Tag Archives: volatility

Looking in the rear-view mirror to avoid hitting something that lies ahead

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By Noah Solomon

Special to the Financial Independence Hub

The vast majority of today’s portfolios represent a Pavlovian response to the obliging nature of markets over the past several decades. The unprecedented increase in the value of risk assets coupled with low volatility have lulled investors into a false sense of security accompanied by an “if it ain’t broke, don’t fix it” approach to portfolio construction and risk management.

Most portfolios are dependent on the next few decades mimicking the last few. Specifically, they are over-allocated towards assets that have performed well during the secular (yet unusual) goldilocks environment of the past 40 years. As is typical of human behaviour, investors are looking in a 40-year rear-view mirror to avoid hitting something that may be in front of them.

What is Normal?

The past four decades have been unusually kind to investors. Strong tailwinds of favourable demographics, low inflation, falling rates and globalization have fueled an unprecedented rise in stocks, bonds, real estate, and almost every other major asset class. While it would be nice if these conditions were the norm, the fact is that they are unique from a long-term historical perspective.

An astounding 91% of the total price appreciation of a classic 60/40 equity/bond portfolio over the past 90 years is attributable to 22 years between 1984 and 2007. This period was also an atypically strong period for real estate, representing 72% of total appreciation over the past 90 years.

Notwithstanding some painful bumps along the way, including the tech wreck of 2000-2002 and the global financial crisis of 2008, the investing experience of most people today has been a proverbial walk in the park. An entire generation of investors has never experienced anything like the 86% peak-trough decline in equities of the 1930s which resulted in two decades of lost performance. Nor has it faced anything remotely like the 25% decline in U.S. Treasury Bonds during the stagflation-plagued 1970s.

What If?

Nobody (including us) can know for sure what the future holds. However, there are strong reasons to suspect that the road ahead will be drastically different than the unusually smooth path we have been on for the past several decades. Historically high asset valuations, record corporate and sovereign debt levels, $17 trillion in negative yielding debt, the lowest capital gains taxes in U.S. history, historically high income disparity across the developed world, and a global rise in populism and protectionism all suggest that, as Dorothy stated in The Wizard of Oz, “We’re not in Kansas anymore.” Continue Reading…

Are stock markets ingenious or insane?

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Janice Gill/Unsplash

By Steve Lowrie, CFA

Special to the Financial Independence Hub

You’ve probably heard the expression, “crazy like a fox.”  If you’ve ever watched a winter fox in action, you know what that means.  Hunting for prey, the fox will leap around in seemingly insane gyrations until … wham!  It’s scored a tasty tidbit hiding in the snow. 

Has the stock market gone similarly crazy lately?  Like the fabled fox, there are actually some incredibly sensible dynamics behind the market’s seemingly manic moves.  Let’s cover three reasons why investors should ignore its transitory twists in pursuit of satisfying returns.

Market pricing vs. economic indicators 

To the surprise of most, markets surged in April, with the US stock markets experiencing their best monthly rally since 1991 and the Canadian stock market since 2009.  

So far, May isn’t looking too bad either.  But why?  Why would markets spring upward while the economy remains in such a deep freeze?  The explanation is relatively simple, if often misunderstood:

  • Economic indicators are in real time.  Unemployment is high right now.  Government debt is piling up.  Coronavirus is ravaging our personal and economic health today.
  • Market pricing is forward-looking.  When the market is rising, it suggests there are more buyers betting that things are likely to improve than there are sellers betting on even darker days ahead. This doesn’t mean they’re correct, but relatively efficient markets often do “know” a bit more than any one of us can know on our own.

Market efficiency

This leads to another source of confusion for investors and the popular press alike:

  • The markets can be crazy-volatile in the near-term.  Nobody actually knows what market prices are going to do next: not even the market itself.  To know, we’d first need to correctly predict each new economic or other trends that might change things.  Plus, we’d need to know how the market is going to react to the interplay of every force, combined.  No wonder it may often feel as if the markets are disconnected from reality. Continue Reading…

Bond ETF discounts during recent periods of Volatility

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Rich Powers, Vanguard head of ETF product management

By Rich Powers and Scott Johnston, Vanguard Americas

(Sponsor Content)

The waves of volatility from the coronavirus outbreak have reached every corner of the financial markets. For bond ETFs, the waves have resulted in both volatile market price swings and larger-than-usual gaps between market prices and net asset values (NAVs).

When the gap is positive (that is, when the market price is greater than the NAV), it’s called a premium. A discount occurs when the NAV is greater than the market price. While such gaps can be unsettling, history shows that premiums or discounts are always present with bond ETFs, and their widening amid market volatility tends to be short-lived.

Bond ETFs are an important source of liquidity

Along with heightened market volatility in the bond market over the last few weeks, there’s been a drop in liquidity of many types of individual bonds: that is, the willingness of market participants to buy and sell. Bond ETFs, on the other hand, have maintained their liquidity and have been the primary mechanism for price discovery in the fixed income markets.

In such a volatile environment, bond ETFs can be expected to trade at discounts or premiums. Though discounts and premiums of this breadth and magnitude are rare, bond ETFs have been tested during prior bouts of volatility and actually do a good job of reflecting in real time the value of the underlying fixed income securities. In times of volatility with rapidly evolving macroeconomic, interest rate, and credit environments, investors should expect premiums or discounts in bond ETFs. Bond ETFs tracking similar benchmarks have experienced large variations in market returns as well.

Fewer inputs can create greater price disparities

Discounts and performance differences reflect the fact that there are two ways to determine portfolio values. In setting end-of-day NAVs, ETF pricing specialists use both actual trades and an adjustment factor based on bid/ask spreads for bonds, especially for bonds that haven’t traded recently. Market prices, in contrast, are collectively determined by ETF investors and “market-makers.” If, as happened in the second last week of March, bond trading is fairly diminished in the underlying market, NAV calculations will have fewer inputs and thus there’s an increased chance for differences from market prices.

Unlike a NAV that’s calculated by a pricing provider, market prices for bond ETFs reflect the market’s minute-by-minute judgment, which includes factors such as:

  • Valuation estimates of the underlying holdings by market-makers.
  • Supply and demand for the ETFs.
  • The cost for providing liquidity in fast-moving markets where underlying bonds may have less liquidity.

Since these calculations have different inputs, investors should expect different outcomes, particularly in volatile markets. When viewed over longer periods — say a month or a quarter — these short-term disparities are generally imperceptible, as they are over a “normal” day or week. Continue Reading…

Speculative Volatility in a free society

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American economist and 2013 Nobel Prize Laureate Robert Shiller in 2014

By John DeGoey, CFP, CIM

Special to the Financial Independence Hub

The final chapter of Robert Shiller’s book Irrational Exuberance has the same title as this blog post and contains a cogent synopsis regarding what some people believe is going on now.  In essence, stock market valuations (especially in the U.S.) have been high for years and most people (investors and advisors alike) didn’t seem to be fussed about it.  Here’s a verbatim passage from the book (page 225 of the 3rd edition), which was written in 2014, when markets were substantially lower than they were when the current down draft began:

The high stock market levels did not, as so many imagine, represent the consensus judgment of experts who have carefully weighed the long-term evidence.  The markets have been high because of the combined effect of indifferent thinking by millions of people, very few of whom have felt the need to perform careful research on long-term investment value, and who are motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom.  Their all-too-human behaviour has been heavily influenced by news media that are interested in attracting viewers or readers, with limited incentive to discipline their viewers or readers with the type of qualitative analysis that might give them a correct impression of fundamental value.

My translation of that passage might be as follows:

People make decisions about the value of stocks in general in a vacuum of personal experience and in the context of what others are doing; not in the context of whether stocks are cheap or expensive as compared to historical metrics.  Consequently, “groupthink” causes people to make their personal decisions based on the consensus behaviour of others, who, in turn, are not really looking at valuations, either.  The media exacerbates this behaviour.

On the following page, Shiller is even more pointed:

Understanding how social forces cause speculative market moves has been a major theme of this book.  It is so difficult for most of us to figure out which moves are caused by sensible good reasons and expert opinions and which are caused by human imagination and social psychology.  I hope that the argument to this point has made it clear that, as these major markets go, it is often the latter that drives prices.

My  translation: Continue Reading…

Is now a good time to buy stocks? Look beyond the headlines to find out

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Examine The Theories That Forecasters Rely On To Predict Market Swing: And Learn Their Flaws

The universe is constructed in such a way that nothing is certain. You can always come up with perfectly rational reasons why something won’t work. But people find ways to overcome obstacles, and some businesses succeed despite risks.

Is now a good time to buy stocks? Below are a couple of factors to consider. 

Editor’s Note: This piece originally ran last July so is not specific to the current Coronavirus-induced volatility; however, the general principles still stand up nicely.

Also, see this Inner Circle hotline from Pat that appeared on Friday March 6th:

A special note from Pat…

Right now I’m working on a special report on the COVID-19 virus, which will go out to our Inner Circle Members [on Tuesday of this week.] It will tell you, among other things, that if you liked your portfolio when the coronavirus scare began a few weeks ago, you should probably hang on to it.

However, if you are like a lot of investors, you may often wonder if you should stick with your portfolio as is, or make changes.

In the upcoming special report, I’ll tell you what I’ve told our portfolio management clients what they should do in a variety of special instances that you may already be wondering about, such as:

  • How today’s market might affect your retirement plan if you’ve already retired…
  • How to decide if you should put more cash in the market…
  • What the market downturn means for the market for the rest of the year and beyond…
  • and How the “Conflict of Interest” factor can help you navigate through the “virus crisis.”

Look for Pat’s special report on COVID-19 and its impact on your investments in this coming Tuesday’s Inner Circle Q&A.

[For those not currently members, here is the link to join.]

 

Is now a good time to buy stocks? Understand pendulum theory and you will understand the past

You could sum up the investment version of the pendulum theory like this: stock prices alternate between periods of overvaluation and undervaluation; the degree and duration of each period of overvaluation is related to the degree and duration of the subsequent period of undervaluation, and vice versa.

In other words, pendulum theory says that when stocks head downward after a period of overvaluation, they won’t stop at fair value. Instead, they’ll keep dropping until they hit lows that are in some sense as out-of-whack as previous highs, or close to it.

Pendulum theory is a handy way to label the past, and it gives you a sense of how stock prices behave. But it’s useless at predicting the future or timing the market. That’s why pendulum theory generally plays a small part in successful investing. If you qualify as a “successful investor,” you probably recognize that the market never gets so high that it can’t go higher, nor so low that it can’t drop some more. This is a key part of understanding the stock market.

Is now a good time to buy stocks? Consider this valuable concept to gain another perspective

Here’s one of the most valuable things you should recognize as an investor: “A rising market climbs a wall of worry.” In other words, you need to recognize that a stock market’s rise automatically generates negative comments. The higher and/or longer the market rises, the more negative comments it generates. These are the bricks in that wall of worry.

The inevitable building of this wall grows out of human nature. Many people are instinctively cautious or conservative. When they see a stock or the stock market go on a rise, they look for reasons why the rise may falter or reverse. That’s especially true of stock market commentators. When a stock or the market rises beyond their expectations, they dig deep for hidden flaws. Continue Reading…

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