Market Insights: Investment Bouquet

Market Insights: Investment Bouquet

In the spirit of Valentine's Day, we thought we would share this recent quote from sagacious market strategist Jeff Saut: "Folks, this business is NOT a science as many pundits would suggest. It is an art form whereby you connect a number of data points and hopefully weave them into an investment bouquet!” An investment bouquet, what a thought! In past market insight posts, we have described parts of our investment process and decision making in terms of being probabilities as opposed to sure things. With incredible amounts of economic information coming in from so many sources on a daily basis, over time we have learned to focus on the longer-term leading indicators that have been successful for us in the past, in addition to looking at the underlying breadth/strength and sentiment of the markets as opposed to outright price levels to determine potential turning points in the market, and removing most of the noise out there primarily from the media.

In our Fourth Quarter Wrap-up commentary that we posted on January 11th, despite the carnage we had witnessed, our positive fundamental core thesis was unchanged. In addition, our Milestone Recession Risk Composite had yet to flash a warning signal, and it still hasn't today. With many factors at play, but primarily the Fed Policy mistake in early December, we believed the market swoon was an event-driven crash, as opposed to a recessionary signal. We continued to see very little stress in the credit markets, and with that among other things, we felt it prudent to stay the course. In our view, the current secular bull market could still likely have years left to go. 

We will continue to use our objective indicators to guide us through this cycle, rather than reacting to fear. These indicators will provide the necessary warning signals when they are needed most, and keep our process focused on the long-term as opposed to making hasty decisions. We want to point out that there were all-time record outflows of U.S. equity mutual funds in December, only to see a large amount of inflows again in January. It is this short-term selling at lows and buying back at higher levels that causes much of the underperformance of the retail investor market. As you can see from the following charts based on data from the Dalbar Institute, investors are their worst enemy. Even more concerning than the underperformance of the average investor vs. the market, is the underperformance of the average investor compared to the average mutual fund (second chart). This is due to investors selling their funds based on fear and buying them based on greed, also known as the behavioural gap. 

So where do markets stand now? After enduring a non-recessionary market crash in December, equity markets have had a sharp recovery back to around their 200-day moving averages. Markets would still need to rise another 6% or so to get back to the highs made in September. Typically, but not always, markets that have a good start to the year run out of energy in mid-February. This combined with short-term overbought readings makes us believe that there is a good probability of markets stalling out or pulling back in the near-term. Although there are many headwinds worth noting (slowing global growth and softer economic data, Brexit is unclear, toxic U.S. political environment, difficult trade negotiations with China, easing of earnings growth), this also suggests that the U.S. Fed will be more dovish over coming months which should help support markets. At this point in time, however, our primary recession indicators for the U.S., including a strong credit market, still point to moderately low risk.