Opportunity is Knocking - iA Investment Update

iA Investment Update

Opportunity is Knocking

Given recent market volatility please find below the commentary

from iA's Investment Management team led by Clément Gignac, Senior Vice-President & Chief Economist, and Sébastien McMahon Senior Economist.

In addition we are also sharing Forstrong Global Asset Management's views on how investors should respond to current market conditions from Tyler Mordy President and Chief Investment Officer. You'll find Forstrong Global Asset Management's funds in our latest Portfolio Samples for February 2018.

iA Investment Management

What’s happening?

After 2017 turned out to be the less volatile year on record, one was to expect that the calm would not last eternally. After all, as physicists say, what cannot last forever will eventually stop.

After a roaring start to the year, which saw January rank amongst the best starts ever to the S&P 500, volatility did return with a bang. The genesis of the pullback clearly lied in the synchronized jump in interest rates, as the U.S. tax reform was quickly priced into inflation expectations. The second leg, however, was likely caused by the unwinding of the retail short-volatility trade, made possible by the advent of ETFs.

Many signs were pointing towards some short-term vulnerability in the markets: the 14% gap between the level of the S&P 500 and its 200-days moving average, or the fact that we had just recorded the longest stretch without a 3% drawdown since 1950, at 448 days (see table below), to name a few. As is common during corrections, we quickly shifted to a “stock market” instead of a “market of stocks”, leaving few places to hide.

What to do now?

We remain firmly in the camp that this is a buying opportunity, since we see a prolonged business cycle. None of the fundamentals have changed even one bit, and this pullback simply gives a good entry point heading into RRSP season. Also, it is worth nothing that historically, when the VIX index jumps to current levels, the expected return over the next 2 to 3 months is firmly in positive territory (see table below).

A short-term, 10%+ correction is a normal occurrence, happening historically once every 9 months on average (the last one was in early 2016).

We also know from history that a bear market, which is defined by a 20%+ fall from the recent peak, coincides with recessions, and our economic dashboards are still flashing green. In fact, historically, we have rarely seen a bear market starting when the S&P 500 is at or below its long-term trend, as it remains currently despite the recent hefty valuations (see chart below).

The result is that the S&P 500 went from a hefty valuation of 18.5x fwd earnings in late January to a more reasonable 16.7x as of February 6. And as equities were hit pretty much everywhere across the globe, we find ourselves with much more attractive pricing everywhere. For example, the S&P TSX is trading at 14.7x fwd earnings, the same level as in early 2016 when the world was fearing a recession. In a nutshell, whatever markets you liked in late January, you should now love in February.

Where to from here?

Our view is that the global synchronization story remains well anchored, that inflation should be climbing slowly from here on, and that the Fed should hike 3 to 4 times before the year is done. So, nothing changed in our macro view and we still expect to end the year with positive returns on equities, and the 10-year rate above 3% in the U.S.

As we have warned for some time, a healthy return of volatility should remain a major theme in 2018, favouring an active management style. 

iA Investment Management

Volatility Returns: No Need To Panic

Dear Advisor,

Volatility has returned to world financial markets. In fact, one volatility index saw its second largest jump in 32 years. What to make of all this?

Actually, recent declines do not catch us surprised. To start, market volatility, sell-offs, excessive surges and periodic crisis are all normal. Historically, US equities tend to have 10% declines every 9 months on average. 

What is not normal are years like 2017 where the US stock market's maximum decline from peak to trough was just 3%. It was quite the run. But during these periods, investors must not lose sight of context nor become complacent with current conditions.

What's Happening

Heading into 2018, Forstrong's Investment Team was expecting volatility to emerge. Why? First, despite relatively robust global growth, investor expectations had become too high relative to the fundamental outlook. As we wrote in the December 2017 issue of Super Trends and Tactical Views (read here ):

"... from time to time, markets run ahead of themselves, setting themselves up for a stumble. The issue today is that the underlying fundamentals and the behavioural side of markets are showing conflicting signals. In this environment, the right thing to do is reduce risk and rely on global diversification for defense."

Secondly, many global Super Trends are now shifting. Household incomes are finally rising. Fiscal stimulus levers have been engaged. And, animal spirts are back. The game is changing.

During these transitions, heightened volatility typically surfaces as new leadership takes hold.

What To Do

The drop on Monday triggered a number of panic-type readings. During times like these, it is always useful to revisit the role of the portfolio manager: why do clients pay us to manage their wealth? It is not for flawless clairvoyance. Rather, we are paid to anticipate probable risks, prepare for opportunities and, importantly, not lose our proverbial minds when everyone else has lost theirs.

More often than not, large declines from a high tend to lead to capitulation that creates a strong rebound. In order to successfully navigate these dynamics, a disciplined decision-making framework that can extract emotion from the process is crucial. Forstrong's investment team remains committed to this approach.

Looking ahead, the best possible defense against market volatility continues to be wide global diversification with an orientation to the longer-running macro themes playing out in the world economy (the rise of the Asian consumer, inflationary dynamics emerging, etc.)

Our global ETF portfolios have already been positioned for such trends and shifting regimes, with an ultimate goal of avoiding the "big mistakes" and continuously adapting in an era of new realities. That remains the best way to secure the financial futures of your clients.

Sincerely,

Tyler Mordy

President and Chief Investment Officer  

IAG Individual Investment & Retirement Products Sales Team