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Feb 10, 2022

Hockey sticks and rollercoasters

Over the past four years of market activity, the last two have taken a markedly different shape causing many of us to forget what a “normal” market actually looks like. This commentary takes a high-level look at how volatility has played out in the past four years, and what January 2022’s performance could signal for the coming year.

Scott serves as Chief Investment Officer, and has in excess of 25 year of experience in investment management and equities research.
  • The shape of volatility
  • What does a “normal” market look like?
  • Thoughts on January

Investment professionals love to use the phrase “expect more volatility”. Volatility, in the context of markets, is a measure of the rate at which prices change. The wilder the price movements, the more volatile the markets are.

The shape of volatility

Volatility can signal either higher or lower prices, but market commentators usually talk about it in negative terms. At the end of a good year for stock markets you’ll often hear forecasters say, “buckle up” as they warn of more volatile days ahead. While the expression is overused, it proved accurate for those predicting a rougher ride at the start of 2022 as stock and bond prices fell rapidly in some markets.

In the past two years, we’ve experienced a market that resembles a hockey stick. Figure 1 shows Canada’s main index (the S&P/TSX Composite) beginning January 2020 and ending December 31, 2021. The chart starts out okay, but quickly falls as the market corrects as we enter the pandemic in March 2020 (this is the blade of the stick).

We then see a steady, almost uninterrupted, move upwards for the next 21 months (this is the shaft of the stick). Over this two-year period, the Canadian market total return was almost 15% per year! These are great returns, but what’s truly interesting about this period is the lack of corrections after the lows. The market shrugged off an incredible amount of uncertainty and negativity since March 2020, to move almost relentlessly higher. It’s not normal.

 

Figure 1: S&P/TSX Index from January 1, 2020 to December 31, 2021

S&P/TSX Index 

Source: Bloomberg

 

What does a “normal” market look like?

To remind ourselves of what is normal, let’s look back to the two full calendar years before COVID-19. The economy was growing at a reasonable pace and inflation was benign. The job market was strong. Although there were clouds, such as the China/U.S. trade war, overall, the economy was functioning well.

What about the markets? Figure 2 charts the S&P/TSX Composite from January 2018 to December 31, 2019. This period looks more normal for the markets. If the past two years were a hockey stick, the two years before COVID-19 were more like a roller coaster that slopes up to the right.

There were some peaks and valleys with one major downturn, caused by rates rising a little too high. Overall, it was a good two years with the Canadian market producing a total return of around 6% per year. It’s interesting to note here that the major downturn in December 2018 wasn’t as severe as the one in 2020, but took a lot longer to bottom.

 

Figure 2: S&P/TSX Index from January 1, 2018 to December 31, 2019

S&P/TSX Index from January 1, 2018 to December 31, 2019

Source: Bloomberg

 

Thoughts on January

After the first month of 2022, headlines were focused on the market having a negative run and many commented on how we’d just had our worst month since March 2020. Yes, the market was down. In Canadian dollar terms, the U.S. market (S&P 500) fell 4.8% while global markets were off 3.3% (MSCI World ex USA). Canadian bonds returns were negative while the S&P/TSX fell 0.4%.

These returns aren’t great, but they’re also not that bad when put into context. It’s normal to have negative months and it’s normal to have corrections. It’s just been a while since we’ve seen it and that can feel uncomfortable. It’s also a good reminder that anything can happen in the short term, and it’s best to plan for the unforeseen. Investing is a long-term endeavour.

What does January’s performance mean for the rest of 2022? Although we’re positive on equities, no one knows for sure until after the fact. We are seeing a trend develop: the market is punishing companies that have high valuations and slowing growth, while still rewarding firms that can deliver solid results. It’s a sign of a return to fundamentals that we expect to continue as rising rates cut down on investors’ appetite for speculation.

Overall, we expect more volatility this year (there’s that phrase again), but that doesn’t mean it will be a bad year for the markets. It just means we’re returning to normal. Finally.

Sources: FactSet, Bloomberg

 

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