The Roller Coaster Returns

Just in case anyone had forgotten that stock markets can go down as well as up, we were shocked back to reality this week.  But the fact that the TSX was down 4.6% on the week and the S&P 500 was down 6.4% (-3.5% in Canadian dollar terms) was not the real story.  The real story came during Thursday’s session when in a span of just a few minutes the Dow, which was already down about 400 points plunged further to be down nearly 1,000 points, or about 9% on the day.  However, just as quickly as it had fallen it then rebounded to close the day down 348 points or 3.2%.  Of course this had a significant impact on other markets as well, including bonds and currencies.  The Canadian dollar saw one of its wildest single day swings in recent memory.  The CAD/USD exchange rate which opened the day at about 97 cents had been trading in the 95.5 cent range and as stock markets plunged, the CAD hit an intra-day low of about 93 cents.  By the end of the day it closed just above 95 cents.  Those are huge moves for our currency in a single day.

All of this of course brought back painful memories of late 2008 and early 2009 for many investors.  So should more of this be expected going forward?

The very extreme and short-lived drop in the equity markets Thursday afternoon is still not fully understood.  While initial reports had suggested an order entry error was responsible, that is looking less likely at this point.  It appears that computerized program trading was partially responsible, but regulators in the U.S. are investigating to try to understand what actually happened.  In the interim many of the trades that took place during that very brief window of free-fall have been cancelled (both in the U.S. and Canada).

Seeing a 5% to 6% decline on the stock markets during a week should come as no surprise, although a 600 point drop in a matter of minutes is highly unusual).  The rebound since the March lows of 2009 has been almost straight-up and a pull-back should be expected.  Whether this turns out to be a modest retreat in the continuing uptrend or indeed a significant inflection point is impossible to determine.  As we discussed in an article we wrote on March 23, 2009 (Do We Feel Better Yet), attempting to move into and out of the market based on one’s perception of its short-term direction is futile, and the risks of being wrong are costly.

Over the past couple of days we have spoken with many of our managers and have heard a common theme; they are still finding great companies whose stocks are trading at very reasonable prices.  Most managers, if they are truthful, will readily admit they don’t know where the stock market is going over the next month or even the next year, but what allows our managers (and us) to sleep at night is that they feel they own outstanding businesses and the earnings growth those companies are generating will be reflected in higher prices at some point in the foreseeable future.  The ups and downs of the broad market indices from day-to-day and week-to-week can be unsettling, but the true value of the underlying businesses eventually shines through.

None of what has happened in the past week, including the ongoing events in Greece and the broader European region, have altered our strategic positioning within client portfolios which was detailed in our  our quarterly newsletter Compass Spring 2010.  We continue to feel that:  investors should focus their fixed income investments on high-quality Canadian fixed income issuers with a shorter than normal duration, and that selective equity valuations remain attractive globally.