Weakness May Present Buying Opportunities

We would also point out that, contrary to popular belief, July and August have historically delivered solid average returns, which may indicate that the current market weakness could lead to buying opportunities. Rather than relying blindly on seasonality, we would however recommend that before stepping back-in to less defensive areas, investors keep an eye on selling pressure to eventually capitulate and momentum to turn back up.

Revisiting Margin Debt
Despite the recent weakness and negative headlines in the market, we believe the cyclical bull market is still intact. Over the last decade the U.S. Federal Reserve has aimed for soft economic landings which involve low interest rates and most recently, quantitative easing. Though this allows for the economy and thus equity markets to rebound quickly, many structural issues remain and it can be argued that economies may not be able to naturally evolve and effectively adapt. A consequence to the easy monetary policies however is the encouragement of leverage. A closer look at the last two equity bull-markets show that they were better described as leveraging and deleveraging events, which is why correlation amongst individual equities went straight up as leverage got sucked out of the system during the downturn of the markets. Margin debt, as a result, provides a good indication of when the bull-markets or leveraging cycles are near its top. As indicated in the chart below, as the NYSE Margin Debt level still remains above its 12-month MA, we believe this still favours equities over fixed-income. Additionally, as the 12-month rate of change in the index has a tendency to go parabolic before the market top, we view this as a positive for equities as we have not seen any such movement thus far.

Portfolio Positioning
As recommended in our “June Weakness” Report, the short-term tactical positioning was to increase exposure to defensive areas such as fixed income and utilities. We also mentioned that Exchange Traded Funds (ETFs) such as the BMO Short Corporate Bond Index ETF (ZCS) and the BMO Equal Weight Utilities Index ETF (ZUT) allow investors to make portfolio reallocations quickly and efficiently.