Rational Advisor

While short term the markets may remain volatile, it’s important for investors to remain focused on the things they can control, which includes the quality of their investments and the diversification of their portfolios. Short-term issues will come and go, but quality and diversification above principles will be key to reaching your long-term goals in our view.

As expected, the Bank of Canada left interest rates on hold at 4.5% after raising rates in July. However, the Bank changed its wordings regarding future rate increases. In the past, the Bank noted that given the strong economic conditions, future rate increases may still be needed to contain inflation. With the current issues in the credit markets, the Bank noted that this could lead to slower economic growth, and ultimately decided it would be prudent to leave rates unchanged. Thereby implying that future rate increase may not be in the picture.

If there’s one positive in this week’s market action, it’s that the sell-off isn’t any kind of mystery. The market endured numerous days in August when stocks were sold indiscriminately because of vague rumors of hedge fund problems, subprime blowups and frozen credit-market assets, forcing investors to dump what could be sold - highly liquid equities.

This week? This week there was a terrible US jobs report, and it has people thinking more about the possibility of a recession, so investors were selling stocks. And it comes at a time when the collective mind of the markets were already abuzz with nervousness. Six months ago this same report probably wouldn’t have any effect on the market, but when the market is skitzo anything like this is going to send it for a spin.

Investors reacted to news that the U.S. economy lost 4,000 jobs in August - the first monthly drop in payrolls in four years.

Employment figures for the previous two months were also revised downward by 81,000 jobs.

Let me see, the population of the US is around 300 million, 4,000 jobs were lost, - No kidding – Real Estate is down, therefore the construction industry is down – what did you expect, of course there would be job losses. Who were the bozo analysts that didn’t expect job losses (They were the one’s working at the brokerage houses – trying to pump up how good things were)

4,000/300 million = 0.001% - freakin insignificant – can you hear me laugh.

Even if it was 4,000 per month it would only by 0.016% of the total population

Not a reason for the markets to panic. But then, when people are panicking any excuse will do.

With so much of Canada’s economy linked to what happens in the U.S., the Toronto stock market also fell back, even though Canada’s job report for August was stronger than expected.

That greatly boosts the likelihood of an interest rate cut of up to half a percentage point by the U.S. Federal Reserve on Sept. 18.

Normally, the prospect of lower interest rates would boost the market. But the depth of the weakness underlined by the jobs report had some whispering the “R” word - recession - and that led to selling as soon as the markets opened.

However, a negative jobs report doesn’t necessary portend a recession. A negative non-farm payrolls report has predicted twelve of the last four recessions.

What’s needed is for the US Fed’s to put a message out there of reassurance that they still know where the economy’s headed.

And that may involve letting down the markets, possibly by not cutting rates as aggressively as some investors now expect.

I think the market’s going to be disappointed with what Fed does in September; they’ll only do a quarter-basis-point cut this month, while the markets want half a percent.

Yet this bull market might not be over. The stock market is having a difficult time digesting the news from the subprime-mortgage market; the oscillations in the credit and money markets, and now, Friday’s surprisingly bad report about August employment

The big fear on Wall Street is that the growing mess in the mortgage market may trip up the second-longest uninterrupted bull market in history, after the run-up from 1990 to 1997. But would that be so terrible?

There have been 10 official bear markets [a drop in equities of at least 20%] since 1946, based on the S&P500 index [and 23 bear markets over the last 80 years]. Those last ten plunges, on average, have erased nearly a third of the market’s value over 490 calendar days, according to S&P. Even worse, the market has needed an additional 669 days, on average, to make up those losses.

But what if the market sell-off doesn’t go that far? Since 1928, there have been 87 corrections [a loss of 10% or more], according to a recent tally by Ned Davis Research. That works out to slightly more than one a year, though since the end of World War II, there have been significantly fewer such downturns. So a correction of 10% a year should be expected. Notwithstanding these 10% corrections, the markets have progressed further up.

More important, corrections are far less destructive. For instance, since 1946, corrections in the S&P500 have driven down stock prices by about 14%, on average. Given that equities are already off by about 5% since July 19 - and have fallen as much as 11.9% if you count intraday highs and lows for the S&P500 - the market may have already sustained a good percentage of its potential losses. (Again, this is if we’re headed for a correction and not a bear market.) Historically, corrections have lasted only about a third as long as bear markets. In fact, the 16 corrections in the S&P500 since 1946 have lasted an average of only 148 calendar days. And several recent corrections have been far shorter.

For example, the three corrections in the late ’90s - in 1997, 1998, and 1999 - lasted only 51 days, on average. By comparison, the sell-off that began on July 19 is already 45 days old. Since 1946, it has taken the market just 111 days, on average, to rise to pre-correction levels. So it’s about eight and a half months total on the way down and then back up. One of the most opportune times to add is at the mid point.

There are a lot of things that are good in todays markets as compared to other corrections or bear markets. We have low stock-market valuations, healthy corporate fundamentals and negative sentiment signals, such as high put-call ratios, which usually are a contrarian signal. Also, positive technical signals abound, including insider buying..

Stocks are trading at 15 times forward earnings, and their attractiveness compared with a 10-year US Treasury’s yield below 4.5%. This suggest that a rout in the broader market is unlikely under all but the most dire economic circumstances.

Investors should take some comfort in that, given that they are supposed to be in equities for the long term. At the very least, the speed at which markets historically recover should give investors confidence not to react so hastily to the current troubles.

To be sure, no one is wishing a correction on this market. But corrections are a healthy means of relieving the excesses in the market and of restoring a healthy respect for risk. That has already happened in this sell-off. Over the last month, shares of high-quality blue-chip domestic stocks have held up better than small-cap stocks. And mutual funds that invest in the stable developed markets of have lost less than funds that invest in emerging-market stocks.

Whether or not we’re technically in a correction, a sell-off of this magnitude was long overdue. It’s been about four and a half years since the last correction. The last official correction was from Nov. 27, 2002, to March 11, 2003. Over that short period, the S&P500 slumped 14.7%. But that correction, in particular, offers investors a good lesson. Even though you may be scared to stay the course amid rising volatility and falling stock prices, keep in mind that corrections can shift back into bull markets just as quickly as bulls slip into corrections.

What are we to make of all this? One obvious conclusion is that focusing too intently on the day-to-day gyrations of the stock markets can be damaging to your health, both mental and financial. Anyone who makes hasty sell decisions in the midst of a mid-day market slide is likely to regret it later, perhaps within hours.

The more fundamental lesson, I suggest, is that if you have a sound plan stay with it. I know its tiresome to keep hearing that good companies are still good companies, even when their share price drops, but its true. The Banks are down from their June highs. Does that mean they are on the skids and you should get out fast? Hardly! The same could be said of many other blue-chip stocks.

Please don’t misinterpret my words. I am not advocating complacency. Quite the contrary. I expect the market turbulence to continue for the next few months and I would be amazed, and delighted, if the TSX manages to avoid losing ground between now and the end of October. We’re entering into what has historically been the worst time of the year for stocks the financial equivalent of hurricane season, so be prepared.

If you feel that you have a portfolio that can ride out these storms with minimal damage, then sit tight and wait for better times to return. But if you’re even a little concerned about your current holdings and your asset mix, take time now to reassess the situation, discuss it with your financial advisor.

Rational

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