This week we saw the markets close out the month of July on a challenging note as the week saw a lot of economic data that was a mix of both positives and negatives. Throw in the geopolitical issues around the world ranging from Argentina once again defaulting on its debt (it seems like they do this every 10 years or so); Israel and Hamas continuing to fight in Gaza; topped off with the tragedy of the Malaysian Airliner being shot down over eastern Ukraine and the Russian sanctions that have followed, and you get a recipe for investors to take some money off the table, so to speak, on the last day of the month.
Not surprisingly, this morning we have seen an increased commentary within the financial media of “is this the long awaited correction?” The short answer to that is that we simply don’t know. But what we do know is that both August and September have, since 1988, been the two weakest months within the capital markets. Thus, having a bit more cash on hand, whether or not we actually get a “correction”, just feels prudent in our view.
In a quarterly commentary that we received from RP Investment Advisors, who manage some alternative strategy fixed income assets on behalf of our clients, they wrote that they prefer to have a conservative positioning currently as they feel volatility will return to the capital markets and those that have the capacity to take advantage of that opportunity when it arrives will benefit the most. When we see an institutional fund manager who has a record of providing positive monthly returns to clients nearly 90% of the time making a comment like this, we take notice.
A few weeks ago we wrote about correlation and the complacency we had seen within the markets (remember the chart with all the asset class line going in the same direction). Warren buffet once wrote that, “only when the tide goes out do you discover who’s been swimming naked.” His point being that a rallying market disguises the difference among asset quality and valuation. Only when volatility rises, i.e.: the tide going out, do investors ever see this differentiation. It is our opinion that what we are starting to see is the normalization of asset correlations.
So while this may have the look and feel of a market correction, we feel that the return of more normal asset correlation and market volatility is healthy as it will serve to wash out any exuberance before a “bubble” actually forms, such as saw in 2000 and again in 2008. Right now we do not see excessive valuations for most equities, however we have seen credit spreads become quite tight, meaning that certain fixed income prices are getting expensive.
In all, our message this week is that investors should continue to own more equity than bonds. That being said, the importance of asset diversification and risk reduction should be the priority, as our view towards the market remains optimistic, with a cautious tactical tone.
Economic data has, in general, been strong in the United States and somewhat more muted in Canada, notwithstanding the recent inflation surprise. News overseas was also positive, with an upside surprise in Chinese manufacturing and Eurozone economic activity, along with the United Kingdom also posting strong annualized growth last quarter. Thus while the magnitude of the recovery for the second half of the year remains uncertain, the visibility has definitely improved.
The upcoming BC Day long weekend looks to be a warm one, so for those heading to the beaches of Stanley Park or Kitsalano, don’t forget your sunscreen. For those of you heading out on family holidays to the many Provincial Parks around BC, please check with BC Parks as many areas of the Province still have campfire bans in effect.
Have a great weekend.
Thank you for your trust.
As always, we welcome any feedback.
The Dekker Hewett Group