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Liberty Enewsletter LIBERTY International Investment Management MARKET UPDATE Q1 | March 31, 2020 IN THIS 1 Lessons to be learned from the 2007-2009 stock markets 1 Why we don’t believe this will be a V-shaped recovery ISSUE: 1 Brokerage analysts don’t add value 5 Fun with Math: Focus on growing dividends, not dividend yield 10 Client Q&A: David Driscoll answers your questions It was only a matter of time before a spark created the In the following pages, we’ll look at the markets, explain sell-off of a very expensive stock market. In this case what happened and what investors should be doing. it was the Covid19 pandemic that essentially stopped It hit hard and fast humans and their lifestyles in their tracks. The table at right illustrates the monthly volatility of all asset Benchmark returns for 2020 (in CAD$) including dividend reinvestment classes. In March, it wasn’t just At April 6, 2020 stocks that sold off as both JANUARY FEBRUARY MARCH APRIL bond and preferred share Equities markets were clobbered, too. TSX Index 1.74% -6.09% -17.38% 5.62% This is what it looks like when S&P 500 Index 1.93% -7.04% -12.35% 7.03% panicked investors sell. In this EuroStoxx 600 Index -0.52% -7.85% -22.32% 1.31% case, it was primarily large MSCI Global Index 1.38% -7.23% -8.30% 4.86% institutions that had to raise cash to cover their obligations. Bonds & Preferred Shares Canadian Mid-Term Corporate Index 2.88% 0.24% -6.96% -0.13% For bonds, the sell-off was Canadian Long-Term Corporate Index 4.36% -0.69% -13.04% -0.69% rapid and violent. After central Canadian Preferred Share Index 0.05% -3.27% -22.71% 5.26% banks around the world cut Canadian Real Return Index 3.56% 1.03% -4.53% 0.46% interest rates, bond markets US Long-Term Corporate Index 5.89% 2.56% -3.28% 2.12% returned to some form of US Preferred Share Index 3.43% -3.21% -9.27% 1.18% normalcy with positive returns Data Courtesy of Bloomberg LLP in April. 1 | January 1 to March 31, 2020 © 2020 Liberty International Investment Management Inc. The Covid19 virus struck hard and fast, shutting down ones. When prices declined, investors focused on vast swaths of industries, notably airlines, restaurants, negative information and over-weighted the probability cruise lines, hotels, retailers and the entire oil and gas of the trend. sector. As the dominoes dropped, volatility raised its ugly head and the market losses picked up faster than Adding to the negativity bias, another behavior came expected. into play – the herding bias. As the name suggests, investors mimicked the panic that other investors Understanding Volatility experienced without taking into consideration their To understand what happened, let’s clarify the own judgment and unique situation. This led to a higher difference between fundamental volatility and price volume of sellers which in turn led to declining prices. volatility: If emotions create “mood swings” in markets, should we Fundamental volatility is the change in price following let computers and algorithms be the only traders? In the new information about a company (quarterly results, week of March 23, 2020, robots played a major role in news of acquisition or new research and development the intra-day and day-to-day volatility. These programs results, etc.). This change in price – an increase or and algorithms are designed to trade based solely on decrease depending on the news - is based on facts and specific sets of data inputs. valuation of that news on the overall business. For example, if a trading robot is designed to buy a Price volatility refers to the rate of the stock’s price stock if the price falls by 10% and sell the stock if the change. External factors, related or not to the business price increases by 10%, trades are executed on the same of the company, play a role in the movement of price. stock by this robot within a few days, thus increasing One important external factor is investors’ emotions. the volatility of that stock. Now, imagine this trading pattern executed by the multitude of robots around the In their book called “Behavioral Finance – What everyone world and you get a partial explanation of the “mood needs to know”, authors Baker, Filbeck and Nofsinger swings” that markets experienced during the week of defined behavioral finance as the study of the influence March 23rd. of psychology and other disciplines on the behavior of financial practitioners and the subsequent effect on Also, the circuit breakers designed to pause the market markets. No doubt that the volatility we experienced in when the volatility is too high didn’t work as well as the last few weeks was driven in large part by investors’ expected. Historically, when markets resume, a change emotions. in behavior occurs as human traders have had the chance to calm down and regroup. Humans are creatures of habit. With the sudden social distancing rules and the closure of all non-essential This is not the case anymore. As computers trade based businesses, our daily lives have dramatically changed, on the latest data, we don’t see significant changes in and we have been thrown into a more uncertain future. behavior after the pause. Some investment dealers shut This event influences our psychological state. off some algorithms because trading activities didn’t make sense in such intense volatility. In extraordinary For that reason, investors have exhibited negativity conditions, technology combined with human biases. This means that investors gave more judgment is the optimum system. psychological weight to bad experiences versus good 2 | January 1 to March 31, 2020 © 2020 Liberty International Investment Management Inc. Hypothetical Portfolio Total Return to the market low on March 23, 2020 COMPANY SYMBOL RETURN COMPANY SYMBOL RETURN COMPANY SYMBOL RETURN A.O. Smith AOS 16.1% Femsa FMX 32.2% Novo-Nordisk NVO 2.7% Balchem Corp. BCPC 7.2% Halma plc HLMA 23.3% Novozymes A/S NZYMB 2.2% Becton Dickinson BDX 17.3% HDFC Bank HDB 47.2% Paychex Inc. PAYX 33.3% Chubb Ltd. CB 31.9% Heico Corp. HEI 34.8% Rollins Inc. ROL 6.7% CN Rail CNR 15.6% Interek Group plc ITRK 30.3% Roper Technologies ROP 19.7% Coloplast A/S COLOB 19.0% Jardine Matheson JM 3.5% Stryker Corp. SYK 32.7% Cognex Corp. CGNX 23.7% Lindsay Corp. LNN 2.3% Thermo Fisher Scientific TMO 12.1% Danaher Inc. DHR 11.6% Littelfuse Inc. LFUS 34.0% Toromont Industries TIH 22.4% Dassault Systemes DSY 14.6% Lindt & Sprungli LISP 2.5% TD Bank TD 31.7% EssilorLuxottica EL 22.1% NextEra Energy NEE 15.7% Unilever NV UN 14.0% Average Return: -14% Data Courtesy of Bloomberg LLP. All performance numbers are in Canadian dollars and are compound annual rates of return with dividends re-invested. Also, there are no trading costs or taxes incurred. The solution to deal with market volatility is to: prospective performance. The following hypothetical performance is for illustrative purposes only and A. Have a fully diversified portfolio that can is not a guarantee of future results. This is not a manage the risk and the heightened volatility recommendation, nor an offer to sell or buy, the and reduce the losses. securities described herein.” B. Understand that this economic malaise isn’t over. The Hypothetical portfolio total return, with 20% cash C. Let history be a guide. and 80% invested in stocks, dividends re-invested and D. Have a plan ready to execute to take advantage converted to Canadian dollars, dropped only 14% to the of market opportunities. market low on March 23rd. The fully diversified portfolio During this time, the stock market index losses ranged In our December 31, 2018 newsletter, we introduced from down 22% (S&P 500 Index) to down 34% (the a Hypothetical Liberty portfolio where we discussed Canadian TSX Index). The average index return was Alpha as an investment concept. Let’s look at how it down 28%. performed from January 1, 2020 to the market low on Total return of Index Funds to the market low on March 23, 2020. March 23, 2020 INDEX SYMBOL RETURN Before we get to that, we need to bring in the lawyers to S&P 500 INDEX S&P 500 22.3% provide the usual disclosure that this is a hypothetical portfolio. MSCI GLOBAL INDEX MSCI 23.7% DOW JONES INDEX INDU 26.8% “The portfolio shown above contains hypothetical EUROPE STOXX 600 SXXP 27.9% data. Specifically, returns of the portfolios represent RUSSELL 2000 SMALL-CAPS RTY 32.7% hypothetical rather than actual returns. Hypothetical CANADA TSX S&P/TSX 33.5% results differ from actual performance insofar as Average Return: 27.8% they have the benefit of hindsight in the selection Data Courtesy of Bloomberg LLP. All performance numbers are in Canadian dollars and are of securities based upon their actual rather than compound annual rates of return with dividends re-invested. Also, there are no trading costs or taxes incurred. 3 | January 1 to March 31, 2020 © 2020 Liberty International Investment Management Inc. Here are some of the reasons why the Hypothetical In the investment industry, portfolio managers are portfolio outperformed the indexes: rated based on their ability to consistently create positive Alpha. → When liquidity dries up, companies that generate free cash flow often perform better. The quality If the positive Alpha is 2% or greater after fees, they’re of these firms is shown during market corrections deemed to be doing a good job.
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