‘Empty Calories’: Why investors’ bloated year-to-date returns mean nothing

Felix Narhi cannot resist the urge to look at the 18.4 per cent year-to-date return his portfolio has generated in 2019 and scowl.

After falling nearly 20 per cent at the end of 2018, the S&P/TSX Composite Index has completely recovered its losses and raged to a new all-time high. In the new year alone, seven companies listed on the index have boosted their investors’ portfolios by more than 50 per cent (All YTD figures are as of the close on Monday, April 29).

Hexo Corp., the best performing Canadian stock of 2019, is up by more than 135 per cent.

But in a market that has rapidly bounced back from a crushing end to 2018, one where the recovery came after central banks quickly adopted a dovish tone, and one that continues to surge forward on high-beta stocks, Narhi said measuring returns by a year-to-date metric is misleading.

It’s all but useless to Narhi, who keeps always sets his gaze on long-term horizons — three to five years at least. It’s never been an accurate way to judge a portfolio, he said, and it’s even less reliable in the current market climate.

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“I’d suggest some of the year-to-date returns are unwinding that ridiculousness that happened in December,” said Narhi, who is the chief investment officer and portfolio manager at PenderFund Capital Management in B.C. “It basically corrected something that probably shouldn’t have happened.”

“A lot of people are still probably negative or crawling out from that period.”

The same can be said about the skewed returns of the TSX’s top movers in 2019. Yes, their stock prices have risen considerably, but the move upward only came after an equally punishing downward move.

Take Hexo, for example.

While the Quebec-based cannabis producer is up an incredible 135.88 per cent since January, it is only up 25.96 per cent since Oct. 1 — one week before the global sell-off began.

Of the Top Ten stocks in 2019, Aurora Cannabis Inc., ATS Automation Tooling SYS and CannTrust Holdings Inc. are each up more than 46 per cent year-to-date but have produced negative returns since Oct. 1, with CannTrust in the deepest hole, down more than 22 per cent.

When the returns period is adjusted to begin on Oct. 1, only Cronos Group Inc, Shopify Inc. and Ero Copper Corp remain in the Top Ten.

The others are replaced by a list that is predominately made up of miners such as Kirkland Lake Gold Ltd. and Alacer Gold Corp.

Their returns may be even more misleading because they’re taking place in an environment where the earnings that companies are posting market wide are not supporting their growth since January, according to Brooke Thackray, a research analyst at Horizons ETFs who studies market trends.

Neither is the economy, he said, which contracted 0.1 per cent in February when a 0.3 per cent boost was expected.

Perhaps more worrisome is that the volume on the TSX was flat in January and February and declined in March and April, Thackray said.

“You’re looking at them to rise at the same time to show there’s increasing interest and more conviction,” he said.

When asked what that meant for year-to-date returns, Thackray said that “empty calories is a really good way of saying it.”

What can be taken away from the list of top movers and their astronomical returns, said Greg Taylor, portfolio manager at Purpose Investments, is that it appears investors may just be chasing big wins.

He described the current movement as a case of FOMO: the fear of missing out. After a wide sell-off at the end of 2018, Taylor said a lot of investors were left with high cash positions and scrambled to reinvest them when the TSX began picking up momentum. That brought more “greed” to the market, he said.

“As you come in and watch the markets grind higher every week and people are looking at the indices up 15 per cent, they’re saying: ‘Well, I’ve missed something, I’ve got to put this cash to work,’” said Taylor, who added that prices have been artificially inflated through a wave of share buybacks.

The fact that cannabis stocks are what is leading the TSX forward and not energy or financials is worrisome for Taylor. Their gains have been based on market sentiment alone, he said, which was boosted by the Bank of Canada pausing rate hikes.

The cannabis sector has not posted strong earnings. Hexo and Canopy, the top two movers on the TSX, both posted net losses in their most recent reports. If earnings don’t improve by the third quarter, Taylor worries that investors may begin to question their valuations.

If investors aren’t troubled by the lack of earnings growth for some of the stocks that are currently boosting their portfolios, Narhi said they’re putting themselves at risk of giving those returns back.

“If you get 50 per cent returns on something you don’t understand, it probably makes more sense to sell it and admit you got lucky and move on,” he said.

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