Despite a strong month in July, the third quarter was a tough one for financial markets. The S&P/TSX Composite Index dropped 9.1% and the S&P 500 Index dropped 7.1%. The increased volatility seemed to be linked to the combination of commodity weakness, the risk of US monetary tightening and concerns surrounding Chinese economic stability.

Given the volatility in the markets, we thought it might be useful to:

  • provide our views on the market outlook;
  • comment on our recent decision to sell Valeant Pharmaceuticals; and
  • include a video discussing the outlook for Q4 with Brian Belski, chief market strategist at BMO Capital Markets.

We believe this will prove to be a short term correction and a healthy pause in the bull market cycle. Worldwide, central banks continue to hold rates near historic lows. Leading indicators suggest that GDP will not contract, but rather will grow modestly.

Corrections tend to be short-lived: multiple sizable corrections within a calendar year are actually quite common throughout history. But deep and lasting selloffs usually happen only when the economy is in, or is on the cusp of, recession. We expect financial markets to rally in the fourth quarter, and we believe equities will outperform bonds over the next 9-12 months.

Despite the volatility, we’re pleased with how well our Discretionary Platform investment process has been working. We continue to see the stronger companies on a relative strength basis outperforming the broad markets. In fact, our model portfolios probably would have been positive for the quarter if the Democrats -- in the midst of a US election campaign -- hadn’t decided to target drug companies in the last week of September. Valeant dropped almost 20% on September 28th. Most of the other drug companies dropped significantly as well. As a result, Valeant fell out of our top stock choices and, as our investment process demands, we sold it.

Of course we would have preferred to sell Valeant even one day earlier, but there was no way for us to have known the Democrats’ plans. The sale of Valeant from all client portfolios, however, does provide a good example of how quickly we move when a stock falls out of our favoured list. Valeant may bounce back in the coming months or it may do poorly if the Democrats continue to go after the drug companies. At the end of the day, most clients on the Discretionary Platform enjoyed a nearly 45% gain since we bought it in our client portfolios last November. While we are sad to see it go, our discipline says to sell it and move on to something else which is showing greater strength.