Back in play

A bullish case after a month of suspense on the sidelines

For parts of this year, investing felt a little too easy. And when things are too good to be true, that’s often a sign you should begin to prepare for something bad to happen. Since August, many have been on guard for some sort of volatility to enter the market. Yet, outside of a few one-off down days, it hasn’t shown up.

So far, this year has surprised many market observers, as pretty much everything has worked. Equities are near all-time highs, bonds are doing okay, and even the safe-haven gold is up. But the risk is that we might have gotten ahead of ourselves and priced in too many positives while ignoring the big risks in the market.

For most of this year, investors have been sitting in cash, or fully hedged, waiting for a “dip” to buy. But it never came. And every headline that caused markets to move higher increased the pain for those on the sidelines.

The problem with this latest rally is that all the positives priced in at these levels won’t all actually happen. Investors have begun to expect 1) no recession, 2) strong earnings, 3) aggressive rate cuts, and 4) massive China stimulus. While you can imagine a scenario in which some of those can occur, it’s almost impossible to have them all occur at the same time. That may have been the realization that markets are beginning to wake up too.

With the omnipresent U.S. election campaign, many traders stepped away from their keyboards for most of October, and volumes were being dominated by algorithmic trading and the options market. Betting sites were calling for Trump to win, and that outcome is now priced as another market positive. But with polls so close, and with so much uncertainty, who really wanted to make a bet? It reminds me of the phrase “picking up nickels ahead of a steam roller.”

So, when bond yields began to creep higher through October due to fears of more deficit spending, the risk in the overall market increased exponentially. Earnings season is just beginning, and it needs to be perfect. To date, that hasn’t been the case.

The result for October was a flattish performance for most markets, which feels like a loss after the strong gains to start the month. But it does allow those on the sidelines an opportunity to get back in.

There remains a bullish case for markets. The U.S. economy remains strong, and we should get certainty once the U.S. election is settled. Valuations, while not cheap, aren’t expensive either. Dips will be bought, and a cushion should be provided for any selloff.

The last part of October was not easy for investors, but it shouldn’t be. That isn’t a cause for concern; it’s more of a return to reality.

Greg Taylor, CFA, is the Chief Investment Officer of Purpose Investments Inc.

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