Behavioural finance analyst Ken Norquay says it is clear that the economic world is in chaos. Conservative investors should be much more cautious than usual.
In today’s world of fake news and too much information, it is often difficult to get a clear picture of what’s really happening. In this article, we look for clarity in the financial world. Once we have a clearer idea of what’s actually happening, we can formulate an appropriate reaction.
These are two separate and distinct steps: 1) clarify what’s actually happening, and 2) react appropriately. Many investors don’t use this approach. Instead, they plan to ‘not react’ no matter what happens. Then they analyse the economic world so as to support their passive view. This is ‘curve-fitting’. We will NOT be curve-fitting—we will NOT be looking for reasons to NOT react.
Our contention is that conservative investors can increase their long-term returns by participating in rising financial markets and avoiding down trends. For us, clarity means clearly identifying the trend or direction of a given financial phenomenon. Let’s now review our usual financial phenomena and clarify the wild and woolly action of the past few months.
US and Canadian stock markets
A dynamic down trend began on The Day of Twenties: 02/20/2020. Both the DJII and TSX composite dropped 38 per cent, and have since bounced back up by about half of the decline. Blue- chip market indices were trading like penny stocks and commodity futures! Clearly that was the ‘spike top’ we warned about in our last article. When speculative securities have spike tops, the norm is a 50 per cent initial re-tracing and then a downward follow through. At this time (early May 2020) the 50 per cent re-tracing has occurred. Following the longest bull market in US history, the bear market has finally begun. The trend is down.
US and Canadian bonds/long-term interest rates
Are you superstitious? On ‘The Ides of March’, Sunday, March 15, Jerome Powell, the chairman of the US Federal Reserve Board (the FED) announced that the FED would resume its QE monetary policy by buying long-term US treasury bonds without limits. Without limits? The FED was going to buy as much long-term paper as it takes to bolster money supply and keep interest rates low. The FED would print as much money as it takes to maintain liquidity in the economy. Clearly Powell has identified deflation as the main problem and will do “whatever it takes” to prevent deflation in the US economy.
After a few sharp zigzags and a few financial articles about negative interest rates, the bond market has stabilized. Statistically, the wild gyrations of the bond market have re-established the long-term down trend of both US and Canadian interest rates. They say investors should never ‘fight the FED’. (This means we should always invest in the same direction as the FED—and right now it is trying desperately to re-ignite inflation and keep interest rates low.) The long-term trend of US and Canadian bonds is UP—and this uptrend began in the early 1980s.
The USD vs. the basket of non-US currencies
For me, this is the unexpected surprise in The Corona Crash of 2020. The US dollar had moved up from just over 96 on New Years to just under 100 on the day before the crash began on 02/20/2020. In three weeks it dropped to under 95. In the next two weeks it bounced to almost 103 following FED Chairman Powell’s ‘print-as-much-as-it-takes’ Ides of March announcement.
These are HUGE gyrations for the reserve currency of the world’s banking system! Eventually, it settled down just over 100, even as the US government started distributing their newly created money, by issuing cheques to a variety of American businesses and individuals. The rise in the US dollar, even as the supply of US dollars increases without limit, shows just how strong the force of deflation is. The long-term trend is NEUTRAL. The short-term trend is UP. But the real story is how serious deflation really is.
The CAD and the price of oil vs. the USD
The loonie is acting like a petro-currency again. When oil prices collapse, the loonie collapses. When oil rises, the loonie rises. Since July 2008, when oil peaked at around $145 US per barrel, there have been three distinct slam-dunk declines and two major price recoveries. Each time, the declines went to a new low and the recoveries failed to go to a new high.
The same cycle has occurred in the Canadian dollar. At the three cyclical tops, the loonie peaked 3 to 13 months before oil peaked. The two cycles bottomed approximately simultaneously, less than a month apart. Both oil and the Canadian dollar have been in long term down trends since 2008. In making asset allocation decisions, the wild intermediate term trends of oil and the loonie are more important than this12-year trend. The loonie’s low occurred on March 20 and oil on April 21, 2020. It is too early to say whether those extremes ended the recent, violent short-term down trends, but for now, both oil and the loonie have reversed from down to up.
Precious metals prices
The trend of gold remains UP since its confirmation in June 2019. The up trend began in December 2015, stalled until June 2019 and continues higher now. The past few weeks have seen wild swings for both gold and gold mining stocks. This volatility is one reason why financial planners avoid precious metals investing. They risk losing clients because of their professional insensitivity to these swings. For volatility-sensitive investors, buying in regular intervals helps keep their emotions at bay. In the short term, gold’s current dynamic rally is running out of steam and needs time to cool down.
Right now, there is a valuable lesson in market psychology at play in energy investing. The financial press is full of gloom and doom about oil prices. Terms like ‘glut’, ‘subsidy’, ‘negative pricing’, ‘suspending dividends’, ‘preserving cash’, are used to predict even lower oil prices. There is a strong negative tone about investing in the energy sector. This is the investor attitude that occurs at bottoms in a market cycle. Contrast this with an RBC survey of the optimism/pessimism of US investment managers toward the stock market. Their April 2020 survey showed 60 per cent of managers were bullish on stocks, 20 per cent bearish and 20 per cent neutral. When the cyclical low for the stock market arrives in a few years, there will be very few bulls and many gloom and doom articles about why we should not invest in the stock market. Do you remember my article about Bob Farrell’s “The Three Cs of a Bear Market”? At the beginning of a down trend, investors see the decline and are complacent. Then, as the market continues lower, they become concerned. In the final stage of the long-term decline they capitulate, selling off their stocks aggressively. The Royal Bank’s survey shows that, having witnessed a 38 per cent decline in only a few weeks, the most sophisticated American institutional investors are complacent about the risk in stock market investing.
The market and economic world has come undone in the past two months. Amidst all the chaos, a few things are clear:
1. The central banks of most modern countries are taking extreme action to counter deflation. From this fact, we must conclude that deflation is a real threat.
2. The blue-chip stock market indices of modern economies have performed like penny stocks. And, so far, investors’ collective reaction is complacency. This is bearish. But, the FED and other central banks are printing money. This is bullish. The global pandemic has severely damaged the normal flow of money in the economies. This is bearish. As usual, there are two sides to the discussion. But, because of the increased volatility and emotion in the market, it is easier to make investment mistakes. In times like these, luck is more important than usual. Because of these facts, we should invest more conservatively than normal. Safety first is more important than usual.
3. In the economic world, everything is connected to everything else. Oil prices affect house prices in Calgary. Chinese deflation affects the action of Chinese real estate speculators in Vancouver. Trade sanctions against Russia affect Russian oil production, which affects oil prices in the USA. It’s all interconnected, like a house of cards.
It is clear that the economic world is in chaos. It’s correct for conservative investors to be much more cautious than usual.
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 may be reached at firstname.lastname@example.org.
This is an edited version of an article that was originally published for subscribers in the May, 2020, First Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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