Defence!

March 6, 2020

MARKET INSIGHTS

DEFENCE!

Media reports need to be fast and snappy i.e. (“The Dow lost 1200 points today!”).

But these dramatic summaries do not need to be understood by investors as indicative of their personal portfolios (i.e. if these are personally designed and actively managed).

In fact, performance ranges widely dependent on the specific portfolio composition.

To date this year, there is a 30% difference between the best and worst-performing sectors. On Thursday, several companies reached all-time highs.

This is typical during any period of high market stress (whatever the cause).

Certain sectors, such as the defensive, domestic, dividend-paying group, always perform relatively well.

We see this again in 2020 (with the coronavirus being the current risk):

As of Thursday night, the leading year-to-date sectors in 2020 are the expected groups including utilities (up 11.2% in Canada, up 4.7% in the US,) and real estate (up 6.7% in Canada, up 1.3% in the US).

The worst sector is energy (down 29.4% in the US, down 29.8% in Canada).

Concentration in the defensive sectors protects investors’ capital even under the current market stress conditions. 

The standard defensive shift from the steeply underperforming cyclical sectors toward the quality dividend sectors is, yet again, proving very worthwhile in preserving capital over the shorter term.

This is not indicated in the headline reports of the broad markets indices.

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NOTES FROM THE REAL WORLD …

The current sharp market decline was created by the usual culprits. 

• Overly aggressive hedge funds found themselves needing to reposition quickly at the earliest sign of risk. 
• Then, this sell-off was magnified by trend-following computer programs.

Private clients have not, by and large, been the sellers.

From a longer-term perspective, the current market decline has only brought the broad markets back to their decade-long uptrend channel (see below).

As is always the case, panic selling will be recognized as overdone and will create several “Buy Low” opportunities (at some point in the future).

Typically these opportunities will appear first in the traditional defensive, high dividend sectors (which will benefit particularly from the incredibly low bond yields).

The just-released monthly US jobs report confirmed continued strong growth with 273,000 new jobs, a 50-year low jobless rate (3.5%) and solid wage growth of 3.0%.

The Canadian labour market numbers showed similar positives.

The continuing well-performing economy will provide a strong foundation for a market recovery, once the current trading decline ends.

Patience is required though.

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A NOTE ON INTEREST RATES

The nervousness of the broad equity markets has been far exceeded by the nervousness of the bond markets which are achieving all-time lows in yields.

The historical all-time low for long term government bonds (10-year US Treasuries) was 1.36%. It was considered unimaginable that yields could go lower.

At present, the US 10-year yield is down to 0.72%. The similar Canadian rate is 0.70%. It is unclear how low these yields will go. (In Europe and Japan, similar bonds have had slightly negative yields for years).

Corresponding to equity and bond market concerns, both the Canadian and US central banks dropped their short-term rates this week by 0.50%.

This short rate drop is immediately flowing through to variable-rate mortgages, home equity credit lines and other prime rate based mortgages.

The futures markets expect the central banks to continue lowering short rates.

Lower yields on longer bonds will flow through to fixed-term interest rates i.e. fixed-rate mortgages.

This creates a miserable environment for conservative investors dependent on interest payments from fixed-income (GICs, bonds) for their retirement income.

However, for borrowers, owners of real estate, and long term investors in dividend-paying equities, the broad market turmoil is working in their strategic favour.