Your market outlook is filtered by your point of view

Our job, as conservative investors, is twofold: (i) To safeguard our money; and (ii) To get a reasonable return commensurate with our risk tolerance. Ken Norquay, author of the behavioral finance book Beyond the Bull and frequent contributor to The MoneyLetter, argues that the stock market has entered the high-risk part of the long-term cycle and that conservative investors should be more concerned with preserving capital than getting a higher return. Short-term government bonds and treasury bills are the safest investments.

Oceans of global economic data can distract us from what we should focus on. And what that data means depends on your personal point of view.

How must the economic world look to Russian investors? Russia exports oil and gas to Europe. From June 2014 to March 2015, oil prices dropped in half versus the U.S. dollar, and from June 2014 to February 2015, the ruble dropped in half. These are staggering jolts for the Russian economy. In which currency are Russian/European oil deals made—rubles, euros or U.S. dollars? If we take the Russian point of view, we will understand how important these seemingly unpredictable details are.

If Russian/European oil deals were done in U.S. dollars, as so many international oil deals are, the Russians are experiencing both the good news and the bad. Oil prices dropped in half in U.S. dollars; therefore Russia’s oil revenue dropped in half. But because their currency dropped in half too, in rubles, they break even. Consider the impact on the Russian economy if their oil deals were done in euros—or in rubles.

Russian communists like to think they can control and manage their economic world, but they can’t. How can Russians manage the value of the U.S. dollar versus the euro, or the price of oil and gas? They can’t!

In international economics, everything is interconnected. Everything affects everything else. What a complex knot it is! How can we keep clarity in our market outlook for such a world?

It is important that we not view the economic world objectively, as we were taught in school. The Russians see things differently from the Europeans. North Americans see things differently from South Americans. There is no such thing as objective thought in international finance. However, as soon as we think from the point of view of our own family’s well-being or our own country’s well-being, we can more easily untangle the knots of financial interconnectedness. Let us review several of the world’s economic trends, and try to sort out how they affect our personal position as investors.

U.S. market outlook reverses to downtrend, risk moves up

First of all, let’s review our thesis that in spring of this year, the U.S. stock market reversed from an uptrend to a downtrend and that stock market investors now face significant risk. You can follow our reasoning by reviewing our articles in The MoneyLetter from earlier in 2015.

We also note that the Canadian stock market has been in a downtrend for 13 months, since September 2014. Canadian and American investors should reduce exposure to the stock market now.

The greenback’s dramatic uptrend

Secondly, we observe that the American dollar, when measured against the basket of non-U.S. currencies, was trendless from the financial crisis low of 2008 to July 2014. Then it broke into a dramatic uptrend, increasing 25 per cent in the eight months from July 2014 to March 2015. At the same time, the Canadian dollar declined 20 per cent from US$0.925 to $0.74. (Note: The top of the actual long-term uptrend-to-downtrend reversal of the Canadian dollar occurred in July 2011 when the commodities boom ended. The loonie is currently down 29 per cent from its July 2011 high.) In our March 2014 article of The MoneyLetter, we advised: “We [Canadian investors] profit from the downtrend of the Canadian dollar by increasing the foreign content of our overall portfolios.”

Commodities’ peak and fall

Thirdly, commodities markets peaked in 2011. The price of base metals, precious metals, energy and agricultural commodities have been in downtrends since then.

Fourth, the most dramatic economic trend of 2014 was the utter collapse of the price of oil. It dropped by more than 50 per cent in the nine months from June 2014 to March 2015.

Contrasting economic performances of Canada, the U.S. and Europe

The Canadian economy slipped into a recession in the first six months of 2015. Other economies where oil exports play an important role also felt the negative impact of the collapse of the price of oil and gas.

The U.S. economy has been slowly recovering and holding its own since the recession of 2008-9. The “quantitative easing” monetary policies implemented in 2008 have done their job. American were hoping that the “easing” could be slowly withdrawn as the economy grew and real estate prices recovered. It’s been a long slow ride.

