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Posted by Craig Basinger on May 9th, 2022

Time Slows During Corrections

Spending all my years on this planet and not traveling at extreme speeds, time has always seemed pretty linear and constant. Just check your watch. However, you can also think of time as how your brain codifies and references the flow of events. Think of the common phrase, “time flew by.” But during periods of emotional discomfort, it often feels like time slows or drags by.

We are deep in a correction that encapsulates multiple asset classes. And it is not just weakness, the daily gyrations are truly breathtaking. Over the past ten trading sessions, the U.S. S&P 500 has seen five sessions with daily returns +/- 2%. For anyone who invests, this is creating a great deal of uncertainty. Is my portfolio correctly positioned? Should I do something? And to top it all off, time sure seems like it has slowed down.

very broad correction

During periods of heightened volatility (aka markets dropping), the risk of making an emotionally induced behavioural mistake is the greatest. This often translates into making a portfolio mistake. Emotions are nice to have, they but tend to get in the way when investing. To help control our emotions, we will turn to facts and a longer-term perspective. It may not make time speed back up, but it could help reduce the risk of making a mistake.

This is a dramatic price correction across most asset classes – We can attribute this drop in prices of assets to any number of factors. Inflation got a bit out of control, central bankers are pivoting from doves to hawks very quickly, valuations got too far stretched, the economy is starting to slow, and yields, both nominal and real, are rising. Then there is the war, the pandemic appears to still be an issue, and commodity prices have spiked higher. It is possible we missed a few more.

Let us not forget that markets, both equity and bonds, enjoyed returns well above historical norms over the previous few calendar years. This is a brief repeat from last week, but worth reiterating: If you assume long-term equity returns are 7% and bond returns 4%, that means a plain vanilla 60/40 portfolio (60% equity/40% bonds) should deliver about 5.8% annually. Some years will be higher, some lower. However, the last few years have been higher, materially so. Annual returns for a plain vanilla balanced strategy have been +16%, +9% (including a bear market drop) and +12% in 2019, 2020 and 2021. Those are juicy returns or at least above norms. And while bonds fell 3% in 2021, 2019 was +7% and 2020 was +9%, both above norms.

Asset price got over inflated, both bonds and equities, now they are mean reverting to the long term trend

We are not saying bonds or equities can’t go lower from here. Instead, we are suggesting putting the recent weakness in prices into a longer-term perspective. We all enjoyed outsized returns over the past few years because of a number of factors. Consumer behaviour pivoted to more goods spending over services, which is better for equity market earnings. Stimulus was unprecedented and left on too long to help mitigate the impact of the pandemic, which weighs disproportionately on some cohorts of the economy while benefitting others. Altogether, this goosed asset prices from equities, to bonds, to real estate.

Now that spending is pivoting back to normal (normal balance of goods vs services spending) and central banks are removing stimulus—the goose is deflating. Stock and bond prices have reacted quickly, given quick to adjust pricing. Real estate may be a longer adjustment process, a drawdown to less transparent pricing.

Turning to valuations, it is safe to say much of the froth is now long gone. In fact, valuations in equities have come down substantially. In late 2021, the Nasdaq was trading 35x earnings; it is now 24x. The S&P 500 has dropped from 23x to 18x and the TSX from 20x to well below historical norms at 13x. Now valuations do not mark tops or bottoms in markets, but they do influence forward-return expectations. And if there isn’t a full-blown recession looming, the return outlook has improved.

valuations - increasingly interesting

Bond valuations (yields) are also becoming more enticing. That is what happens when the price of bonds drops, the forward yields rise. Given the pain in bond land, yields are up substantially. The Bloomberg Canada Aggregate carries a yield to worst of 3.5%, the U.S. Investment Grade index has a yield of 4.4%. Don’t forget in that earlier chart comparing returns with a longer trendline, that trendline used a 4% return for bonds as the assumption. We are kind of there.

bond yields certainly starting to offer some value

Given the price gyrations, there is no doubt emotions are elevated. Staying the course and not overreacting is often the best path through these kind of markets. Or for those with the stomach, there are things on sale out there. It may hurt a little bit to trade, but investing is often like going to the gym—if it doesn’t feel a bit awkward or if there is no degree of discomfort, you just are not doing it right.

— Craig Basinger is the Chief Market Strategist at Purpose Investments

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Sources: Charts are sourced to Bloomberg L.P.

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Craig Basinger, CFA

Craig Basinger is the Chief Market Strategist at Purpose Investments. With over 25 years of investment experience, Craig combines an educational foundation in economics & psychology with years of experience in both fundamental and quantitative research. A long-term student of the markets, Craig’s thoughts and insights can be seen in his Market Ethos publications and through his regular contributions on BNN.

Craig and his team bring a transparent and cost-efficient approach to investment management. The team provides asset allocation OCIO services and directly manages over $1 billion in assets. The team manages dividend mandates, quantitative risk reduction strategies and asset allocation services.