Two mistakes that can cost in these volatile times

Markets are off to a rocky start this year and, not surprisingly, we are seeing investors exhibit some of the classic behavioural flaws that can lead to big mistakes in portfolios.

While we can't change the path of the market, being self-aware can help investors make informed decisions based on the facts, not just their own emotional tendencies.

To help get you started, we'll discuss two of the most prevalent errors that investors make in this kind of environment — hopefully walking through them will challenge you to think differently and avoid the traps that too many investors are falling into.

Anchoring in the wrong spot can sink ships

I read an article this week that explored how Shopify, one of the biggest pandemic winners, had fallen nearly 75 per cent from its highs, giving up all of its outperformance over the S&P 500 going back to January 2020.

Shopify's fall is no secret, but focusing on the sell-off gives the impression that stock might now be one heck of a buy. Now, instead, what if you couldn't see the stock chart and I told you the shares had performed just as well as the S&P500 over that time span. Would it change your opinion on whether to buy or sell?

This is an example of anchoring bias, where your analysis depends on your starting point, or anchor.

Another good example is energy. There is no shortage of pundits recommending investors sell their oil stocks simply because they've doubled in the past 12 months, a case of textbook selective anchoring. But what happens when you move that anchor back a few years? Over the past five years, the Capped Energy Index is up only 21 per cent and well below WTI oil prices, which are up 106 per cent. Using that frame of reference, one might conclude that oil stocks are still undervalued, something corporate results seem to bear out.

Take Cenovus (CVE), for example. This week, it announced profitability has risen sevenfold, that it was tripling its dividend, removing its hedges and planning for further debt repayment and share buybacks from the massive amount of free cash flow being generated by oil prices.

The economy is not the stock market

Another common misconception investors fall victim to is thinking the stock market is a direct reflection of the economy.

Despite disappointing U.S. GDP numbers on Thursday, which came off a high baseline from the previous quarter and contain a number of one-off impacts, we think the U.S. economy is one of a few that can weather the inflation storm and rising interest rates. It has record-low 3.6-per-cent unemployment, 11.3 million job openings representing a seven-per-cent rate, and strong consumer spending that even grew at 0.7 per cent during the Omicron wave.

That said, the Total Return SPX is off to its worst start in 34 years. The poor performance is happening because of the index's heavy concentration on long-duration growth stocks that are highly sensitive to interest rates. For example, prior to this year's sell-off, Goldman Sachs research showed that Microsoft, Google, Apple, Nvidia and Tesla accounted for more than one-third of the S&P 500's return in 2021. Interestingly, to reinforce my point, these stocks rallied on Thursday's disappointing GDP print on the expectation that it will cause the Fed to slow the pace of rate hikes.

Here in Canada, we have the opposite view on the economy, which is too reliant on a debt-fuelled households that have gone all-in on real estate speculation, one of the largest drivers of our growth. And they appear to be all-but-ignoring the Bank of Canada's warnings that higher rates are coming. According to Better Dwelling, Canadians took out $2 billion in HELOC debt in just 28 days in February, the biggest splurge since 2012, and now owe 1.4 per cent more in HELOC debt than they did a year ago. Balances haven't been this high since December 2020.

While our economy appears more fragile, that doesn't necessarily translate to the S&P TSX, which has a 32 per cent weighting to financials, 13 per cent weighting to energy, 12 per cent to industrials and 11.5 per cent to materials. According to JP Morgan Asset Management, these are the sectors with the highest correlation to U.S. 10-year Treasury yields, meaning they are the ones to own when interest rates are rising and inflation is strong.

For some perspective, the S&P/TSX was actually up 3.8 per cent at the end of Q1, before giving up this gain. At a one-per-cent drop this year, it is still much better than the S&P 500 (down nearly 12 per cent) the Nasdaq (down nearly 19 per cent) and the MSCI EAFE index (down 12.5 per cent). Looking ahead, we think there is still room for that outperformance to widen.

To conclude, watching out for the dangers of anchoring and understanding the basic interplay between economies and stock markets will help any investor avoid the big traps laying in wait in today's markets.

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/ oversight and advanced tax, estate and wealth planning.