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Hochachka: “We think investors should stay the course"

Hochachka: “We think investors should stay the course"

Posted on: August 25, 2015
Author: Staff

The markets have been big news for the last few days, with sharp declines followed by rebounds followed by questions from investors. We sat down with Chief Investment Officer Gene Hochachka for answers to a few of those questions. What are the main reasons for the sharp declines in global stock markets over the past few days?

GH: The main reason given by most media is that a decline in Chinese economic activity has spooked investors. We agree that something has spooked investors, because this decline seems driven by sentiment rather than fundamentals, but China’s trade ties are sufficiently small that a slowdown in Chinese economic growth will have only a very small direct effect on the North American economy. What do you mean by sentiment and fundamentals?

GH: The price of stocks, bonds and anything traded on a public market will fluctuate significantly if investors become either overly enthusiastic or pessimistic. We attribute to sentiment those price changes that have little connection to what we call the facts on the ground. What are these current facts on the ground?

GH: The U.S. economy is better than it’s been in many years, so much so that its central bank may soon start to pull away from low interest rates in order to prevent any overheating of the U.S. economy. The U.S. economy is creating jobs at a healthy clip, and its banks and housing market have both recovered from the damage they both endured during the 2008-09 financial crisis and global recession. And what about the facts on the Canadian ground, and elsewhere?

GH:Canada’s economic growth is currently weaker than the U.S.’s but that’s mainly a result of the significant slowdown in Alberta’s energy sector, in turn a result of the steep drop in oil prices since last year. Canadian energy company stock prices are down 40 to 50 per cent since that time, and this is due not to sentiment but rather is attributable to fundamentals, namely that their revenues and profits dropped commensurately with the oil price. Job growth in the rest of Canada has been lethargic the past couple of years, but in light of the lower Canadian dollar and Bank of Canada interest rate cuts this year, should improve.

Even in Europe, the most recent data show ongoing growth in the very largest countries, along with a turnaround in the beleaguered economies of Spain and Italy. So, back to that first question, is there a main reason for the sharp declines we started the week with?

GH: There is no overarching fundamental economic reason for the last few days’ stock market selloff, which, in turn leaves investors’ sentiment as the culprit. Should Canadian investors be concerned about a slowing Chinese economy?

GH: No, unless they put all their eggs in the Chinese stock market. We’ve always cautioned investors against concentrating their investments, and instead have preached the benefits of effective diversification across different geographic areas and industries.

Having said that, the negative sentiment now emanating from China’s stock market has temporarily affected stock markets around the globe, so there’s been nowhere to hide (other than perhaps in government bonds, whose interest rate won’t even cover inflation). But positive and negative excesses of sentiment eventually dissipate, and when they do, stock market prices reflect fundamentals and reality.

As Warren Buffett's mentor Benjamin Graham said, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”

The direct (fundamental) impact a slowdown in China’s growth will have on the Canadian economy will be quite small, due to the modest size of the trade flows between the two countries. For example, exports to China represent only about 1 per cent of annual Canadian economic output. Even if those exports were to decline by a fifth, a huge drop in and of itself, the net impact on Canada’s economy would be only about one-fifth of one percent. Based on what’s happening in the markets, what should investors do?

GH: We think investors should do nothing—they should stay the course.

First, the past few days have to be put in proper context. Even after the 10 percent slide in a period in the last five days, the U.S. market is down only about 7 per cent for the year and overseas markets are down only 1 per cent. If we add back the impact of rising foreign currencies, both the U.S. and overseas stock markets are still in positive territory for the year.

The same is not true of the Canadian stock market, but that’s due mainly to the outsized impact of low oil prices on Canadian energy companies’ stocks.

Most importantly, we think investors should continue to implement their strategic investment plan, regardless of stock market gyrations. Financial markets have always been and always will be choppy, but seeing through their short-term fluctuation and staying the course in order to take advantage of their long-term gain is integral to investment success.

For a more in-depth look at China and the North American economy, read Gene's article on