Last Wednesday, we stared into the abyss for the second time this month.
The Dow plunged more than 800 points, its fourth-worst day in history in terms of point loss. The week before, we saw the seventh-worst day for the Dow, a drop of 767 points. The TSX, meanwhile, lost more than 300 points Wednesday, its worst loss since October.
Rallies on Thursday and Friday restored some degree of investor confidence. But this is no time to feel at ease. We are facing some unprecedented circumstances. Start with negative interest rates. Over US$15-trillion in bonds worldwide are offering returns of less than zero. You’re paying governments and big corporations such as Nestle to hold your money. That pattern is escalating.
Now, a Danish bank is offering a 10-year mortgage at a negative rate to borrowers. It’s paying you to borrow! I’ve never seen anything like this and it’s a dangerous warning signal. What happens to bank profit margins in these circumstances? How do insurers earn the projected actuarial returns to fulfill their policy obligations if interest rates drop to near zero or, worse, below? Financial institutions in Europe are coping with these issues right now. Is North America next?
Then we have the Trump trade wars to worry about. The President doesn’t see this as an issue. Rather he blames the recent turbulence in the stock markets on the failure of the Federal Reserve Board to cut rates sooner and more deeply. But, in fact, Mr. Trump’s tariff policies are exacerbating an already fragile global economy.
Fortunately, not all the news is bad. U.S. consumers, the driving force of their economy, continue to spend at a surprising rate, given all the gloomy news. The U.S. Commerce Department reported on Thursday that retail sales in July were up a seasonally adjusted 0.7 per cent from the previous month, the strongest showing since March.
Whether that can last is another story. On Friday, the University of Michigan reported that consumer sentiment index declined in early August to its lowest level since the start of the year, coming in at 92.1 compared to 98.4 in July. Chief economist Richard Curtin said consumers reacted negatively to the news that Washington plans to introduce tariffs on an additional US$300-billion worth of Chinese imports.
People were also concerned about the quarter-point rate cut by the Federal Reserve Board. "The main takeaway for consumers from the first cut in interest rates in a decade was to increase apprehensions about a possible recession," Mr. Curtin wrote. "Consumers concluded, following the Fed's lead, that they may need to reduce spending in anticipation of a potential recession."
In short, fear of a recession may contribute to it actually happening.
Amid all this turbulence, what should you do? I have five suggestions.
Review your portfolio. I’ve advised this before, but many people are gripped by inertia and uncertainty when it comes to financial decisions. It’s time to suck it up and act. If you have more than half your assets in equities, you are exposing yourself to serious risk. You can make changes now or regret not acting later.
Own bonds. Yields have fallen a lot, providing windfall profits to bond owners. But we’re nowhere near through this cycle. As the economic situation worsens, bond yields will fall more, pushing up prices.
For more adventurous (and risk-tolerant) investors, the best profit potential is in long-term issues. The iShares Core Canadian Long Term Bond Index ETF (TSX: XLB) was up 18.55 per cent year-to-date as of the close on Thursday. Conservative investors should stick with iShares Core Canadian Universe Bond Index ETF (TSX: XBB), which is ahead 9.52 per cent year to date.
Own gold. Mounting global economic problems have propelled gold to the US$1,510 range, the highest level since early 2013. With interest rates now negative in parts of the world, one of the impediments to holding the metal is removed – the fact it pays no return.
I expect the price to keep moving higher. You can profit by investing in the world's largest gold fund: SPDR Gold Shares (NYSE: GLD). As of the end of July, it was up 11.13 per cent year to date. The expense ratio is 0.4 per cent. It closed on Friday at US$142.81.
Own interest-sensitive stocks. The numbers tell the story. The S&P/TSX Capped Utilities Index was up 24 per cent year to date as of Friday. The S&P/TSX Capped REIT Index was up 15.34 per cent. What more evidence do you need?
Raise cash. In rough times, cash is king. These are rough times. I suggest you have enough to cover your needs for 12-18 months, so you don’t need to sell assets into a bear market.
Hopefully, this gloomy picture will turn around. Mr. Trump could do it in a single tweet, declaring a trade truce with China. But if that doesn’t happen, the steps I’ve outlined above will reduce your risk and hopefully even generate some profits.
Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters.