There’s a lot of noise right now and a fair amount of fear. Here’s a quick snapshot of some of the headlines you may have encountered over the past few days: Yikes. Here is a simple fact: most wealth investors don’t have all their money in equities, and if they do, they didn’t buy the S&P 500 at the exact moment that it reached its high on February 19. This peak-to-trough decline, the scariest number possible, is the one that’s always quoted in the financial media. It does not speak to the silent majority of investors who have a retirement account, a savings account and perhaps a corporate account. Most investors accumulate investments over time, and as their lives evolve, their portfolios evolve with them. Most people, somewhere along the way, learn about diversifying, with different parts of their portfolio softening the drops during periods like this. If this sounds like you, your accounts might be down a bit now, but not anything like the numbers you’re reading in the media. Reach out to your advisor and get an update. There’s an old saying, “Where there is space, there is fear.” The financial media gets that. During times like this, their viewership goes up, which increases their ad revenue. At the end of the day, volatile markets, for them, are good for business, regardless of what they do for your nerves and your pocketbook. Boiled down to its essence, investment is about the process of decision-making, not the decisions themselves. You can make one or two bad decisions with a good result, but you can’t make a series of bad decisions over the long-term and not have it end badly. Unfortunately, investors are often put in a position of making these decisions without any formal process. Our solution: Have an investment philosophy, a guiding set of principles that will work in a world that is in a state of constant change, often with dramatic impact on financial markets. At TD Wealth, we call that philosophy “Risk Priority Management,” and it provides the foundation for how we make decisions. More importantly, it provides our clients Market Insights March 11, 2020 Silent Majority If you are going to make predictions, you better be excellent at it. The world is so complex, making predictions is a low-odds proposition. • Oil plunges 24% for worst day since 1991 • Dow loses over 2,000 points, worst single-day drop ever • The S&P 500 suffers the quickest correction since the Great Depression • Market Extra: How an ‘oil shock’ and coronavirus combined to wreak havoc on stocks and global financial markets • Traders recap scary week on Wall Street and see more wild times ahead PAIR | Portfolio Advice & Investment Research Brad Simpson, Chief Wealth Strategist and Head of PAIR
Transcript
There’s a lot of noise right now and a fair amount of fear. Here’s a quick snapshot of some of the headlines you may have encountered over the past few days:
Yikes. Here is a simple fact: most wealth investors don’t have all their money in equities, and if they do, they didn’t buy the S&P 500 at the exact moment that it reached its high on February 19. This peak-to-trough decline, the scariest number possible, is the one that’s always quoted in the financial media. It does not speak to the silent majority of investors who have a retirement account, a savings account and perhaps a corporate account. Most investors accumulate investments over time, and as their lives evolve, their portfolios evolve with them. Most people,
somewhere along the way, learn about diversifying, with different parts of their portfolio softening the drops during periods like this.
If this sounds like you, your accounts might be down a bit now, but not anything like the numbers you’re reading in the media. Reach out to your advisor and get an update. There’s an old saying, “Where there is space, there is fear.” The financial media gets that. During times like this, their viewership goes up, which increases their ad revenue. At the end of the day, volatile markets, for them, are good for business, regardless of what they do for your nerves and your pocketbook.
Boiled down to its essence, investment is about the process of decision-making, not the decisions themselves. You can make one or two bad decisions with a good result, but you can’t make a series of bad decisions over the long-term and not have it end badly. Unfortunately, investors are often put in a position of making these decisions without any formal process. Our solution: Have an investment philosophy, a guiding set of principles that will work in a world that is in a state of constant change, often with dramatic impact on financial markets. At TD Wealth, we call that philosophy “Risk Priority Management,” and it provides the foundation for how we make decisions. More importantly, it provides our clients
Market InsightsMarch 11, 2020
Silent MajorityIf you are going to make predictions, you better be excellent at it. The world is so complex, making predictions is a low-odds proposition.
• Oil plunges 24% for worst day since 1991
• Dow loses over 2,000 points, worst single-day drop ever
• The S&P 500 suffers the quickest correction since the Great Depression
• Market Extra: How an ‘oil shock’ and coronavirus combined to wreak havoc on stocks and global financial markets
• Traders recap scary week on Wall Street and see more wild times ahead
PAIR | Portfolio Advice & Investment Research
Brad Simpson, Chief Wealth Strategist and Head of PAIR
I 2
Market Insights: Silent Majority
PAIR | Portfolio Advice & Investment Research
with the knowledge, and the comfort, of knowing how we are going to make decisions with certainty, particularly when uncertain things occur.
