MARKetS REPORT Q3 2019
The stock market is designed to transfer money from the active to the patient. - Warren Buffett
The four most dangerous words in investing are: ‘this time it’s different’. - Sir John Templeton
I hope you had a great summer and have the opportunity to enjoy some pleasant fall weather as we head into the final few months of the year. I am writing to bring you up to date on some key market developments over the 3rd quarter of 2019 and to provide some context for how your investment portfolio may have performed during those past 3 months ending on September 30th.
Many of the main themes that have affected global asset markets in 2019 – including U.S.-China trade tensions, political uncertainty due to the Brexit negotiations, and slowing economic activity – continued in the third quarter, resulting in somewhat choppy market performance. Nevertheless, market participants ultimately found reasons for optimism in moderate inflation, generally positive corporate earnings reports and supportive business conditions. As a result, many global bond and equity markets posted gains for the quarter in what is typically a slow season.
After reaching a new high in the prior quarter, the U.S. equity market fell sharply near the end of July and remained volatile over the next several weeks before climbing higher again. The S&P 500 Index, an index of the 500 largest U.S. publicly traded companies, finished the latest 3-month period up 3.0% and held a gain of 16.9% so far this year in Canadian dollar terms. The U.S. market rally has been broad-based in 2019, with particularly strong results for companies in the utilities, information technology, and real estate sectors.
In Canada, the S&P/TSX Composite Index also weakened in late July, but bounced back with a rally that was fuelled by companies in the financials and consumer staples sectors. The Canadian benchmark gained nearly 2.5% for the quarter, and was one of the best-performing equity markets globally, with a year-to-date gain of 19.1%.
Performance for the MSCI EAFE Index, which captures performance for large and mid-cap companies in 21 developed markets across Europe and Asia, was more muted. The index rose slightly by 0.3% in Canadian dollars for the third quarter, bringing its year-to-date gain to 9.9%.
With global growth slowing, the expectation of rate cuts by leading central banks led government bond yields lower through much of the three-month period. The U.S. Federal Reserve cut its policy rate twice (by 0.25% each time) in the third quarter – once in July and again in September – citing risks including trade tensions with China and slowing growth overseas. The European Central Bank responded to slower economic growth by taking its key lending rate into negative territory and re-starting its bond purchase program to ease credit conditions. The Bank of Canada, however, bucked the trend, pointing to a strong economy for maintaining its overnight lending rate at 1.75%. The FTSE Canada Universe Bond Index, a broad measure of Canadian government and corporate bonds, was positive by 1.2% for the quarter and up 7.8% for the year-to-date.
Commodity prices also moved during the summer months. Gold rose 5.1% to $1479.50 $US/oz and Silver rose 11.5% to $17.09 $US/oz at the close on September 30, 2019. Oil prices fluctuated as well and then dropped to close lower on September 30th. Of the most heavily watched oil contracts, West Texas Intermediate (WTI) dropped by $4.40 to $54.07 $US per barrel and Western Canada Select (WCS) dropped by $3.10 to $41.37 $US per barrel.
Emotional Rescue
Let’s assume you initially invested $100,000 into a portfolio and kept it there for 20 years. The annual return averaged 15% per year, and the volatility (the up and down of the portfolio) was 10% per year. After the 20 years, the initial $100,000 investment would have grown to total $1,636,654. By any standards that is a very good portfolio and you should be very happy with the results. However, emotionally speaking, you may never be happy with this portfolio. 1 This is explained by the Nobel prize winning economist Daniel Kahneman as the Prospect Theory.
1 Source: Fooled by Randomness: The Hidden Role of Chance in Life and the Markets, by Nassim Nicholas Taleb (2001).
The Prospect Theory states that for every good result a person sees, 1 Unit of Emotion is gained. But, when a bad result is seen, 2 Units of Emotion are lost, since a loss has twice the emotional impact for humans. The Prospect Theory has a large role in how people play lotteries and buy insurance policies. It is also why TV news start with a murder or car accident…it has twice the impact as a feel good story about a kitten being rescued.
And now, back to the portfolio above. If you are checking the portfolio once per year, based on the volatility and average rates of return above, there is a 93% chance that you would be looking at a positive return versus a 7% chance you are looking at a negative return. That is approximately 19 emotional units gained (19 positive results times 1 emotional unit) versus 2 emotional units lost (1 negative result times 2 emotional units). Emotionally you end up with almost 10 times the gains to losses. You feel good, and your portfolio looks good too!
If you checked on your portfolio more often, you might not feel as good (emotionally speaking that is). If you check your portfolio 4 times per year (quarterly like this newsletter) you have a 77% chance of seeing a gain. Now the ratio of your emotional gains (61.6 eu’s) compared to your emotional losses (36.8 eu’s) is getting much smaller. You still have more gains to losses, but emotionally the gap is closing to about 2 to 1 gains to losses. You still feel good about the portfolio, but just not as good.
If you check your portfolio monthly, you have a 67% chance of seeing a portfolio gain. But now the Emotional Units are about even. There are 240 opportunities to look at the portfolio, 67% of the time it is positive, therefore 160.8 positive emotional units are generated. This compares to 33% of the 240 times as negative (79.2), times twice the emotion for negative, equals 158.4 negative emotional units. This is a great portfolio, but you can’t even smile at the results. And it gets worse.
If you checked this portfolio every day, over the 20 year life of the portfolio, you have a 54% chance that it gained money from the day before. This is based on the volatility of 10% per annum (which includes the ups and the downs) on the way to a 15% annual return. By checking daily you have experienced 3942 positive emotional units, but you have also experienced 6716 negative emotional units. And 20 years later you feel like crap.
Now I can understand how someone would want to see how their investments are performing. However, as shown above, excessive checking can lead to stress and possibly lead to poor investment decisions. And seeing a stock market ticker, or a daily index summary, on BNN, CNBC, Bloomberg News, CNN, CBC, or any other 24-hour news feed is just as bad. Someone might even abandon an investment plan as successful as the one above just based on the emotions of reviewing their portfolio too frequently. Turn off the TV and go for a walk. You and your dog will both be happier.
Further on down the road
Looking ahead, global growth is expected to continue, albeit at a slower pace than we have seen recently, while the risks stemming from trade disputes and political upheaval could continue to affect global economies and markets. At these times, it’s worth bearing in mind that markets rarely move forward without temporary corrections or bouts of volatility. I continue to believe that a diversified portfolio that features active management and is suited to your time horizon and tolerance for risk remains the best strategy for helping you achieve your financial goals. Should you have any questions regarding your portfolio, please do not hesitate to contact my office.
All the best,
Mark McConnell, BA (Economics), DipBIS
Senior Investment Advisor, Branch Manager
Mandeville Private Client Inc. is a member of the Investment Industry Regulatory Organization of Canada and a member of the Canadian Investor Protection Fund.
This publication contains the opinion of the writer. The information contained herein was obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made by the writer, Mandeville or any other person as to its accuracy, completeness or correctness. The information in this letter is derived from various sources as of 9/30/2019, including CI Investments, Fidelity Investments Canada, Globe and Mail, National Post, Bridgehouse Asset Managers, oilprices.com, yahoo.com and Trading Economics. Index information was provided by Bloomberg. This material is provided for general information and is subject to change without notice. Although every effort has been made to compile this material from reliable sources; no warranty can be made as to its accuracy or completeness, and we assume no responsibility for any reliance upon it. Before acting on any of the above, please contact me for individual financial advice based on your personal circumstances.