The economy is exhibiting signs of stalling but the stock market appears strong. What can be done to protect your investment portfolio? Here are some signals to consider and why you may need to ease up and manage your risk.
The number one failure by professional investment managers and individual investors is linking the strength of the stock market to the strength of the economy. At times these can merge but there is no real correlation between the two.
The strength of the economy is a direct reflection of consumer confidence and spending. There are many measures to determine the health of the economy but in simple terms a person can get a pretty good snapshot by looking at the employment numbers and the (“GDP”) Gross Domestic Product. GDP is a measurement of the dollar value of all of the country’s goods and services produced per capita. In developed countries such as Canada or the United States a strong economy has a GDP of between three and four percent. Less developed countries can have 6.8 percent as in China or India with 6.7 percent in 2017, Canada with 3.0% and the USA at 2.2%.
Central banks produce their annual expectations for the coming year. In this way an investor or Portfolio Manager (“PM”) can gauge the strength or weakness of the economy. With these numbers an analyst can predict the currency and whether interest rates are likely to rise, fall or remain constant. So let’s take a look at the predictions of 2019.
International Monetary Fund (IMF) forecast for 2019 as of April 2019:
China falling to 6.2% it’s weakest pace since 1990
India growing to 7.3% but down from earlier forecasts
USA unchanged from 2018 at 2.5%
Canada downgraded to 1.5%
World downgraded to 3.3% from an earlier forecast of 3.5%
(Reasons given: Brexit and the U.S. / China Trade War)
Yet with all of the economic signals of slowing consumer spending, bankruptcies, disappointing corporate earnings we experience new stock market highs. The recent IPO by Uber opened at $45 per share down from an expectation of $70 to $75 per share. Uber management stated they do not foresee profits any time soon or ever. With that being said the offering sold out.
Some analysts comment of more new highs to come and others are stating that caution is prudent but nobody is saying SELL. Why is there such a discrepancy in expectations?
There are two major answers to that question:
- PM’s are afraid of leaving money on the table. If they move to cash and the market continues its rally they will lag their competitors for new assets and year end bonuses;
- Euphoria. I believe we are in the euphoria phase of this current Bull market.
Now that we know our own economy is experiencing slowing growth, but also other country’s who we export to or import from are also exhibiting slower growth which translates into reduced consumer spending. Then why is the stock market continuing its rally and flirting with new all-time highs.
Largely the reason is the stock markets of the world rise or fall as a result of reactionary opportunity. Investment time horizons have decreased thanks to day trading and computerized modeling. In order to sustain a long term perspective an investor must be prepared to undertake market swings, sometimes large market swings.
Are the markets reacting to economic news? Yes but then later in the day they reverse again as profit taking kicks-in. Are they paying attention to longer term indicators? Not really because if they were we would hear of PMs moving a percentage of their assets into cash. Another reason to support the claim of reactionary opportunism is that the Uber IPO actually had more than a single investor. I can’t think of a single time when a company declares they are likely to never turn a profit and don’t fade-away into obscurity.
Oh wait, there was a time from 1995 to roughly 2000 when the world experienced the dot-com bubble. This was at an early time of the internet when virtually any internet based technology company whether they were viable or not could go public.
The NASDAQ stock index went crazy moving from 600 to 5,000 points. Dot-com companies were run by people who were barely out of university and were going public. They were raising hundreds of millions of dollars of capital without a clear business plan and many more had no earnings whatsoever. Employees were paid with free pizza and given company shares to off-set the fact they were not making money.
In 2012 Jesse Colombo said it well “For example, Pets.com, which had intended to become an online pet products retailer, was losing money before it went public and raised billions of dollars. Numerous dot-com companies wasted millions of dollars on frivolous parties to celebrate their IPOs. There are even stories of dot-com employees who walked around their offices barefoot and played foosball and video games during the work day. At the peak of the dot-com bubble in 1999, it was said that a new millionaire was created every 60 seconds in Silicon Valley.”
Sound familiar. When you observe these actions you know the markets are in the euphoria phase. Oh wait, we just witnessed Lyft’s IPO in March launch at $72.00 per share, today it closed at $51.09 down 29 percent in 6 weeks. Uber which was expected to open in the same $72.00 range opened at a reduced IPO price of $45 and by days end closed at $41.57 down 7.6 percent. I’d say we are in a clear euphoria phase of the bull market, wouldn’t you?
Now the question is what do we do. An individual investor may elect to move to cash and wait. A professional Portfolio Manager may find that decision rather extreme. The fund or PM would more likely initiate a rolling hedge to protect him in the case of a pull-back and allow his profits to run. As with all market corrections, nobody knows for sure the date it will occur nor how low the markets will correct.
So here’s what you do, start taking profits and leave your money in cash. If you are the owner of a mutual fund, a hedge fund or an RRSP or 401k you will need to trust them to do the right thing. Problem is that history tells us they will do nothing except be surprised at how such few people could predict the carnage. One thing I will tell you for sure is that when panic selling kicks-in all you will be able to do is watch the horror as it will permeate your television and newspaper headlines. The smart investor will sit back and smile because he has been taking profits on market strength. In the years to come we’ll have given this time a cute name like we did with the dot-com bubble and the sub-prime mortgage crisis.
What would I do, I’d call my mutual fund or hedge fund company and ask them what they’re doing about hedging my investment portfolio.
Dwayne Strocen is a derivatives specialist with expertise in analyzing and hedging market and operational risk using exchange traded and OTC derivatives. Website: https://www.genuinecta.com