Saturday, July 23, 2016

Earnings Update:

25% of S&P 500 companies have reported Q2 earnings:

68% have reported better than expected earnings, beating estimates (this is equal to the 4 year average of "beats", but slightly better than the 5 year average of 67%).

The blended actual earnings plus estimated earnings (for those not having reported yet) is - 3.7% (vs. -5.5% expected at the end of June).

As we have suggested and is evident in the historical data, companies like to under-estimate and over deliver: The 5 year average of earnings "beats" adds 4.2% to expected revenues, which would put the neutral earnings growth level at -2.7% for Q2 (from the originally expected -5.5%).

To date, earnings (from the reporting companies) are 6.7% higher than expected (vs. the 4.2% 5 year average).

In a nutshell, earnings are off to a better than average start.

This coming week (July 25- 29), close to 40% of S&P 500 companies will report Q2 earnings.

Apple earnings results (to be reported on July 26) are a relatively significant contributor to the over-all results: Q2 earnings are expected to be $1.40 per share vs $1.85 a year ago.

Over the last 3 years, the I-phone product segment has generated approximately 60% of Apples revenue. The I-phone product segment is expected to show a decline in revenue of 22% over the last year.

Apple has a weight of just a little under 3% of the S&P 500.

Looking forward to Q3, analysts are now estimating a slight decline in Q3 earnings growth:

At the beginning of April analysts expectations for Q3 were for an earnings growth rate of 3.3%. This has been lowered to - 0.1%.

(all data is courtesy of FactSet: July 22, 2016 report)

Sunday, July 24

Follow High Rock sponsored athlete Miranda Tomenson.

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Friday, July 22, 2016

The Blind Leading The Blind 
(And Other Cliche's)

I have spent the last week digging through as much of the written material that I could find that justifies the world of stock market investing's excitement with the "record highs" announced (it seems) each day for the Dow or the S&P 500.

People much smarter than I, have been warning of the heightened levels of uncertainty in the post-Brexit world, however the stock market continues to climb the "wall of worry" (an old stock market cliche) as investors appear to be happy to take on increasing levels of risk.

The folks at the forefront, the central bankers of the world really don't know what to expect next (although they continue to announce that they are ready and prepared for anything), but they are thrilled with the abrupt decline in volatility since the Brexit spike. They are all gathering at the G20 Finance Ministers and Central Bankers fest in Chengdu, China this weekend.

As a contrarian at heart, this does create quite a conundrum for me, pitting my good fundamental sense against the urge to pinch my nose and hold my breathe and jump in as some advice channels might suggest.

But then I think: what was that rather sensible rule we all were taught when we first began to swim?

If you can't see the bottom, don't jump in. 

Then for a reality check, have a look at the fear and greed index:

"Greed" is just coming off the highest level since 2014 (and we know what followed that: a significantly better buying opportunity). 

We all want stock markets to go up (because we like any asset that we own to improve in price) and in time, if the fundamentals warrant it, they will. But don't get talked into buying at the highs because the euphoria of the moment and some salesperson (more intent on the sale than your personal well-being) gets the better of you.

Stay safe!

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Wednesday, July 20, 2016

High Yield Bonds: Debunking The Myths

When a corporation needs to raise money in the bond market, the rating agencies will attach a "risk weighting" to that particular bond based on its research of the issuing companies ability to pay the interest due as well as the repayment of the full principle. 

According to the S&P scale (there is more than one rating agency, but I will follow the S&P scale for simplicity):

AAA is the highest rating and "the obligor's (issuer's) capacity to meet its financial commitment on the obligation is extremely strong".

Then there is AA (slightly more risk) and A ( even a bit more risk) and then BBB: which has "adequate protection parameters", but... "adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitment on the obligation".

All of the above are classified as "Investment Grade" bonds.

Below that, from BB through to C, levels of risk (of being able to meet financial commitments) do increase and as a result an issuing company must give better terms to the buyers, usually by raising the yield but also by adding security as well.

D is when a bond is in default.

The point is, that with increased risk, there is potentially a higher return that goes with it and that needs to be factored into the equation.

But what, historically is that risk? The term "junk" bonds has been used in the past, but what does that mean?

Let's look a little more closely:

The Capital Structure of a corporation (and who has priority to get paid in the event of a liquidation) looks like this:

High Yield bonds reside in the first two levels and have seniority to convertible debentures, preferred shares and common shares (which are at the bottom and from this perspective have greater risk).

Risk -Adjusted returns:

Over the last 5 years (to April 30) Canadian HY had better risk adjusted returns than the TSX or the Preffered Share Index.

This year alone, the year to date Total Return on The Advantaged Canadian High Yield bond fund (AHY.un ) on the S&P/TSX trading price is about 12.5% compared to the Preferred Share Index ETF (CPD) where it is -1.3%. 

