North American stock markets have marched higher this year, reaching historic highs in April in Canada and early May in the US as investors shrugged off concerns about the global economy, US-China trade tensions, and worries that equity markets may be in overvalued territory.
In mid-May, the S&P/TSX and S&P 500 had managed to achieve double-digit percentage gains year to date, each up more than 13%. That is in spite of US President Donald Trump’s recent surprise decision to put a halt to trade negotiations with China after earlier pronouncing his optimism that he would be able to sign off a momentous deal.
The equity markets’ rebound from the December lows to new highs was primarily driven by the technology sector, which outpaced all other sectors during the first few months of the year, elevating the benchmark US and Canadian stock market indices to their new highs.
Recently the so-called FAANG stocks have gained momentum, with Alphabet, Facebook and Apple experiencing what some market commentators call “bullish breakouts”.
But it hasn’t been smooth sailing for all technology-related businesses. During May, Lyft and Uber came to market in much anticipated billion-dollar IPOs that ended up being major disappointments for investors. Lyft set the tone, losing 20% from its opening price by the end of its second day of trading and well below its $72 IPO price. Uber followed in its footsteps, falling 18% in the first two days of trading (more than 7% on Friday and then 11% on Monday) from its $45 IPO price.
Unicorn IPOs disappoint
These disastrous IPOs may be a harbinger of a weaker IPO market ahead for so-called unicorns that have yet to report profits or convince investors that they are likely to anytime soon. They also highlighted that today’s tech market is not entirely different from the dot-com bubble in 2000 when investors clamoured for stocks in companies that had yet to turn a profit and were left reeling after they fell off a cliff.
The main difference is that today’s unprofitable tech companies can raise much more significant amounts of funds and are better financed at an early stage than their dot-com predecessors as they vie for market share dominance.
One criticism of these IPOs is that these unicorns should have come to market earlier in their business lifecycle because private investors have already participated in a significant proportion of the potential offered by these companies before the shares were made available to the public.
It is also an acute reminder to investors that they need to be particularly cautious in the hunt for businesses that are likely to be viable and profitable over the long-term. The goal is to buy quality companies without overpaying.
Global trade tensions persist
Global trade developments have continued to dominate the headlines, with US President Donald Trump initially highly optimistic about his ability to negotiate with China. In mid-May, however, he did an abrupt about-turn and, instead, raised tariffs on $200bn of Chinese exports and then put Huawei on the US’s “Entity List”. This prevents the Chinese telecommunications company from buying parts and technology from US suppliers. China threatened to retaliate to the tariffs, and market commentators foresaw a lengthy period of tit-for-tat trade moves, accompanied by market volatility and uncertainty.
In the UK, Prime Minister Teresa May agreed to depart after the latest Brexit deal bid, with the government indicating that lawmakers will be able to debate and vote on the Withdrawal Agreement Bill, the legislation required to enact May’s Brexit deal, in early June. However, the country remains as divided as ever about whether Brexit should proceed or not.
Job numbers surprise on the upside.
In North America, recent US and Canadian jobs numbers for April were surprisingly strong, dispelling concerns about the pace of economic growth. In the US, jobs numbers grew by 263,000, and unemployment fell to an almost five-decade low. Meanwhile, Canadian jobs made their biggest gain on record, rising 106,500 in April, with the unemployment rate declining to 5.7%. Economists took this as confirmation that the economic growth was back on track after a six-month lull.
During April, both the Bank of Canada and US Federal Reserve turned dovish, indicating that they were unlikely to raise rates again this year on growth concerns and still low inflation rates. They also reduced the pace of monetary policy quantitative tightening to ensure there is enough liquidity to bolster the system in the event of a financial crisis. With interest rates already so low, central banks don’t have much room to move in the event they need to bolster the financial system.
Undervalued stocks offer investor opportunities
Even though markets are near all-time highs, there are still opportunities to be exploited in undervalued sectors and companies. I have highlighted this in the past in an article entitled: Finding Bargains when the Fed Says Equity Markets are Overvalued.
Back then, the Fed was concerned that a significant stretching of equity valuations had occurred during the preceding unprecedented period of monetary stimulus. Conditions now are somewhat different, with monetary policy at the tail-end of their stimulus programs and central banks easing off as and when they feel the financial markets and economy can absorb tighter liquidity conditions.
As then, my view remains that the debate as to whether overall market indices are overvalued or fairly valued is not all that significant for the long-term, bottom-up investor. Instead, investors need to approach the stock markets with the understanding that opportunities exist in all markets and market conditions and are best capitalized on by focusing on specific companies.
Moreover, there are attractive opportunities to be found in turnaround situations, where quality companies have been subject to a period of temporary poor performance or adversely affected by the prevailing economic conditions. In particular instances, management has the necessary leadership qualities and strategic direction to get performance back on track, and thus, these companies offer potential other investors don’t see.
It is impossible to predict macro-economic changes and how these will impact on stock markets with any degree of certainty from day to day. Instead, the astute investor who takes a bottom-up approach to investing will ultimately benefit from investing in companies based on their unique merits and their ability to deliver in the medium- to long-term rather than on what overjoyed investors are willing to pay at a point in time.
As always, the opportunity to outperform is substantially increased if you invest in a globally diversified portfolio of undervalued stocks. When one region or sector of the stock market is under-performing, other stocks in different geographies and economic climates provide a valuable buffer, potentially holding up the portfolio’s overall performance.
Garnet O. Powell, MBA, CFA is the President & CEO of Allvista Investment Management Inc., a firm with a dedicated team of investment professionals that manage investment portfolios on behalf of individuals, corporations, and trusts to help them reach their investment goals. He has more than 20 years of experience in the financial markets and investing. He is also the Editor-in-Chief of the Canadian Wealth Advisors Network (CWAN) magazine. He can be reached at firstname.lastname@example.org