In times of trouble

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  By Guest Blogger Sinan Terzioglu

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Since 2010 CNBC has run over 100 episodes of its Special Report “Markets In Turmoil” with the most recent one aired a few days ago.  With the S&P 500 down  approximately 13% in the first four months of the year, the 4th worst start to a year in US market history, it’s not surprising to see the media at it again, inducing fear and making investors feel like this time is different.

If history is any guide this market storm is just like every other one, and will pass.  In the year after the 100+ times that CNBC ran its Markets In Turmoil episodes the broad US equity market has had a positive return 100% of the time with an average return of 40%. While the market can easily be lower in the following twelves the probability of it being significantly higher in a few years is very good.

Volatility is never easy.  Nobody likes to see the value of their portfolios drop but if you own a balanced and diversified portfolio that holds a combination of government bonds, investment grade corporate bonds, preferred shares and growth ETFs that contain the world’s most profitable corporations, the biggest risk is not what the markets will do but what you will do and the potential of you deviating from a well-constructed long term plan.

The pain of paper losses makes many feel like the right thing to do is to stop the portfolio bleeding by going to cash and then getting back in when the headlines are better. But as the famous UK-based fund manager Terry Smith says when it comes to market timing there are two types of people: 1) those that cannot time the markets; 2) those that do not know that they cannot time the markets.  Missing just the 10 best days of any decade has resulted in a significantly lower average annual return so you are much better off to stay out of your own way.

Have Confidence In Your Holdings

So long as valuations and growth projections are fair, all balanced and diversified portfolios should hold ETFs that have allocations to the most profitable corporations in the world. In the US this can be accomplished by having an allocation to the S&P 500 index which holds the 500 largest companies in the US by market cap.

Currently 5 companies – Apple, Microsoft, Amazon, Alphabet/Google and Meta/Facebook – account for over 25% of the index.  While this level of concentration is a bit of a concern they have become heavy weights for good reason.  Collectively they have no net debt and have generated record free cash flow of $300 billion+ in the last twelve months up from $100 billion 2017.  They earn an average 25% on their capital employed and are returning tens of billions of dollars a year to shareholders.  These companies are a big part of the success of the S&P 500 over the last decade and I am confident they will continue to help the index get back to all-time highs in the years ahead as their projected growth is still very healthy.  This is not a time to be afraid of owning ETFs which have allocations to companies such as these.

Over the years our big 5 Canadian banks have proven how resilient they are.  Following the financial crisis of 2008-2009 they were recognized as some of the strongest banks in the world and since then they have only gotten stronger.  Our banks earn returns on their equity of 15%+ – a fair bit higher than all the largest banks around the world. Their balance sheets are amongst the strongest globally and they’re very shareholder-friendly as they reward their stockholders with dividend increases most years.

Banks such as Scotia and BMO have been paying dividends to their common shareholders every single year since the 1800’s.  They have never missed a single payment even during the Great Depression, both World Wars and all the recessions over the last 150+ years.  Our banks continue to grow at a healthy pace and have been expanding their wealth management divisions globally so they continue to diversify their businesses geographically and not be as reliant on the Canadian economy.  With a such long history of profitability and a proven track record of weathering economic storms and times of war this is not a time to be afraid of owning Canadian ETFs that hold our big 5 banks.

All balanced portfolios should include an allocation to preferred shares, especially rate reset preferred shares at this time of the interest rate cycle because their dividends will get reset high as interest rates rise.  When preferred shares are held in non-registered accounts holders will benefit from the Canadian dividend tax credit resulting in a higher after-tax yield than interest bearing bonds held in non-registered accounts.

An underappreciated fact about Canadian preferred shares is their excellent credit quality because every single penny of preferred share dividends must be paid before a single penny of dividends are paid to common shareholders.  If your preferred share ETF holds the preferred shares of Canada’s most profitable corporations such as the Canadian banks and you know they have never missed a payment on their common shares then you should have full confidence that they will not miss a dividend payment on your preferred shares.  Diversified Canadian preferred share ETFs hold the preferred shares of companies such as Fortis, Brookfield Asset Management, BCE and Enbridge which all have long histories of consistent dividend payments through many economic cycles.  This is not a time to be afraid of holding a basket of preferred shares of companies with stable and predictable earnings.

100% of Market Corrections Have Been Recovered

Since 1928 the average intra-year drawdown for the S&P 500 has been ~16% so what we are experiencing right now is not out of the ordinary.  Going back to the market top of 2007 the S&P 500 is up ~9.70% a year (including dividends) despite:

·         2008-2009 financial crisis
·         2010 flash crash
·         2011 European debt crisis
·         2011 US credit rating cut
·         Double dip recessions fears in 2012
·         2014 Ebola outbreak
·         2015 China Yuan devaluation
·         Worst December (2018) since the Great Depression
·         Fasted ever 35% decline in March 2020

Most years there seems to always be worries that the media makes us feel like this time is the different but the reality is what drives markets over the long term is corporate profit growth and profits have been very healthy recently and will very likely continue to be over the next few years.  The fundamentals of the largest companies are as strong as ever.  Even after experiencing the first pandemic of our lives the US  market is up over 20% from the highs before the COVID crash.

Don’t Be Distracted

Market drawdowns often feel like they will last a long time but in realty most have not lasted very long.  Since 1950, the S&P 500 has undergone three dozen corrections and 22 of these have found their bottom within 104 days.  Only on 7 occasions since 1950 has a correction lasted longer than 288 days, and it’s only happened twice since 1982 (the bursting of the tech bubble in 2000-2001 and the 2008-2009 financial crisis).

Since 1960 the S&P 500 has only gone 3 months without making an all-time high 30 times.  So while the market can drop further from here worrying about it and letting your portfolio value be your only feedback mechanism is not productive to you reaching your long term financial goals.

As Garth says, so long as you are balanced and diversified there are times to feel good about your portfolio and there are times to ignore it and this is one of those times.  The very best thing you can do right now so that you stay on track to achieving your long term financial goals is to add to your portfolio and continue adding whenever you can.  The next best thing you can do is to tune out the financial media.

Sinan Terzioglu, CFA, CIM, is a financial advisor with Turner Investments, Private Client Group, Raymond James Ltd.  He served as vice-president of RBC Capital markets in New York City and VP with Credit Suisse in Toronto.