Flying Pigs and Falling Knives!

For anyone not living under a rock, it is pretty clear that the start to the year has been bad. Almost all stocks are down and there remains this ho hum market complacency that the bears believe will bite harder at some point. The bulls see this as just another garden variety pull back in this new generation of volatility.

There are a few parts of the market that are feeling the sharp end of the stick. The rest of the world has title pigs and/or are catching a falling knife. The clear and most obvious sector for Canadians is the commodities or resource sector. A strong argument could also be made about the few pharma stocks we have here in Canada. Valeant, for example, was close to $350 in early August of 2015 and finds itself at around $125 today. These types of experiences are difficult by any measuring stick.

The real challenge has been finding the bottom. The fundamentals and/or quantitative approaches have been underscored by a variety of different influences, leaving people feeling like they are catching a falling knife. The visual of this suggests that you grab the blade more often than the handle and cut your hand – a bloody hand is not good!

We have talked about oil in the past, and perhaps the reason is because it hits home the hardest for us as Canadians, but it is also starting to tell a very interesting story. Most people look at the price of West Texas Intermediate as their barrel of oil reference. The black gold is currently trading around $31 to $32 US dollars per barrel. The chart below shows the price of oil over the last decade. Clearly we are now trading below 2008/09 crises levels. 

Source: VIP Wealth Solutions and Bloomberg

At every inflection point in the past couple of years, investors have been punished for stepping into the oil or energy trade. The reality is that this is not a permanent condition. Will oil stay low forever? We don’t think we are smart enough to answer that question in a short paragraph, or maybe at all. However, history has demonstrated on more than one occasion that these types of shocks do not represent a new paradigm. We extended the view of oil out a bit further to gain a deeper perspective. At current prices, we are back to a 2004 pricing environment.

Source: VIP Wealth Solutions and Bloomberg

For most, 2004 is a distant memory but let’s consider the state of the union with some satire and context:

Jan 7: President Bush proposes new tax cuts to stimulate the slumping U.S. economy.

Today Trump is running for president. Trump claims, implausibly, to be worth over $8 billion. (Forbes puts his net worth at half that amount.) But even taking him at his word, that sum is less impressive than you’d think. As several writers have pointed out, if, in 1988, he had simply put his money in a stock index fund, it would be worth $13 billion today. In effect, his post-1988 business career has cost him $5 billion (maybe more). Source: New York Times.

Feb 3: President Bush sends Congress fiscal 2004 budget, proposing to bring federal outlays up to $2.23 trillion and incur record deficits in coming years.

Did we not just see a video like this?

Feb 11: Alan Greenspan tells Congress that the economy may not need a stimulus and warns that deficits predicted under Bush's stimulus package could hurt the economy in the long term.

Yup, it did in 2008 and today the economy seems to be ticking along.

March 20: The Iraq war begins as the U.S. launches Operation Iraqi Freedom.

ISIS – just maybe there is a real problem in that region? Humm….

April 9: The IMF releases its spring "World Economic Outlook," projecting a slight increase in real GDP growth for the European Union (from 0.8% in 2002 to 1.1% in 2003) and a slight decrease for the United States (from 2.4% in 2002 to 2.2% in 2003).

IMF October 2015 US growth outlook for 2016 is 2.8% Source: IMF

May 29: Microsoft agrees to pay $750 million to AOL to settle an antitrust suit filed by Netscape, a division of AOL.

Ask any 10 year old what Netscape is or AOL for that matter – crickets……

June 25: The Federal Reserve cuts short-term interest rates again by a quarter of a point, bringing rates to their lowest level since 1958.

I think we just moved off of zero.

July 3: The U.S. Labour Department reports the jobless rate increased to 6.4% in June, the highest rate in nine years.

Current data suggests a 5.5% U.S. unemployment rate. Source: Department of Labour

Dec 11: The Dow Jones index of stock prices closes at 10,008.16, an 18-month high.

Dow is at $16,491 today. Source: Bloomberg.

Dec 24: One Euro is worth U.S. $1.24 in the world's foreign exchange markets, an appreciation of U.S. 21 cents since the beginning of the year.

Euro is at 1.08 today.

What does this all suggest? Well, not much has changed in some respects while in others it has changed a lot. Will oil go to ZERO and to negative prices? No. Will it be higher again in the future? Yes.

How about the other unloved sectors of the Canadian landscape? For years, the Canadian Banks have been the darlings of the world banking system; better capitalized, more conservative, better risk management etc. Let’s have a quick look at Royal bank as an example. The stock trades at about 10 time’s earnings with a 4.43% dividend yield (about 7.3 times better than the 5 year Government of Canada Bond). If we look at the price earning chart of Royal, some might infer that the current valuation is low (with reason) based on historical shocks in the past 10 years.

Source: VIP Wealth Solutions and Bloomberg

Can valuations get lower? Sure. But some of these asset classes are looking like historical lows, or at least in modern history. So what should one be doing? Buy assets when they are cheap and sell them when they get expensive - we think is how the saying goes.

Many assets are now cheap and some of them may be cheaper tomorrow. A couple of quarters or years from now, profits will be present and PIGs will FLY!


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