Global Economic Growth:

All Eyes Focused On The US

As I have been suggesting (ad nauseum), there are structural adjustments taking place at the consumer level in the US economy that have yet to become part of the conversation.

Traditionally, the US Federal Reserve's mandate tends to be the main focus: "maximum employment and price stability" and the current conversation surrounding the next move in interest rates (to the upside) is focused on these 2 key issues.

However, there are many moving parts to the US economy outside of those 2 issues that also need to be respected.

The consumer is 2/3 of the US economy and while they are getting more and more employed, they are earning less and their spending habits are shifting:

I have talked a great deal about the aging Baby Boom cohort focusing more on surviving retirement without running out of money and the (now largest) Millennial cohort with less money to spend and considerably different consumption priorities.

Next Monday (August 3) we shall see key Q3 data on July Personal Income and Consumption that will give some further insight into the US economy's progress and the consumer that drives 2/3 of it.

• Fed Chair Janet Yellen and the Federal Open Market Committee, expect enough improvement in the US economy to start raising interest rates this year. 

Yesterdays FOMC release:  http://www.federalreserve.gov/newsevents/press/monetary/20150729a.htm

• BOC Governor Poloz "hopes" that a growing US economy in the 2nd half of 2015 will pull the Canadian economy out of its current slump.

However, initial Q3 data are not impressive:

Consumer confidence appears to have peaked and retail sales are slowing.

Automobile sales lead consumer spending higher in Q2 (+2.9%), spurred by cheap financing (low interest rates), but Q2 GDP still fell short of expectations:

If the US Fed were to raise rates it might choke off an economy that is growing, but at a significantly slower pace (at the moment) than is expected.

A slower growing US economy may hamper economic growth on a global scale as most other economies, outside of the UK, are still struggling.

In other words, the Fed's decision will have a global impact  and they are certainly aware of this:

"When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."

The charts are better at:

http://www.highrockcapital.ca/scotts-blog.html

Practicing What I Preach

(Author and Granddaughter)

I had the great pleasure to have spent the week with my 18 month old granddaughter this past week (hence limited blog writing capability) but a ton of fun trying to keep up with that bundle of energy.

And how (you might ask) did the financial education (see last Monday's blog) part of that experience work out?

I failed miserably. 

We visited (at an appropriate distance) with all the various wildlife in their natural habitat (bears, snakes, eagles, osprey, loons, fishes), played ball, participated in water activities, watched "Bubble Guppies"and brushed teeth routinely,  but perhaps it was a bit "too early" to discuss compounding and the rule of 72 every night before bed.

Nothing like a little dose of reality to bring me back into line, but I won't give up so easily, it is as important as good dental hygiene.

• So what happened in the financial world this week (oh yes I am paying attention)?

and more importantly why?

• Commodity prices continued to tumble in a sign that the global economy is struggling.
• New home sales in the US surprised to the downside and prices are down 1.8% over last year.
• Q2 corporate earnings announcements continued and to date 187 S&P 500 companies have reported.
• While earnings are generally better than expected (76% have reported better than the mean expectation), revenues continue to struggle (only 54% are beating expectations).
• In fact, according to FactSet EarningsInsight:

"For Q2 2015, companies are reporting year-over-year declines in earnings (-2.2%) and revenues (-4.0%). Analysts do not currently project earnings growth to return until Q4 2015 and revenue growth to return until Q1 2016. In terms of earnings, analysts are currently predicting a decline of 2.4% in Q3 2015, followed by growth of 3.4% in Q4 2015. In terms of revenue, analysts are currently projecting a decline of 2.8% in Q3 2015 and a decline of 0.6% in Q4 2015, followed by growth of 5.7% in Q1 2016. For all of 2015, analysts are projecting earnings to grow by 1.5%, but revenues to decline by 1.9%. " 

• If companies can't grow revenues, it is indicative of a consumer who is consuming less (one of our themes for 2015 and quite possibly beyond) and once again begs the question: how can share prices continue to grow if companies can't grow revenue?
• Earnings per share data show that at current prices, the S&P 500 companies are trading at 12 month forward Price to Earnings levels of 16.7 which is well above the 5 year average of 13.9 and the 10 year average of 14.1.

