Why is the Market Up?

In this Newsletter, I will share my thoughts about why the market is up, and what, if anything, we should do about it.  

In my April Newsletter (apologies for the fact that there was no newsletter in May, June or July!), I set out a series of strategies to buffer against the possibility of a big drawdown in the market.  Well that post did not age well, but it’s still good to keep those strategies handy just in case. That’s the thing with investing; there are so many moving parts influencing the market in various (and sometimes surprising ways) that it’s really difficult predict the future in the short run. 

The Market Might Stay Up…

In the long run, statistics show that the market will be up 2 times out of 3 and I try to keep that in mind to temper my worries about the mismanagement of US economic policy. Understanding that the market is forward looking and currently up, perhaps all this tariff drama is not a thing when it comes to stock prices… is that possible?! Alternatively, perhaps this is just an example of an irrational market that is too positive. Nevertheless, investor sentiment seems to remain buy, buy, buy! Economic data, though mixed at this time, is not as bad as everyone predicted and seems to support this positivity to a certain extent. 

… Or Maybe It Won’t…

However, economic data tends to lag and it takes a few quarters to determine if an economic contraction is taking place and if company earnings are being affected. I do believe that negative data is on the way and that the risk of a big, prolonged drawdown is still very high, especially knowing that the current US President may be dreaming up new ways to shock the market.  Why would the drama end with the tariffs?

… Or Maybe It Will…

On the other hand, governments who like to spend a lot of money tend to be good for the stock market.  So it’s hard to believe that the US could fall into a recession while its spending is set to increase, generating more economic activity.  

…Or Maybe It Won’t

But this approach falls apart when prolonged deficit spending creates so much debt that paying the interest on that debt becomes difficult.  At that point, governments need to cut back (and become unpopular) or risk destroying their economy like a third-world country.  Unfortunately there is always incentive to spend government money in order to get re-elected. 

So The Debt Is a Thing, Right?

Are we headed toward debt destruction? Yes and No. Debt isn’t a bad thing if it’s managed correctly.  Think of your mortgage, or your car.  These debts create opportunities such as housing your family, getting to your job, etc. It’s all good as long as the dept is affordable. So how much debt is too much for the US economy? That is the big question. No one knows for sure. I’d guess that it’s likely more than people think. There is a limit though, and the higher the debt goes, the more likely it will reach it. It’s like a jack in the box – if you crank it forever, it will eventually pop. The US debt to GDP ratio is ~ 125%. This compares to Canada at ~ 110% and Japan over 200%.  No one seems to be too worried about Japan, so it could be a decade or more before the US debt to GDP ratio becomes a real problem.

The Market Does Not Seem To Care

As previously mentioned, the market seems to be unfazed by all the geopolitical risk. It’s getting used to the political madness and discounting the implications, assuming that actions such as tariffs will soon be reversed. This is narrow-minded in my opinion. The party will come to an end sooner or later and as a result, returns over the next few years may become muted. We simply can’t keep averaging 14 % annualized returns (which we have seen over the last 12 years).  An eventual reversion to the mean as it relates to returns is a near certainty.

Will We See Bad Returns for Years to Come?

Not necessarily. There is always money to be made somewhere and a good investor needs to keep their options open and consider other markets. It’s a big world out there and not long ago, international markets were competitive with US markets. US exceptionalism is a recent phenomena that is not necessarily here to stay. Innovation may still thrive in the US, but if we are looking for good returns, these may be more easily found in the UK or in the emerging markets. So there is hope for the small investor!

How Is My Defensive Portfolio Doing?

It’s been validating to see that the Hobby Portfolio has done super well, even when the market was down earlier in the year. The defensive strategy paid off.  Interestingly, as the market recovered, my lead in the market held, which suggests that the market has rotated a into broader and safer stocks.  This is somewhat surprising considering that big moves up or down tend to be linear – in other words, the stocks that fall are usually the ones that rise the most. Not so much this time.

Also surprising is in the last 3 months, only Information Technology and Communications Services sectors beat the average 9.66% SP500 return.  Every other sector under performed. 

Staying the Course

Because my portfolio is beating the market significantly, I have to be careful not to muck it up by making too many changes. My emotions are making me want to sell all my US positions and reinvest in Canada or abroad, especially as the US dollar keeps slipping.  However, that’s likely not a prudent strategy as the US market will continue to be the dominant country as it relates to world economic activity.  Retreating from that market could severely impact my returns if I am wrong.  

So diversification is key and that may mean some additional adjustments away from an expensive market to more reasonable priced markets, while maintaining a reasonable presence in the US market. My plan is to sell at least one more US position and repatriate those dollars back to my Canadian accounts. At the moment, US stocks represent ~ 37% of my portfolio, which is much less than the msci world index of 70 % or so.  I will soon hold only half the weight of the world index’s US component. 

Looking Forward

As outlined above, the US market could tank due to a prolonged contraction of the economy or it could surge as a result of the big spending bill stimulus.  Over the remainder of the year, maybe we could even see both. The only certainty is that no one knows for sure.  The Hobby Portfolio is ready no matter what happens.  Are you ready?

Marc’s Monthly Moves

• Buy Lululemon (LULU)
• Buy BCE small position
• Sell AX

Marc’s Portfolio YTD Performance

• Portfolio return: +14.7% (including currency loss)
• Portfolio return: +17.3% (without currency loss)
• S&P 500 return: +9.66 %
• RSP ETF S&P equal weight +6.07% 
• TSX: +12.85%

The portfolio is over performing the sp500 by 7.64% points.