Pete Seeger’s 1950s hit ‘Turn! Turn! Turn! To everything there is a season’ popularized the message of Ecclesiastes 3:1-8. So why, behavioural finance analyst Ken Norquay wonders, does the securities industry present the stock market as one long, volatile, linear up trend?
Most people today experience time in linear terms. We appear to move from the past, to the present and to the future. It’s hard for us to imagine time in any other way. But, our foremothers and forefathers experienced time cyclically. In their agricultural society, time was experienced as repetitive cycles.
Every day they would experience night and day. Every year, winter, spring, summer, autumn and winter again. Repetitive cycles in time. Would it help us invest more wisely if we thought about the stock market in terms of repetitive cycles instead of linear movements?
Buy low, sell high
Is the stock market a series of alternating bullish and bearish seasons just as farming is a series of alternating planting and harvesting seasons? The industry presents the stock market as a long, volatile, linear up trend where investors should buy and not worry about the ups and downs. Why do they not present equity investing as a series of alternating bull and bear markets, where investors should attempt to buy low and sell high?
The legendary mutual fund manager Sir John Templeton used to say: “We shop the world for bargains (i.e. under-priced stocks). We hold them until they are fully valued.” Sir John was a master at buying low and selling high. Why has the investment industry abandoned this approach and wholeheartedly embraced the linear time model of a stock market where the down part of the cycle is considered ‘volatility’ within a long term up trend?
It’s about profit. Investment professionals make money from retail clients either by charging a fee for managing their investments or a commission for executing buy and sell orders. When discount commissions were introduced, the industry swung its emphasis to the more profitable management fees.
This little quirk of profitability accounts for the change in the way investors perceive time in the stock market. The focus is now on the investor rather than the investment. Modern humans live our lives in linear time: we are born, we grow up, we grow old and we die. We believe the stock market is like that. It grows almost 10 per cent per year over the long term, and has minor ups and downs along the way.
But that’s not what’s really going on
If we regard the stock market the way a farmer regards agriculture, it looks entirely different. We see a time to plant and a time to reap the harvest: a time to buy and a time to sell. The buy and sell timing is not tied to our personal life, but to the psychology of the investment community.
The stock market is based on alternating cycles of economic optimism and pessimism: it’s psychological. The stock markets become overpriced when investor optimism bubbles into a frenzied froth of buying. This is a cycle top. Super-skepticism is the opposite of this unbridled enthusiasm, when investors dump their stocks into the market in fear of losing even more money. This occurs at the bottom of the cycle.
The most recent cycle bottom occurred in 2009 amidst news of bank failures and a real estate collapse. The most recent top occurred over the year 2018 following the parabolic rise in the US market after their presidential election. The market is now in the down part of the cycle where optimism gives way to fear and pessimism.
The up part of the cycle (2009–2018) was accompanied by a massive liquidity binge by the US Federal Reserve Board. Their famous QE3 program amounted to printing money: the nation whose currency is the reserve currency of the world’s banking system printed money on a massive scale not seen since the 1930s. The S&P500 index rose 341 per cent from its low in March 2009 over the nine year bull market, the longest period in American history.
Note: Although this bull market was the longest, it was not the biggest in terms of percentage gain. That honour goes to the 1932 to 1935 bull market, which rose over 500 per cent from low to high in approximately 3 years. It too, was powered by aggressive monetary stimulation by the FED.
MAGA spawned an excess optimism
The up part of that spectacular liquidity-driven bull market is easy to see. Psychologically, investors went from fear of a collapse of American industry (GM and Chrysler went broke) to rosy optimism about Mr. Trump’s plans to make America great again. This excess in optimism was difficult to see because of the very negative way the press covers US politics. If you want to find the optimism, ignore the media and look at the market itself: the major US stock market averages all went into parabolic rises following the presidential election in 2016.
Our view is that the very sharp declines in February and October-December 2018 signaled the top and the market is currently in a long-term cyclical down trend. That’s how it looks to those who experience the market as cycles in human psychology.
How does the market appear to the customers of Fidelity, the world’s largest mutual fund? This is a ‘cut and paste’ from Yahoo! Finance in early February: “Despite severe market volatility last year, investors saving for retirement are not panicking, according to a new report from Fidelity. . . . Despite the drop, Fidelity reports that “very few” people decided to make changes to their investments during the tumultuous fourth quarter, in which the S&P 500 lost 14 per cent.”
In other words, Fidelity is telling us their clients are still optimistic about the future of the stock market. (Note: Fidelity claims to have 30 million customers. That’s close to the total population of Canada!) Ironically, very sharp declines like we saw in 2018 are caused by institutional selling. Money managers like Fidelity sell en masse. It appears that Fidelity is cautious and its customers are optimistic.
Long-term trends affecting investments
Let’s review the long-term financial trends that most impact our investments.
The US stock market is in a long-term down trend, as outlined in our opening commentary. It touched a new all-time high last September, and collapsed to its low for the year in December.
The Canadian stock market’s long-term trend is also down. But because of weakness in the resource sectors, the TSX did not enjoy the spectacular upward blitz experienced by US investors; expect the ensuing decline to be less severe too.
Long-term US interest rates as measured by the 20-year+ bond market: Interest rates are going up. Bonds have been in a bear market since summer 2016. This trend has been confirmed by the FED, which has raised short-term interest rates several times in the past two years.
Canadian interest rates are moving, but not in lock step with American. The increases are not quite as much. The long-term trend of Canadian interest rates is up.
The US dollar vs. the basket of non-US currencies has been neutral and trendless since spring 2015.
The Canadian dollar vs. the US dollar has been neutral and trendless since the winter of 2016, after the severe drop in world oil prices.
Use ETFs for bonds, currencies, energy and precious metals
The price of energy in US dollars has been in an uptrend since winter 2016, but has undergone a sharp downward move from October to December 2018. The long-term trend is still up. Short term traders can look for opportunities in oil or gas exchange-traded funds (ETFs). Avoid energy stocks: they are more risky because of the bearish bias of the overall stock market.
Gold, priced in US dollars, is neutral and trendless on the long term. A weak short-term rally appears to be ending. Traders should look for entry points in bearish gold or silver ETFs during the next few weeks.
We have briefly reviewed the price trends of several independent financial entities. The investment industry relies heavily on private investors owning individual corporate securities traded on the stock markets. But modern investors do not have to be restricted by that premise. We can invest in bonds, currencies, energy and precious metals without having to risk our capital in a down trending stock market.
ETFs like SPDR Gold Trust (NYSEARCA—GLD) and iShares Silver Trust (NYSEARCA—SLV), and a host of open-ended bullion funds can be used to invest in precious metals. ETFs like United States Oil Fund (NYSEARCA—USO) and ProShares Ultra Bloomberg Crude Oil (NYSEARCA—UCO) can be used to invest in oil. Invesco CurrencyShares Canadian Dollar (NYSEARCA—FXC) can be used to invest in the Canadian Dollar vs the US Dollar. Bonds can be purchased as mutual funds or ETFs. There is no shortage of alternatives to stock market investing.
Ken Norquay is a Chartered Market Technician and author of the book Beyond the Bull which discusses the impact of your personality on your long-term investing: behavioural finance. He can be reached at firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the February 2019/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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The MoneyLetter •5/2/19 •