October 1, 2018

2018 Third quarter update

For the quarter beginning on July 1 and ending on September 30, 2018

The third quarter solidified the two-track narrative taking form in the North American markets. While the TSX has remained static, the S&P 500 continued its race higher hitting new record highs.

While the second graph could be interpreted as a strong continuation of the longest advancing market in modern U.S. history, a closer look shows that the S&P 500 now looks more like a heavy train pulled ahead by a couple of locomotives than a furious herd of charging bulls. Without the widely beloved FAANG stocks (Facebook, Amazon, Apple, Netflix, Google), the performance of the U.S. index would be negative for the first half of the year. In other words, only 1% of the index was responsible for the positive return.

Speaking of FAANG, two publicly-traded companies reached a market capitalisation of $1 trillion, which had never happened before. Apple was the first on August 2 followed a month later by Amazon. Since we have several hockey fans among our readers, we decided to involve Toronto Maple Leafs forward John Tavares to put things in perspective. Boasting the NHL’s highest annual salary at $15.9M, we calculated that if John were to invest 100% of his salary at a 4% rate of return every year, he’d have to play for 200 additional seasons to save enough to buy Apple or Amazon outright. Needless to say, that is a lot of money for just a single company.

These facts confirm what our investment team has been seeing for a little while now. Excluding the high-flying tech stocks, the market is growing cautious on a background of tight labour markets and increasing interest rates. For several quarters we’ve been reducing our exposure to growth stocks and rotating into cheaper stocks with steady and proven business models. If the tide turns and the economy slows down, we’ll be defensively positioned with more positions that do well in times of recessions.

Although we think we’re approaching the end of the cycle, getting conservative means in no way getting out of the markets. We are long term investors and we do not try to trade in and out of the market. The reasons are quite simple. First, we have yet to meet a human being (or a computer) who can accurately predict market gyrations and constantly make money acting on them. Second, we don’t want to be sitting on the sidelines when the market gets his best days. As the following figure shows, missing out on just a handful of days can dramatically reduce long term investment returns. Unfortunately, the market has a tendency to offer its best days right after significant drops. Too many investors get fearful and sell after the drop only to miss out on the recovery. This behaviour, although understandably human, can become very expensive.

While the markets have been kind to investors during the past 10 years, we think that above average performance must one day return to average. Therefore, we are rotating our portfolios towards defensive positions. As you’ll see in the accompanying document detailing last quarter’s trades, we are increasing our exposure to sectors like consumer staples and healthcare.

As always, our own money is invested alongside yours. You can rest assured that we put all our thoughts and efforts into offering you the best management for your wealth.

We hope everything is to your entire satisfaction.

Sincerely,

 

The Gingras Barrette Group