Rational Advisor

Election Year volatility is again here

Virtually every US election year produces its volatile moments, and we are in the midst of that scenario.

The US is perhaps the most important economy in the world, so uncertainty as to it’s future direction and economic well-being play a greater part in a US election year. And most of the concern happens to be around the mid point of the year.

Today’s story is around Oil, and the global slowdown it produces. What will the US presidential candidates do? Can they do something? Is the world in trouble.

All of this is heightened by triple-digit losses in indexes, caused by concerns around Oil prices and downgrades in financials, a disappointing earnings report from companies such as Research In Motion Ltd.

Though the indexes haven’t met the technical definition of a bear market — a 20% drop — stocks’ recent drubbing has made their recovery from mid-March to mid-April, during which the Dow rose 11%, look like a short-lived spike within a longer, deeper downturn.

All of these concerns coming together are making people think that perhaps the world has changed.

Let’s look back at some of the key drivers of these worries

Oil

The concern has been that there is not enough Oil in the world, that demand is high, primarily from Emerging economies such as China and India. From the supply side, all nations have stated at the recent meeting in Saudi Arabia, that there is enough supply to meet all needs. They in fact decided to increase their quotas. On the point of demand, subsidies to nationals of these emerging countries have been reduced, causing the price of oil to go up for the consumers, and thereby impacting demand. Remember the average wage in these nations is much lower than the developed nations as such spending on oil will hurt much more.

The real reason for the appreciation of oil can probably be laid at the foot of analysts, speculators and the geopolitical confusion around the world in Oil rich nations.

As analysts come out with ever increasing forecasts, they through the media fuel the fear and cause speculators to increase their momentum. CIBC World Markets economists predict crude will hit US $200 a barrel by 2010. This would equate to $30 increase per year, and the thinking in most people’s minds goes it would be $350 by 2015! At which point most of us would be taking the bike to work!

The main thing that would drop the price of Oil is The price of Oil. As it goes ever higher, it like any other commodity will reach a point where people will reduce their consumption. We may well be there, as sales of scooters have shot up. But like every other bubble, the end will be dramatic and surprising, and it could appreciate beyond any sanity - we may well be there already.

Should we chase this bubble as it increases further and further? Not in our rational minds. Because the other such bubbles also ended very surprisingly and shockingly - Real Estate in the US in 2006, Technology in 2000, Gold in 1994, Asian markets in 1997, Japan in 1991 etc.

Please note most analysts are not out there to provide information to the public. They are there to promote the investment vehicle their investment firm wants them to push. And the biggest clients to an investment firm are the one’s that provide the largest commissions, as such in these days it is the commodity traders and the hedge funds with all these derivatives. So to help these special clients, analysts come up with varied reasons as to why a particular security or commodity should do better or worse. Remember it was these same analysts and investment firms that helped fuel the “great” stories of Nortel to $120, when it was really worth $2, Bre-X, Enron, Loewen Group, etc.

Commodity-related companies make up 50 per cent of the S&P/TSX and by nature they’re very volatile. So, we’ll probably see more continued volatility in this area.

Poor Earnings and Financials

The recent news was around Research in Motion RIM. The stock fell over 13% in a day, even though the BlackBerry maker said revenue and earnings more than doubled in its latest quarter. What was the reason for the drop, earnings per share fell short of analyst’s expectations.

Again these Analysts are promoting the fears about a company that has shown an increase in revenue. We are not recommending the position, since its valuation is rich. But the fact that it dropped because it did not meet someone’s expectations is wrong.

The Financials are still feeling the impacts of the Credit Crisis in the US. And again the analysts have promoted the fear that more write-downs of losses need to be done. Perhaps, they will. But what we can recognize is that Financials are strong businesses in Canada. It is a closed market, there are only 6 major banks, not a 100. And they have the ability ot increase their service charges.

Those woes have cast doubt on the economy’s ability to rebound in the second half of the year, which many on Wall Street had expected as recently as a month ago. The hope was that a mix of Federal Reserve interest-rate cuts, tax rebates and a winding down of losses at financial institutions would trigger a midyear rally in the stock market.

What will it take to turn the stock market around?

Three things: lower energy prices, easing of credit conditions, and reduction in confusion around the US presidency and the US dollar.

It’s going to take some time. The US Election is in November, companies will improve their balance sheets and earnings as write-downs move further into the past. And Oil prices will go lower as the increase impacts the consumer more and more.

Every US election year has had similar volatility, and yet, by the end of the year once a clear commander-in-chief has been elected and policies established, sanity has resumed its path.

This is not like the 1970’s when we had high Oil prices and stagflation.

First, central bank policies are different this time. They plan to resist inflation. Second, in the 1970s, workers, who had appreciably stronger unions than today, were able to pass through their costs of living in the form of wage increases. That set off a wage and price spiral. This time it’s different, central banks will fight inflation and accept some stagnation. And the unions now have much less power.

Companies have been keeping stronger balance sheets since the 2000 technology crash, and are more prudent in their spending. At some point this cash will be deployed into doing mergers and acquisitions, as the stronger companies feed on the weaker ones.

What’s an investor to do?

There are six essentials when a Bear market comes along; which nobody knows when it will occur, what will cause it, how severe it will be or long it will last.

1-stay cool - don’t panic

2-call for help - talk to your advisor, they’ve been through this before

3-get some perspective - realize that this is not the only time that a bear market has happened, also that the long term stock market chart points upwards over the last 200 or so years. If it was so miserable at some point it should have gone down to zero - never has!

4-move slowly and with great care - think carefully about your decisions

5-consider actually feeding the bear - the best way to tame the bear is to feed it so that it becomes your friend

6-remember that the bear will eventually go away.

Also,

Understand their portfolios are made out of companies that have good revenue models and balance sheets. At times the valuations that some analyst determines may not meet with the analysts expectations, but they will still continue to provide revenue.

Understand that your portfolio includes Government of Canada bonds that continue to provide income and provide a level of stability.

Understand that all of your investment managers are at their desks, monitoring, analyzing and ensuring that no extra level of risks that can impact your portfolios long term objectives are being taken, positions are being bought, advantages are being taken.

The things we do today will only be realized in the future, as sanity come back.

Understand that we will remain rational in an irrational world

Comments RSS