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Posted by Ethan Dang of McIver Capital at Canaccord Genuity

on Monday, 29 October 2018 11:39

Stock Market

“Everyone wants happiness. No one wants pain. But you can't have a rainbow, without a little rain.” ― Anonymous

Global stock markets are in the midst of a pullback and corrections never feel good. In the short-term, investor sentiment can swing wildly, causing volatility in the markets. Psychology is an important part of investing and we can often be our own worst enemy in making sub-optimal decisions in times of volatility. This is due to the natural wiring in our brains, where fear triggers a flight instinct. Our brains also have a tendency to project recent trends into the future (recency bias), which collectively, can cause crowd sentiment to hit extremes. For long-term investors, empirical data and experience have shown that times of pessimism often present opportunities.

The current market pullback was triggered over fears of a prolonged trade war between the U.S. and China (tariffs), rising bond yields (tighter financial conditions), faster U.S. interest rate hikes (hawkish U.S. Federal Reserve) and so on. These factors can lead to slower global economic growth over time. As sentiment soured, selling in highly crowded trades, such as the FAANG (Facebook, Apple, Amazon, Netflix and Alphabet’s Google) stocks added fuel to the fire.

As of writing, North American markets are off 8-10% from their summer peaks and international developed markets (ex-Canada & U.S.) are off about 18% from their peaks. Markets are attempting to put together a short-term bounce, but the bounce has been weak thus far. This leads us to think that this pullback could go lower for longer. Some markets (such as S&P500, TSX, Japan) are trading at or near first support levels now, but if those supports are violated, markets could go lower from current levels.
The reason why your portfolios hold different asset classes is to provide negative correlation and it is during these times of stress that bonds and gold shine and the cash reserve provides dry powder to capture opportunities.

Longer term, stock valuation is mainly driven by corporate earnings and dividends. The earnings season is underway, and thus far, we are seeing strong corporate earnings (second best quarter in a decade). Companies in both the S&P 500 andTSX Composite are showing positive revenue growth (top line) and earnings growth (bottom line). Furthermore, corporate stock buyback programs are set to restart this quarter and are expected to provide support for the markets. Overall, economic data and indicators, such as consumer spending and business investments, suggest that this is still a healthy market pullback in the context of a late-cycle, bull market. We expect to see rotation into value and defensive sectors like health care and consumer staples as the cycle continues. The key to sound investing is to remain focused on the long-term horizon as short-term market volatility is inevitable and is part of investing.

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