Third Quarter - Market Update

October 2013

“For every complex problem, there is an answer that is clear, simple, and wrong.”

  H.L. Mencken – 20^th Century American Journalist

“Everyone has a plan until they get punched in the face.”

  Mike Tyson – Former Heavyweight Champion of the World

Q3 Market Re-Cap

The world’s stock markets posted strong returns in the third quarter of 2013, staging a healthy rebound from the summer’s lows. As they have for several years, fixed-income markets continued to be driven by central bank policy, and they had mixed results for the period.

Bond yields rose and prices declined throughout the three-month period due to widespread anticipation that the U.S. Federal Reserve would scale back or “taper” its US$85 billion per month asset purchase program. In September, however, the Fed confirmed that it was leaving the program unchanged, awaiting further evidence of the economic recovery’s sustainability. The yield on the 10-year U.S. Treasury had climbed to 3.0% by mid-September (up from about 1.6% in late May), but began falling after the Fed’s announcement and finished the period at 2.6%.

Prices for other interest rate-sensitive asset classes, including investment-grade and high-yield corporate bonds, and real estate investment trusts, had also declined in tandem with the spike in bond yields, but regained some ground late in the third quarter. The DEX Universe Bond Index, which represents Canadian corporate and government bond prices, eked out a gain of 0.1% for the three-month period, though it was still down 1.6% for the year-to-date.

Global equity markets, meanwhile, were buoyed by continued modest economic growth, low interest rates and the Fed’s commitment to its stimulus program. U.S. stocks as measured by the S&P 500 Index reached a record high during the quarter, adding 5.2% for the three months and bringing its gain to 19.8% for the first nine months of the year (in U.S. dollars). Overseas, European bourses added to their gains for the year despite the difficult economic conditions in much of the region. In Asia, Japan’s Nikkei Index continued to move up, posting a world-leading return of 39.1% for the year-to-date. Investors also shrugged off their concerns about emerging markets, as these regions rebounded with a positive return for the quarter.

In Canada, the S&P/TSX Composite Index rose 6.3% on the strength of gains in every sector except utilities. Materials and financial stocks in particular helped the market, as commodity prices turned around, helping to lift metals and mining shares, and Canadian bank stocks rose with strong earnings reports during the quarter.

Market Insights & Commentary

It has now been five years since U.S. investment banking firm Lehman Brothers failed in September 2008, triggering the global financial crisis. Although effects of the crisis still linger, the good news is that the world economy is gradually healing. Over the past five years, the coordinated efforts of governments and central banks to return confidence to the financial system have been largely successful. The global economy remains on a path of slow growth, while corporate profits, employment and housing data have shown improvement. Inflation remains under control.

Equity markets have recovered strongly since the crisis, though with high levels of volatility. Markets remain sensitive to short-term disruptions, such as the U.S. government shutdown in the first week of October. In fact, the last five years have been an excellent time to be investing. For the five-year period ending September 30, 2013, the S&P 500 had an average annual compound return of 9.4% and the MSCI World Index, 7.8%. The S&P/TSX Composite Index lagged but still had a respectable return of 4.8% (all returns in Canadian dollars). This shows how maintaining a disciplined and diversified investment program can succeed, even through incredibly difficult conditions.

Sticking to Your Plan

Most investors might nod their heads to facts such as the ones above, and can agree to a plan for their portfolio by identifying the parameters within which their investments will be managed. Of course, agreeing to that plan is the easy part. The true test and ongoing challenge is sticking to any plan once it’s been implemented. As former heavyweight champion Mike Tyson pointed out, it’s easy to stick to your plan when things are going well, but it’s when investors get bloodied from market setbacks that sticking to their plan becomes the challenge.

It’s for that reason, when the markets are in turmoil, some investors will look for bold advice or dramatic shifts in their portfolios like moving all of their capital into cash or all into stocks. Unfortunately, the track record of those dramatic shifts is not a happy one. A few examples to illustrate the point:

·   During the tech mania of the late 1990’s, many investors abandoned the principles of sound diversification and over-weighted their portfolios with technology stocks.

·    Immediately after 2008, a search for safety led to large cash outflows away from stocks and into bonds, meaning that some investors missed the recovery since the market bottomed out in the spring of 2009.

·       While most investors initially agree to geographic diversification of their equity investments, many find it difficult to stick to that commitment. After a period of strong performance such as Canada saw in the last decade of the U.S. is seeing today, the instinctive response is often to over position a portfolio into what’s been doing well and to abandon what’s been under-performing, when in fact investors should do exactly the opposite.

In the words of the opening quote from H.L. Mencken, each of these examples was seen as a clear and simple answer to a complex problem of where to find the best returns in an uncertain environment. In the search for that clear answer, many investors abandoned the plans that they’d agreed to in calmer times, and did the wrong thing.

For this reason, one of the critical roles of any trusted advisor should be to offer a voice of reason and act as the emotional anchor – keeping investors’ highs from being too high and their lows from being too low. For many clients, helping them adhere to their plan, sometimes against their instincts, is how a good investment advisor provides the greatest value. There are occasions when sticking within the parameters of your plan may feel boring, but history shows that the key to successful investing is having a sensible plan, and then sticking to it. 

Uriah Kane, BA, CFP

The information provided herein is derived from various sources, including CI Investments, Signature Global Asset Management, Cambridge Global Asset Management, Globe and Mail, Dan Richards Client Insights Template Q3 Client Letter, National Post, Bank of Montreal Economics, and Trading Economics. Index information was provided by TD Newcrest and Bloomberg. This material is provided for general information only and is subject to change without notice. Every effort has been made to compile this material from reliable sources; however, no warranty can be made as to its accuracy or completeness. Before acting on any of the above, please contact me for individual financial advice based on your personal circumstances.