Rule of Thumb for Investing: Reversion to the Mean

June 6, 2017

 

The U.S. equity markets continue to outpace the Canadian equity markets this year after underperforming during 2016.  The SP500 (broad US market) is up 9.39% so far in 2017 while the Canadian market is up .88% (as represented by the TSX60).

 

Diversification continues to show rewards as last year’s outperformer often becomes this year’s disappointment.  In equities there are no straight lines. 

 

A much better rule of thumb in investing is ‘REVERSION TO THE MEAN’.  Over longer periods, various asset classes will achieve there expected return based on the volatility of the asset class.  Higher volatility will usually mean higher average returns.  A poor or lower than average return will often be followed by a period of outperformance and vice-versa.

 

That is the major reason we will generally look at 5 year periods when analyzing a portfolio.  Five year periods (ten are better) are more accurate in determining performance.

 

CDN$

 

The CDN$ continues to be a hot topic though it has been less of a factor during 2017 than it was in the 3 previous years.  The chart below shows the recent downtrend BUT it is currently at the top end of that trend.  A move above 75 cents would suggest a reversal.  In a recent meeting with a PROMINENT bond manager from Fidelity a rebound in the CDN$ was anticipated and 80-85 cents was mentioned…however the CDN$ now has the largest ‘short’ interest ever against the currency.

 

SUGGESTIONS TO PROTECT FROM RISING CDN$:

  •          Switch I-shares XAW to Blackrock maximum equity fund (fund of ETF’s but lower currency risk than XAW)

* The information contained herein may not apply to all types of investors. Please consult a professional before making an investment decision.

 

Two of the factors that have an effect on the relationship between the CND$ and US$ are interest rates and oil prices.  Both countries will have some increase in longer term interest rates but Canada may lag in changing rates giving the US$ currency some strength in the short term.  That is probably already priced into the conversion. 

 

Oil prices also have an effect since commodities are a large part of the CDN economy.  The chart below shows that oil prices have been in a downtrend BUT a move above $52 would break the recent history of lower highs.

Personally I am not a believer in significantly higher oil prices due to several factors including:

  •          Technology disruption  FRACKING and ELECTRIFICATION (Tesla)

  •          Demographics which point to less consumption and more savings

 

However opinions are like belly buttons…everyone has one :) 

 

Most client portfolios tend to be tilted towards benefiting from a stronger US$ versus CDN$.  If you want to be CURRENCY NEUTRAL or ELIMINATE currency exposure please let me know.

 

I will end this version of ‘for what it’s worth’ by relaying a few comments/opinions from Jeff Moore (bond portfolio manager with Fidelity)

 

  •          Sub 2% growth for U.S. economy

  •          Slower not faster productivity and investment

  •          Some of the major economies (Japan & Germany) have FALLING population

  •          Most major economies have an aging population

  •          Full employment may cause a ONE TIME pop in interest rates BUT otherwise slower and lower tightening cycle

  •          Probable rate hike in June for U.S. and then 2018

  •          BANKING CRISIS is ‘out of the money’…maybe 10% pullback next correction

  •          CDN$ up to 80-85 cents (though I have an equally smart person who is predicting lower than 70 cents (maybe both right eventually J)

 

My summary: own bonds/fixed income for INCOME not growth.  Will provide some safety as well in times of trouble.

 

 

 

The views expressed do not necessarily reflect the opinion of Argosy Securities Inc. This does not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. Please consult a professional before making an investment decision.

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