Birch Leaf Investments

With recent market volatility, we needed some historical perspective on how the Canadian stock market has performed over time and whether a buy and hold strategy is an effective strategy in the age of the high frequent trader. We decided to look back at the historical calendar returns of the S&P/TSX total return index over time and examine the extent and frequency of gains versus losses in the Canadian context.  We used the S&P/TSX Total Return Index which includes dividends as the most appropriate benchmark to consider. We used a random period of fourteen years ending December 2010 and tabulated the number of times the market was positive and the number of times the market was negative over this period. We also tabulated the respective returns for each year.

Did you know, over the last fourteen years, the Canadian stock market recorded:

• A negative return only 4 times out of the 14 year period or 28.57% of the time.
• The cumulative negative return for these fourteen years was -59.59%.
• Over the same time frame, the stock market was positive 10 out of the 14 periods or 71.43% of the time.
• For the 10 positive periods, the cumulative total for the positive returns was 199.18% or 3.34 times the absolute negative number.

It is interesting to note why we have such a fixation on the negative experience in the market place.  The numbers would suggest that the inherent risk present is not staying invested.  It should also be noted that over the entire fourteen year period, the Canadian stock market had an 8.23% return on a compounded basis over this entire period.  In other words you would have made more than 200% on your initial investment.

For the long term investor, the numbers would support the notion that a buy and hold strategy is alive and well and indeed holds substantial merit and frequent trading could be considered a questionable strategy in and of itself.  Over periods of market volatility, long term investors quickly become short-term traders when the market has a setback.  The higher risk strategy of trading suddenly appears more attractive as stocks start to fall.  Long term investors suddenly start to time the market or reduce exposure to the market and raise large cash positions.  While some professional money managers have proven some adeptness in successfully employing this strategy, for the uninitiated, the odds are not in your favor.  Once you have raised the cash position, when do you put the money back to work?  Where do you invest the money?  After the last 2008 - 2009 debacle some investors remained in cash and never saw the benefit of a rising stock market that materialized in 2009 and 2010.

While we are not happy with the current state of international affairs and the stock market in general, the odds of past experience would suggest that it is not a good time to second guess the “house”.  The numbers of past experience would suggest to stay invested.

The difficulty in raising cash positions lies in the ability to identify tops and bottoms of the market.  Usually a bottom or a top in the market unfolds over a number of months.  For many investors, they are unable to distinguish between a normal digestion period for a stock and a major topping process.  Trend analysis would suggest that an ongoing trend in a stock may take some periodic setbacks to its overall trend.  Should one sell a stock every time a stock faces one of these pullbacks?  The opportunity costs are unquestionable.  Trading costs also begin to mount as well.  Tax consequences also surface as a consideration as annual trading reports are calculated each year.  Recognition of losses for a taxable account can leave you out of a position for a minimum of 30 days, so any trading must be considered carefully.  We are all for reevaluation and possibly redeploying assets that represent positions that are in excess of 10% of the portfolio.  Rebalancing a portfolio recharges the potential total return for a portfolio and reduces the overall risk.

It is easy to be pulled away from a strong long term strategy when markets are under pressure.  The numbers would suggest that it is important to stick with your long term strategy and remain mindful of getting caught up in the emotional drive of the stock market.  Opportune selling times rarely surface during periods of elevated emotions.