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Aug 01, 2014 | Dian Chaaban


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Is this the market dip (aka sale) we’ve been waiting for? Even if it is, markets like today can make even the most confident investor feel uncomfortable. Money is emotional and as rationale human beings, it’s normal to feel a sense of loss when the screen is painted red. Then again, if you have time on your side, you may have felt more like that woman from the Ikea commercial...
So, why is this happening?
 
Concerns about Europe’s banking system, fallout from the Russia/Ukraine conflict, uncertainty about the Fed’s rate-hike timeline and Argentina’s missed debt payment have created simultaneous splashes, encouraging the summer equity pullback many of us have been anticipating for so long. The TSX was down 1.6% during the week, the S&P 500 dropped 2.7% for the week and closed 3.2% off its recent high. The small-cap Russell 2000 closed down 7.8% from its March peak. In better news, China and Hong Kong rose 2.8% and 1.3%, respectively, on continued improvement in economic data and sentiment.
 
Regardless of if this is dip or not, it’s the confidence in resources like my brainy Portfolio Advisory Group and analysts alike that help disciplined investors like yours truly to focus on the bigger picture - rather than the day to day market hiccups. That said, there have got to be some things that we’re worried about – and here are 3 of them:
1) Credit risk
2) Interest rate risk across asset classes; and
3) The importance of geography and sector allocation.
 
[Big chunkers, stop reading here. Small chunkers, please read further >>> to find out what the heck that means, read the chunkers edition of WOTS below]
 
1) Credit Risk – Last year marked a record year in new-issue volume in high-yield and institutional loan issuance. In conjunction with this surge in supply, credit spreads have also narrowed below historical averages and corporate bond yields sit near all time lows. This type of environment offers investors very little compensation for the risks inherent in the corporate bond market, such as default risk and liquidity risk.
 
Read more here: Proceed with Caution - provides further context on the ballooning risk appetite in the new issue market (page 12) and Rethinking Exposure to High Yield Bonds - highlights the importance of credit risk
 
2) Interest Rate Risk Across Asset Classes - Typically, when we think of interest rate risk, we’re concerned about the impact of rising rates on fixed income portfolios. Interestingly, based on how investment portfolios are positioned today, the risk posed from rising rates may be more significant for your equity portfolios as opposed to your fixed income portfolios.
High dividend paying stocks have served investors well for the past five years in this low interest rate environment. They have not only paid attractive dividends, but also generated significant capital appreciation. However, with a potentially different backdrop going forward and still elevated valuations, investors may have to properly adjust their total return expectations.
When it comes to your fixed income portfolios, we’ve been pretty good at reducing duration where possible so the risk exists if rates do not increase or do so at a substantially slower pace than we need.
 
3) Geography & Sector Diversification - The Canadian market is naturally heavily skewed to Financials, Energy and Materials. Sure, a home bias will always exist, but there are some benefits to owning high quality businesses in different geographies and sectors that are not well represented in our country. As Canadians, we can enhance our exposure to sectors such as Health Care, Technology, Consumer Discretionary, and Consumer Staples.
 
Even with a week like this one, I believe that the global outlook remains attractive. Thanks to positive developments in China, headwinds have diminished slightly for the global equity market - giving us more confidence to let winning positions run and helping advisors like this one sleep a little better at night.
 
Read further by clicking here for this week’s Global Insight Weekly where we take a closer look at what prompted the equity pullback, patience with the high yield bond correction the global roundup.
Enjoy the long weekend (I plan on testing out my new golf tips from last week).