With this commentary, we plan to communicate with you every month about our thoughts on the markets, some snap-shots of metrics, a section on behavioural investing and finally an update on some of the people at MacNicol & Associates Asset Management (MAAM). I hope you enjoy this information, and it allows you to better understand what we see going on in the market place.
“There are risks and costs to a program of action. But they are far less than the long-range risks and costs of comfortable inaction.” – John F. Kennedy
Market Commentary: Continued Separation
The most discussed figure over the past month has undoubtedly been the Non-Farm Payrolls report, referenced on page one, stating that the US economy added only 38,000 jobs over the month of May, compared to estimates of 164,000. For those unfamiliar, the Non-Farm Payroll figures are used as a proxy for job growth in the US, and effectively states the number of jobs added across all sectors of the economy, excluding farm, government, private household and non-profit hiring. In total, this analysis covers approximately 80% of all areas of work which contribute to national GDP. It should go without saying, then, that a ‘miss’ of this magnitude has a large impact on investor’s and citizen’s opinions of the health of the overall economy, and by extension, the stock market. This report was the worst of its kind since the recovery began in 2010, and coincided with a downward revision of the March and April reports as well. Due to its dominance of the headlines and overall general importance to the US economy, we thought it would be of interest to discuss this report specifically, while also mentioning other important international economic occurrences as well.
Despite the gloss and headline attraction of the magnitude of the miss in Non-Farm Payrolls, there were, however, some logical contributing (and temporary) factors that influenced the report. For example, there was a large strike of Verizon employees, which temporarily removed 35,000 workers from the payroll figures; the strike has since ended and will in turn contribute positively to next month’s report. The next point of consideration is the inherent volatility of this data. For clarity, reference Exhibit 1 below, which charts Non-Farm Payrolls over the timeline of the whole recovery. It can be seen that, over the past 5 years, there have been several instances of temporary dips in the data, all of which have resulted in a swift recovery.
This does not, however, mean that we are completely writing off this data point as anomalous or inconsequential; we view it as being a continuation of a trend, rather than a signal of imminent collapse. Consider that, over the last 12 months, the US economy has added 2.4 million jobs, compared the 3 million added over the year prior. The Bureau of Labour Statistics has also revised downwards their forward estimates of hiring expectations the last three months in a row, and the Wall Street Journal reports that temporary hiring – which is often hailed as a leading indicator for overall job market health – has completely stalled throughout 2016. It follows, then, that the May data point, while shocking, is indicative of the continuation of a trend, not the beginning of a new movement, which is often the way it is currently being articulated.
Moving forward, there are two possible scenarios that this employment profile may represent, one of which is positive, the other of which is negative. The positive scenario is that the US economy is nearing what is known as ‘full employment’, which is supported by the above-stated low unemployment rate of 4.7%. Simply put, there are less positions being added because there are less people looking for work and available to hire. The eventual effect of such a scenario is upward pressure on wages for existing workers or relaxed hiring stipulations; both of these events would be positive for the economy. The alternative interpretation, however, is that the overall economy is slowing, and thus less able to add more jobs. This scenario is not out of the question, seeing as the current economic recovery has now extended to being the longest of its kind since the post-World War 2 era. Support of this theory lies in the fact that wages have not been growing strongly, and that the low unemployment rate is skewed by the continued to decline of the participation rate (Exhibit 2), which marks the number of Americans actually included in the labour force. It is vitally important to monitor ongoing data moving forward in order to properly gauge which theory comes to fruition, however, we thought that it was valuable to know that slowing notional job growth does not necessarily mark the death knell of an economy.
The other most-headlined story of the month has been continued discussion in regard to the ‘Brexit’ or the impending decision on whether or not Britain will leave the Eurozone. Although many pundits have articulated their warnings of the dire economic impacts of Britain leaving the group, the ‘exit’ campaign has gained popularity, and recent polls show that it is actually the favoured option by the public at the moment. Without attempting to predict the future, we must remain cognizant of the volatility and subjectivity of such polls, while being prepared for any worst-case scenario. A successful ‘Brexit’ would undoubtedly cause increased volatility and fear in international equity markets and currencies, with a Bloomberg analysis this morning stating that European equities could suffer as much as 24% from such an event. It is our continued belief that strong holdings in physical and alternative assets and safe haven stores of value such as precious metals are the best way to protect portfolio value from such possible future volatility.
