Monday, September 26, 2016

Positioning For A Recession



"...I have been following your and Paul's blogs...based on what you have been saying, there is a high risk of recession (vs. others stating the exact opposite). What sort of approach would you take in the face of a recession?"

An excellent question (as are all questions)! Thank you.

Let me start by saying that we all want asset prices to go up (especially those that we are invested in) because it lifts the value of our net worth and gives us confidence in the future. 

A great many in the investment advice world (who believe in being fully invested at all times) will focus on the long-term nature of investing to suggest that it is best to just ride out the cycle and in time, asset prices will once again start to rise and in the meantime dividend and interest payments will cushion the downside.

To this, I cannot disagree.

However, if we can find ways to take advantage of what we believe will be lower asset prices (of those assets that we want to own) in the future and add value and reduce risk to our client portfolios, then we also think that in our clients best interest (and ours because we do invest in the exact same models as our clients) that we should do so.

Our fixed income model will likely be (initially) weighted to have longer duration (a longer average term to maturity) than the index. If and when the recession cycles through its term, we can adjust accordingly to take advantage of yield curve shifts (flattening first, then steepening eventually).

We think that stock markets historically are vulnerable to significant price corrections in a recession, so we would continue to maintain under-weight holdings in our global equity model until we felt that valuations had returned to more reasonable levels.

In the meantime, we also have our tactical model, where we can look for opportunities outside of the mainstream market's where individual company circumstances are not being impacted by the macro-economic cycle and where we are almost fully-invested (at the moment).

This represents a great deal more work (fundamental research) for us (than just telling our clients to wait it out), but in the end, is that not what they are paying us for?

If our assessment is incorrect and a recession does not occur?

We (at High Rock) are a discretionary portfolio management company and can act quickly and efficiently on behalf of our clients (silmultaneously) should we determine that the economic climate has changed (and valuations are more reasonable as a result) and we need to return to a more fully-invested situation.

To date, within our more conservative view, we are ahead of our benchmark index in returns (after fees and costs) for ourselves and clients (accross all of our portfolio combinations) and we are prudently taking less risk to get there, so right or wrong on our macro-economic outlook, we are still getting better risk-adjusted performance (portfolios have less volatility).

What makes you sleep better at night?

Waiting it out?

Or having managers working hard to find the safest way to continue to get growth?

There is an alternative.


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Thursday, September 22, 2016

Fed Lowers US Economic Growth Outlook


No surprises here for us. No interest rate increase (as expected).

"The Committee judges that the case for an increase in the federal funds rate has strengthened but decided for the time being, to wait for further evidence of continued progress toward its objectives."


Then they issued a revised economic outlook for growth to 1.8% from 2%.

So I ask you my friends, what am I missing?

A lower economic outlook is not a strengthening case for raising interest rates.

Consumers are not spending and businesses are not investing because they lack confidence in the future. Confidence does not come from interest rate moves or quantitative easing, it comes from believing that incomes and earnings will grow in the future.

As I have often said on this blog and in our weekly client webinars, there is just far too much uncertainty at the moment and until that gets sorted out, economic growth of any significance is not going to happen.

Brexit, Trump, Terrorism, North Korea, Syria, Russia (and others that I have missed): nationalism, populism and push-backs against globalization continue to threaten the global economy.

Enormous global debt levels and inflated asset prices because of low interest rates are weakening the structure of the global economy and there is, at the moment, little ammunition left for central banks to stimulate growth and have room to act if there is another economic or geo-poilitical shock.

An economy growing at 1.8% does not suggest the equity market analyst projections of 13% earnings growth for 2017 are anywhere close to being realistic. 

So it is hard to believe that the stock markets should be up 6% in 2016 whether you are looking forward or backward (2016 earnings growth is projected to be flat: -.2%) 

Analysts projected 6% earnings growth for 2016 at the beginning of the year and consistently revised these down over the course of the year.

This economic cycle which began back in 2009, is now over 7 years old and is sending signals that it doesn't have much left in the tank. The coming recession, which will happen eventually, will likely not be as steep and deep as the last one, but it will happen and the sooner it does, the sooner the excesses will get shaken out and then we can get back to some better growth potential for the future.

Historically, stock markets do not perform well in recessions, so we remain defensive and caution others to follow suit.


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Wednesday, September 21, 2016

Central Banks (Part 2): Bank Of Japan


Good reading for today at the link above.

Yesterdays client Webinar:


Tune in to BNN at 3:45pm today to catch Paul chatting about the Fed with Catherine Murray.

Monday, September 19, 2016

Central Banks As Economic Leaders
Awkward!

Back in the days following the great recession when the US Federal Reserve needed to supply some "extra" ordinary monetary stimulus in an attempt to re-build economic and investor confidence they introduced Quantitative Easing as a bold new step and it had the impact that they were looking for. They followed with two more efforts and financial markets went into a dither which was dubbed the "taper tantrum" in 2013 when it became clear that they were not going to follow with more.

In 2011, The European Central Bank, facing a debt crisis and a currency crisis adopted the extraordinary measures to subdue the negativity. Again a successful effort as calmer financial markets followed in their wake. There have been a number of extraordinary measures added since then and the Bank Of Japan and  Bank Of England also joined the party.

However, like Pavlov's dog, financial markets, it appears, have become expectant of something each and every time that central bankers make their interest rate decisions. 

When they hold back on further stimulus, it causes convulsions. When the Fed raised rates in December of 2015, volatility spiked in January and February of 2016. Central bankers live in fear of volatility and the end result of how that impacts economic decision making, so they have taken on a leadership role that necessitates making financial markets happy in order to keep volatility at bay.

