The unfamiliar market volatility this year has many investors wondering if a day of reckoning is coming. After many years in a row of gains, isn’t a major correction inevitable, even imminent? I hear questions from clients more often than usual about whether now is a good time to invest. Meanwhile, the media (over-the-air, online or on your doorstep) features a stream of sensationalistic predictions. This is because fear drives the ratings that sell advertisements. The cold truth is that financial markets are efficient enough to make futile most efforts to pick the timing of pullbacks or rallies. My clients all have strong “since inception” rates of returns because we have remained invested in top-grade common stocks “since inception.” Wealth creation happens when we get invested well and stay invested well.
The most obvious risk today is well known, rising interest rates could put pressure on asset values by increasing the cost of capital. For example, investors who borrow money to buy stocks would experience higher interest expense as pressure to sell stocks to cover their loans. At the same time, bonds paying higher interest rates would beckon investors to buy bonds instead of stocks. But rising interest rates also put downward pressure on the market prices of bonds. And corporate bonds, in my judgment, are the most overvalued assets on the planet! So we can easily envision a “melt-up” in stock prices as money pouring out of bond market finds a home in the stock market. And then we must not forget that today’s rising interest rates are accompanied with favorable consensus economic forecasts. My corporate executive clients tell me that corporate tax cuts in the United States will have a powerful positive impact on corporate earnings. As you can see, an attentive assessment of the investment environment leads one to see all sorts of possible near-term future scenarios.
My tactical approach for adjusting your portfolios is to define a range of possible near-term scenarios for the economy and for financial markets. The next twelve to eighteen months could unfold in any number of different ways. With that range in mind, I can design a portfolio that should operate like an “all-terrain” vehicle by helping us to get through a variety of investment climates. A quality stock like Loblaw, for instance, provides both some protection against the risk of an economic downturn (people need to eat) and some protection against the risk of price inflation (grocers can pass on rising prices to customers). Investments hold special appeal when they can see us through various unforeseen investment environments. I conclude that now is as good as any time to be opportunistic for the same reasons that previous years were good times to be somewhat defensive. We don’t need to know the near-term future in order to create long-term wealth.
Mark Lloyd, Ph.D.
Vice President & Portfolio Manager