Donald Trump was told to vacate the premises and contrary to his forecast, the markets did not crash.

In fact, they jumped the most in a month since well before my career started 35 years ago.

Our sense is that Mr. Trump will continue to captivate a certain percentage of the population in order to stoke his need for attention and of course, dollars.

His disruptive impact on business confidence will quickly wane. The sharp performance in the markets has likely been most impacted by the positive developments on the vaccine front.

Timing issues aside, the end of the pandemic is in sight and is allowing investors to begin to quantify their recovery.

This all makes sense to us and we are thrilled, along with everyone else, to see hope give us sustenance over the coming long winter months.

While we are thrilled, we are not alone in our enthusiasm and thus, we are increasingly getting a mild case of anxiety over the growing roar of the bulls.

The following chart shows the ratio of bulls to bears. When the ratio moves past 3 (it is 3.75 now) it indicates that perhaps too many have moved to one side of the boat.

 

As you can see, investor attitudes are quite volatile, tending to ebb and flow with good and bad news with excess optimism or pessimism usually providing contrary warning signs.

Another of our favourite indicators tracks the number of companies trading above their 200 day moving averages. Readings below 20 mean you close your eyes and buy.

Readings greater than 80, you have a strong warning of a pending correction. As of Friday morning, we were at 86.

This indicator says nothing about timing but it does have good predictive tendencies as it usually highlights in real time how the optimism or pessimism of the previous indicator is being reflected in trends of stock price behaviour over a broad array of companies.

 

 

So, what could instigate a correction and what should we do, if anything, to protect your portfolios?

Let us look at a list of six potential catalysts that could cause a tumble, with the stark understanding that usually the actual cause of these downturns is something that is unanticipated.

Everyone is expecting that the U.S. Senate will remain majority Republican, limiting the new President from accomplishing too much “bad stuff” like raising taxes or regulating banks. The runoff election in Georgia is on January 5th, and the fate of the Senate rests there. Frankly, we don’t think this will have a durable impact on markets, so we discount the worry to at most, a potential short-term hiccup and thus not worthy of making any major changes to portfolios.

Too much money being printed causes investors to lose faith in the credibility of the U.S. Treasury, triggering interest rates to soar. The problem with this theory is that all countries are in the same boat. So where would investors go, and to whom would they sell all their holdings if widespread panic ensued? There really is no exit for most investors, so once again, we don’t put much weight into this argument.

Political gridlock will create a fiscal cliff whereby the lack of agreement to print more money causes a double-dip recession. Our view, backed up by decades of proof, is that politicians have no problem spending our money. It’s where it comes from and who pays that is at the heart of the debate. We feel confident that should things start to get wobbly on the growth front, money will be found to bail-out the situation. Additionally, the economy seems to be doing well with employment rebounding, income rising, savings rates high – and capable of falling – as consumer and business rebuild inventories and goodies to make themselves feel better.

The impact of the second wave of Covid-19 is worse than anticipated and causes widespread economic devastation before the positive impact of the vaccines can be realized. This could overwhelm the banking sector and cause market panic. The great financial crisis of 2008-09 taught the authorities that banking crises are very detrimental. That being said, the banks are much better capitalized than they were in 2008-09.

Iran loses patience and attacks Israel, or a different war breaks out in the Middle East. The history of war and subsequent market impacts vary. Wars have historically been getting less ‘messy’ and impacting far fewer people. We do not mean to downplay the tragedy and hardships of war, merely to point out that there have been many wars in the past 40 years and the markets have usually only moved higher.

There could be setbacks to the vaccine, and its effectiveness or distribution.

So, the question is, if we think we could experience a correction then what, if anything should be done? We don’t know when, if, or from what level we may experience a correction.

While these indicators and risks are real, we just don’t know if it’s worthwhile acting. We take a long-term approach to investing and it has rewarded you, our clients, well.

Simply look at the positive effects of not focusing on the short-term this year!

The trick to good long-term results is sticking to your knitting and being prepared to ride out the rough patches.

For example, Amazon.com has experienced three drops of 30% in the past five years and Apple Inc. has had five drops in excess of 30% in the past eight years.

Nonetheless, both companies have been exceptional investments over these time periods. These two companies are not unique in your portfolio.

This highlights one of our key fundamental investment beliefs. We don’t invest in stock prices but rather in businesses.

Business valuations move slowly and are not subject to investor moods in the short-term.

Stock prices have everything to do with investor emotion in the short-term and, as you can see from the first chart above, moods move rapidly and frequently from bullish to bearish.

However, the strategy of ignoring mood swings and sticking to fundamentals has paid off over the longer term.

Related stories: The Crash & Recovery of 2020: Key Takeaways