Once in a Blue Moon
According to the Association of Federated Press (AFP), a blue moon is a rare phenomenon.
Technically, it means there is a second full moon appearing in a single month. More rare still is a blue moon on New Year’s Eve which happens about every twenty years.
Why in a financial quarterly newsletter are we writing about rare astronomical occurrences? Well, as you may have guessed, it sets the scene for what we want to share with you in this report.
Usually when stock prices go down, bond prices go up. When bonds go down it’s usually because investors are shifting into cheap stocks, causing stock prices to go up. Hence, a portfolio of both asset classes tends to smooth out the ups and downs, giving investors a more comfortable ride.
Further adding to the shock absorption of volatility that can come from owning stocks are the other two asset classes found in your portfolios, namely cash and alternatives such as gold.
What is very interesting about the last month though, is a “Blue Moon on New Year’s Eve” has occurred in the financial markets. Restated, a rare occasion that happens so infrequently its last occurrence is a distant, faded memory. However, in June the Federal Reserve (FED) chairman said they would look to stop Quantitative Easing (QE – the stimulus of injecting money into the financial system) because the economy, employment and housing were doing well. Normally this positive sign would cause stocks to rally. Not this time.
Instead of stocks rallying, they dropped sharply. Why? Well, as some pundits have put it, it’s like the “punch bowl” has been taken away, or will be. In other words, the free booze, QE (money printing), that has supported the economy, jobs, real estate and company profits will be taken away. Thus the fear is things will take a turn downwards which is why stocks recently fell by about 7% on the TSX over a span of just over 30 days.
Interestingly, in addition to the FED taking away the QE (money) they said they may raise interest rates if required. This little piece of news had a double negative effect. First, if rates rise, mortgages, car loans, credit card and corporate borrowing costs all go up, thus negatively impacting spending, the economy and corporate profits. This comment caused stocks to decline further.
More important though, was the impact of potentially higher interest rates on the price of bonds. As always happens when interest rates rise, or are expected to rise, the value or price of a bond will drop just as we’ve seen this past month. In fact, all interest rate sensitive investments like REIT’s and Preferred Shares dropped in value. As such, just when bonds are needed to act as a protection against stocks dropping, they too have declined. Think of an unexpected giant pot hole that pops the tire and bends the rim.
As we limp into the repair shop, we find out our system shock absorbers like gold in the alternatives basket of the portfolio, also broke down from the impact of the FED’s announcement. Today’s thinking is if the endless printing of money is going to stop, then we don’t need gold as a protection against paper devaluation.
Short term versus long term. While it’s surprising and even upsetting to see three of the four baskets (stocks, bonds, alternatives vs. cash) in one’s portfolio go down temporarily, it’s important to remember not to let our emotions cause more damage by “changing” things abruptly. Stocks go up and down, we all know that. Usually over time they are higher than what we paid which is how we make capital gains part of our returns.
In the interim, dividends being paid help add to the returns and allow us to be patient. Bonds on occasion do decline in value as they have this past month. It’s important to remember this likely will not occur very often. Likewise, the alternative asset class typically rebounds over time. If anything, today’s prices in all three categories warrant serious consideration for investing more money or repositioning cash into the bargains available.
Time: the healer of all wounds. As we know from past experience, time has a way of curing today’s ailments. Even on a short term view, if one looks at their April statement they’ll see what was arguably an artificial valuation, a high point if you will (meaning stocks had run up hard and fast for six months straight). When compared with a June statement one cannot help but think “I’m down $X .” Yet, if emotion is removed and last November or last June’s prices are used, one most assuredly would see the different valuation points in time and say “I’m up”. Controlling our perspective is the first step to controlling our emotions, which makes for better investment decisions.
The point is to be logical and objective so as to make rational, not emotional decisions.
Darren Buma, CPA, CA
Darren has a passion for small business and loves to work with both budding and experienced entrepreneurs. After articling with KPMG and receiving his Chartered Accountant designation, he left to explore the world of small business. What he was expecting to be a short exercise turned into nine years of excitement. During that time he helped to grow and operate a variety of private companies in both commercial real estate development and computer software development.
In 2004 Darren joined KWB so that he could have the best of both worlds, running a small entrepreneurial firm and being in a position to help entrepreneurs like you, grow your business and secure your future. He became a partner at KWB in 2007. His knowledge and advice isn't just academic, Darren lives the roller coaster of entrepreneurship that you ride every day.
Aside from his responsibilities at work, Darren is active in the community. He is a past Chair of the Edmonton Chapter of Financial Executives Canada, sits on the disciplinary tribunal roster for the Institute of Chartered Accountants of Alberta, and is active in minor hockey both as Treasurer for his local hockey association as well as coaching numerous hockey teams over the years.