An Update on Canada
In Canada, the most frequently-discussed items have been in regard to the Fort McMurray wildfires and the housing markets, particularly in Toronto and Vancouver. Fort McMurray, thankfully, seems to be stabilizing, with the fire being controlled and a reported 90% of the city being saved from significant damage. The Globe and Mail reports that the fire, which at its peak spanned an area larger than PEI, has been largely contained and that just under half of Fort McMurray citizens have been able to return home. Economically, this means that the region – which produces ~1.5 million barrels of oil daily – will be able to return to full capacity soon, and that the economic drag will hopefully be abated.
Prime Minister Justin Trudeau referred to Canada’s hot housing market as ‘a real drag’ on the Canadian economy, and Finance Minister Bill Morneau has pledged a ‘deep dive’ analysis of both Toronto and Vancouver to attempt to discover and address the primary drivers of the precipitous surge in prices in both of those markets. Year-over-year, Vancouver homes appreciated 30%, while Toronto home values grew by 15%.
The underlying economics of most major and Canadian-relevant economies remains precarious, and as such, our stance on the capital markets remains in line with that belief. Along with maintaining our belief and positions in alternative assets and precious metals as portfolio insurance, we are also pursuing a tilt towards value stocks and away from high growth sectors. We believe that certain out-of-favour sectors such as energy are beginning to show real value.
Behavioural Investing: The Endowment Effect
This month we will study the “Endowment Effect” and how it creates behavioural impacts on investors. The endowment effect can be defined as the perception that something one personally owns is more valuable than what someone else would value it at (Exhibit 2). The distorted perception can come from an increased attachment or comfortability from such item. In terms of trade, a seller experiencing the endowment effect will value their item higher because they view the sale as a loss. This is seen in an experiment where half a group of randomly assigned students is given mugs to sell, and the other half are prospective buyers (Kahneman, Knetsch, and Thaler, 1990). The results showed that the sellers valued the mugs up to three times what any buyer was willing to pay, exhibiting loss aversion; the sellers view losing the mug as a high cost, whereas the buyer only views receiving it as a small gain.
Investors can be harmed by the endowment effect in two ways. The first comes from an overvaluation of personal assets, whether inherited or bought. The overvaluation compared to market price can often lead people to realize a value much lower than what they had originally expected. The second way is from loss aversion. When investors believe the value of their asset is higher than what the market currently states, they would rather hold onto the asset or invest more capital into it in the belief that it is mispriced, than realize the loss. More often than not however, investors are only typing up more capital and time, ultimately leading to a greater loss than the one they hoped to avoid.
In order to avoid the endowment effect, it is important for investors to remain impartial, and to scrutinize assumptions. Doing thorough valuations with a wide range of sensitivity analyses will allow investors to see a potential range of possible values for their asset, curbing the impact of receiving a lower price than anticipated. An additional technique is to put yourself in a buyer’s shoes, if you did not currently own this asset, how much would you be willing to spend in order to obtain it?
Over the past several months I have been helping my very good childhood friend with his fund raising event. In the spring of 2016, Harry McMurtry began his walk from New York City to his hometown, Toronto, to raise money and awareness for Parkinson’s research. He is accompanied on the walk by Sue Thompson of Toronto and Dr. Ross Sugar of Baltimore, MD. As Harry, Sue and Ross all have Parkinson’s disease, walking up to 15 miles a day for 45 days is a tremendous challenge and one that makes this event a much bigger story about the disease itself.
Diane and I joined Harry and his team over the Victoria Day weekend in Albany, NY and walked with them for a day. The 15 miles were far more tiring than expected and we gained an even greater respect for Harry, Sue and Ross and what they accomplish every day. Their challenges put a lot of other things into perspective.
David A. MacNicol, B.Eng.Sci., CIM, FCSI
MacNicol & Associates Asset Management Inc.