Video - Stock Cycles
In this, our expert Louis Wermenlinger demystifies stock market cycles. He explains market cycles and the lessons you can learn from them, such as how to anticipate a recession, the most common portfolio management mistake and a simple strategy for taking emotion out of the equation.
SUBJECT : Stock Cycles
EXPERT : Louis Wermenlinger
VERSION : English
Note: The information in brackets "[...]" describes the visual and audio content of the video other than the dialogue or the narration.
[Elegant music begins. Different parts of Desjardins Securities' head office appear on screen including, primarily, the prestigious trading floor where many employees work. These images give way to a shot of the firm's logo and the dsia.ca website. This shot gives way to Mr. Louis Wermenlinger, whom we see appearing on a balcony overlooking the trading floor where employees are busy working].
Louis Wermenlinger (CA, MBA, CIM, Vice-President and Director, Portfolio Management - Brokerage and Private Management Division, Portfolio Manager): Today, I have chosen to talk to you about market cycles and the lessons to be drawn from them.
As you certainly have observed, the economy is not a long and calm river…. Periods of economic growth are followed by slowdowns and contractions, also known as recessions. History repeats itself, but always with variants from one cycle to the next. For example, the last two recessions occurred alongside the bursting of a bubble, the technology bubble in the late ’90s and the real estate bubble more recently.
Economic cycles have a major impact on financial markets. When a recession is drawing near, equity markets decline, anticipating lower corporate profits. By way of contrast, the bond market becomes a refuge as it benefits from an easing of monetary policy, meaning lower interest rates, the main remedy used by monetary authorities to stimulate demand and investments to get the economy moving again.
This movement goes into reverse when investors expect an economic recovery and transfer funds into stocks, leading to higher share prices. This is when the best returns are generally to be had. Later on, equity markets generate worthwhile but less spectacular yields. Eventually, the economy runs out of steam due to a range of factors such as higher interest rates to contain inflationary pressures, imbalances, the correction of excesses, and so on. Then it’s back to the beginning of the cycle.
How can you anticipate a recession? Certain leading indicators activate a yellow light warning us that the risk of a slowdown is increasing. For example, a negative interest rate curve (with short-term rates higher than long-term rates), a reduction in money supply and a decline in the Baltic Dry Index (an index of marine cargo prices) are leading indicators. A sharp rise in oil prices is also a bad sign since higher energy prices slow the economy. These indicators are imperfect. It is therefore useful to take account of the trend shown by several indicators before coming to a decision.
The most common error in portfolio management is to invest based on the prevailing mood. Real risk is generally high when perceived risk is low. When the end of a cycle is approaching, investors are optimistic, and good news are discounted in share valuations.
In contrast, real risk is generally low when perceived risk is high. Prices are depressed because economic performance is poor and corporate earnings are low. When the inevitable recovery looms on the horizon, prices go up.
This makes it a good idea to sell shares when the climate is euphoric and to buy shares when despair prevails. Unfortunately, this runs counter to nature, and most investors, guided by emotion, buy when a large part of the cyclical rise in stocks has already occurred and sell to protect their capital when shares have already fallen.
Here is a simple recipe for removing emotion from the investment process. First, determine the target allocation of assets that suits you based on your age, risk tolerance and financial goals.
Next, take profits through a target return when an asset class has gone up. For example, if your profile is 50% bonds and 50% stocks, you can sell stocks when the proportion of this asset class has reached 55% following a 10% rise on the markets. The proceeds from the selling are then invested in bonds to bring you back to the target which is 50/50.
This method lets you take profits gradually while remaining in each asset class to benefit from a subsequent rise. It also enables you to buy in an asset class cheaply. In other words, you sell high and buy low.
There exist a number of variants. An investment advisor can help you set a target allocation matching your profile and apply this method in a disciplined way.
Thank you for your attention!
[The music begins again. The dsia.ca website address appears in the middle of the screen and the following text appears at the bottom of the screen « Desjardins Wealth Management Securities is a trade name used by Desjardins Securities Inc. Desjardins Securities Inc. is a member of the Investment Industry Regulatory Organization of Canada ( IIROC ) and the Canadian Investor Protection Fund (CIPF). ». These images end with the Desjardins Securities logo. ]