks, bonds and commodity prices are heavily influenced by investors’ expectations of the future. Each financial market tends to peak and bottom at different points in the business cycle. An expanding economy is generally favourable for the stock market; a weak economy for bond prices; and an inflationary economy for commodities. The overall stock market tends to lead the general economy with stocks going up before the economy peaks and falling before a recession begins. However, the stock market is made up of companies from many sectors which rotate in and out of favour during the phases of the business cycle. The image below shows a typical market cycle and indicates which sectors tend to outperform the broader market at particular times.

Economic recoveries are often led by consumer spending so the retail sector is considered a leader of the broader stock market. It is usually one of the earliest sectors to peak and also to bottom. The same holds for the banking, housing and construction industries which are heavily influenced by interest rates. As interest rates are cut, demand in these sectors grows, as does their stock price.

The table to the left shows the performance of each sector during and after the tech bubble burst in 2000 and the financial meltdown in 2008. The first column has sector performance during these bear phases and the second is the initial recovery phase. The inverse relationship in this case is striking. Those sectors which performed the worst in the falling market tend to increase the most when the market rebounds. Conversely those that had done well during a falling market returned a relatively flat performance when the market recovered. There is a pattern to these rotations which investors can exploit. The industrial and manufacturing sectors usually follow the movement of retail and construction. As inventories become depleted, demand for more manufacturing and industrial output increases. Because the economic environment and news is often bad at this point, investors tend to be cautious and initially invest in companies with good earnings and cash reserves. As the bull market grows, investors tend to place money into relatively speculative stocks such as technology companies. In the later stages of expansion, when interest rates are rising, the capital goods, basic materials, and energy industries tend to thrive as they expand capacity and bid for increasingly scarce resources.

Value stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

The two sides of January

Most investors have heard of the January Effect which is the observation that January has historically been one of the best months to be invested in stocks. However there is another January Effect which states that, “as goes January, so goes the year”. While January has produced positive performance 66% of the time between 1968 and 2017 for the S&P/TSX Stock Index, it has also produced negative performance one-third of the time.

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What is striking is that in years when January had a positive return, those returns were well above average relative to the returns in other months of the positive January years. For example, of the 33 Januarys with positive performance, the S&P/TSX was up an average of 4.3%. The next best performing month in those years, as can be seen in the table to the left, was December which returned half that amount at 2.1%. Conversely, when January had negative returns, -3.5% on average; the remainder of the months of the down January years produced better returns. Although in total only 7 months had positive returns, they were more than enough to lift the overall years performance into positive territory but still well behind the 50 year average market performance and still further behind the years where stocks came roaring out of the gate in January.The chart below depicts the average annual cumulative returns for months that had positive Januarys and negative Januarys net of the S&P/TSX average annual return for the period. While the relative performance between good and bad months of January time periods did narrow over the course of the year, it clearly shows that the opening month of the year often sets the pace and influences the remaining months of the year. We then looked at how these markets performed for the full year. In those years where January was positive the S&P/TSX (including dividends) returned 12.6% versus an average of 10.7% for all 50 years reviewed; a 17.8% improvement. On the other hand, negative Januarys underperformed the market as a whole by -39.3%. These numbers confirm that “as goes January, so goes the year”, translating into above or below average annual performance in those years.

The most widely accepted explanation for the January Effect is tax-loss selling. The tax circumstances of taxable investors are often more important than a security’s fundamental valuation, as such investors will sell whatever securities are required at the end of the calendar year to establish capital losses for income tax purposes and then repurchase the shares after a prescribed waiting period. As the waiting period most often expires early in the next year, the repurchase orders flood the market in January, hence creating abnormal returns in the month. In addition to tax issues, researchers have also suggested other reasons for the January effect. One is “window-dressing”, as portfolio managers unload their embarrassing stocks at year-end so that they don’t appear on their annual report, and then redeploy the proceeds in January. Another reason, which we may see more of in 2018, is short sellers covering their successful short positions early in the next year so they usually do not have to pay taxes on the gains until April of the following year.

Whatever the explanation, predicting the future is impossible (even if it is only one month’s prospects), but it is good to know the end result is just a question of how large the annual gain will be on average. Because it is clear that investors should not be out of the market if January is a good or bad month because the returns over the rest of the year are just a question of magnitude. Of course one must always bear in mind that past performance does not mean this trend will continue. It will be interesting to see how it plays out in 2018.

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

VANISHED – CANADIAN STOCK VOLATILITY

Investors had taken most of the summer off as the S&P/TSX stock index drifted aimlessly, trading between 15,500 in May and 15,000 at the end of August, but since then it has undergone a steep 7.5% increase. Of course for those investors who closely follow the market, it seemed to be moving in all kinds of directions, falling for a week, rallying for two and jumping about like a chicken on a hot tin roof the rest of the time.

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If investors were to glance at volatility measures however, they would come away yawning. The socalled “fear gauge” has been nothing but a sea of tranquility. The best level of fear gauge for the Canadian stock market is the Montreal Exchange’s Implied Volatility Index VIXc (or MVX prior to October 2010) which measures the implied volatility of the iShares CDN S&P/TSX 60 Fund (XIU). VIXc is a good proxy of investor sentiment for the Canadian equity market: the higher the Index, the higher the risk of market turmoil. A rising Index therefore reflects the heightened fears of investors for the coming month. A high VIXc is not necessarily bearish for stocks, as it measures the fear of volatility both to the upside as well as the downside. The highest VIXc readings will occur when investors anticipate large moves in either direction. Only when investors anticipate neither significant downside risk nor significant upside, will the VIXc be low.

The chart below shows the VIXc values as well as the S&P/TSX Stock Index. Currently the VIXc is trading around 8.2 which is very low and confirms that the market is not anticipating any dramatic swing in volatility for the foreseeable future. Low levels of implied volatility are often good periods to enter the market as the risks are relatively low. Equity markets tend to disconnect from their underlying values in periods of high volatility as investors scramble quickly to trade those shares that are coming in or going out of favour. On the other hand, a peak in volatility in down markets can be a useful indicator as it closely precedes a market bottom. Think of 2008 when the VIXc spiked to 88 nine days before the market bottomed, in 2011 the VIXc spiked to 37 the day before the market bottomed and in 2015 the VIXc spiked to the 33 which was the day the market bottomed. Following the years the Canadian stock market experienced significant declines, the VIXc shone the light on the pending major stock market recovery.
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Another factor to consider when assessing the timing of a move to equities is the current cash on hand. Not only are retail investors switching from cash and bonds into equities, but hedge funds and institutional managers have been moving this way for some time. Back in 2009 hedge funds and experienced investment managers were well ahead of the retail crowd in buying up equities early in the rally, as they covered short positions and began accumulating long positions. The amount of cash on the sidelines currently has the potential to drive forward a long term equity rally. While it is difficult to say when a rally will begin, savvy investors may want to use this period of low volatility to add to equity levels.

Market Data

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only