Data is from Bloomberg, Total Return based on daily data from Dec 31, 2015 to July 19,2016. High Rock Capital Management is the manager of AHY. This is in no way a recommendation to purchase or sell any security, but only as an example of a basket of Canadian High Yield securities for illustration purposes. 

Obviously, we have a bias towards high yield at High Rock, because that is an area of our expertise. However, the evidence is clear: it is a good, non-correlated asset class that can add diversity and yield to a portfolio in a properly structured way (which should be discussed with your advisor to ensure suitability for you).

At High Rock we use some very specific and well-researched High Yield bonds to add value to our Fixed Income and Tactical models. Some have provided some very good risk-adjusted returns to our and our client's portfolios thus far this year.

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Monday, July 18, 2016

Earnings Update

7 S&P 500 companies have reported Q2 earnings so far. 140 more will report this week.

With S&P 500 prices at close to record highs, price to earnings ratios are also at (expensive) recent highs: the backward looking, trailing 12 month P/E ratio is at 19.4 (the highest level since 2010):

The 15 year average is 17.6.

On December 31, 2015 the trailing 12 month P/E was 17.9. Since then S&P 500 prices ("P") are up 5.9%. Earnings ("E") are lower by 2.5%.

The more forward looking, (forward) 12 month P/E ratio is at
17.1, close to the high in May of 2015.

The 10 year average is 14.3.

The 12 month forward Earnings Per Share are unchanged from the fall of 2014, prices are higher by approx. 10%.

Earnings for Q2, 2016 are expected to have grown at a negative 5.5%. For all of 2016, at a level of +0.3%.

From a fundamental perspective this just shouts expensive, expensive, expensive! 

At the moment, however, there is more buying than selling and that is driving prices higher. Obviously the buyers are not so interested in the fundamentals.

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Thursday, July 14, 2016

Observations And Questions

Hi Scott,

Just listened to this week's webinar - I do appreciate the work that goes into every Tuesday - thanks.

I do have an observation and a few questions to share / ask . . .

First, an observation . . .

The fact that all the central banks are still in a loosening and easy credit world seven years after the financial crisis is troubling.

There is no historical precedent for what we are seeing. As a result, the financial trends that we have become accustomed to for the past 3 to 5 years are changing in a significant way - the 60 / 40 model performance for the past three to five year will not be easily matched with strengthening deflationary pressures.

It's my assumption that you are subtle trying through blog postings to prepare clients for this realization - though I find the 3 to 5 year performance reference within the webinar(s) counters the messaging.


It's my impression that a 60 / 40 model provided satisfactory returns during normal economic environment (past 3 decades) - it may not be well suited for our present historical precedent.

1) The corporations domiciled in the US (50% portfolio) + (26% other (international)) . . . all these boats have risen in the past with significant central bank liquidity. A great many may not under deflationary pressures, e.g. financials. Is the equity ETF component heavily weighed in financials?

2) Regarding the bond ETF, what type of bonds are within the model portfolio?

3) NIRP (negative) interest rates is an attempt by central banks to monetize deflationary debt - soon they maybe forced to unleash helicopter money, hence inflation. Is the High Rock tactical strategy flexible and robust enough to counter these opposing financial environments as they unfold in the future with non-correlated alternative investments?

I welcome your thoughts and comments.

Kind regards,

As always, excellent questions, Thank you!

We are certainly in uncharted territory and record low (or close to) bond yields tell us that, at least for the time being, safety is in demand.

In the meantime, equity markets are more like a casino  every day (and I loathe gambling). The very low risk-free rate of return, as a result of central bank stimulus, drives those who desire to get a higher rate of return into riskier and riskier assets.

But that is today and could possibly last until the next recession re-adjusts the way investors are currently thinking. Behavioral Finance experts suggest that one of the human emotional "errors" (of investing) is to project the current circumstances out into the future indefinitely (termed: Recency Bias). In actual fact, economic periods cycle: low growth, low inflation into higher growth and higher inflation and back again, although the time frames for this may vary.

Long-term rates of return will also cycle.

So we must accept that, in time, the average rates of return will move higher and lower (above and below average) as well.

But we must also always remember the fact that historic returns are in no way a guarantee of future returns.

There was a time in 2010-2013 when investors wanted a greater risk-premium for owning equities (and they were relatively cheap in terms of earnings per share). 2014 to now has seen that risk-premium evaporate and earnings per share metrics take a back-seat to the gambling mentality (with the desire for more "immediate gratification"). As we evolve through the cycle, this too will change, but again, the timing is not necessarily predictable (although we do try to give it our best "guesstimate").



For more detailed information on these "benchmarks" please check the links for the fact sheets that should give you all the information that you are looking for.

Remember that (for us) these are just performance gages (and by no means a recommendation for purchasing them). In other words, if you just bought these index ETF's in your portfolio and (avoided paying us our fee) you would get the advertised return (less the small MER).

So our job (as portfolio managers) is, over time, to give you a better return than you might get by just owning the ETF's.