European economics is similar to American. Their central banks have eased their monetary policies, and their economies have recovered. The colorful nationalistic flashes from Portugal, Italy, Ireland, Greece, Spain (the so-called “PIIGS”) have made European economics more fiery than American, but the causes and effects within the two economies are similar.

From March 2014 to March 2015 the euro declined 25 per cent against the U.S. dollar.

‘The skillful use of blunt instruments’

Can those well meaning managers of the central banks of Europe manage their currencies and commodities prices? Can the Bank of Canada control the price of oil and gas, or copper, or grains? Former Prime Minister Lester Pearson said it best when he quoted one of his old economics professors, describing the operation of the Bank of Canada as “the skillful use of blunt instruments”. All central bankers are in the same jam as the Russians: try as they will, they can’t control it. If they could, investing would be easy. (Note: What about those well-meaning managers of your equity mutual funds or your pension plan? What can they do when autumn leaves start to fall?)

How does all this affect me?

Our point is that managing economic trends is impossible. Rather than dream about someone managing the unmanageable, investors should manage themselves. “What’s in it for me?” is a valid question in the economic world. How do all these monetary complexities affect me?

Americans’ investments are most affected by attempts by The Federal Reserve Board (“The Fed”) to manage the U.S. economy. One important measure of Fed policy is interest rates. Increasing rates means monetary policy is being restricted, decreasing rates means easier money. Easy money contributes to stock market up trends. Tight money eventually moves the stock market lower.

The Counter-Cyclical Model

This simple mechanical fact is the basis of our Counter-Cyclical Model for judging the long-term trend of the stock market. At stock market tops, long-term interest rates bottom (i.e., the long-term bond market peaks). Then, about six months later, the stock market peaks. And about six month after that, the economy starts to weaken. This time ’round, the U.S. bond market peaked in January/February 2015, the U.S. stock market peaked May of 2015 and we expect weakness in the U.S. economy in the last quarter if this year or early next year.

Question: What about all those other trends—oil, currencies, commodities, employment, housing starts, inventories? How do they fit in to the puzzle?

Answer: Those statistics help the central bankers do their job of trying to manage the unmanageable. Their job is to protect their country’s economy. They do this by “the skillful use of blunt instruments.”

Our ‘blunt instruments’

Our job is to protect our personal economic well-being. We do that by managing our investment portfolios—also, by means of the skillful use of blunt instruments. These are our blunt instruments:

(i)  Owning an investment or not owning it.

(ii) And when we own it, how much do we own?

All those statistics don’t help us manage our personal investments. When oil prices drop in half, when the Canadian dollar drops 20 per cent, when the euro and ruble and U.S. dollar rise and fall, how should we react? What should we react to?

Two things to watch

My suggestion is that we react to two things only:

(i) The trend of long-term interest rates in the U.S.A. In the past, the peaking of long-term interest rates has preceded an uptrend-to-downtrend reversal in the U.S. stock market.

(ii) The attitude of U.S. investors toward stock market investing. In the past, investors have been overly optimistic at stock market tops and overly pessimistic at bottoms.

Our job versus the central banks’

We can leave the nuances of economic analysis to the Bank of Canada and the Fed. Let them sort out election results, currency wars, commodities prices and the economy. Let them do their job and let us do our job.

Our job, as conservative investors, is twofold: (i) to safeguard our money; and (ii) to get a reasonable return commensurate with our risk tolerance.  As speculators, our job is to maximize our returns and minimize our risk.

The stock market has entered the high-risk part of the long-term cycle: Conservative investors should be more concerned with preserving capital than getting a higher return. Short-term government bonds and treasury bills are the safest investments. Speculators should investigate selling stocks short or speculating with put options. Gold appears to have bottomed (finally!) and junior gold mining stocks have speculative appeal.


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

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