Stock Market Recovery Continues

Previous Investment Updates have been pointing out how prices for oil and
other commodities have been falling in recent months, which should produce
lower inflation numbers next year. This should reduce the prospect that the Fed
will raise interest rates as much as has been expected. This, in turn, should be
positive for stocks.

This is exactly what has been happening lately. The headlines at the Business
Insider on August 10th was “Global Equities Rally After US Inflation Cools.” The
headline at Reuters on Wednesday was, “Wall Street Rally Lifts NASDAQ 20%
From Low As Inflation Fears Ebb.” The Globe and Mail headline was, “Stocks
Rally As Cooling Inflation Eases Rate Hike Fears, Sending NASDAQ Into New
Bull Market.” This shows that other investors are now accepting what we have
been aware of for some time now. The main reason for the lower inflation figures
this week was lower gasoline prices, which I pointed out in a recent Update.

The S&P 500 was down 24% at the low on June 17th and is now down 12%.
One half of the losses have now been recovered. (Charts from WSJ)

The NASDAQ is now up 20% from the low, meeting the parameters to qualify as
a new bull market. However, it is still down 21% from the high last November.
Nevertheless, meaningful progress is being made, as it seems that we have seen a
peak in inflation. If inflation has peaked, then interest rates may also be near a
peak. Investors were expecting interest rates to move much higher two months
ago.

 

I believe investors were overly concerned about rising inflation and interest
rates because they were looking at what had happened in the past 12 months
instead of thinking about what was likely to happen to inflation 6 to 12 months in
the future.

Stock prices for companies around the world tend to move in the same
direction, but the magnitude of the price changes can vary. The standard practice
for individual investors and professional money managers in Canada is to invest
one third of money allocated for equities (equities is just a more formal name for
stocks) into Canadian equities, one third into U.S. equities and the remaining third
into international equities. This practice came about by looking at the rate of
return for these various regions over the last 50 years or so. However, if we
examine 16 to 18-year cycles, we will see that U.S. stocks have performed much
better than stocks in other regions of the world when the U.S. economy and stock
market are in a growth phase for 16 to 18 years, as is the case now. The chart
below shows that the S&P 500 is approximately half way through this growth
cycle. (See the area shaded in green.)

What has happened in past growth cycles has been repeated in the current
growth cycle. The table below shows the returns for Canadian investors for
various assets for 1, 5 and 10 years up to June 30, 2022, when stock prices were
near the lows for this year.

The S&P 500 was down 7.2% for one year, which was less than a loss of
10.4% for MSCI World (representing global or international stocks) but more than
a loss of 3.9% for the S&P/TSX (Canadian stocks). The surge in commodity
prices helped the TSX to limit losses this year. The S&P 500 had a compound rate
of return of 11.1% for 5 years compared to 8.1% for global stocks and 7.6% for
Canadian stocks. For the last 10 years, the S&P 500 has appreciated by 15.6%
compounded annually while international stocks grew by 12.7% and the TSX by
8.2%.

U.S. mid-sized companies underperformed in the 1-year category with a loss of
14.1%, but had a 5-year return of 7.8%, beating the TSX but slightly
underperforming international stocks that gained 8.1%. U.S. mid-sized companies
outperformed international stocks and the TSX for 10 years with a total return of
13.9% compounded annually.

A mix of Canadian bonds lost 11.4% in the last 12 months and gained only
0.2% compounded annually over the last 5 years. The gain over the last 10 years
was a paltry 1.7%. The performance for U.S. Investment Grade Bonds for U.S.
investors was not much better. U.S. bond results were a little better due to a
weaker Canadian dollar.

A good way to see which asset class is the strongest is to compare which
stocks are rising the most when stocks are rising, or falling the least when stock
prices are declining. This is called relative strength analysis. This form of analysis
eliminates all emotions and just shows us where the money flow is the highest and
where investors feel they can earn the best return. One of the best companies I
have found for relative strength research is SIA Charts, based in Calgary, Alberta.
SIA Charts recently posted this table, showing that U.S. stocks have now moved
up to the top spot for relative strength for various assets. International stocks are
in the #5 spot while Canadian stocks are at the bottom with the worst relative
strength at #7.

