Wednesday, March 14, 2018

US Economy Raging?

"The economy is raging, at an all time high, and is set to get even better" according to President Trump.

This morning, US retail sales, as reported by the Commerce Department, notched their third consecutive month to month decline:

In the US, interest rates are rising and it is widely expected that they will be increased by another 1/4% next Wednesday following the US Federal Reserve's Federal Open Market Committee (FOMC) meeting to determine the course of monetary policy (and possibly another 2 or 3 times in 2018).

As we mentioned on our weekly video, the US economy is pretty close to full employment at 4.1% (latest data from last Friday).

Historically, just before a recession (blue shaded area), unemployment reaches its lowest point (top of the economic cycle). When it starts to move higher, intersects with the 3 year average and passes through it, a recession usually begins.

A client, obviously with way too much time on her/his hands (humour) actually watched our weekly video and asked for the "narrative" behind the statistical correlation, so here goes: 

This situation tends to happen as a response to the US Fed raising interest rates, which is intended to slow the economy (and the prospect for future inflation) and which historically has lifted the unemployment rate.

In the current debt-laden (record household debt) economy, rising interest rates will increase the amount of money required to service that debt and give the consumer less purchasing power. The consumer is 2/3 of the US economy. Three months of declining retail sales may just be telling us about the state of 2/3 of the US economy (especially in light of the purported benefit of the US tax cut). When the consumer stops spending, inventories rise and businesses have to slow production. This increases the potential for layoffs and the possibility that unemployment rates will start to rise. Add in what also might be an unwanted impact (more unemployment) of protectionist trade policy. So we circle back to the history of unemployment rates and recessions.

As portfolio managers, we have to make some determinations as to how best allocate assets to our clients (and our) respective portfolios. We try to use a number these indicators of the state of the economy to get a handle on where we are in the economic cycle and by virtue of that, which assets might be vulnerable.

Historically, stock markets don't like recessions. As stocks have become relatively expensive over the last couple of years, they are likely to be more vulnerable, especially at this late stage of the cycle. That would indicate to us, as portfolio managers, that despite the emotionally charged equity market environment, being fully invested in equity assets may not be especially prudent.

As for the latest on the US economy in the 1st quarter of 2018 (following today's retail sales data): Growth  is expected to be only +1.9%

Raging? I don't think so.

Thursday, March 8, 2018

The Case For Other (Non-Correlated) Assets

Despite the fact that stocks (especially US stocks) have been in a bull market since 2009, we were reminded in the first week of February that, as an asset class, there is vulnerability to the potential of severe price swings.

If they can go up dramatically, they can also go down dramatically. Some folks are willing to take on that kind of risk, but others are not so comfortable when they look at their portfolio give up 5 or 6% over the course of a week.

And there may be more of it to come:

As human beings we are conditioned to be very happy as long as things are going positively. When it turns and goes in the other direction, we tend to not be so thrilled. Some folks look at their portfolios daily, which is akin to driving with your nose pressed against the windshield, but they just can't help themselves.

Certainly it is good to have equity assets for growth purposes, but a balanced portfolio (with other asset classes) that are not correlated with equities will help alleviate the potential for the sleepless nights that accompany stock market volatility and the inevitable down-turn (markets just don't always go in one direction, they cycle, it is just natural).

So being a little less dependent on equities may be a necessity if you are going to want to continue to get growth when the downturn comes. It may have already begun.

The historically natural offset to high risk equity assets has been to balance them with a collection of high quality government and corporate (investment grade bonds). However, low interest rates have made those correlations less and less realistic (especially as inflation concerns, which erode the value of bonds, are climbing).

We at High Rock have found some alternatives over the last couple of years (because, surprise! we think that stocks are expensive) in other non-correlated assets for our clients: a collection of Canadian High Yield bonds that have had a better than 14% average annual return over the last couple of years, with less than half of the risk associated with stocks and an opportunity in preferred shares that brought a one year return of better than 20%. All of our clients have participated in these in some manner, depending on the structure of their asset allocation strategy (based on their goals as set out in their Wealth Forecasts).

And, no surprise, our client portfolios did not experience the heart-wrenching swings of traditionally balanced portfolios in that crazy first week of February.

Always remember that past performance does not guarantee future results, but at High Rock we work darn hard to provide our clients with the best possible risk-adjusted returns.

When stocks are sliding, you are going to want to have some other opportunities to rely on. When traditional bond assets don't provide it, what are you going to do to continue get growth?

Monday, March 5, 2018

Financial Advice Or Portfolio Management?
There Is A Big Difference, Did You Know?

Most of it lies in the obligation that the advisor owes to the client:

The Investment Industry Regulatory Organization of Canada requires the advisors under its registration (a Registered Represenatative) to provide a "duty of care" to their clients. 

