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Predictably Irrational:

Irrational Pessimism and Irrational Optimism – Winter 2015-2016 market comments


Last year on March 20, 2015, I wrote an article titled, “Everyone is a genius in a rising market”.

 Before I continue, I should point out that trying to time the market (attempting to predict stock market highs and lows) is a discredited investment strategy. My deep concern and caution last year about stock market corrections was not an attempt to “market time”, but an observation about excessive optimism – perhaps even irrational optimism. Students of behavioral economics (I am one of them) believe that human behavior is by far the most important determinant of investor success. Specifically, what we do with our investments after we’ve bought them is the key to our success as investors or our failure. In March 2015, I felt that there was an excessive number of media articles about buying indexes or index-like investments. Some even went as far as to say that professional financial advice cost too much money and buying an index on a smartphone was an inexpensive way of jumping into the stock markets. Active management using a financial advisor, according to the media, was dead.

 That advice was not good to start with and the timing couldn’t be worse. Just a few weeks later, both Canadian and European markets peaked out and started their steep declines. As at the time of this writing, Canada’s stock market delivered a negative 25% loss ( based on 52 week high/low) to index investors in just 9 months, and European indices experienced a similar loss of about negative 22% (based on 52 week high/low). The U.S. fell in tandem (although to a lesser degree) with the decline starting just a bit later in the last half of May 2015.

 Almost all Canadians now know that the collapse in energy prices meant that 2015 was a bad year for Canadian stock markets, and that our year-end statements will likely reflect poor Canadian performance. Canada’s economy didn’t do all that well either. Canada spent the first half of 2015 in recession and the Bank of Canada’s efforts to stimulate the economy by lowering interest rates (twice) did little to improve things other than reduce the value of the Canadian dollar to about $0.68 USD.

 If you held foreign investment funds however, there was a very good chance that your fund held its value despite falling markets or even made money due to the depreciating dollar. Foreign currencies appreciated against the Canadian dollar, giving these funds a nice lift as the Canadian dollar nosedived.

 Big Trouble in China

 Market sentiment is a curious beast. When the Chinese stock market dropped over 40% last summer due to lower economic growth, no one noticed. In January 2016, it was a different matter as news headlines everywhere were reporting Shanghai index numbers daily.. Most foreign investors perceive Canada as strictly an oil producer. Evidently in the eyes of many foreign investors, we produce nothing else and we might as well be a third world emerging market country. If perception is reality, Canada would be its poster child.

 Canada’s stock market and its dollar appear to move lock-in-step with the price of crude oil. As Benjamin Tal, economist for CIBC aptly describes it, “The market is not really trading on fundamentals – it is trading on market sentiment.” The market was “overshooting with momentum”, he said.

 When perception is not reality, this means that such disparities create investment opportunities.

 Last year, I was concerned about a stock market correction. I counselled risk-adverse investors to place new money into fixed income investments rather than equities.

 Now that we have had a significant correction in the markets, we can now start to employ our buy-low strategy and buy equity funds (investment funds that have stocks in them) and invest 10% of our free investable cash into Canadian and possibly, European funds. However, please contact me to ensure that these recommendations are suitable and appropriate with respect to your personal situation.

 Source and references:

Yahoo Finance

https://ca.finance.yahoo.com/echarts?s=%5EGSPTSE#symbol=%5EGSPTSE;range=1y

 Marketwatch

http://www.marketwatch.com/investing/index/SPX/charts?chartType=interactive&countryCode=US

http://www.marketwatch.com/investing/index/SXXP/charts?chartType=interactive&countryCode=XX

http://www.marketwatch.com/investing/index/SHCOMP/charts?chartType=interactive&countryCode=CN

Bloomberg

http://www.bloomberg.com

Currency charting: http://www.xe.com/currencycharts/?from=CAD&to=USD

Benjamin Tal – Deputy Chief Economist, CIBC World Markets phone conference – 2016 Global Economic Outlook ( Friday, January 15, 2016, 11:00 a.m. ET)

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