The aging American bull market survived yet another test. Statistically, September has been the worst month for US stocks. But, on October 4, the S&P500 rose to a record intra-day high of 2540 and closed at a new record high of 2537. At this time last year, the US stock market seemed stagnant, ready for a fall. But the 2016 US election seemed to change all that. The S&P500 is up 20 per cent in the 11 months since election day. And the up trend continued right through the weakest month of the year. Is this unprecedented strength as real as it appears?
Let's review a bit of American economic history. In 2008-9 the world experienced a liquidity crunch, triggered by the US mortgage crisis. The world's central bankers responded by flooding their economies with money. The Americans had Quantitative Easing-QE1, QE2, QE3. It seemed the Q-easy money days would last forever. (The term 'quantitative easing' referred to an aggressive form of easy-money monetary policy. In the old days, this strategy was referred to as 'printing money'. The government sold short-term treasury bills and used the cash to buy long-term treasury bonds.)
The reason they were so successful at countering the crunch was that they had learned a lesson from the 1929-1932 liquidity crunch. At that time, central bankers implemented their liquidity flood slowly, until the depressed economy finally started to get a bit of traction. This time (2008-2009) they rushed to flood the economies with liquidity. Now, eight years after the actual crunch, the economies are starting to get a bit of traction.
During the 1929-1932 cash crunch, the Dow Jones Industrial Average (DJIA) dropped about 90 per cent. During the 2008-2009 crunch, it dropped just over 50 per cent. During the 1932 to 1937 liquidity flood, the DJIA rose almost 500 per cent. During the 2009-2017 liquidity flood, it has so far risen 245 per cent. From the 1937 top to the 1942 bottom, the DJIA dropped just over 50 per cent. When the current liquidity-driven bull market ends, we can expect a similar decline.
But, when will this 8-year bull market end?
That was a trick question. It is not important for you to predict the top. But it is important to react when the uptrend of the stock market finally stops and the downtrend begins. Don't lose your retirement savings when the inevitable bear market unfolds. If the stock market drops about 50 per cent again, as it did in 2001-2002 and again in 2008-2009, it will have to then double for you to break even. These giant market declines destroy your long-term rate of return. The key to healthy long-term rates of return is to avoid loss by avoiding the stock market in times of high risk. And in the financial world, high risk comes and goes like the autumn breeze.
Let's review the major financial trends that most affect Canadian investors, and try to judge the risk levels of our portfolios as the investment climate moves from a solid autumn to higher-risk winter.
The US stock market averages touched a new high in September, confirming its long-term uptrend.
The TSX Composite had a strong September, but is still below its February 2017 high of 15,943; it's approximately at its September 2014 high of 15,580. The long-term trend of the Canadian stock market is still neutral, or trendless.
The yield of long-term government bonds, both in Canada and the US, reversed from a downtrend to an uptrend in summer of 2016. Over the past few months, the uptrend has been more pronounced in Canada. American long-term interest rates have dropped slightly, while Canadian rates have risen.
The US dollar, measured against 'the basket' of non-US currencies, has been in an uptrend since the financial crisis of 2009. In the past few months, it has declined somewhat, but the long-term trend remains up, albeit a weak up trend. The Canadian dollar measured against the US dollar, has been sharply up in the past four months. This up trend has been so strong, that it has confirmed that the January 2016 low (the loonie had dropped to under 70 US cents) was THE low. The long-term trend of the Canadian dollar is up.
The price of gold vs. the US dollar bottomed in December 2015, and has been in a weak, volatile uptrend since.
Energy prices have been in an uptrend since the 8-month, slam-dunk bear market of 2015-2016. At this stage, oil prices have regained only 1/4 of their decline. Economies of oil-producing nations are still hurting. Economies of oil-consuming nations have benefitted.
Equity mutual funds perform poorly when stock markets are weak. That's why your Canadian growth funds have been so mediocre since 2000. When the Canadian dollar was weak, your US mutual funds did particularly well. Both the US stock market and the US dollar were strong. Canadian investors enjoyed a double uptrend. But those days are gone: US stocks are up and the US dollar is down vs. the loonie. In our last column, we suggested selling some stocks and equity mutual funds using the 'reversal model' as our sell signal. We continue to recommend this strategy. Because the US stock market moved up, our sell signal has moved up. If the S&P500 drops below 2300, reduce your exposure to equities by selling your weakest stocks.
In times of rising interest rates, long-term bonds, bond funds and high-yield mutual funds do poorly. You should reduce your holdings of these investments now. The fixed income part of your portfolio is best invested directly in short term government bonds-not bond mutual funds and not GICs.
In times when the Canadian dollar is falling, Canadian investors should have significant foreign investments. However, the Canadian dollar is currently in a long-term uptrend; it is prudent to have mostly Canadian investments now, and only small exposure to foreign securities.
I'd like to address an important point from our look at the similarities in economic history between 1929 to 1942 and 2007 to 2017. Easy money policy attracts speculators. Although most economies have experienced 10 years of easy-money monetary policy, speculators are not rolling the dice in the stock market. This time around, the speculation has been in real estate. As increasing interest rates cool the fires of speculation, most of the losses will occur in real estate, not in the stock market. When the cash crunch hit the US in 1929, the main casualty was the stock market. When it crunched in 2007, most of Americans' losses occurred in real estate. This time around, the excess is in real estate. Canada is particularly vulnerable right now.
Stock market speculators should continue to work in Canadian oil and gas stocks and precious metals stocks. Gold, silver, oil and natural gas are all in long-term up trends right now. And, the Canadian dollar is also in an up trend. You will have many opportunities in speculation if you focus on individual gold, silver, oil and gas stocks that are in up trends. In our June 2017 issue, we listed several examples of stocks in up trends. This is an updated list of stocks that I favour right now:
Canadian Natural Res (CNQ); Encana (ECA); Suncor (SU); Advantage O&G (AAV); Canacol Energy (CNE); Enerplus (ERF); Freehold Royalties (FRU); Kelt Exploration (KEL); NuVista Energy (NVA); Paramount Resources (POU); PrairieSky Royalty (PSK); Vermilion Energy (VET); iShares S&P/TSX Capped Energy Index ETF (XEG); Dalradian Resources (DNA); Sabina Gold & Silver (SBB); Premier Gold Mines (PG); Osisko Mining (OSK); Seabridge Gold (SEA); Semafo (SMF); NovaGold Resources (NG); OceanaGold (OGC); Centerra Gold (CG); New Gold (NGD); Iamgold (IMG); and Franco-Nevada (FNV).
These are volatile stocks in up trends. If you like to trade, use your trading system on these Canadian resource stocks. They all trade on the TSX; some also trade on US exchanges.
Two notes of caution: (1) The US dollar has been in a short-term down-trend for several months and could bounce up at any time. This will put downward pressure on gold and silver prices. (2) When the US stock market starts to go down in earnest, precious metals stocks will feel the downward pressure too.
One note of encouragement: several of these energy stocks have just gone to new multi-week highs. If your trading system calls for buying breakouts, you will find some gems on this list.
Ken Norquay, CMT, is the author of the book Beyond the Bull which discusses the impact of your personality on your long-term investments: behavioural finance. He can be reached at: kennorquay@yahoo.ca.
This is an edited version of an article that was originally published for subscribers in the October 2017/First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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