In all market environments, returns are driven by three factors, says Tom O’Gorman of Franklin Bissett Investment Management.
1. The fundamentals of sectors, stocks and bonds.
2. The overall valuations of stocks, and where spreads are for bonds.
3. Technical factors that impact market sentiment.
When markets dip and are volatile, you can look for opportunities in sectors where prices have fallen due to technical, rather than fundamental, weaknesses. For companies, fundamental weaknesses can include poor earnings growth or bad management. When stock or bond prices dip due to technical factors, that means you can then buy high-quality stocks and bonds at low valuations, even though they’re worth more and will still perform well over the long term.
“In this most recent period of volatility, the movement lower in bond prices was due to technical factors,” says O’Gorman. For example, many investors were worried that ratings agencies were going to downgrade investment-grade energy companies to below investment grade. But this was because of weak oil prices, and not because these companies were fundamentally weak.
In contrast, when market volatility is related to problems with companies, you can adjust your exposure or hedge your portfolio. Rather than accept poor market returns, O’Gorman says, “We use derivatives strategies to reduce our exposure to interest-rate, duration, yield curve and credit risk.”
Jolene Laing, an associate portfolio manager at Scotia McLeod, prefers to take risk in the equity portion of her portfolio. “I’m not super creative with my fixed income because it’s safe money. That’s the place to be cautious.” She’s mostly invested in government bonds, and typically splits her fixed-income holdings between Canada and the U.S. But, she’s also maintained small global positions, such as investing in bonds in Latin American.
When analyzing equity markets, she says red flags you can look for include:
- when a company’s paying out more in dividends than it’s earning (that’s a potential sign the company’s dividend may not be sustainable); and
- when a company’s borrowing a lot of money and running up its debt-servicing ratio.
You can also analyze a company’s principles and practices. For example, Laing always considers a company’s ethics (like its carbon footprint) before purchasing.