What goes up, must come down – eventually. Most investors know that, but the question of “when” has money managers torn between taking cover or riding out the pandemic bull market that has the experts perplexed.
Since the initial lockdown shock that trimmed roughly 30 per cent of the value of the S&P 500 and S&P/TSX Composite Index in the winter of 2020, the U.S. and Canadian stock market benchmarks have almost doubled in value as the economy reinvents itself for a post-pandemic world.
“There’s something very interesting going on in the market because sectors are regaining their strength one by one. That’s not to say we can’t have a small correction, but we think that there are significant shock absorbers in the market,” says Diana Avigdor, vice president, portfolio manager, and head of trading at Barometer Capital Inc. in Toronto.
Much of the equity market’s strength is being fuelled by rock-bottom borrowing rates as central banks maintain low interest rate policies to keep cheap money flowing.
But that strength doesn’t appear to be waning as pockets of inflation appear and central banks signal they will eventually need to raise interest rates. Ms. Avigdor interprets the positive reaction to looming interest rate hikes as a sign of stability.
“The market is digesting bad news in a good way,” she says.
While the strength of the stock market is fairly broad across sector lines, technology has been leading the way as distancing protocols place a higher demand for remote communication. The tech-heavy Nasdaq – which includes heavyweights such as Apple Inc. AAPL-Q, Facebook Inc. FB-Q, Netflix Inc. NFLX-Q, Amazon.com Inc. AMZN-Q and Google Inc.’s parent company, Alphabet Inc. GOOGL-Q – has advanced from the winter 2020 low by 125 per cent, but Ms. Avigdor doesn’t believe share prices have risen beyond their earnings capabilities.
“The valuations don’t bother us in a bull market,” she says, adding there’s still upside potential for tech and big banks.
“Right now we’re pretty diversified, but we are overweight on technology and financials,” she adds.
Part of Barometer Capital’s investment strategy is to squeeze every cent out of stocks as they advance and place stops – automatic sell orders – when they show signs of weakness.
“As a strategy, we let our winners run. We don’t sell our winners,” Ms. Avigdor says. “If we started to see lockdowns to the same extent when [the pandemic] started, then we’re going to have to reassess.”
Patrick Kim, partner and portfolio manager at Georgian Capital Partners Corp. in Toronto, also believes broad equity markets have plenty of room to run, and investors concerned about high valuations run a bigger risk of being on the sidelines.
“I don’t think this recovery is going to be measured in months. It’s going to be measured in years,” he says. “You may get a 10-per-cent pullback, but it may happen after the markets run up another 20 per cent. Better to stay invested as the recovery continues because we’re not done with the recovery.”
Mr. Kim says he expects some of the big technology darlings that have driven the market surge will continue to advance as earnings grow.
“When you look at names like Apple and Microsoft [Corp. MSFT-Q], you can argue they’re quality names that are delivering earnings right now – and they’re going to deliver earnings over the next 12 months,” he says.
However, he cautions investors could risk paying too much for technology stocks without proven track records for earnings growth.
“You can’t put Apple and Microsoft into the same category as Zoom [Video Communications Inc. ZM-Q] or Peloton [Interactive Inc. PTON-Q],” he says. “You can still be fully invested but be careful about what type of valuations you pay.”
Mr. Kim says long-term investors who are nervous about paying too much for stocks but need growth to reach their savings goals should hedge against declines in hotter sectors by keeping their portfolios diversified in other sectors and geographic regions.
“With a balanced, diversified portfolio you should still be able to target a high single-digit return over an annualized period going forward,” he says.
In contrast, John De Goey, portfolio manager, Wellington-Altus Private Wealth Inc. in Toronto has been sounding the alarm about overvalued equity markets since even before the pandemic.
“Right now it’s difficult to be optimistic,” he says. “Markets were expensive then. They are more expensive now. The economy was moderately strong then. It’s more tenuous now. We are in a multi-asset bubble that has been perpetuated and exasperated by loose fiscal and monetary policy as a response to COVID-19.”
Mr. De Goey blames central banks, including the Bank of Canada, for keeping interest rates too low for too long. The current regime of rock-bottom interest rates goes back to the 2008 global financial meltdown when cheap cash was needed to keep the system from freezing.
He says markets have become too comfortable with low interest rates and expects prices to crash as central banks begin raising them.
“The only thing that’s keeping markets at their lofty levels is, literally, unprecedented fiscal and monetary stimulus,” Mr. De Goey says.
He says the large technology stocks are currently double their fair value based on historical valuations.
To hedge against an inflation-fuelled selloff, he has his client’s money in non-traditional assets such as gold, private real estate that produces income from rents, and money market funds.
Mr. De Goey’s also taking short positions through custom-built inverse notes that go up when markets go down and down when markets go up. They include a 10-per-cent barrier for losses, which has already been enacted as markets advanced.
“At a minimum, all of my holdings will hold their value no matter how much the market craps out,” he says.
In the meantime, his portfolio returns have been relatively flat as markets advance.
“I’m taking a few blows because my clients are feeling they’re missing out,” he says.