Most of that falls under the "know your client" rule. In essence this means that an advisor, when they sell you a stock, bond, Mutual Fund or ETF (and they are selling it to you, so they are in fact salespeople) must be able to determine if the investment is suitable for you. That is the extent of it. Once you own it, the responsibility shifts to you, the buyer / owner of that investment.

If that investment should become unsuitable at anytime following the sale of it to you, ultimately the advisor can avoid responsibility for the sale of that investment by claiming that it was suitable when you bought it.

That is something that can be a pretty horrible experience for you if you get blindsided.

A portfolio manager, who has discretion over the portfolio of the investments that she/he purchases on your behalf, has a much deeper level of responsibility. They have a legal fiduciary duty to make sure that the investments you own continue to be suitable. That is a very big difference.

A portfolio strategy, therefore, must be based very specifically on your personal goals, timelines and ability or desire to take risk and how much risk is relevant for you.

More importantly, this requires regular monitoring and review of your circumstances and strategic adjustments should they be required.

Equally important, especially for us at High Rock, is that we have no conflicts of interest: we invest our money in the exact same assets as our clients and we are not commissioned salespeople. So we always put our clients interests first, ahead of our own.

A portfolio manager may not necessarily be licensed under IIROC. In fact, from my own personal experience, it is considerably more difficult to become a licensed portfolio manager under the Ontario (or other provincial) Securities Commission than it was under IIROC. 

The real question becomes (now that you are aware of the difference): Why would you want less, if you can have more? Especially if it doesn't cost more. In fact, I think that you will find with High Rock, we are comparatively cheaper than most advisors and other portfolio managers (relative to the level of service and competence that you get).

Something to think about.

Thursday, March 1, 2018

A Tough Month For Global Stock Markets
And It Is Not likely The End Of It

All Red (negative) for the month of February (on the right above, circled in blue). We have not seen that since the beginning of 2016.

So where do we go from here? 

More selling than buying, with some huge swings in prices in relatively short periods of time, has lifted volatility levels. Technically, the inability of the market to return to its highs will mean that traders will likely experiment with price exploration and discovery to the downside (barring any significant development to the contrary) until they find the levels that buyers are comfortable with. Last time it was at around 2530 to 2550 on the S&P 500 (200 day moving average).

Higher volatility, historically, can signal the end of one trend and the beginning of the next. Until that yellow line in the above chart is breached by more buying than selling, the short-term price trend will be to lower highs and lower lows and better value for making purchases. 

The smart money will likely be patient to see what develops.

Fundamentally, US stock prices have way outperformed the economy for the last 8 or 9 or years (as a result of easy monetary policy and excess liquidity in the financial system).

And that has made valuations (Price to Earnings Ratios) expensive.

Either stocks need to get cheaper or the economy (and earnings) needs to accelerate, alot. Even GDP growth of 3% will not push the economy up to the lofty levels where stocks have gone. 2018 earnings have already built in an 18% growth rate into 12 month forward looking P/E ratios (above) .

The latest US data suggest that tax reform has boosted US incomes and consumer confidence, but in January the consumer was not buying, especially durable goods. As I suggested in my blog on Tuesday, the specter of rising interest rates may just be beginning to take its toll on very debt burdened households. 

Higher employment costs may also come in to play in the earnings equation (revenues minus increased costs). Something that will need to be monitored.

While stocks were looking for buying support through February, bouncing all over the place with the increased volatility (and ending significantly lower on the month), High Rock Private Client portfolios were flat to slightly higher, but not experiencing anywhere close to as much volatility.

And always remember that past performance is no guarantee of future returns. However, at High Rock we work darn hard to get the best possible risk-adjusted returns over the long term for our clients (and ourselves)!

Tuesday, February 27, 2018

US Interest Rates May Go Up By A Full 1% This Year!

So say some analysts, following new US Federal Reserve Chairman Powell's first testimony to the House Financial Services Committee. His "personal outlook for the economy has strengthened since December".

As we suggested on our weekly video, there is plenty of economic data coming at us this week and today the Conference Board suggested that the US Consumer is the most confident that they have been since 2000!

Interestingly, the US consumer is also facing record debt levels: 

And if interest rates go up, that is going to have an impact on their ability to service that debt. Which may also impact their spending (and the consumer is 2/3 of the US economy). At the moment, however, it appears that the tax cut euphoria is winning the day and giving hope that incomes will experience a an up-tick to assist in covering the higher costs of household debt. We shall see.

Meanwhile, both stock and bond markets reacted with selling and correlations look like, for the moment, that they are not necessarily providing protective cover.

While the stock market up-trend from 2009 remains intact until the S&P 500 breaches the lower trend-line at about 2250,

The higher levels of volatility in financial markets and the prospect of higher interest rates (and less liquidity in the financial system) may give pause to those that are still bullish of equity markets this late in the cycle. 

Risk is at its highest levels when prices are at their highest levels. This is meaningful to us at High Rock.

Sunday, February 25, 2018

Canadian CPI Year To Year +1.7%: 
How Does This Compare To The Change In Your Cost Of Living ?

