If you looked at headlines last week, you undoubtedly would have been made aware that markets corrected rather dramatically. Despite being overblown by said headlines, recent market movements are a clear sign that market volatility is returning to more normal levels following the unusually long period of calm we enjoyed during 2017.
There are a number of reasons why we think markets have become turbulent again. In short, we think there is a lot of sentiment—opinions, feelings and emotions—that are causing market volatility today.
Global trade, interest rates and lingering European concerns
The most obvious contributor is the possibility and gravity of an all-out trade war between China and the United States—notably the participants in the world's largest trading relationship.
Additionally, while interest rates are still quite low historically, bond yields climbed higher last week over rumblings that perhaps the Federal Reserve is raising interest rates too quickly.
Beyond post-Brexit uncertainty, we've seen concerns about Italy's budget, which was submitted to the European Union (EU) for review this week. The proposed budget would see Italy's deficit rise to 2.4% of the country's GDP in the coming years, which is well above the maximum deficit level (0.8% of GDP) allowable under EU mandates. If Brussels rejects Italy's budget, this could set the stage for a showdown between the country and the EU.
Volatility is normal and part of a healthy market
No matter the causes at any given time, we know that volatility, the tendency for returns to vary around their average, is a normal occurrence in global stock markets. It's part of normal and healthy market behaviour. History shows that it's unrealistic to expect markets to go up all the time without volatility.
Recent market movements should serve as a reminder that we need to continue to manage portfolios with discipline and remain properly diversified.
In the short term we are not making any major changes to our portfolios in response to market volatility. That said, we continue to assess what's driving market risk. We examine economic and fundamental data, and we will continue to re-adjust our positioning as needed.
At the moment, our proprietary bear market indicator, which looks at inflation, economic growth, corporate conditions and capital markets, tells us that current market gyrations are normal, and not a descent into bear market territory.
Making the case for equities
Presently, our indicators and analysis generally suggest that stocks will continue to outperform bonds over the next 12 months. Markets and economies around the world enjoyed a synchronized period of economic growth in 2017 that transitioned into early 2018. But, we expect to see some divergence going forward.
Regarding growth, we have seen the U.S. take the lead in North America, with Canada not far behind. European data appears to have peaked and China is carefully managing its slow down.
Our tactical positioning
We've expected for some time now that volatility would return to markets in 2018. Over the past quarter we made some changes to our mix of equities:
- We've significantly reduced our underweight position in Canadian stocks because we expect oil prices to remain firm, and possibly move higher in the future. We also see Canada benefiting from U.S. economic strength.
- We've increased our overweight U.S. position because the economy and corporate earnings are very strong and continue to be boosted by recent fiscal stimulus efforts.
- We've reduced our overweight position in Germany and France. Although indicators suggest stocks there will remain in positive territory, we think the Eurozone business cycle has peaked. The economy is still growing, but at a slower rate than before.
- We introduced an underweight to emerging market equities, as many face domestic challenges. The higher U.S. dollar and interest rates also make it more difficult for emerging market companies to do business. Trade tensions continue to affect the picture, as well.
- We've reduced our U.S. dollar overweight position as we could see some downward pressure on the currency if markets rally.
- We are now slightly overweight the Canadian dollar, given that NAFTA uncertainty has been removed. We also expect the Bank of Canada to continue to raise interest rates alongside the U.S. Federal Reserve, a positive for our currency.
Stick to the plan
MD is watching and managing all of these market risks (and others), as we manage your portfolio on a day-to-day basis, so you don't have to. Remember that market volatility is a normal part of investing and a sign of a healthy market—in fact, it can provide us with opportunities to add value over time.
Stay disciplined and stick to your long-term plan.
Talk to your MD Advisor if you have any questions about recent market movements, your portfolio or our recent tactical portfolio adjustments. He or she will be happy to provide you with more information.