Juggling Dynamite

Danielle was a guest with Jim Goddard on Talk Digital Network talking about recent developments in the world economy and markets.  You can listen to an audio clip of the segment here.

Last August I explained that oil and credit strains were set to lead Canadian banks and the broader TSX lower:

Make no mistake: as the energy and realty sectors stumble, so do the banks.  Down over 4% this month, Canadian financial shares are finally repricing for the compounding strains at hand.  Since financials are the largest weight in the TSX (34% of its market cap), the broad market will have to follow suit.

So far, including the big bounce back from March 23 to May 11, the Canadian finance sector (XFN) is presently 30% below its February 19 high, while the broader TSX is -13%.  Neither looks likely to have seen its lows for this bear market.

U.S. financials are also -33% from their February high and the S&P 500 about -13%.  In first-quarter earnings to the end of March, US banks startled some optimists with a fivefold increase in their loan loss provisions.

Compressed interest rates and mounting loan defaults are bad for banks all over, but Canadian banks–with lower capital markets revenue, higher oil sector exposure and more heavily indebted households–stand to underperform their American counterparts this cycle.

The CD Howe Institute declared this month that Canada entered recession in March.  Typically recessions average a year or so with banks reporting rising credit losses for a few quarters.

This recession, though, is above average on all counts.  Canada’s gross domestic product is on track to contract an annualized 45% in the second quarter, and -9% for the year–assuming a solid recovery in the second half.  Capital Economics estimates that Canadian households are missing 21% of their wage income even with herculean government support programs. The Bank of Canada is forecasting mortgage arrears to double the levels seen during the 2008 ‘great’ recession.

Coming into 2020, even without a pandemic, our end of cycle base case was for a 50% decline in Canadian financial shares–similar to during the 2000-02 and 2007-09 bear markets.  Given present facts, it’s not hard to argue that repricing this time could well be steeper.

As I wrote last September when stock markets were rising and macro data weakening, bear markets with loss cycles greater than 20% are inevitable and recurring, but it’s not necessary that individuals lose along with them.

The last decade has seen the longest financial market expansion in history to some of the most extreme valuation measures ever, and still, most participants and professional asset allocators have no plan other than to hold and hope that price appreciation continues indefinitely.  It never does.

Most stay long and wrong even though minimizing losses and having cash to buy assets near cycle lows are the most defining imperatives of compounding positive returns over an individual’s life cycle.  It’s for this reason that Warren Buffett’s long proclaimed number one investment recommendation is Don’t lose money!  And yet, most continually ignore this to their great detriment.

Riding rising markets during expansion cycles requires no skill.  Effective management has rule sets to help anticipate down cycles and position to benefit through them.  As Hedgeye CEO, Keith McCullough, put it today:

“Almost anyone can run money on the long side of Equities, in any country, when the equivalent of the VIX is trending and trading in the range of 8-16. That would be the equivalent of driving a car in London without anyone to pickup/dropoff and/or having any risk to manage. Not everyone runs money well in a developing or ongoing bear market (VIX 20-80 range).”

If you were shaken at the drawdowns in your savings from February 20 to March 23 and relieved by the rebound into early May, you have entered this bear market wrong-footed, and probabilities are that the pain is far from over.  It’s not too late for self-preservation, but time is of the essence.