January and the beginning of a new year drives a significant number of inquiries about what we do at High Rock for our Private Clients. Wealth and portfolio management encompasses much more than just investing. Planning and forecasting play a major role. As I have suggested many times (ad nauseum), you only have to take risk when safe investments don't give you enough return and growth in your savings and assets to stay ahead of the increase in your cost of living.

A 90 day Government of Canada T-bill which is the safest of all assets available trades at or about 1.2% on the wholesale market. After all the commission and fee deductions, etc., a retail or individual investor would be lucky to get 1%.

So we can call 1% the Risk-Free rate of return (at the moment). 

Let us just suppose that your cost of living increases each year at or about the average rate of the Consumer Price Index (CPI). The base was set at 100 in 2002 and 16 years later it sits at 131.7, so it has averaged close to a 2% increase for the last 16 years. For comparison purposes (to your own personal circumstances), this is the "basket of goods" and the % weight assigned to each major category:

Depending on what, how and where you consume, there will be some discrepancy between your household spending and the above, but let's settle on 2% as a rounding number.

You are not going to be able to stay ahead of your increased cost of living by investing in risk-free assets at or about 1%.

How much risk do you have to take?

It does not take much to get the phone ringing off the proverbial hook (although these days it is mostly panic emails) at High Rock when volatility strikes and investors get a taste for just how much risk they have in their portfolios.

Needless to say, even a nicely balanced 60% equity portfolio felt the full impact of the most recent correction, let alone some of the 100% equity portfolios that have been knocking on our doors.

Even if you only read my blogs once in a while, you will know that what we do at High Rock goes much deeper than just popping our clients into a "one size fits all" balanced portfolio.

It takes a much greater amount of work and research to determine what risk is appropriate relative to each of your goals. That is why we do what we do. We want to make sure that we are upholding our fiduciary duty to our clients. That means that we must always be conscious of what risk we place you in when we build an investment strategy and why it is that we are taking that risk.

Your cost of living, which is very particular to your family, is a very important aspect of the planning process. The greater our understanding of that, the greater the understanding of what risk you have to assume to keep the growth of your money well ahead of the inflation in it.

Investing is so much more than gambling on a collection of companies future growth and cash flow. It is understanding why you need to take that risk in the first place and is that risk appropriate for you to be taking.

Thursday, February 22, 2018

Should You Borrow To Invest?

It is RRSP deadline time. You have until March 1st to make a contribution for the Tax year of 2017. The maximum contribution that you can make is 18% of your 2016 earned income, up to a maximum of $26,010 (less any pension adjustment).

A common question around this time of year is: "should I borrow to max out my RRSP"?

And my simple and yet rather complicated answer is:

It depends!

If you go to this link: Tax Calculator, you can figure out what your tax savings will be for your income and contribution level.

Then you have to factor in the cost of borrowing.

Lets just say that you borrow $20,000 at 5%, that is going to cost you $1,000 in interest over the course of the year. That interest is not tax deductible.

According to the tax calculator (above), if your income for 2017 is $100,000, your tax savings (if you reside in Ontario) would be $7,622.

Here is the catch: at some point in the future, you are going to have to pay income tax on the $20,000 when you withdraw it from your RRSP (or perhaps your RRIF if you take it out after you turn 72).

We all have no idea what our income tax rates will be in the future, but we can all likely expect that tax rates are not going down.

We also have no idea what return we will achieve on the invested $20,000, but history suggests that 6% (before fees) should be a reasonable expectation for a globally diversified and balanced portfolio (but remember, always, that historical performance is not a guarantee of future returns).

Fees: you have to make sure that whatever you invest in, that you are very cognizant of the costs of investing. 

If you buy (or your advisor buys for you) a mutual fund, what are his / her fees and what is the Management Expense Ratio (MER, found in the small print).

For example, the RBC Balanced Fund takes 2.16% (lower right of the above) for its troubles. It's 10 year return has been 3.7%. Add in the MER and it has been 5.86%, so close to the 6% before fees number that I suggested above, although they beleive that they should get about 2/3 of your return for their trouble.  Amazingly, $5.6 billion think that this is OK (that is the amount of money invested in the RBC Balanced Fund). 

Oh and by the way, at High Rock we can basically cut that in half and offer all sorts of inclusive personal service and fiduciary responsibility.

Most importantly, we will do a Wealth Forecast for you that will help determine if it is appropriate for you to borrow for your RRSP or not. For that matter, we can tell you if, given your personal financial circumstances, whether borrowing to invest makes any sense at all.

Here is my point: you can crunch the simple math and determine if that works for you. However in the larger context of your goals and objectives, time lines and risk tolerance, does it make sense?

Only if it fits into your plan. So you need a plan to determine if it makes sense, otherwise you are rolling the dice. Are you a gambler? Or are you a steward of your families wealth

Big difference.

Plan first.