Principle 2, “Invest like an owner,” seems particularly relevant right now:
Let’s review the cold hard factsThe volatility over the past few weeks has been intense, reaching a peak on Monday, March 9, with risk assets declining meaningfully and “risk-free” assets like government bonds climbing to unprecedented levels and, conversely, shrinking yields. The yield on 10-year U.S. Treasuries fell to 0.31%. Think about that for a moment: buy a 10-year bond is basically like not getting paid to lend your money to the U.S. government for 10 years.
These are truly unusual times, with a high degree of uncertainty. In our “Certain Uncertainty” note (February 27), we wrote about the difference between risk and uncertainty. Uncertainty pertains to unpredictable events that are impossible to quantify. Nobody likes uncertainty — it’s uncomfortable and difficult to understand and impossible to make plans around. And this is precisely why financial assets perform so poorly in the face of significant uncertainty, as in the current environment.
We continue to emphasize the importance maintaining an investment discipline with true diversification in this environment. This is the time you want to ensure your portfolio is well-diversified, not just across asset classes and geographies, but also across risk factors and macroeconomic environments. This way, your portfolio is not overexposed to any adverse event that could potentially have an outsized negative effect.
Look at the period between 2009 and 2020 (Figure 1). Despite everything we endured, markets climbed and climbed. It’s been a hard ride, rocky at times, but even the most myopic investor has to admit, we’ve achieved strong returns over the past 11 years (133 months). Even in the face of many adverse events, markets took two or three steps forward, one step back, and the economy grew.
Source: Bloomberg. As of March 9, 2020
Figure 1: A long hard trip where preceptions changed a lot
“The era of big data, low trading costs and massive product proliferation has created an environment where, far too often, client investment portfolios have more in common with casino-like statistical strategies than they do with a well-constructed foundation for wealth. A banker’s methodology towards credit, a prudent stance to fiscal policy and a visionary approach to products and services — these elements comprise the foundation of why, how, and with whom, we deploy capital.”
I 3
Market Insights: Silent Majority
PAIR | Portfolio Advice & Investment Research
When there was a fall, central banks adjusted, businesses adjusted, and markets renewed their climb. Let’s look at max drawdowns and the time of recovery (Figure 2). Interestingly, as we moved away from the fear of the financial crisis, recovery time shrank. Perception is an incredibly important part of investment. Panic/euphoria is a key sentiment gauge that has proven to be very useful in the past, given its high-probability predictive outcomes. A move into panic territory is often a powerful marker for upside potential.
Principle 3, “Embrace human behaviour,” can be applied here:
What we knowFirst and foremost, none of us knows where this ends. As it relates to the decline in equity markets, we know that equities bottoming is a process, not a specific point in
time. Slowly but surely, supporting factors have emerged to contain the outbreak, to calm fears, and to get the economy moving. While the situation in Italy continues to escalate, with restrictions on personal movement and public gatherings, the situation in China is improving every day, with new cases of COVID-19 now falling.
Governments around the world, moreover, are taking action. The U.S. Federal Reserve made an emergency inter-meeting rate cut of 50 basis points on March 3 to proactively support the economy, followed by the Bank of Canada’s 50-bps cut on March 4. A few other central banks have also cut rates. Central bankers and finance ministers have said they are prepared to use “all appropriate policy tools” to combat the risks posed by the outbreak. Rate cuts, of course, won’t help contain the spread of the virus, but they confirm that governments are doing what they can to support the economy.
U.S. President Donald Trump announced after the market closed on March 9 that he would announce details of a relief package on Tuesday, March 10. Some of the possibilities being discussed include a payroll tax cut and relief to hourly workers suffering from the economic fallout of the coronavirus. President Trump also said the government would look at providing assistance to the airline, hotel and cruise industries.
Economic UpdateU.S. economic data over the past 10 days has been mixed. Prior to the recent increase in infections, the economy was on decent footing, with no signs of pressure on the employment front. Indeed, February’s jobs report was solid. A soft international trade report, however, has dampened TD Economics’ view on Q1 growth. Despite the resilience on display, cracks are starting to appear. Concerns about the spread of the virus were voiced in the comments section of the ISM surveys, and were clearly on display in the Beige Book.
