Delayed Landings

We find ourselves in a period where sentiment could be aptly described by Charles Dickens’ classic line: “It was the best of times, it was the worst of times...” Today’s narratives are seemingly contrasting. On one side, we are living in an era of unprecedented technological advancements and some of the highest standards of living in history, marked by improved quality of life, increasing wealth positions and one of the highest life expectancies. On the other, however, rising living costs, heavy debt burdens, sluggish productivity and ongoing geopolitical tensions are casting shadows over this progress. Economically, we find ourselves in a transition, with an economy that’s neither great nor terrible.

Some have termed it a “delayed landing,” with the markets unusually quiet in the first half of 2024 as we lingered in this middle ground. Since the start of the year, market observers have been closely watching central bank monetary policy decisions as economies averted a hard landing. Let’s not forget that the multiple rate cuts anticipated at the start of the year did not largely materialize as economies, especially the U.S., performed better than expected. Over the summer, the S&P 500 made headlines for going 377 days without a selloff greater than two percent — the longest stretch since the financial crisis. The CBOE Volatility Index (VIX) fell to its lowest levels not seen since November 2020.

This period of calm was abruptly interrupted when the Bank of Japan surprised the markets with a rate hike at the end of July. While central banks globally were raising rates to fight inflation in 2022 and 2023, Japan had been the exception. As a result, the Japanese yen became the currency of choice for “carry-trade investors,” who borrowed low-interest-rate yen to invest in assets denominated in higher-interest-rate currencies. At the end of these trades, investors converted funds back into yen to repay the loans, in a leveraged strategy known for its considerable risks. Indeed, the yen’s rapid appreciation in August, prompted by the rate hike and other factors, led to significant losses in these carry positions, prompting the Nikkei to experience its worst day since Black Monday in October 1987. North American markets jittered, and the VIX spiked to its third-highest level in its history.

Yet, seasoned investors accept that volatility is an inherent part of the markets. A look back at the S&P/TSX Composite since 1985 reminds us just how common volatility is:

• A 5 percent drawdown is almost guaranteed each year, occurring 95 percent of the time;
  
• Double-digit drawdowns of more than 10 percent have happened 56 percent of the time;
  
• Despite positive annual returns over 70 percent of the time, the average intra-year drawdown has been -15 percent. The market declines even when it rises.

Periods of volatility should always be anticipated. During these times, it is important not to let short-term fluctuations disrupt long-term financial plans. One of the most challenging aspects of investing is resisting the temptation to follow the herd. Consider the merits of having a solid investment plan — and sticking to it.