Bradley's Brief — Q2 2020

by Scott Ronalds

It was a remarkable quarter for investors as stock markets rebounded sharply, bond prices rose higher, and overall confidence improved in spite of a pandemic that continues to rampage many parts of the world. Below is our Chief Investment Officer's (Tom Bradley) letter to clients from our Quarterly Report, in which Tom provides some further context and insights on the current environment.

If you’re confused, you’re not alone. I am too. The bounce back in stocks after the March selloff wasn’t a surprise, but the magnitude and power of it has been.

It doesn’t feel like a V-shaped market recovery (straight back up after the down) fits with the social and economic outlook. Nor does it make sense that consensus estimates for U.S. corporate profits in 2021 and 2022 show a quick recovery to levels above a very robust 2019.

When confused, we go back to our 3-part analytical framework: fundamentals, valuations, and investor sentiment.

Fundamentals is a catch-all for the economic factors that impact corporate profits (which drive markets). On this front, it’s become apparent that reopening the economy won’t be easy. Government support will come to an end (taxpayers can’t afford to maintain the current level of assistance) and there will be plenty of missteps. We won’t know the true state of the economy until the subsidy tap is turned off. Not until then will we know how families are doing and if businesses that are running far below capacity can afford their rent and loan payments.

I’m a big believer in the adaptability of human beings and organizations. The planet will adjust to the new normal quicker than most people think, but there’s no doubt the range of possible outcomes is still very wide.

Valuation, the price we pay for an asset, helps make sense of what we don’t understand on the fundamentals front, but there are crosscurrents here too. The bond market’s low yields are telling us there’s trouble ahead, as are large parts of the stock market. Stock prices for companies that are economically sensitive, involve the movement of goods and people, and/or are reliant on human contact, are far below their previous highs. Investors are taking the view that ‘things will never be the same’ and as a result, price-to-earnings multiples reflect a subdued recovery.

The ‘never the same’ scenario, however, has had the opposite effect on firms that did well during the lockdown. This select group, mostly technology based, have seen their profit expectations and valuations skyrocket. Here, investors are focusing on the positive end of the range.

The one valuation input that impacts all stocks is interest rates. Rates, which have been low for some time, have gone lower and are expected to stay there. This is important for stocks — lower rates translate into higher P/E multiples — and goes a long way to explaining the market’s recent rise.

Investor sentiment is the part of the framework that helps us act when expectations (fundamentals) and/or valuations are at extremes. How optimistic or fearful people are, is a useful contrarian indicator at times when investors are overwhelmingly bullish (or bearish). Indeed, when stocks were melting down in March, we were able to chin ourselves up to buy equities partly because the panic was palpable. The risks were in plain view.

Today, sentiment is just as confusing as the fundamentals. There’s a general belief that the future will be difficult (bearish), but there’s also a confident contingent of investors who are actively trading stocks and snapping up risky, high-yield bonds.

In your Steadyhand portfolio, we’re taking both views into account. As you’ll see in this report, we have stocks that are benefiting from the ‘never the same’ scenario and others that must prove themselves. We’re OK with this blend because we don’t believe it’s the time to act boldly based on one view of the world.

We encourage you to read the rest of our Q2 Report, where we provide more details on our specific strategies and what we've been doing in each of our funds.

Why investors shouldn't give up on the 'buy and hold' approach

This article was first published in the National Post on July 4, 2020. It is being republished with permission.

by Tom Bradley

I received a note last week from a reader who took issue with my ‘buy and hold’ investing philosophy. “It usually works over the long term but not always,” was the way he put it. He also said there are no “hard rules” around investing and that investors need to think outside the box. “Only the savvy short to mid-term traders will be making money in the times ahead.”

In this volatile, go-go market, the tried and true methods are vulnerable to criticism. There is a steady stream of articles about Warren Buffett being washed up while more investors are trading aggressively and making money.

But before we throw Warren and time-tested principles under the bus, we need to understand the critiques and test them against an appropriate time frame. In the case of buy and hold, we first need to define it.

For some, it means buying a dozen dividend stocks and tucking them away. Or never selling their beloved Apple and TD Bank. For the purposes of this article, buy and hold refers to investors who stick to a target asset mix. For example, a 60/40 investor who keeps the equity content of her portfolio at 60% in all types of markets.

Doesn’t always work

It’s a certainty that our 60/40 investor will experience short-term losses when stocks drop significantly. No amount of diversification or astute stock picking will offset market forces.

By the same token, she can be assured that when the recovery comes, she will also participate. Over longer periods, the chart of her portfolio will go up and to the right, with lots of zigs and zags along the way. A steady flow of dividends contributes to this trend.

Investors who are timing the market, or shorting it, are swimming against this ‘up and to the right’ stream. They need to be extra good at implementing their strategy.

Lost years

My reader rightfully pointed out that the downdrafts can be severe at times. After the great financial crisis in 2008, market indexes like Canada’s S&P/TSX Composite took four to five years to get back to their 2008 highs.

There are, however, two problems with this statement. First, these indexes don’t represent an investor’s experience. They are price indexes and don’t include dividends. Total return indexes, which do, recovered in half the time.

Also, the S&P/TSX Composite is not like a typical portfolio that has exposure to fixed income and non-Canadian stocks. Bonds increase in value in bear markets and the Canadian dollar tends to drop, which moderates the weakness of foreign stocks. Well-diversified portfolios declined much less in the financial crisis and earned back their losses in 18 to 24 months.

Missed opportunities

There’s a perception that buy-and-hold investors can’t take advantage of opportunities when markets are down. The assumption is their portfolios are static. In our 60/40 example, however, this is only true with respect to asset mix. The holdings that make up the portfolio will adjust and evolve over time. Moves are made to keep the portfolio on plan, most of which fall into the category of rebalancing.

This year for instance, our 60/40 investor needed to add to stocks in March after they dropped below her target level. If she was truly rebalancing, she would have added to stocks or funds that were down the most. Today, any contributions would be allocated to fixed income.

Outside the box

The key to any strategy, buy and hold included, is to give it a chance to play out. You can’t hop on and off and expect to be successful. This doesn’t preclude you from changing to another approach that fits your personality, skills, and needs better, but wholesale changes should be done rarely and with careful thought.

It can be expensive to switch from indexing to trading stocks, or focusing solely on low-volatility stocks, or trying to time the market (i.e. trading commissions, transfer fees and capital gains taxes) and there’s often a short to medium-term performance shortfall. Numerous U.S. studies have shown that when pension funds change investment managers, the fired ones do better on average than the shiny new ones in the subsequent few years.

The buy-and-hold approach has been out of vogue before, and will be again, but it has a lot going for it. It’s simple to implement and, like Mr. Buffett and other investment tenets, has served investors well over many decades.