The Bull Fights on...officially

History often repeats itself. Yet, the most bitter disappointments are felt when moody markets defy all expectations.

Many analysts and pundits have compared this bull market to the dot.com bubble, which bubble is mainly justified by the excessive valuation of the technology stocks. By way of history, just before the dotcom bubble fizzled back in the year 2000, the market touched new highs in August before hell started to break loose. In August 1987, the bull market peaked just about two months before the October 19 crash. August rallies can be misleading, and it's very common for markets to start correcting when decision makers return from summer vacations.

So while August 2018 marked the end of the correction, and the official confirmation that the bull market is still on, we are not reading too much into it. It could certainly encourage the bulls to keep buying. The bullish argument is that, although liquidity is gradually shrinking, there is still abundant money to be invested, and US stocks are the only game in town. With interest rates expected to rise further, bonds are hardly an attractive choice, say the bulls. Europe has got its problems, and emerging markets are enduring a crisis as we speak. And, if trade wars intensify, the Us Dollar will be the currency of choice. So as investors hunker down in the perceived safety of the US Dollar, some of their US liquidity has to be parked in US stocks.

This could all be true. But another possible reason for a market melt up (i.e. one final surge before the end) is that Mr. Market takes pleasure in defying expectations. So if most are saying that stocks are overvalued and global economies will go through a rough patch, why not fool them all and and stage another rally?

Predicting market direction is a humbling experience but it does not dissuade us from taking a view. And the FundScope view has lately been consistent: the bull market is aging. Yes, we might see new highs before this thing implodes, hence we advocate keeping some of your portfolio in equities, even if you happen to be the most pessimistic of investors. That's because the market could decide to prove you wrong, no matter how confident you are.

Having said that, and without trying to predic what happens in the next few weeks, or months, we remain bearish for the intermediate term for the same reasons we have listed in previous updates. Aside from excessive market valuations, liquidity is gradually shrinking. Currently, the ECB bond purchases continue to compensate for the liquidity taken out by the Fed. However, when ECB asset purchases stop at the end of this year, markets will feel the liquidity squeeze even more. This is why, in our previous note, we suggested that one should not keep more than 35%-45% in stocks. We also suggested that much of this allocation should be kept in interest sensitive (i.e. REITS, utilities or even telcos) or other defensive sectors, like consumer staples and health care. Such conservative strategy would allow you to reap some benefit if the market continues to rise, but would likely reduce your losses if the bull market collapses.

How to do you balance your geographical allocation is another factor. As we write this update, NAFTA negotiations seem to be intensifying. There is of course a good possibility that cool heads will prevail, particularly that Mr. Trump needs an agreement just before the November elections. However, trying to predict the outcome with any level of confidence is futile because negotiations could go either way. If, for whatever reason, negotiations fail and auto tariffs are levied, expect some serious damage in Ontario, which would inevitably entail, although not quite the "ruination" of Canada as Mr. Trump thinks, at least higher unemployment in the province and consequently a drop in stocks and the Canadian Dollar rate. Expect also that no further interest rate increases will take place for the foreseen future.

Thus keeping some money in US Dollars, or in (unhedged) funds that invest in US equities is good protection against the worst case scenario of a NAFTA collpase. The downside is that you subject yourself to currency risk, but protection always comes at a price. If you are a retired investor who travels frequently, the currency risk is partly mitigated because you can use your foreign currency savings to cover, or hedge, your travel costs.

New features

This month, we are introducing a new feature to the FundScope website: The FundScope Choice funds. It's an exclusive club of no more than few hundred funds, out of a massive universe of some 20,000 or so. FundScope Choice funds are broadly similar to Honour Roll funds, with one exception: we have excluded cost from the selection criteria.

Excluding cost does not diminish the importance of this factor as a major determinant of future returns. It is still the one and only constant in the ever moving number of performance determining factors. Having said that, the ballooning number of funds and the various series of cost structures have added to the complicated process of comparing apples to apples. Suffice it to say that what you see in the management expense ratio is not total cost. There are other items, particularly if you are dealing with a fee-based advisor.

Thus comparing costs on the basis of MER is not comparing apples to apples unless you level the playing field. We do that by excluding several series of funds from our cost ratings, such as "F" series (and other similar ones). However, such exclusion, while necessary for comparison purposes, has made it difficult for investors and their advisors to evaluate unrated funds. The FundScope Choice selection process enables us to compensate for that, and to recognize superior performers from almost all possible cost structures. Check out this powerful feature, or talk to your advisor about it if you have one, and stay tuned for more...

September 11, 2018