When Good is Bad and Bad is Good in the Markets

 

If you find it challenging to sort out the markets, join the herd. We are in and perhaps always in an environment that is very challenging to connect the dots to make even remote sense of what is going on and how we should invest.

The last weeks if not months have kept investors on edge over whether the Fed is planning to cut interest rates this month or possibly later this year. Strong US non-farm payrolls report reduced pressure on the Fed to make a move immediately which led to a brief correction in indices. Then somewhat dovish comments from US Fed Chair Powell at his semi-annual testimony to Congress sent the S&P 500 briefly to a new all-time high above 3,000 before the index settled back. 

Let’s get this straight. Good news, like more people in the work force, can drive down markets and bad news can move markets up because interest rates may be cut. So good news is bad for the markets and bad news is good for the markets?  Does this mean we should all be hoping for negative economic news indefinitely?

Not quite, even though it appears that a 0.25% late-July interest rate cut has been priced into US markets, we are moving into earnings season and the outlook for corporate earnings may tip the scales on the inverse logic of bad news trumps good news. Recent record highs and /or retests for US and Canadian indices suggest high expectations for results and an increased risk of disappointment. Here is another inverse logic in the markets, earnings may be good but the market wants great numbers so, even on good earnings, prices may fall.

But wait, there’s more, other twists that could either be a drag or boost to the markets: Brexit, the US debt ceiling and trade wars if you want to add more complexity to the guessing game.  I don’t want to diminish the challenges we all face when it comes to investing. But the acronym KISS (keep it simple stupid) comes to mind.

I think of KISS when it comes to investing as indexing.  There is a huge following who will argue that over time the markets always rise, and if you buy an index that replicates the market you will get the long-term benefit of those gains at a low cost. Set and forget, then you get to turn off the noise of the market and your brain. That’s the good, what about the bad?

Many indexes are the market which don’t try to sort out the jumble of the markets for better results. When investors say it is OK to just get the results of the market, it can be setting them up for terrifying results as they are neglecting the downside risks of the market.  The lure of low-cost market returns in a market that has mostly performed well over the past decade has worked in attracting big dollars.

The good and bad news of indexing is you are getting exactly what you are paying for. You get the upside and the downside of your strategy. The chart shows the Canadian S&P/TSX Composite index (blue line), the US S&P 500 index (red line) and the Tycuda Group managed ETF index strategy (green line).  The chart covers the period from 2005 through to present. I know which line I’d prefer.

It’s been over a decade in the Canadian and US markets since we have seen a severe correction. Investors need to ask themselves if their investment process takes into consideration how to manage both the good and the bad. You can ignore reality, but you can’t hide from it.

 
Chart Source: SIA Charts, all data gross of fees

Chart Source: SIA Charts, all data gross of fees