FP Answers: Should news affect investing? And will markets normalize?

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In an increasingly complex world, the Financial Post should be the first place you look for answers. Our FP Answers initiative puts readers in the driver’s seat: you submit questions and our reporters find answers not just for you, but for all our readers. Today, we answer two questions — from Charles and from Florinda — about investing in uncertain times.

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By Julie Cazzin with John De Goey

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Q. As a 50-year-old DIY investor with a portfolio over $1 million, I’m confused. I read the economic news daily and some commentators and economists say the recent rate cuts mean we’re achieving a soft landing. Others say these rates were cut because there’s a recession on the horizon. Who should I believe and should I even let this type of day-to-day news affect me and my investing? — Charles

FP Answers: Charles, both narratives are plausible. As such, either could be right. Perhaps neither will be right. The only thing anyone really knows for sure is that they can’t both be right simultaneously. I suppose we could be in a soft-landing scenario for a while and then come to realize that, as things evolve, we’re in a recession, after all.

So much of economics is forecasting based on best guesses. Even the most reputable experts are only offering their views on how things are likely to play out. The fact is that no one knows, so any planning done with a high degree of confidence in one narrative or another is risky. If day-to-day headlines are affecting you, there’s a reasonable chance that you have a portfolio that is not suited to your circumstance. It is better to be confident in the general direction of where your account is headed than to presume certitude about specifics.

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The best portfolio is one you can live with. Therefore, I’d advise you to consider how your portfolio might perform if we were in a soft-landing scenario and if we were in a recession scenario. It might be best to be flexible and to favour those things that might do at least somewhat well in either scenario. Bonds, for instance, would likely hold up fairly well either way. In terms of what to avoid, it might be wise to reduce exposure to those things that might take a tumble, such as vestments in small company stocks and U.S. stocks, which are both likely to drop a fair bit in a recession scenario.

Q. I’ve read a lot of economic and financial news over the years in the hope that it would help me make better investment decisions. When it comes to stocks and financial markets, I’ve noticed that some commentators talk about ‘reversion to the mean.’ But I’ve also heard people say ‘markets can stay irrational longer than you can stay solvent.’ When can investors expect valuations to normalize? And does it matter to know these times? — Florinda

FP Answers: Florinda, the saying you reference is indeed true for most people (obviously, I have no idea how long you could personally remain solvent). My view is that markets — especially the U.S. stock market — have been frothy for years. I’ve been concerned since the beginning of 2020, before most of us had ever heard the word COVID-19.

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The main takeaway is that markets always normalize and revert to the mean eventually, but that it can take a long time for that to happen. A major thought leader in the finance industry, co-founder of AQR Capital Management LLC Cliff Asness, recently wrote a paper called The Less-Efficient Market Hypothesis. In it, he argued that a few factors, most notably the rise of meme stocks and gamification, have made markets less efficient over the past quarter century.

The offshoot of that viewpoint is that asset bubbles are not only more likely to form, but that they are likely to persist at irrationally high levels for much longer than might have been the case previously. No one knows when — or if — bubbles will burst. If you’re genuinely concerned, you should probably make adjustments now in anticipation of what might happen. Of course, before you do that, you also need to make peace with the opportunity cost associated with taking risk off the table if the bubble doesn’t burst in the short to medium term.

John J. De Goey is a portfolio manager with Designed Securities Ltd. (DSL). The views expressed are not necessarily shared by DSL.

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