Stock Market Update

January 2019

Happy New Year!  I hope you had a wonderful holiday season and are now (enjoying) getting back to a regular routine.  Here is my update on the 2018 stock markets. Please let me know if you have any questions or comments.

2018 was the first year in a while that stock markets ended negatively. Here is how the markets looked at Dec 31.

2018 Market Performance

  • The TSX (Canadian stock index) was down -11.6%.
  • The S&P (US stock index) closed down -6.3% although in Canadian dollars it was up 2%
  • The MSCI World (global stock index)was down -2.6% (in Canada dollars)for 2018.

(As a bit of interest,Bitcoin (CAD) closed at 5,345 for the year. YTD it was down -70.8%.)

These returns don’t tell the full story.  Both the TSX and S&P 500 were up for a good part of the year.

  • The TSX reached a high on July 12th and then bottomed on December 21st, for a total drawdown of 16.8%. 
  • The S&P 500 peaked on September 21st and bottomed on December 24th, for a total drawdown of 19.7%. 
  • The last quarter of the year is when there was the most downturn in the market.

How’s 2019 looking?

Since the lows on December 24th, to the end of the day on Jan 11th, the S&P 500 is up over 10% and that includes recovering from a big drop on Jan 3rd.  The TSX is also up 8.4% since Dec 24th.  Volatility is definitely continuing. 

If the low on Christmas Eve marks the bottom of the sell-off, it won’t be the first time we’ve had a steep correction that side-stepped a bear market (which is a drop of 20%). We witnessed similar declines in 2011 and 1998 in the US. In both cases, a recession was avoided.  It’s been 10 years since a bear market, and we are closer to the next than the one in 2008.

The biggest concern for stocks is when a recession happens, and although it is getting closer it seems unlikely to happen this year.  Most of the indicators and experts don’t think a recession will happen in 2019.  Without a recession, a bear market is usually brief (and relatively shallow) and there have only been two of them in the last 75 years.   And without a recession stock market drops are often followed by big rebounds.

I understand that it can be unsettling to see your statements drop in value.  For right now, when markets do go down, most of the money is made in the markets at the top or the bottom. Or as Warren Buffett says, “Be fearful when others are greedy and be greedy when others are fearful.”

We know that historically speaking, investors have been more rewarded by staying the course or buying during pullbacks than they have by running for the sidelines.

For long-term investors, volatility like that of the last few months isn’t something that should cause panic.  The economy is on strong footing and markets don’t go up in a straight line. Indeed, the market can and does act erratically in the meantime as we have seen. That is the reason that the stock market gives returns that, over long time periods, are likely to be significantly higher than those for cash or bonds, precisely because a strong stomach is required at times.

For long-term investors, those who are younger, or those who are placing money in the market, there can be huge opportunities right now. 

What do we do to manage?

We plan for market ups and downs by:

  • Being diversified in different assets classes including real estate, mortgages, and hedge funds etc. that don’t necessarily move in the same direction as stocks. 
  • Owning company/investments around the world including Canada, US and international not just in one area
  • We also focus on companies that pay and increase their dividends. 
  • And we put some of our investments into fixed income (bonds).  Which haven’t had great returns, but they are meant to protect our capital when the markets go down. 
  • The managers we use have lots of experience and are also taking advantage of the dips to buy stocks at lower prices. 
  • We continue to buy regularly through dollar cost averaging

And most important we have financial plans that factor in market and other life changes to keep you moving towards your goals with confidence.

Want to understand more about 2018?

During 2018, there was a lot of volatility (ups and downs), often on the same day.  This was much different than 2017 when there was little volatility, but it is returning to what is normal in the stock markets.

2018 has been described as a year of transition in the markets, particularly for the US. The transitions happened there because:

  • There was a readjustment of the outlook for corporate profits, which were very strong in 2018 and that led to concern about how they will be in 2019. 
  • There was concern with the US Federal reserve and how much more they will raise US interest rates.  Increased rates cause fears that it might stifle economic activity in 2019 and lower profit growth.  That concern seems to have been reduced recently with the latest public comments from the Federal reserve. 
  • We’re also experiencing heightened uncertainty brought on by the ongoing trade war between China and the US.
  •  In addition, key technology stocks that had been market leaders for several years lost their mojo and pulled on the major averages.

With the peak-to-trough decline in the S&P 500 Index totaling 19.7%, it didn’t reach the 20% threshold, which is the commonly accepted definition of a bear market.

Please contact me if you have any questions or concerns.

For those that like charts and numbers, you can read below:

Right now the S&P 500 Index is currently trading at an estimated 15.09 forward price to earnings ratio (see Figure 1), which is well under its 25-year average of 16.1, and that the price/earnings ratio continues to be the best long-term predictor of equity returns.

Figure 1: S&P 500 Valuation Measures

Source: J.P. Morgan

As of November 30, earnings per share for the S&P 500 Index are $41.52, which is still breaking records and is predicted to go even higher in upcoming quarters, according to J.P. Morgan Chase (see Figure 2).

Figure 2: Corporate Profits

Source: J.P. Morgan

The average intra-year market drop is 13.8% according to J.P. Morgan Chase, and that the market has been positive in 29 of the last 38 years (Figure 3). Those are good odds for any long-term investor.

Figure 3: Annual Returns and Intra-Year Declines

Source: J.P. Morgan

Bear markets generally accompanies a recession (2% of the time they don’t), and we are not nearing a recession.

Figure 4: Recessions and Bear Markets

Source: J.P. Morgan

Indeed, Figure 4 not only shows that the typical bear market accompanies a recession, but that it lasts about two-and-a-half years and creates a 30% decline.

Without a recession, the bear is usually brief (and relatively shallow) and there have only been two of them in the last 75 years.

Since 1949, there have been 13 instances where the S&P 500 dropped 20% or more.  Only 5 of those 13 instances went further than a 30% decline.  Each one of those 5 were caused by either a commodity spike, aggressive central bank activity, or extreme valuations, none of which apply today.

According to Figure 5 below, there is no current sign of a recession, as the Index of Leading Economic Indicators remains positive (albeit slowing a bit), so it is likely that any correction or bear will be brief in duration (six months or less).

Figure 5: Conference Board Leading Economic Index With 
Recessions Highlighted

Source: Advisor Perspectives

Finally major market declines are usually met with big rebounds

Here are the worst performing quarters in history for the S&P 500, along with one, three and five-year performance figures from the end of these terrible quarters:

You can see the ensuing 12-month, 36-month, and 60-month performance was positive the majority of the time, with respectable annualized gains.

Having said all of that, the current expansion is the second longest in history, and therefore the recession is likely coming sooner rather than later, so we do need to prepare for the bear market.

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