Secular Market Trend: The secular market trend is the overarching driving force behind the market, from a long-term perspective, which can persist for beyond a decade. Simply put, the secular market trend is the long-term direction of the market; secular bull markets are characterized by generally rising stock markets over a period of 10 years or more, and vice-versa for secular bear markets. Secular market trends are typically driven by structural economic, political, or demographical changes which serve to assert long-term effects on an economic environment. For example, the post-World War II era was a stereotypical secular bull market. Large changes were occurring across Europe and North America; millions of soldiers were returning home, pent-up consumer demand was released, birth rates exploded, credit availability rose dramatically, and the United States’ interstate highway system was under heavy development. These structural changes allowed the Dow Jones index to surge 5 times between 1946 and 1966.  Secular bear markets are also driven by long-term structural forces. For example, between 2000 and 2013, we had the dot-com bubble, 9/11, numerous accounting frauds, the 2008 mortgage crisis, high oil prices, and two wars in the Middle East. In the year 2000, the S&P 500 hit 1,500; however, this level was not achieved again until the spring of 2013.

Cyclical Market Trend: The cyclical market trend is typically driven by short-term forces, which are often in contrast to the long-term fundamental themes. Typically, cyclical trends are driven by investor behaviour, and often only persist for a year or less. For example, a cyclical bear market will be characterized by a market correction of between 10% and 20%, and is often related to equity valuation levels out-pacing economic growth. 1987 was a good example of this, when the Dow Jones fell 34% in the time span of only a few months. Despite the pull-back in the equity markets, strong structural trends persisted, allowing the Dow Jones to continue its upwards long-term trend. Across the secular bull market of 1982 to 2000, the Dow Jones returned 1214%.  Any given secular market trend will include various cyclical trends which serve to shake the confidence of investors; secular bull markets will have various cyclical, short-term, bear markets, as well as all secular bear markets experiencing short-term rallies.

Given this information, it is clear to us that the key to long-term results is being aware of the overall secular trend of the market. However, that being said, it is also important to also be wary of times when cyclical movements are likely, despite the long-term view. We are of the belief that the North American markets remain in a secular bull market environment, which began in 2013. However, we are also presently cautious of a potential pull-back in the near term. As stock markets have surged off of 2008 bottoms, we believe that they have reached valuation levels that are stretched given current economic growth. As such, we remain ‘cautiously optimistic’. Given our view of a secular bull market, we would view any cyclical pull-back as a buying opportunity for the long-term. Historically, secular bull markets have lasted an average of fifteen years, and our current bull market is only in its sixth year. Although valuations are high, corporations currently exhibit all-time high margins, with no imminent reason for this to change, the U.S. shale oil boom continues, despite low oil prices, demographics are becoming younger and increasingly educated, cloud computing and ‘the internet of things’ movement are poised to dramatically transform our technology, and unemployment is at a six-year low. These are some of the main factors we believe to be driving the current secular bull market, and in the event of a pull-back, we believe that these factors will serve to limit potential downside and propel the markets forward for years to come.

 

Behavioural Investing:

 

For the behavioural section of the monthly, we thought that we would detail another important aspect of investing, known as ‘Gambler’s Fallacy’. This phenomenon describes an investor’s tendency to believe that an event is more or less likely to happen, given a certain event or series of events that have previously occurred. Much like other areas of behavioural finance, Gambler’s Fallacy is heavily linked to other key aspects of the discipline, namely over-confidence and confirmation bias.

 

The example typically used to explain Gambler’s Fallacy is that of a coin flip.  If a coin is flipped 10 times, and it comes up as tails every single time, there will be many individuals who will believe that the next flip will have a higher probability of being heads. However, a coin flip is an independent event, and the odds of each outcome are 50/50 every time.

From a wealth management perspective, this can lead investors to perform irrational actions, based on loose logic. Many investors tend to sell stocks, based solely on the fact that they have risen for quite some time. In conjunction, many investors tend to hold stocks for too long, based simply on the fact that the price has fallen for so long and simply must come back. This logic is dangerous, and also flawed.

In order to avoid the ‘Gambler’s Fallacy’, it is important to remain grounded in analysis, and maintain a firm investment objective for each of your holdings. Your investment objective should lay out the value proposition of the investment, and specifically outline the payoff and how it outweighs the risk. Until this investment outline changes, your opinion on the stock should remain the same. To revert back to the coin flip example: as long as the outcome probability is split 50/50, you should be impartial as to which outcome you predict. The only scenario where you should reconsider your opinion for the future is when the original rules of the game have changed.

From a wealth management perspective, this can lead investors to perform irrational actions, based on loose logic. Many investors tend to sell stocks, based solely on the fact that they have risen for quite some time. In conjunction, many investors tend to hold stocks for too long, based simply on the fact that the price has fallen for so long and simply must come back. This logic is dangerous, and also flawed.

In order to avoid the ‘Gambler’s Fallacy’, it is important to remain grounded in analysis, and maintain a firm investment objective for each of your holdings. Your investment objective should lay out the value proposition of the investment, and specifically outline the payoff and how it outweighs the risk. Until this investment outline changes, your opinion on the stock should remain the same. To revert back to the coin flip example: as long as the outcome probability is split 50/50, you should be impartial as to which outcome you predict. The only scenario where you should reconsider your opinion for the future is when the original rules of the game have changed.

 

Naima is back!  Here are some of her thoughts about being back from maternity leave:

After welcoming my second son Amir in September, I am proud to announce my return. Being a mother of two boys has brought my family such joy and happiness. Although at times it becomes very busy, it is nice to see the two boys interact with each other. Maternity leave has allowed me to spend those precious moments with my newborn but at the same time, I miss interacting with adults.  It feels great to connect with our clients and partners again and talk about my journey as a mother. Moreover, I can now help provide exceptional client services again. I am excited to be back and pick up where I left off.

Scott Baker’s children are older than Naima’s and are busy with their own lives.   Scott’s eldest daughter Elena just returned from playing a concert at the Symphony Center in Chicago (she plays Flute and Piccolo) with the Toronto Youth Wind Orchestra.  She is looking forward to the finish line of a very successful first year at the University of Toronto in Music and Language. She is heading to the east coast this summer to participate in a French speaking co-op program.  Scott’s other daughter Clara is working on her Bronze Medallion so she can earn some money this summer as a lifeguard.  The family is off to Stratford for March break.  Scott has just spent four days skiing in -25 degree weather at Mount Tremblant, definitely testing his commitment to the sport!

Thank you for taking the time to read this month’s commentary.  All of us at MAAM including Diane, Naima, Erin, Jay, Scott, James, Ross, David S and myself thank you for your continued trust, confidence and friendship.

Sincerely,

David A. MacNicol, B.Eng.Sci., CIM, FCSI

President

Portfolio Manager

MacNicol & Associates Asset Management Inc.

March 2015