They do not cherish this role.

They want business leaders to use the "cheap money" to invest in their businesses to increase productivity and enhance economic growth. Instead, lingering uncertainty has pushed business leaders to take a more short-term view: buy back their company's shares, pay more dividends out to shareholders and not necessarily make the longer-term investments in productivity and growth.

But, having had to adopt this leadership role, central banks are not certain as to what to do next.

The Fed wants to "normalize" interest rates, but there will be consequences (probably a recession) and are they ready for those? They will make their announcement at 2pm on Wednesday. 

The Bank Of Japan decision is due out late Tuesday (11pm EDT) and it is unclear whether they will stay on the fence as did the European Central Bank or make bold new moves in monetary stimulus. There are arguments for both sides, but they will likely be reluctant to add to a policy that has so far had a limited impact.

Central bankers would certainly like to hand off the reigns of economic leadership and move gently into the background in their intended "supporting" role, but there appears to be nobody willing to take those reigns.

Until that happens, it is likely that the global economy will struggle.


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Saturday, September 17, 2016

Always Interesting Conversations With Clients:


As it is part of our regular service to meet in person (or via webinar) with our clients at least every 6 months, it does allow some important dialogue as part of our on-going desire to keep open the channels of communication: in addition to our weekly webinar, almost daily blogs and a wide open 24/7 policy for staying in touch for whatever our clients immediate financial needs might be.

The 6 month review is important because it allows us to not only answer any questions about what we are trying to accomplish on behalf of our clients but also allows them to judge their progress against what their Wealth Forecast (last updated and revised 6 months ago) is suggesting where they should be.

During the conversation with a client in a recent 6 month review, he suggested that it was just hard to "wrap his head around of all the changes in the banking world today", but he especially wanted to make sure that he did not get "caught out" in the next market sell-off (because through the recovery and up until recently (when he became a High Rock client) his rather expensive mutual funds had not returned to pre-2008 levels), so he had kept a savings account (with a reasonable sum in it) with the same financial institution that also held his now shrinking mortgage.

Here is an example of how folks looking for "safety" are being conditioned to think that a financial institution is providing it, when that exact same banking institution is allowing you to have a savings account that earns you maybe about 0.25% on your account balance (which you are lending to the bank) and at the same time the bank is turning around and lending to you (for your mortgage) at a rate in and around 3%.

As a client of that bank, you should be infuriated because the bank is taking a 2.75% spread on your money from you!

The shareholders (of the bank) love it (it is pure profit).

As we will often say at High Rock, there are alternatives: If you can possibly earn 4-5% on your money (after fees and costs)  with low levels of risk (and plenty of that in cash / cash equivalents) why would you:

1) be anxious to pay off a 3% mortgage?

 and 

2) why would you lend money to that same financial institution (who lends to you at 3%), basically for free? They would never do anything for you for free.

There are so many options for folks that are looking for great service and direction with equal or better safety (Canadian Investor Protection Fund) features outside of the mainstream banking and insurance institutions. Just because they are large and have been around for a long time, it doesn't necessarily ensure the quality of care or safety, for that matter.

Times are changing, there is a better way to save, grow and invest your money (and still get the service that you want).


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Friday, September 16, 2016

Slower Growth, Higher Inflation In The US And  Growing Canadian Household Debt


Back to things economic as we wait for next Wednesday's FOMC interest rate decision: 

Thursday was a day of significant data releases (otherwise referred to as a "data dump") in the US which showed slowing retail sales and industrial production (more than had been anticipated) and enough for the Q3 GDP Now forecast (that we show each week on our weekly client webinar) to be lowered from 3.3% to 3%, largely because the consumer has decided to put off purchases ahead of a highly uncertain presidential election.

Meanwhile, this morning, the latest Consumer Price data showed that the "core index" grew at an (higher than expected) annualized 2.3%, with medical care and shelter (among other items) leading the way. 

The Federal Reserve's dual mandate includes price stability (low inflation) and full employment and if they focus solely on these two items, some may argue that it is enough to raise interest rates.

The other camp will argue that there is also "behind the scenes" data (like consumer activity and business investing) that auger for future economic growth to slow (putting pressure on employment / unemployment data down the road) and that this should inspire caution among Fed decision makers.

Here at High Rock, we will argue that a Fed rate increase will only put the US economy closer to recession.

It will also create significantly more volatile financial markets.

The odds-makers will suggest that it is unlikely for a rate increase at next Wednesday's 2pm announcement, but the odds-makers were wrong about Brexit as well.

Whatever the case, higher interest rates south of the border will put upward pressure on 5 year mortgage rates in Canada because Canadian and US bond markets tend to trade fairly close together. This in turn, can tend to put upward pressure on mortgage rates, but likely nothing too significant at this particular moment in time (but longer-term it is something to consider).

The problem, in Canada, is that Household Debt to Income ratios have reached another record:



 Higher debt servicing costs  (that would come with higher interest rates) could make the housing market tremble.

In Canada, the Bank of Canada only has one mandate: price stability. If we should see inflation rise (forcing higher interest rates) without correspondingly stronger economic growth (and household income), that could certainly spell trouble.

Something (another risk, albeit not a near-term one) to think about.

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Thursday, September 15, 2016

Things That We Just Have To Shake Our Head At:


Today I was "out-blogged" by my High Rock business partner:

So I send you the link as suggested reading!


Enjoy!