What 2015’s tumultuous markets taught Bay Street

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Scores of best and worst lists are penned in December, for everything from corporate acquisitions to catchy pop songs. As nice as it is to recall what's happened, it's often more valuable to use these reflections as reminders of what we learned in the past year.

That's especially true for business and finance in 2015. Because it was such a wild year, there are significant lessons we can't afford to forget.

It is incredibly tough to stop a bubble

No matter how often we write about potential market pitfalls, few people care until things start to fall apart.

In 2015, three major markets either collapsed or were incredibly volatile despite dire warnings – energy, China and high-yield debt. The latter is probably the most perplexing.

With energy, few people predicted such a dramatic crash. With China, it's tough to get reliable economic information, so investors had some reason to be skeptical of negative predictions.

For high-yield debt, though, the dire warnings have been sounded for years. People have argued – almost screamed, even – that investors weren't paid enough to invest in risky companies.

But because benchmark government interest rates were so low, meaning investors were starved of yield, so many chose to ignore the caution.

Now, the high-yield market's tanking and the pain has spread beyond existing backers. Companies who desperately need cash will have trouble raising funds because investors are so gun-shy.

Watchdog's tough rate rules proved worthy

For the first few years after the 2008 financial crisis, Canadian insurers were rather mad at the Office of the Superintendent of Financial Institutions. The watchdog's strict rules around interest rates forced these companies to assume that rock-bottom rates would last for a very long time in their financial projections. The insurers wanted to assume these rates would revert to the historical average.

OSFI was accused of being overcautious, which forced the insurers to shore up more capital than they otherwise would have needed. That meant they had to store extra money to ensure they can pay out future insurance obligations because they can't rely on high bond yields or market returns to generate extra cash.

Then came 2015, when Canadian interest rates were slashed twice. Heading into the new year, the Bank of Canada doesn't see the economy looking healthy until at least 2017, which means interest rates are likely to stay low until at least then.

Turns out that extra caution wasn't frivolous.

Slow and steady pays off in the long run

In capital markets, there is a long-standing belief that companies must take advantage of open windows. Markets can turn quickly, so it is best to finance as soon as investors start showing interest.

That philosophy still exists, but people seem to adhere to it with even more fervour these days. Because markets are so volatile, issuers are piling in as soon as a window seems open – something proven by the flurry of initial public offerings this spring and early summer.

This year, we were reminded that being overzealous can backfire. Because so many companies rushed to go public, buyers eventually grew tired of all the opportunities. This change of heart hurt a number of issuers who were late to the party because they arrived right before it was shut down.

Sleep Country Canada, for instance, doubled the size of its deal, but then paid the price for sapping investor demand. The shares traded under water, or below their new issue price, for many months after the deal.

Cara Operations Ltd., by contrast, didn't increase the size of its IPO, even though it was many times oversubscribed. That helped attract investor support once the shares started trading and the stock is now up 30 per cent – despite a recent price correction.

The same goes for Hydro One Ltd., which was privatized in a $1.8-billion deal. Even though the massive privatization was oversubscribed, the government didn't try selling more shares than it originally intended, nor did it raise the deal price. So far, investors have shown their appreciation.

Eventually, hysteria subsides and flaws are punished

In hot markets, investors are willing to overlook a lot and they make simple justifications for their irrational decisions. In mining, so many people were willing to believe Chinese demand could never be curtailed; in energy, few people were alarmed by explosive supply growth.

Such fervour eventually subsides. It can take some time, but when it does, the hottest companies are often those that suffer the most.

This is a crucial lesson to keep in mind in 2016. So many Canadians have sold commodity-based companies and plowed their money into non-resource stocks. The fear now is that we've overrotated, so much so that people aren't buying non-resources based on real earnings expectations and instead because, well, what else is there to invest in?

If that's true, never forget: Hysteria eventually fades.