One notable supporter of the correction forecast is Harry Dent, the
economist who called the collapse of Japan, the dot-com bubble, and the
2007 housing bust. Mr. Dent is now predicting what he calls, a
“once-in-a-lifetime crash” in the next three years. He has long been known
for his bold predictions, and his current expectation that stocks will drop
between 70% and 90% in the next three years. If that were to happen, we’d
see the S&P 500 fall from its current level, roughly 2,430, to between
243 and 729.
Demographics, debt, and real estate
The foundation for Mr. Dent’s bold forecast is demographics, and
specifically that the Baby Boomers are now getting older and starting to
die. According to his research, the generations after the Boomers are not
large enough to replace the Boomers’ spending and consumption, which could
be disastrous for the economy and markets.
Another factor cited was the high level of debt carried by consumers. There
was some deleveraging that happened after the 2008 financial collapse, but
today, debt levels have again reached worrisome heights. In the U.S.,
consumer debt is now at levels in line with 2008. Here at home, consumer
debt reached 167% of disposable income in the first quarter of 2017. Should
we see any meaningful increase in interest rates, the cost of carrying
these elevated debt loads will also increase, eating away at consumers’
spending power, creating a drag on economic growth.
There are also concerns around the fragility of the global real estate
market, and geopolitical concerns, which on top of the demographics and
debt levels, creates an almost “perfect storm” for a major market
correction.
Now before you pack up the car, head to Costco to load up on canned goods
and shotgun shells, and move to a cabin in the woods, I’d suggest you take
a deep breath, and relax. The forecasts by commentators such as Mr. Dent
are designed to create headlines, and ultimately sell books and newsletter
subscriptions.
Déjà vu all over again
Yes, markets are overvalued; yes, debt levels are high; yes, the housing
market is potentially in a bit of trouble; and yes, there are lots of
worries around the world. But that does not mean that there will be an
unprecedented market crash. We have seen much of this before. While we are
unlikely to see a crash, it is highly likely we will see a pullback or at
least some period of below-trend growth. Unfortunately, there is no way to
tell in advance how this will play out, or when it will play out. As John
Maynard Keynes is believed to have said, “Markets can stay irrational
longer than you can stay solvent.”
As an investor, times like these can be challenging, to put it mildly.
However, it is times like these where we must stick to our discipline and
focus on the bigger picture. A crash may be coming, but it’s far from a
certainty, and to position portfolios for such a binary outcome may end up
doing more harm than good.
Instead, it is best to look at our investment goals and figure out how much
risk we are comfortable with. People rarely worry about risk and volatility
when things are going well. Then when things get bad, they tend to
overreact and make choices that often hurt more than they help. We must
realize that market corrections are part of investing, but if we have built
a portfolio that is in line with our needs, they are certainly very
manageable, particularly over the long term.
Portfolio planning
I continue to keep my asset mixes in line with the longer-term averages.
Equities are expensive now, but looking out over a five-year time horizon,
they are still expected to deliver a higher level of return than bonds.
Turning to bonds, while the return expectations may be muted, they still
need to be a healthy part of your portfolio. If we see a market correction,
it is the bonds in your portfolio that will act as a ballast to help
protect your capital. In most corrections, bonds move up, while stocks move
lower.
With your investment selection, I would suggest you focus on higher-quality
securities, trading at reasonable valuation levels. Look for funds and ETFs
that focus on strong underlying businesses, as it is these businesses that
are expected to withstand any correction better than those highly levered
companies.
If you have had your portfolio invested for some time, it’s a good idea to
rebalance back to your target asset mix. This takes some profits off the
table, and reduces your risk over the long term. Finally, if you are
extremely worried about a market correction, you could always get more
defensive by holding a bit more cash, and reducing your equity exposure by
adding to your investment-grade bond holdings.
There is no perfect solution for uncertain times, but having a strategy and
the discipline to stay the course will likely lead to better long-term
results than making bets on the unknown.
Dave Paterson, CFA, is the Director of Research, Investment Funds for
D.A. Paterson & Associates Inc., a consulting firm specializing in providing research and due
diligence on a variety of investment products. He is also the publisher
of
Dave Paterson’s Top Funds Report,
offering regular commentary and in-depth analysis of Canada’s top
investment funds. He uses a unique analytical approach to identify
funds with strong, risk-adjusted returns, and regularly publishes his
insights and analyses in Fund Library.
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