Big market corrections in 1973 and 2008 led to full-blown recessions, but that's not always the case. Corrections in 1987, 1998 and 2011 did not. Since business cycles are increasingly impacted by financial markets, however, the negative impact of COVID-19, the oil shock and credit risks have placed the global economy on recession watch.
Fixed IncomeGovernment BondsLet’s start by reviewing the incredible activity we’ve been seeing in bond markets. For the past couple of weeks, long-
Figure 2: Everything gets easier with time
Source: Morningstar, ss of March 9, 2020
Year
Max Draw-down
%
Max Draw-down Peak
Max Drawdown
Valley
Recovery Date
Recovery time
(months)
2010 -13.14 5/1/2010 6/30/2010 12/31/2010 6
2011 -17.03 5/1/2011 9/30/2011 2/17/2012 4
2012 -6.97 4/1/2012 5/31/2012 9/30/2012 4
2013 -3.13 8/1/2013 8/31/2013 10/31/2013 2
2014 -3.56 1/1/2014 1/31/2014 2/28/2014 1
2015 -8.89 6/1/2015 9/30/2015 11/3/2015 1
2016 -5.47 1/1/2016 2/29/2016 3/31/2016 1
2017 -0.04 3/1/2017 3/31/2017 4/30/2017 1
2018 -13.97 10/1/2018 12/31/2018 4/23/2019 4
2019 -6.58 5/1/2019 5/31/2019 7/31/2019 2
Traditional finance assumes that all investors are rational and well-informed, and that the economic environment in which they operate has a very mechanical business cycle that follows understood patterns. In practice, human beings learn and adapt as they go along, and so the financial environment in which they function changes accordingly. We believe it is wiser to think of the investment world as a complex adaptive system, and to pursue returns and manage risk based on this view.
term bonds have made dramatic moves as investors run full speed ahead into safe assets. Concerns around the coronavirus virus have led stock markets to suffer considerable losses and, as desperate investors flee into the safety of government bonds, those yields have sunk to record lows. The 10-year Treasury is a proxy for overall conditions in the bond market, and on Monday, it hit an all-time low of 0.31%. This fall in yields, for the most part, was the result of a giant rush for safety among global investors. This move acted as a buffer for many investors’ portfolios for the past few weeks and provides an example of the success of a basic principle of diversification.
CreditAmid rising global growth concerns, the credit markets are facing the typical cyclical headwinds of rising default risk and downgrades. The recent fall in oil prices, due to failed negotiations between Saudi Arabia and Russia, exacerbates these stresses. In the United Sates, which is an important part of the corporate bond market, credit downgrades outstripped upgrades for the week of March 3, with 16 firms receiving a rating change. For the period ending March 3, negative rating changes accounted for nearly two-thirds of all activity and roughly three-quarters of total debt affected in the period. Not every corporate bond in the U.S. high-yield universe has followed the same pattern, however, which makes a good case for active management over passive investing in this area. With the big drop in oil this week, it’s no surprise that energy has been the biggest underperformer, but looking under the hood, it’s mainly the oil field services and independent energy names that had the bulk of negative performance, due to the mounting balance-sheet pressures they face.
EquitiesWhenever we go through a rough patch in equities, portfolio managers are asked to prognosticate: “Have we hit bottom yet?” But the bottoming of equities is a process, not a point on a line graph.
The correct answer to the question is always “Maybe, I don’t know for sure.” Why? Because that’s the truth. Equity markets rarely carve out V-shaped bottoms — an exception would be what happened just over a year ago as we entered 2019 on the heels of a hard sell-off. In that particular case, the market became concerned about the earnings outlook for 2019 and the possibility of a recession. But central bank intervention helped to alleviate those concerns and the recovery took hold.
The more common scenario is a bottom that grinds through a process. Two such instances are illustrated here: (1) the financial crisis of 2008 through mid-2009; and (2) the mid-2011 recession scare. These are chosen because the market just experienced (on March 9) the greatest single-day sell-off since August 2011; and because many people are drawing comparisons between the financial crisis and today’s situation. In the financial crisis, markets were hit by a sequence of events that stepped down to an ultimate bottom (Figures 3). Now, however, that sequence of events is widely blamed on excesses in mortgage underwriting and the residential property bubble that ensued.
While it’s always dangerous to say, “This time is different,” we should remember that, in 2008, the problems that led to the correction and ultimate recession were internal to the market. The problems originated inside the operations of the market itself. The current correction, meanwhile, stems from problems that originated externally — i.e., there is no element of mismanagement or excess on the part of the banking system.
