In my last publication in June, I shared my thoughts on the bear market this year as well as previous bear markets and some best practices on how to deal with them. We had some great feedback on it so here is the link in case you missed it:

 

Petrov Wealth Management Group - The Big Bear Attack! June 2022 (rbcwealthmanagement.com)

 

Before I jump in, allow me to share a few updates on the Petrov Wealth Management Group.

 

Client Appreciation Event was a Success!

 

We had an unforgettable client appreciation event on September 29 on the 41^st floor of Place Ville Marie and I want to sincerely thank everyone who attended. When I started my practice and I was building it from the ground up, I had a vision that kept me going when I had doubts about whether I would survive in this business. The vision was that I would be in that room and surrounded by people I admire and respect, who entrust me with their hard-earned wealth, a team of amazing professionals that trust me with their careers and my family and loved ones who support me through the journey. Again, THANK YOU.

 

Alexander Petrov obtains Portfolio Manager Title & Transition to Private Investment Management (PIM)

 

After meeting strict qualification requirements for education, experience and assets under management, I am pleased to announce that I have obtained the accreditation of Portfolio Manager. Fewer than one quarter of all advisors at RBC Dominion Securities, and an even smaller proportion across the industry obtain this designation. What does this mean for clients?

• As a PM, I can now manage client portfolios on a discretionary basis within the parameters of an agreed-upon Investment Policy Statement (IPS). In other words, I can make investment decisions within parameters on clients’ behalf without the need for approval for each trade. This allows us to make tactical moves quickly and efficiently.

 

• All aspects of portfolio management can be done without the need for delegation to external portfolio managers, from asset allocation all the way down to individual security selection.

 

• I am held to the highest standard of care called the “Fiduciary duty”. As a fiduciary to my clients, I have the obligation to act solely in the client’s best interest – ahead of mine and that of the firm’s.

 

• Stringent regulatory oversight. Given the high degree of responsibility that comes with acting as PM, there is an extra layer of oversight from the regulators and the firm to make sure we stay in line within strict quality guidelines.

 

The Petrov Wealth Management Group moved to Downtown Montreal

 

We have moved to RBC Dominion Securities' Uptown office, located at 1501 McGill College Ave, Suite 2150, Montreal Quebec, H3A 3M8. This has been in the works for a number of years and we are excited to announce that it is finally done. This central location gives us proximity to more clients around different parts of the city and beyond and more visibility with our external strategic partners.

 

We hired a new Associate

 

As the practice continues to grow and as we transition to the discretionary “Private Investment Management” platform, it is of utmost importance to keep delivering an unparalleled level of service to clients. As such, Emilio Vincelli has joined the Petrov Wealth Management team, where his focus will be operations, administration, client servicing and trade execution. Please visit the “Team” section of our website at www.petrovwealth to learn more about Emilio.

 

Market Snapshot YTD

• S&P 500 (-24.71%)

• Dow Jones (-19.55%)

• Nasdaq (-33.48%)

• S&P/TSX (-14.12%)

• Euro Stoxx 50 (-22.29%)

• VEA (-28.96%)

• XBB (-15.45%)

(Data retrieved from FactSet on Tuesday October 11th 2022 at 3:45pm)

 

Theme remains unchanged – Logical Sequence playing out as it should

 

Back in March 2021 (before it was headline news), I had written about the fact that inflation would be inevitable in the near-term given ultra-low interest rates, aggressive money-printing and excess demand relative to supply at the time. When inflation numbers were creeping up, the media’s messaging was that this inflation was “transitory”. It appeared evident to me that many of the contributing factors to inflation were in fact more persistent that the media was suggesting. Now that this persistence has materialized, Central Banks and the Federal Reserve are raising interest rates in an effort to bring down inflation to a more sustainable level. As I have mentioned previously, raising interest rates can reduce inflation but it naturally results in reduced demand and it does nothing to increase productivity and supply. As such, raising rates naturally results in some economic weakness which is why I have mentioned that we could very well be in a recession already. This is a logical sequence in the economic cycle. The cycle is progressing as it always had… Expansion (lower rates, higher economic activity), contraction (higher interest rates, lower economic activity), expansion, contraction, and so on.

 

Since the start of the 2022, markets have been laser-focused on inflation, interest rates and the tone of the Fed. The S&P 500 officially entered bear market territory in June. In July, the US posted 0% month-over-month inflation figures from June to July, which was the first time we saw a hint of a levelling off. As a result, markets immediately reacted positively and we saw a quick 7% recovery in July alone in the S&P 500. Soon after, the Fed made their intentions clear to continue to tighten monetary policy further and the markets swiftly shifted back into bear territory. In addition to these variables, the situation in Ukraine has been escalating, which is affecting markets.

 

All sectors are in the red except for the Energy sector, which is up a staggering 50% in both the S&P/TSX (Canada) and the S&P 500 (US). The jump in energy prices can be explained in part by the situation in Ukraine and the sanctions on Russia. Energy is Canada’s second largest sector, weighing just under 18% of the S&P/TSX Composite Index. In addition, Canada is also significantly underweight in Technology and Healthcare relative to the US and these are the main reasons why Canada has held up better in this bear market in the short-term. Having said that, Canada represents only about 4% of global market cap while the US represents 50% of global market cap and the US enjoys a more broadly diversified economy. I view this as an excellent opportunity for investors who have been overweight in Canada to consider trimming some of their Canadian equity exposure and make purchases on the US side at a relative discount.

