Will Covid-19 precipitate a bear market?

Behavioural finance analyst Ken Norquay says buying energy stocks after the next bear market ends will be like buying the Dow Jones Industrials in mid-1932.

Buying energy stocks after the next bear market ends will be like buying the Dow Jones Industrials in mid-1932.

Modern journalism is characterized by repetition. When journalists repeat the same thought patterns, readers become comfortable with that way of thinking. That’s why, every January, we read so many reviews of the previous year and so many predictions about the New Year. It’s comforting.

But, in the world of investing, comfort can be costly. In my stock market book, Beyond the Bull, I warn that stock market ‘rules of thumb’ change constantly. Investor mood changes as economic cycles unfurl: optimism at tops, pessimism at bottoms. Today’s leaders become tomorrow’s laggards. Popular styles of investing fade into obscurity: value investing works for a while, then growth investing becomes the new way to riches. In the investment world, it’s wiser to be in a state of discomfort, continually wondering where the next loss-producing surprise will come from.

For 2020, we predict . . .

Following this train of thought, let’s refine our investment expectations for 2020. Our theory is that financial trends continue until they stop. (Ouch! Sometimes the truth can be SO painfully obvious!) Our job as investors is to notice when an up trend or down trend ends, and to make the appropriate adjustments to our portfolios. To do this, we need to know when a given financial trend stops. In the zigzagged world of stock prices, this is not easy. We know, with 100 per cent certainty, that our judgment will sometimes be wrong. Our continuing quest is to develop and improve our investment judgment. By doing this, we expect to increase the accuracy of our decisions and improve our long-term rate of return. It’s not about being comfortable: it’s about rate of return.

‘Comfortable’ is a state of mind. ‘Rate of return’ is a matter of accounting. As a market technician, my strategy is to increase our investment rate of return by not losing. We try our best to own investments that are trending up and not own investments in down trends. (Ouch! There’s another of those painfully obvious truths.)

This is in direct contrast to holding a diversified portfolio where some securities go up and some go down . . . and the ‘cash’ component goes nowhere. And you hold some gold ‘for insurance’ (whatever that means…). In the good times our ‘diversification’ rate of return will be fine. In the not-so-good times, it will be not-so fine.

But, good times or bad, we don’t want to be comfortable. We want to be vigilant.

Let’s review our usual financial trends and see how comfortable we feel about holding our portfolio of investments.

US stock market

Early in 2020, American stock market averages rose to yet another new high, extending the longevity of the current bull market to almost 11 years. Although the financial press has long since abandoned this story, it is the most important feature of today’s stock market. The market has never gone up for so long without a 30 per cent decline.

Question: We all know that the stock market alternates between up trends and down trends, between bull markets and bear markets. Why has it now gone up for almost 11 years?

The Short Answer: Liquidity. After the 2009-10 banking crisis, central banks flooded western economies with liquidity: they printed money. Do you remember the three Quantitative Easings—QE1, QE2 and QE3? These were the three stages of monetary power-printing when the US Federal Reserve Board super-stimulated the economy by buying long term bonds. A central bank ‘prints money’ to buy long term government bonds hoping that the money will find its way into the economy and give rise to the multiplier effect where consumers and businesses start the wheels of commerce again. And it worked! Of course, some of that excessive liquidity found its way into the stock market. That’s the main reason behind today’s 11-year bull market.

The Long Answer: Where else did that excess liquidity go? First, excess liquidity went into precious metals, base metals, oil and gas and other speculative commodities. Those markets peaked in 2011. Second, it went into real estate (housing) speculation, which peaked in Canada in 2017, and has not quite peaked in the US as yet.

Summary: The US stock market is in the longest up trend in its history. Uncomfortably long.

Canadian stock market

The TSX Composite Index also confirmed its up trend by reaching a new high this month. The Canadian economy and market are heavily weighted toward the resource sectors and those sectors peaked in 2011. Since then, the Canadian market has lagged behind the US.

Canadian and US bonds and interest rates

The longevity record of the stock market looks like a short-term blip compared to the bond market’s up trend. Bonds began their up trend in late 1981, 38+ years ago! So far, the high occurred in August 2019. The bond market faces a reality not known to the stock market: interest rates do not normally go to zero per cent. For that reason, bond prices can only go so high.

Statistically, since 2015, the Canadian and US bond markets have been more characterized by volatility than trend. We now consider that 38-year long-term up trend of bond prices to have turned neutral. Our analysis will focus more on the 1- or 2-year intermediate term trend of long term bond prices. That trend is currently down for bond prices—up for bond yields.

US dollar vs. basket of non-US currencies

The US dollar has been in a stable, sideways drift since 2015.

Canadian dollar vs. US dollar

Since the low in early 2016, the loonie has been in a trendless sideways drift. During 2019 it zigzagged ever so slightly higher. The trend is neutral.

For Canadians investors, businesses and consumers, this currency stability is quite comforting.

Gold vs. US dollar

Last June 2019, gold reaffirmed its long-term up trend. However, it appears that the first up-surge in price is nearing an end. How can we tell? Have you noticed all the advertising and hype around gold and junior gold stocks? The stock promoters have seen the optimism among unsophisticated investors toward precious metals stocks and are dumping their inflated penny stock mining shares now. Excessive optimism appears at tops, not bottoms. Serious longer-term investors should hold off purchases for a few months until the hype settles down, hoping for lower prices later in the year. Serious traders should consider those bearish gold and gold mining share ETFs for short-term trading.

Energy prices

The price of oil in US dollars has been in an up trend since the oil crash low in early 2016. The trend has been neutral for the last half of 2019. Not even the tension between Iran and the US moved the price of oil out of its sideways ‘going nowhere’ pattern.

Portfolio adjustments

Based on these observations of a variety of financial trends, what adjustments should we be making to our portfolios?

Because the stock market is still in an up trend, we should continue to own stocks. However, because this up trend is the longest in history, we need to be ready to reduce our exposure to the stock market when the trend reverses.

Because of weakness in the resource sectors, and stability in the currencies, it is safe to emphasize US stocks over Canadian stocks.

Because the long-term up trend of gold has resumed, we should continue to invest in precious metals or precious metals funds. Those who would like to add to their positions should wait until later this year before doing so: there is a strong possibility that the first upsurge is over and prices are now cooling off. Gold mining stocks are for traders, not investors.

Energy stocks are in a long term down trend even though the price of oil itself is in a gentle up trend and the overall stock market is in an up trend. These circumstances create a wonderful opportunity for long-term investors. Consider this: Sometime this year, the current record-long bull market will end and the inevitable bear market will begin. A few years later when that bear market ends, the oil and gas stocks will be severely depressed. Electric cars will be all the rage. Global warming’s fuel consumption restrictions will be the norm. Nuclear power will be seen as the answer to the energy shortage. That’s when to buy energy stocks. It will be like buying the Dow Jones Industrials in 1932.

Ken Norquay, Chartered Market Technician, 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 January 2020/Second Report Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.

The MoneyLetter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

Comments are closed.