The Russian invasion of the Ukraine caused prices of commodities to spike
higher, which helped Canadian stocks earlier in the year. History suggests that
commodity prices should be weak for another ten years or so. According to
previous cycles, the rise in the price of commodities this year was a short-term
rise in a very long-term consolidation phase. A similar spike in commodity prices
occurred in the middle of the consolidation phase for commodities in 1990 after
Iraq invaded Kuwait. Oil prices lost most of the gains within six months or so
after the invasion. I would not be surprised if the same thing happened now as the
logistics to get other oil to replace Russian oil are put into place. Crude oil prices
have declined from a peak of US$120 in March and US$166 on June 9th to US$94
now. This is only $11 higher than the price of oil was in October 2021. Diesel
prices have also declined considerably. Lower fuel costs at the pump could
continue to push inflation lower and make costs more stable for businesses. This
would also reduce the pressure for companies to raise prices for other goods.
(Chart for oil below is from Trading Economics)

 

 

In summary, stock prices have finally staged a meaningful recovery since the
lows on June 17th. Relative strength data shows that U.S. stocks are now the
strongest asset class. This is in keeping with what has happened in previous
growth cycles.

Inflation rates are likely to come down, which should reduce the need to raise
interest rates much more. It is highly unlikely that two events like a pandemic and
an invasion of a country rich in resources will happen again in the near future.
This has been like a perfect storm for inflation. The commodity markets and the
economy are adjusting to this “perfect storm” as it winds down. This reduces fear
about runaway inflation and additional interest rate hikes. The result is that
investors are becoming more comfortable with risk.

Commodity prices are likely to stay in a consolidation phase for many more
years. During the 1980’s and 1990’s, I remember reading many forecasts that
commodity prices were going to start another long-term uptrend. However, the
rallies fizzled and the new uptrends did not materialize. History suggests that is
likely going to happen again in the next ten years.

Bonds and GICs are still providing returns near historic lows. With more than
one trillion US$ in cash on the sidelines, more money is bound to make its way
into equities if inflation rates continue to come down. This should enable stock
prices to recover their losses and move to new all-time highs again in due course.
Thank you for your trust and confidence during this time of uncertainty and
market volatility!

 

SAR Update

 

When most people think of search and rescue, they think of men and women in
the outdoors searching the bush, carrying a stretcher on a trail or rescuing someone
in a dangerous situation. However, for every search or rescue task, there are SAR
Managers who are trained and experienced in creating a strategy for how to find a
missing person or bring someone to safety. They can request additional resources
such as a helicopter as well as members or specialists from other SAR teams. They
give us instructions and communicate with us. All of our radios transmit a GPS
signal, which appears on the map on the wall on the right, which is projected onto
the wall. This way they know where everyone is and if we are going in the right
direction. They are just as important as those of us who are in the field.

Information often has to be gathered from family, friends and people in the
area. The SAR Managers also update the family, friends and loved ones on what
we are doing. We respond to the police, fire departments, BC Ambulance and the

Emergency Coordination Center in Victoria. The RCMP are our superiors so we
are under their command. However, searching for and rescuing people is our
Expertise, so they basically watch over us and do all they can to assist us with
information.

We had two more searches in the last week. This is the photo I took of the
RCMP officer passing on information to the SAR Managers in our command
vehicle at 3 am Sunday morning on one of the searches. The gentleman standing
at the back wall has been a SAR Manager on our team for more than 30 years and
has won national awards for his skills and his leadership in using software and
technology to improve all that we do in SAR. The women in the red vest is an
expert in rope systems. The other woman takes care of all the finances and book
keeping for the team. She also looks after all of the equipment in the vehicles and
the base, and we have a lot of equipment. She does an amazing job!. Both of the
women in the photo have more than 20 years of experience on our team. Did I say
this was at 3 am? All of the volunteers in the command vehicle and out in the field
have amazing energy and drive to help people whenever they need it, no matter
how long it takes, no matter how bad the weather is.

If we were operating near a major city, what we were doing might have made
the news. What we do does not often get as much attention as North Shore SAR
does in Vancouver. I cannot say any more about the searches in the last week but
there may yet be some media reports about them in the future. I can share more
information if that happens. Have a great week!