Grand Perspectives

Oct 20, 2017 | Dian Chaaban


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Last week, Mark and I were away on a little anniversary vaca – we started in California for a few days and ended off in Vegas but in-between, we drove along the scenic California Coast, through the desert and all the way to the Grand Canyon. And boy was it grand.

It was the first time seeing the Grand Canyon, for both of us, and we timed it just right so that we could be there for the sun rise – which I would highly recommend doing if it’s still on your list of things to see (or I’m sure a sunset would be just as epic).

 

After the sun rose and we were walking (ahem, busing) to the different viewpoints, I found it remarkable that with every stop your perspective and view of the Canyon changed – which in many ways is a reminder of the countless perspectives we have in life and in business. Professionally for me, it rings true with how we view the market – today, in the future and 30 years ago. As yesterday marked the auspicious 30 year anniversary of Black Monday, and because I’m sure some of you may have seen the charts on social media that are comparing the stock market in 1987 to 2017, I’ve gathered some reassuring facts for you. For those of you who really want to dig deep on the topic, this article by Advisor Analyst does a great job of debunking the theory that another crash is coming.

 

So, let’s go back in time. The year is 1987. Jon Bon Jovi’s “Livin’ on a Prayer” has topped the Billboard Hot 100 list, Lethal Weapon and Dirty Dancing are playing at a theatre near you, and Canada has officially introduced the loonie as its replacement for the $1 bill. US equity markets are up 30% by mid-October, and while oil prices have risen, sentiment remains quite positive.

 

But on October 14, things start to change

News breaks that the U.S.’s trade deficit is going to be expanding more than expected, and the next few days see 2-3% declines as we head into the weekend. On Monday, October 19, 1987, after uncertainty builds over the weekend, markets drop in what continues to be the single biggest one-day percentage decline the U.S. market has experienced – 508 points, 22.6% - the index’s biggest ever.

 

The driving forces behind “Black Monday” will forever be the source of debate, but one probable cause was the Federal Reserve Board, which had raised the discount rate from 5.5% in August 1987 to 6% in October 1987. At the same time, the yield on the 10-year Treasury note soared from 7.23% at the start of 1987 to 10.15% on Oct. 19. Market conditions were deteriorating because of rising inflation, higher oil prices (they doubled over a one-year period), a declining U.S. dollar, rapidly rising yields, and concerns about future earnings growth; and an expanding trade deficit – generally thought to be the proverbial straw that broke the camel’s back.

 

Another likely culprit was program trading, a relatively new innovation that used computer algorithms to buy or sell stocks in large blocks to lock in relatively small profit and a hedging strategy known as “portfolio insurance” that had gained popularity (too much popularity, in hindsight, as too many institutions were on the same side of the trade at the same time). Once panic began to set in, buyers stepped away, computer programs took over and responded to selling with more selling, and subsequently there was no one to step in and buy, so prices collapsed.

 

So, could it happen again?

We believe that the stock market stands on a much stronger fundamental and technical foundation today than it did in October 1987, with less euphoric sentiment, making another crash like 1987 appear unlikely. Improvements in regulations and market structure can be debated, but investors clearly have better access to information and can trade much more easily than they could 30 years ago.

 

This doesn’t mean that should earnings fail to meet analysts’ expectations, stocks wouldn’t be vulnerable to a correction (especially in the more fully valued U.S. market) – and this is a sale we have been anticipating for a while now. As Eric Lascelles, Chief Economist for RBC Global Asset Management, put it when asked if valuations are too bloated, “very few investment categories can be said to be cheap when compared to the historical norm. Bonds yields are much lower than usual and stock valuations are somewhat higher than their historical norm. Similar, credit spreads are quite narrow. Unavoidably, this points to reduced returns in the future. Going forward, equity returns will need to lock back into the underlying pace of profit growth plus the dividend yield, with the risk they might even have to give back a sliver of the valuation gains from prior years. This suggests single-digit rather than double-digit gains. Fixed income returns also look set to be more limited in the future, as capital losses from rising interest rates erode part of the coupon paid out by bonds”. Read more by requesting the latest investment outlook report here.

 

No two crashes are the same. The crash of 1929 led to the Great Depression, with the Dow ultimately falling 89%. The Japanese stock market has yet to recover from its 1989 bear market. Your best plan is to call me and remain calm, take tax losses when you can, and make sure that your portfolio is built to meet your short/mid-term liquidity needs through disciplined asset allocation so that you do not disrupt the integrity of your equities by riding out the turbulence when necessary. Remember that even abysmal events have a shelf life and the essential growth of the economy is what we rely on; people go to work every day and as long as they keeping doing that, the market will do well because at its core, it is a reflection of our hard work.

 

With so much going on and information coming at us from every angle, it's sometimes hard to keep your finger on the pulse of what's happening. In an effort to keep you in-the-know and provide you with some conversation nuggets for the weekend, I've compiled the following hit list to fill your conversation pipeline.

 

Now you are in-the-know with Word on the Street.

 

Enjoy your weekend,

 

D.

Dian Chaaban
Investment & Wealth Advisor
416.842.4234