Figure 3: North American Equities - Financial Crisis
Source: FactSet, as of March 10, 2020
I 5
Market Insights: Silent Majority
PAIR | Portfolio Advice & Investment Research
11,000
12,000
13,000
14,000
15,000 S&P/TSX Composite
0
300
600
Q1-2011 Q2-2011 Q4-2011 Q4-2011
Daily Average Volume
COVID-19 may be exogenous to the financial system, but the measures employed to contain the spread of the virus (like quarantining geographic regions and extending the new year’s break in China) may well stress the payments system. Some companies that have been forced to shut down will indeed suffer cash flow problems. The Fed’s move to lower the cost of money will do little to help with this problem. Lowering rates, however, sends a comforting message to the markets that the central bank stands prepared to take action as necessary.
In many ways, the closer parallel is actually the 2011 recession scare (Figures 4). It was always unlikely that the virus would be completely contained in China, and while the ultimate impact of the virus response to the economy is unknowable at this time, there is certainty that the economic interruption will retard global growth. The market is moving to rapidly discount the extent of the interruption. As it usually goes with these things, the news ebbs and flows on both positive and negative implications until all the news is out. It’s only then that we can be confident that the crisis has ended.
What to do now
1. Be patient. There’s a reason it’s considered a virtue.
2. Make sure you are diversified. Principle 5: “Mitigate outside and inside risks”
3. Ignore market charlatans. Andy Warhol said, “In the future everyone will be famous for 15 minutes.” Let them be. Just make sure you don’t pay for it.
On the outside, fixed-income and equity investments appear very different. But inside, at their core, similar to human DNA, their similarities are greater than their traditional categorizations imply. We call these similarities “risk factors,” and while there are many, we deem the following five as the most important to the management of risk and returns: Equity Risk, Fixed Income Risk, Alpha, Currency Risk and Illiquidity Risk. We believe an approach that takes risk factors into account provides better diversification than the traditional 60/40 portfolio, enabling us to achieve balance across a greater spectrum of asset classes, as well as the underlying sources of risk and returns.
Figure 4: North American Equities - 2011 Recession Scare
Source: FactSet, as of March 10, 2020
900
1,000
1,100
1,200
1,300
1,400
1,500 S&P 500
0
3,000
6,000
9,000
Q1-2011 Q2-2011 Q4-2011 Q4-2011
Daily Average Volume
I 6
Market Insights: Silent Majority
PAIR | Portfolio Advice & Investment Research
The information contained herein has been provided by TD Wealth and is for information purposes only. The information has been drawn from sources believed to be reliable. Graphs and charts are used for illustrative purposes only and do not reflect future values or future performance of any investment. The information does not provide financial, legal, tax or investment advice. Particular investment, tax, or trading strategies should be evaluated relative to each individual’s objectives and risk tolerance.
Certain statements in this document may contain forward-looking statements (“FLS”) that are predictive in nature and may include words such as “expects”, “anticipates”, “intends”, “believes”, “estimates” and similar forward-looking expressions or negative versions thereof. FLS are based on current expectations and projections about future general economic, political and relevant market factors, such as interest and foreign exchange rates, equity and capital markets, the general business environment, assuming no changes to tax or other laws or government regulation or catastrophic events. Expectations and projections about future events are inherently subject to risks and uncertainties, which may be unforeseeable. Such expectations and projections may be incorrect in the future. FLS are not guarantees of future performance. Actual events could differ materially from those expressed or implied in any FLS. A number of important factors including those factors set out above can contribute to these digressions. You should avoid placing any reliance on FLS.
Bloomberg and Bloomberg.com are trademarks and service marks of Bloomberg Finance L.P., a Delaware limited partnership, or its subsidiaries. All rights reserved. All trademarks are the property of their respective owners.
® The TD logo and other trade-marks are the property of The Toronto-Dominion Bank.
Portfolio Advice & Investment Research
Brad Simpson, Chief Wealth Strategist and Head of PAIR
North American Equities:Chris Blake, Senior Portfolio ManagerMaria Bogusz, Senior AnalystChadi Richa, Senior Analyst
Managed Investments:Christopher Lo, Head of Managed Investments Aurav Ghai, Senior Fixed Income Analyst Kenneth Sue, Senior Alternative Investments AnalystMansi Desai, Senior Equity Analyst Van Hoang, Global Macro Strategist
