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Welcome to the CAPCORP Comment
For the week of May 23, 2017
President Trump, NAFTA, McDonald’s and Wal-Mart all made headlines last week. These stories, our regular market updates and a closing comment giving six good reasons to stay invested are presented in this edition of the weekly Comment.
Closing prices (In $US)
Start the negotiations
The Trump administration sent a letter to Congress last week, officially indicating their desire to renegotiate the 1993 North American Free Trade Agreement (NAFTA), triggering a 90-day consultation window before formal talks begin. The letter explains how the U.S. is looking for “free and fair trade” and feel their manufacturing industry has been “decimated” by NAFTA. Some of the key issues which will be discussed include: dairy, auto parts, softwood, digital services, and pharmaceuticals.
The announcement on NAFTA helped reverse the downward trend markets had been following for the first half of the week; however, it was not enough to have them finish “in the green”. The TSX closed the week down 79 points to 15,458. The Dow closed down 92 points to 20,804, and the S&P 500 was off 9 points to 2,381. The Nasdaq dropped 38 points to finish Friday at 6,083, as weak earnings from Cisco contributed to its closing “in the red”.
Members of OPEC stated their intentions to keep supply cuts going through next year. This resulted in the price of crude rebounding 10% since hitting five-month lows 2 weeks ago. The goal to meet/reduce current inventories of oil comes at a good time as the American Petroleum Institute (API) showed an unexpected build in crude reserves. Oil closed up $2.99 per barrel to $50.89 per barrel. Controversy surrounding President Trump, including the firing of FBI Director James Comey, and alleged communications with the Russians resulted in a jump in the price of Gold. It closed up $30.80 per ounce at $1,258.60 per ounce. The Canadian dollar finished up $0.0114 at $0.7403.
Question of the Week: According to a law in Switzerland, you can’t own just one of what animal?
McDonalds celebrated its 77th birthday on May 15th. It has come a long way since its beginnings as a small hamburger stand in San Bernardino, California. Two brothers, Dick and Maurice "Mac" McDonald, opened the stand as "McDonald's Bar-B-Q". It closed for a short time, before reopening in 1948 with a nine item menu including hamburgers for $0.15, cheeseburgers for $0.19 and drinks for $0.10. McDonalds has become the biggest fast-food chain in the world; serving 70 million customers every day with sales topping $24 billion last year.
And speaking of the world’s biggest…
Wal-Mart, the world’s largest retailer reported sales rose for the 11th straight quarter, in a sharp contrast from many rivals who saw their figures drop. Online sales at Walmart.com rose 63%, up dramatically from the 29% growth in the previous quarter. The number of items available, including on its third-party online marketplace, has risen to more than 50 million, up 10 million from a year ago. Wal-Mart reported first-quarter profit of $3.04 billion on revenue of $117.5 billion.
This week in History
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Six good reasons to stay invested
Financial markets often go through phases of relative calm followed by abrupt and often unanticipated spikes in volatility. We experienced this last week with multiple reports surrounding President Trumps’ involvement, or lack thereof, with the Russians. Historically, volatility is most obvious in the equity markets; however, as bond yields hover near all-time low levels in Canada, the U.S. and across Europe, volatility in bond markets has increased as well. Events which create this volatility are beyond our control. Generally, the best reaction is no reaction at all. This week we present six good reasons why staying invested for the long term is almost always the best way to navigate market turmoil.
First of all, market timing is difficult. Trying to make “big bets” and drastic allocation shifts in an effort to time the ups and downs of the market is immensely challenging, if not impossible. This applies to stock markets as well as other markets, such as oil. For example, when the price of crude oil breached US$100 a barrel in early 2008, Goldman Sachs predicted it could move beyond US$200 a barrel in the short term given existing supply/demand characteristics. Indeed, oil did near US$150 a barrel by mid-2008, but at the end of that year Goldman Sachs slashed its forecast to just US$45 a barrel. Similarly, early in 2015 when oil slumped to US$40 a barrel, Citigroup predicted it could fall as low as US$20 a barrel in the near term, only to see it rise to almost $60 a barrel by June.
Second, selling during a correction is betting against the odds. History suggests that periods of sharp decline have often been followed by periods of some of the most favourable returns. For example, “Black Monday” in October 1987 resulted in a 25% drop in the TSX (TSE at the time) to then produce gains of 14.5% in the next 12 months and 42.1% in the next 24 months. The bursting of the Tech Bubble led to a 41% drop in the TSX, only to generate 37% and 57% gains in the following 12 and 24 months. The subprime financial crisis dropped the TSX 43%, followed by 12 and 24 month gains of 47% and 84% respectively. The point is that the strong historical tendency of markets to rebound provides some evidence that fear-induced dramatic alterations to asset allocation are unnecessary for investors who simply stay the course.
Third, the likelihood of negative long-term returns for a balanced portfolio has historically been very low. Stocks have historically outperformed bonds when based on average rolling returns over one, three, five, ten and twenty years. Just as compelling, is the traditional ability of a balanced portfolio to produce positive returns. A global balanced portfolio of stocks and bonds has not produced a negative return over any five-year rolling period since 1970. Although there are no guarantees that the future will resemble the past, history tends to favour long-term investors.
Fourth, volatility breeds opportunity. While economic uncertainty will always be a cause for investor anxiety, the resulting market volatility has historically offered active managers in equities and bonds potential opportunities. Markets sometimes get over-exuberant and prices become excessive. The opposite is also true. Short-term periods of crisis can push prices artificially low, creating excellent opportunities to buy. Portfolio managers can take advantage of temporary mispricing in the market. In doing so, it can create potential long-term profits.
Fifth, market volatility provides an opportunity to rebalance. If a crisis creates an opportunity, then portfolio rebalancing is perhaps the best way to take advantage of that opportunity. Rebalancing refers to selling assets that have gained in value and buying assets that have fallen in value in order to maintain the overall strategic asset allocation of a diversified portfolio. During a market correction, this should result in buying more assets that have decreased in value – an essential part of the process of buying low and selling high.
Lastly, diversification can be most effective when markets are uncertain. Over time, financial markets deal with numerous crises. The last two decades have seen the technology bubble, a credit bubble, the U.S. subprime debt crisis, the sovereign debt crisis in the Eurozone, and more recently, the downturn in oil prices. One reason to hold a multi-asset portfolio is to spread the risk budget across multiple asset classes in order to protect against ensuing market volatility. Having a strategic asset allocation with regular rebalancing can potentially enhance returns, but more importantly manage volatility.
It’s not “timing” the market but instead “time in” the market which makes the difference. Have a plan, stick to that plan as closely as possible, and time will take care of the rest. Happy Investing.
Answer to the Question: Guinea pigs
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