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Market Update - Reasons to be Optimistic

The investment landscape continues to be challenging in 2022. For the month of April, bonds continued to decline another -3%, while world equities fell approximately -8%. Even Canadian equities, which had been the top performer globally this year, fell -5% in April. No matter the investor risk profile (From the extremely conservative, with 100% in bonds to the extremely aggressive, with 100% in equities), there has been few places to hide from portfolio losses.

But despite all the doom and gloom, we are finally starting to see some bright spots emerge in the investment landscape. And while May has seen a poor start – a turn around could be around the corner. Here are my current reasons for optimism:

1) Bond prices are stabilizing

Unlike the first 4 months of the year, bond prices are starting to move up again (while stock prices continue to decline). This is in keeping with the usual trend in markets - where bonds provide relief to balanced and conservative investors during times of stock market declines. Since the start of May, the Canadian bond index is positive, while both the US and Canadian stock markets have declined appx. 5-7%.

Last week's Federal Reserve meeting seems to have been the catalyst for the change, with investors a little bit less worried about rising interest rates. I had talked about bond prices looking oversold in my video update two weeks ago, given that bond prices had fallen -15% to start the year (the largest decline in over 50 years) (see chart below).

Fears of rates increasing were also subdued by yesterday’s inflation report, which showed that inflation had decreased for the first time in seven months.

While I would be surprised to see interest rates fall substantially in the next few months, any potential decline would result in large gains for bond investors. In fact, even a small decline of 0.40% in the Canadian 10-year bond rate (which would bring us back to the level in early April), would result in a +6.4% increase in price (see chart below).

In our managed accounts, we continue to add to our bond holdings – seeing them as a low risk solution to recovering portfolio losses in the near term.

2) Crypto mania is coming to an end

Over the past year, when asked by clients what my biggest concern for the stock market was – my response was Crypto Currency speculation.

Don’t get me wrong, I am not anti-crypto or anti-NFT, but things got out of hand last year (don’t worry if you don’t know what an NFT is, you’re not alone – and many are down over -50% in the last 24 hours…so).

Back in November, the estimated value of the global cryptocurrency market was $3 trillion dollars. Betting on cryptocurrency became ‘easy money.’ As a close client and friend told me at the time, ‘easy come, easy go.’ The problem is that $3 trillion dollars is a lot of money (almost twice the size of Canada’s economy!) – and when that crashes, the globally economy suffers. This week is a great example – where much of the negativity in the stock market can be attributed to investors selling out of everything to cover losses in their crypto portfolios.

In the last 7 days, Bitcoin (the blue-chip cryptocurrency, if you can have such a thing) has fallen -30%.

Bloomberg reported in an article yesterday that Changpeng Zhao, thought to be the richest person in Canada with a net worth of $96 billion in January, has seen is wealth shrink to $11.6B this week.

And probably the most shocking – cryptocurrency ‘LUNA’, a so-called ‘stable-coin,’ has seen it’s price fall from $82.00 to $0.02 over the past 7 days, wiping out $32B in wealth (chart below).

Investing is not a game. Money is not made or lost quickly – rather it takes diligent saving, a long time horizon and a lot of patience.

While I expect that we will continue to see stocks sell-off over the next few days (especially the tech heavy Nasdaq index, which is already down -30% this year), the crypto crash removes a major potential head wind that was looming on the stock market for some time.

3) Investor sentiment is extremely low

I’ve been doing this for 14 years now. That’s not a super long time, but it is longer than probably half the people on Wall Street these days.

I believe there are only two rules that you need to follow to be a successful investor: 1) diversify - diversification is the only way to keep yourself from making mistakes and 2) buy low and sell high.

A diversified portfolio will not keep you from losing money when everything is falling – but it will keep you from losing more than you can recover from. Most importantly, it will keep you invested during the worst periods so you can ride the market back up again. Our portfolio returns this year have not been stellar, but thanks to diversification, our clients are doing better than most.

Buying low is easy, selling high is hard. When you buy low, history would prove that you are almost always correct (my investment in General Motors in 2008 being one exception I can think of…). Selling high is hard, because prices usually go higher. You have to be certain that what you do with the proceeds from sale will pay off in the long-term. Our approach for our managed accounts hasn’t changed in 10 years. We try and accumulate cash when things are good, and we put that money to work when things are bad. Net-net it lowers the volatility that our clients experience and it let’s us snap up some real bargains.

The time to sell high has passed, but the time to buy low is getting better every day. The S&P 500 in the US is down -19.8% from it’s high (at the time of this writing). Historically -20% has been our first entry point into getting more aggressive with our equity weightings. I have told many investors the story of March 2020 - we added 5% to equity for our managed balanced clients when the market fell 20%, again at -25% and again at -30%. Never mind that the S&P 500 didn’t bottom out until nearly -40% down - the result of this was an almost full recovery of losses in just a 4-month period. Our strategy this time around is no different.

Uncertainty abounds and the level of volatility witnessed over the past few months reflects this. However, it is worth noting that Monday’s negative market move pulled National Bank’s market sentiment indicator into ‘Extreme Pessimistic’ territory for the first time since April 2020 (chart below).

Over the past 15 years, when our sentiment indicator signalled an extreme level of pessimism (which happens only 3% of the time), the S&P 500's return for the following 3 months was positive 85% of the time, with an average gain of +8.5%.

I have sent this chart out many times in the past: 2020 (COVID), 2018/2019 (First Cryptocurrency crash) and 2016 (Chinese stock market crash). It hasn’t always been the case, but in all of those instances – it signalled a time to buy (chart below).

4) The economy is still doing really well

There is a lot of talk about recession already - but I think that is premature. Anyone who wants a job right now, can get one. In fact, in the U.S., there are currently 1.8 job openings per unemployed person (chart below - a record high). This is creating wage inflation – which is both bad and good. Bad, in that it perpetuates price increases, adding to inflation concerns. But good, in that it adds fuel to the economy through consumer spending.

Consumer savings are still off the charts with people staying at home through the pandemic. In the U.S., household savings rates are estimated at $2.7 trillion – that’s a lot of economic potential on the horizon (chart below).

Business investment is also near all-time highs – meaning that we should expect to see major economic spending over the next few quarters (chart below).

And lastly, corporate earnings (the fuel for stock prices), are still estimated to be at our above average levels for the foreseeable future (albeit down from near all-time high growth last year)(chart below)

In short, while we cannot rule out new market lows in the short-term and we must continue to monitor inflation closely, the signs we are seeing suggest that the odds are increasingly skewed towards a market rebound.

Finally, I try not to talk about real estate that much – but sometimes you just have to shake your head and laugh. The final chart below shows ‘home prices vs. income’ for both Canada and the U.S. I’ll leave you with that, as well as our current mortgage rates below.

Take care everyone,

- Jeff

For a $400,000 mortgage, owner-occupied, 25 year amortization, 80% loan-to-value, and completing within the next 90 days:

1 year fixed: 3.39%

2 year fixed: 3.69%

3 year fixed: 3.99%

4 year fixed: 4.19%

5 year fixed: 4.29%

5 year variable: P – 0.60%

Rates are as of today, for information-only, subject to change, and only guaranteed after an application has been submitted to the bank for approval.

- Your Creed Capital Management team

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