That is why we like to show them, so that clients can make a determination as to whether we are doing our job as far as returns are concerned. (It is not necessarily always about return, so clients must also put a value on the qualitative aspects of what we do as well).

I remember a discussion with the president of the bank firm who had recently taken over the independent firm that I had been with (we had always had performance on the on-line, client facing, portfolio reporting site, the bank did not) whereby he told me that most IA's (Investment Advisors) at the bank didn't want clients to see their performance. Really? Now why would that be?

Interestingly, the new rules are forcing the reporting of performance and the fees that those advisors take. So clients can make the determination with more information. I would suggest that this transparency will bring about some movement of clients who will now realize that they are not getting what they paid for.

We will welcome them with open arms (and total transparency).

Finally, as you suggest, inflation will return (and the cycle will progress) and there may be a period of time when traditional asset classes do not offer the historic average returns. This is why we have added a third dimension to our offering. The "tactical" (value / opportunity) model. We want to be able to add value when the traditional 60/40 portfolio mix is not giving us the growth that we desire (and yes it could very well hold "non-correlated" assets, if, in our judgment, that is a sensible approach to enhancing risk-adjusted returns.

I hope that this helps and as always, we are more than happy to discuss this in greater detail if you wish.

Warmest regards,

It is great to be able to discuss what matters to readers...
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Tuesday, July 12, 2016

Earnings Season Has Begun:
(Is Anybody Paying Attention?)

Brexit has the headlines, followed by the Italian banking Crisis and of course the new record set by the S&P 500.

The fundamentals remain on the back pages: I had to look long and hard in the Wall Street Journal for what is normally front page news: Alcoa earnings, which traditionally begin the "earnings season". 

No big surprise when I found it: "revenue fell" (10%) and "profits dropped" close to 4% from a year earlier. Of course, these were "ahead of expectations".

What does that mean, "ahead of expectations"?

Basically, the analysts that cover Alcoa (and all the other S&P 500 companies) come up with anticipated earnings results (usually based on some guidance from the respective companies) in advance of the actual release. This allows "forward thinking" investors to determine whether they want to continue investing or not.

When a company "beats" those expectations (regardless of whether they are actually making earnings growth progress or not) there is usually cause for celebration and the share price goes up. Except if they guide to lower expectations farther out into the future.

According to Factset Earnings Insight: on average, over the last 4 years, actual earnings for S&P 500 companies have beat earnings estimates by 4% and 68% of companies have reported better than expected earnings growth. So basically companies like to set it up to garner the more positive news headlines of "beating" expectations.

That being the case, the current earnings growth estimate for Q2, 2016 which is a negative  5.4%, should probably come in somewhere around negative 2.7% based on the average of better than expected "beats" over the past 4 years.

But it is still negative!

And it could be the 5th quarter of consecutive negative earnings growth.

Doesn't that make you wonder why stocks are moving to record highs? The anticipated earnings growth for all of 2016 is just 0.5% (which includes a huge Q4 expectation of 7.2% earnings growth, unfazed by Brexit).

Central bank stimulus and / or lack of higher rates in the US is, for the time being, blinding investors to the realities of the fundamentals because they have nowhere else to go to get yield, despite the fact that forward looking earnings per share data are way above the average. The "risk-free" rate of return is pretty close to 0% ( wholesale 90 day Govt of Canada T-bills = less than 1/2 %), so every investment (that earns better than that) has significantly more relative risk attached to it.

Inflation, while low, is apparently still running in the 1.5-2% range (and as we all well know, our inflation experience may not necessarily be what the "basket" of goods is that makes up the Consumer Price Index data).

So anyone trying to stay ahead of inflation is likely taking more risk now than they ever have because we are in such a low return environment.

The current level of complacency is getting dangerous as investors move to higher yielding, riskier assets.

We shall discuss this and much more on our weekly client webinar today and post the recorded version on our website at or about 5pm EDT, so please feel free to tune in:

Thank you all for your feedback! Please keep it coming...all questions are good questions!

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Monday, July 11, 2016

US Stocks Back To All Time High's
Fear or Greed?

Friday's June US employment data was as big an upside surprise as was May's to the downside (so there is volatility even in hiring data). As I will say each and every time this data is released, it is one months data and subject to potentially significant revisions. In fact May's was revised down even further. As with everything, it is important to view this with some perspective (over longer periods of time) and the "trend" becomes more clear: employment growth peaked in December of 2014 and has been sliding ever since.

But... US stock markets loved this latest data enough to push markets back to their highs.

Does this excite you or scare you?

Well, let's have a peak at CNN Money's Fear and Greed Index:

Extreme Greed!

Some folks must be excited!

How about over time?

Historically, it appears that it is best not to be buying with the "madding" crowd, but to be patient and prudent and wait for the periods of fear (or extreme fear). And they will come, in time.

Our clients all got their quarterly reports sent last week, I don't think that they will be complaining about our low volatility, patient and prudent strategy!

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