 

Essentially , the theme remains unchanged and markets are reacting to the same variables as they were earlier in the year. July was a tell-tale sign that markets are currently tightly correlated to the inflation data in the short-term. I would estimate that we could see reduced volatility and markets may return on their constantly rising trend line once inflation figures return to a more sustainable level.

 

Inflation scenarios (*This specific section is written by RBC GAM’s Chief Economist Eric Lascelles)

 

The most likely scenario is that inflation diminishes over the coming six months, approaching – if not quite fully reaching – a historically normal monthly rate of change. But this forecast, as reasonable as it is, is not the only conceivable scenario (see next graphic).

 

U.S. inflation scenarios suggest return to normal

We assign a 55% chance to this base-case scenario, alongside a 20% chance that inflation remains too high. Technically, this is split into a 10% chance that inflation remains at current levels and a 10% chance that it ascends further. There is also a 25% chance that inflation falls below normal.

 

The existence of a low inflation scenario might be surprising – particularly the notion that it is more likely than the scenario in which inflation remains too high. But with the commodity shock and supply chain problems unwinding, there could be not just a retreat in price pressures but an outright reversal as the underlying cost of shipping products and procuring goods reverses some of their earlier advance. Recessions usually bring powerful disinflationary forces as well.

 

A key goal in this scenario-building exercise is to explicitly acknowledge the low inflation scenario, as it is underappreciated.

 

As depicted in the graphic above, we also contemplate the medium-term inflation outlook. This should be interpreted as representing inflation in one to two years’ time. We believe there is an 80% chance that inflation eventually settles at a broadly normal level (though allowing for the definition of normal to include inflation up to about 3%). That leaves a 10% chance that inflation remains enduringly too high, and a 10% chance that inflation remains enduringly too low. The former scenario represents the failure of central banks or the arrival of additional inflationary shocks. The latter scenario would reflect a deeper recession and/or a stronger tendency for distorted prices to retreat back to their prior levels.

 

Supply chain inflation

 

Inflation deriving from supply chains should reverse as supply chains themselves heal. Examples of important improvements include plummeting container shipping costs (see next chart), a return to nearly normal dry bulk shipping costs (see subsequent chart) and a sharp decline in the anxiety of manufacturing purchasing managers about both inflation and their supply chains.

 

Behavioral Finance basics (Back to Petrov’s commentary as of here)

 

Since 1928, there have been a total of 28 bear markets (S&P 500). The average decline was -35.62% and the average length of time was 289 days. There is an average of 3.6 years between bear markets (Source: Seeking alpha). Ultimately, investor behavior is the determining factor between investing success and failure – not bear markets.

 

Below is a chart that depicts the emotional cycle of the investor. While the ups and downs of equity markets are largely unpredictable, their effects on investor behavior can be observed. Many of us experience a rollercoaster of emotions when investing, which can translate into poor buy-and-sell decisions. (Source: Darst, David M. (Morgan Stanley and Companies Inc.). The Art of Asset allocation, 2003.).

 

This phenomenon is not just a hypothesis – we can quantify this tangibly. Below is a chart showing the S&P/TSX since 2000 and equity mutual fund net sales in the bar charts.

As you can see, investors redeem their equity funds right near market bottoms at lower prices. Investors then typically buy equity funds late into the recovery when it feels more comfortable and when prices are higher. Being a good investor is difficult because it requires you to have tremendous emotional fortitude when the sentiment is pessimistic. In other words, successful investing requires you to constantly fight the urges that make up human nature which feels counter-intuitive. Always remember that when the outlook is grim, prices are lower and when the outlook is optimistic, prices are higher.

 

*Note that the Petrov Wealth Management and RBC Dominion Securities do not represent RBC Global Asset Management or any mutual fund company. RBC GAM was used simply for the purpose of illustration.*

 

Distinguish between the Economy and the Markets

 

What is most often misunderstood by individual investors is that markets move in anticipation of the future and that most variables are usually already factored into the price today (especially in the large-cap space). Most often, retail investors will "blend" macroeconomics and the stock market as one topic in their thought process. It can sound like this:

"Given persistently high inflation, aggressively rising rates, supply and labor shortages and a war in Ukraine, recession risk is rising THEREFORE markets will go down."

All of the macro variables are true but it is key to ask the follow up question: "To what degree have the markets factored these variables into the price today?".

It is useful to clearly distinguish the two and follow this sequence of questioning:

1. What are the variables at play now?
2. To what degree have the markets already priced that in?

 

Once you fully grasp this notion you tend to understand that any conversation about market timing is not worth seriously contemplating. It can make for a fun conversation over dinner though!

 

Bear Market Checklist

 

As an investor, this would be my checklist to know if I am well prepared for a bear market.

• Is my portfolio adequately diversified by asset class, by geography, by sector and by individual company?

• Do I only own fundamentally sound businesses and is there a valuation process for selecting them?

• If I own funds, is there a clear process for selecting them and combining them?

• Is there a rebalancing mechanism in place for my portfolio?

• Do I have a formal financial plan?

• Is my financial plan being reviewed regularly and are the assumptions in my plan still relevant?

• Is there a tax harvesting process in place?

If the answer to any one of these questions is NO, I encourage you to reach out to my team by phone 514-630-1634 or by email at alexander.petrov@rbc.com.

 

I know how unpleasant volatility can be and I welcome any question or inquiry. All precautions have been taken in the investment process and rest assured my eyes are on the road and my hands are on the steering wheel.