An Upside Down World

A client recently asked me what concerned me the most regarding the stock markets. Not one to let a good opportunity to hear myself talk slip by, I offered a ‘teaser’ of an answer: Impotence and Populists. In this month’s IMI, we share ‘what keeps me up at night’ with regards to today’s stock markets and how our investments are positioned to protect investor capital.

It is no secret that the world economy is facing more headwinds today than it was a few years ago. From tariffs to trade wars, economic and political uncertainty are top of mind in all business decision making. In fact, according to the Economic Policy Uncertainty Index, Canadians are more worried now than they were in 20081. When businesses are uncertain of their economic future, they hold back on investing in new equipment, hiring new staff, and generally keeping the economy moving forward. When too many people hold their breath, the economic engine slows down.

In their latest report, the International Monetary Fund, the world’s premier group of Economists, expects ‘Sluggish Growth’ and has cut global forecasts by as much as 10% this year2. Furthermore, as highlighted in this article (Link), many forward looking indicators are flashing bigger warnings than those we saw in the leadup to 2008.

Economic slowdowns are nothing new. Over the last 150 years, recessions have generally occurred every four years on average3 and so its not a matter of if, but rather when, the next recession will arrive. What concerns us is that in almost all previous recessions, central banks, the world’s economic mechanics, have had tools at their disposal to ‘fix’ the problem which may have limited impact in today’s current market. An expression that has been dubbed the four most expensive words in the English language come to mind… This time, it’s different.

Impotence

In the eyes of most, Central Bankers sit in ivory towers reading reems of economic data and then holding meetings to determine which economic levers to pull. The “interest rates up” lever means higher costs for companies, less money to invest, and in turn a slowing economy. The “interest rates down” lever has the opposite effect, encouraging investing by making borrowing cheaper.

Historically speaking, interest rates have been the primary tool that Central Bankers use to impact the economy. In more recent years, this tool’s effect has been blunted by a stubbornly slow economy that has failed to produce the growth figures the ivory tower onlookers seek.

Incredibly, in 2014, the European Central Bank, desperate to spur economic growth, cut interest rates to below zero and into negative numbers. In practice, this rate cut means that rather than rewarding savers for not spending their money and keeping it in the banks, savers are punished for not investing their money. In other words, you could buy a $10,000 GIC that in 3 years time, the bank would give you back $9,500 – guaranteed! What a great deal!

Now this scenario might sound like a purely theoretical idea, but as of September 2019, Switzerland, Japan, Sweden and a few other smaller countries have all set their interest rates at zero or negative interest rates. And at a time when the world economy is growing, albeit slowly! What happens when we see economic contraction? What will Central Bankers do to stimulate the economy, and the impact on investors is anyone’s guess.

Populists

With Central Bankers deprived of their primary economic lever to resuscitate a contracting economy, our attention turns to the tools available to government. Following the great depression, an economic school of thought known as Keynesian theory became widespread. British economist John Maynard Keynes advocated that during times of economic distress, it was the government’s job to stimulate the economy by increasing government spending and cutting taxes.

With the rise of populist politicians whose polarizing politics have led to the neutering of their power by the checks and balance of our political systems, who will have the political capital to launch these much-needed policies should a recession occur? Perhaps more importantly, with many countries nearing record levels of debt, who will pay for the vital economic stimulus?

More recently, we have seen a slew of political policies, from the US Trade War to Brexit, that are akin to putting sticks in the wheels of the economic engine. Worryingly, this trend extends beyond the US and the UK. South Korea and Japan are involved in a pretty serious quarrel of their own that has been escalating quickly, India and Pakistan are once again butting heads while Brazil and Italy deal with internal political situations that do not inspire confidence. In all, seven of the world’s ten largest economies are dealing with ‘populist problems’ that could prevent them from taking necessary action when called upon.

Irrational Exuberance

Despite these concerns, the markets in the United States are still pricing in optimism and growth. This trend is best illustrated by the love for tech stocks, even though many have yet to turn a profit. Take UBER for example, which recently went public amid much fanfare. This long-awaited IPO, the largest since Facebook, netted UBER just under $9 billion. After ten years in business, Uber’s most recent quarter saw it post net losses of $5 billion. In other words, it lost more than half the money it raised in a decade-in-the-making IPO in just 3 months. Yet somehow, investors are still along for the ride…

Where do we go from here?

As is always the case with investing, there are plenty of reasons to be scared. In this excellent piece by CI Investments, they highlight the top reasons investor have been hesitant to invest since the 1930s.

For that reason, we are not advocating a total shift out of the markets. Rather, our focus is on high quality companies that have exhibited an ability to make profits and, for the most part, a tendency to share those profits with investors in the form of dividends. An allocation in bonds, which stand to benefit from falling interest rates, cash and precious metals holdings compliments the equities.

With a focus on quality and safety in the portfolio, we remain optimistic on the future long-term prospects of the investment pool, while remaining cautious in the near term.

 

Sources:

[1] EPU: Economic Policy Uncertainty Index:  https://www.policyuncertainty.com/

[2] IMF: Global GDP Forecast Cuts:  https://www.imf.org/en/Publications/WEO/Issues/2019/03/28/world-economic-outlook-april-2019

[3] FORBES:  Recessionshttps://www.forbes.com/sites/cameronkeng/2018/10/23/recession-is-overdue-by-4-5-years-heres-how-to-prepare/#4f62f55640d8

 

Disclaimer:

No part of this content should be construed as investment advice. Innova Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI). Jean-François Démoré and Cliff Richardson, as agents of Innova Wealth Management/ACPI are registered to provide investment advice in the provinces of Ontario, Quebec, and British Columbia. Investment products are provided by ACPI, a member of the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and the Canadian Investor Protection Fund (www.cipf.ca). All non-securities related business conducted by J-F Demore or Cliff Richardson as representatives of Innova Wealth Partners are not covered by the Canadian Investor Protection Fund and is not under the supervision of ACPI.  

The information contained herein was obtained from sources believed to be reliable, however, we cannot represent that it is accurate or complete. This report is provided as a general source of information and should not be considered personal investment advice or solicitation to buy or sell any securities mentioned. The views expressed are those of the author and not necessarily those of ACPI.