Furthermore, the S&P 500 is struggling:

• Year to date it is plus about 1%.
• It has not been able to get back to the highs reached in May (2135) although there have been a couple of attempts.
• Buying is not materializing (at this point) in any significant way to push new highs and while the "bulls" continue to be positive, the fundamentals do not support it.
• Share buybacks and low interest rates have made a major contribution to much of the growth of the S&P 500 over the last while, but when interest rates start to rise and the Fed's monetary policy becomes less accommodative, these catalysts will lessen and the focus will return to the fundamentals.

So we remain cautious and underweight equities waiting for better value (better reason to buy).

www.highrockcapital.ca

Parents, Teach Your Children Well

It really is never to early to start educating your children about money. Like anything, however, it does require effort.

From the piggy bank to the savings account and beyond, applying the experience of saving and growing money is best taught from the outset.

It is a wonderful thrill for a child to feel the weight of the gathering nickels, dimes, quarters, "loonies" and "twonies" in a container of some sort and to understand that if you spend that money it is no longer there (especially if the item purchased is consumed and no longer provides utility). But, if you save it, there are some really powerful feelings that come with the continuing growth (accomplishment for one). 

Like anything taught, repetition and structure will help make it stick. Unfortunately, cultural influences (the consumer society in which we live) will provide on-going challenges, so it is even more important to build it in to your child's (or grandchild's)  regular routine (like brushing their teeth).

It is as important as that. 

Understanding value (in financial terms) will be one of the most essential aspects of their lives as they grow (and may be helpful in future years when you, as a parent, have to start giving reasons for saying "no"). Knowing what happens to that saved money when it is spent frivolously and is "gone" (and you have to start all over from the beginning), is a pretty daunting experience and a compelling lesson. Learned early enough, it might just stick.

Like anything, the more enjoyable the routine, the more likely that it will continue. 

So play the "what if" game for a few minutes each day:

"What if" we get to $100 and start to earn a return (not much in a bank account at the moment, but it is a place to start) that helps to add to her/his savings. That can also be powerful, if you can forecast how much they might have in 1, 2, 3 or more years with a combination of saving and compounding. Then you have the ability to set goals and there is nothing better than the life lessons learned from setting and achieving goals, regardless of your age.

So set some goals and track them.

Pretty soon, you have a plan.

Everyday, check the plan. 

One day they may just thank you!

Back To The Future: Is Canada Heading For "Stagflation"?

Canadian inflation (core CPI) is running at an annualized rate of 2.3%, according to this mornings data release for June. That reading is up from last month's 2.2%.

Meanwhile many economists and perhaps even the Bank Of Canada see a chance that Canada's economy has entered into a recession (BOC cut the bank rate by 1/4% earlier this week).

5 year Government of Canada bond yields are below .75%, inflation is running at higher than 2%, that means that buyers of those safe 5 year bonds are giving up at least 1.25% each year after inflation (a negative "real" return). How long will bond investors be prepared to put up with negative returns? 

While the Bank Of Canada has cut the bank rate by 1/2% (and there is speculation that they may cut again by another 1/4 %) thus far this year, Canadian banks have only cut their prime rates by 1/4%. 

Clearly there is a disconnect from what has been the usual economic progression. We are indeed in uncharted territory, post oil price shock developments.

Meanwhile, inflation data from the Euro area and the US this week show a slight uptick in inflation in those economies as well.

Low interest rates and low "real" (after inflation) returns are forcing investors into riskier assets (like equities), driving prices for equities higher.

Meanwhile corporations are buying back their own shares at levels not seen since 2007 (according to Bloomberg) further pushing equity prices up.

This is in fact distorting earnings per share data. While earnings are stagnant or declining, fewer shares make the EPS data look better. But even EPS data is well above it's historical averages.

Folks, there is a whole set of situations developing that just do not make reasonable sense from my perspective at the moment and that warrants caution. 

Bank Of Canada Depending On US Economy For Help,

but Cuts Bank Rate by 1/4% 

The BOC July Monetary Policy Report released today expresses hope that future US economic growth will rescue the Canadian economy.

"Overall, as U.S. demand growth becomes more durable and non-energy exports regain momentum, business confidence will likely strengthen and the natural sequence will reassert itself. A pickup in business investment growth should follow as firms look to increase capacity to meet stronger domestic and foreign demand. In this sequence, investment in machinery and equipment is expected to be the main source of growth in business spending, supported by robust demand in the manufacturing sector and favourable financing conditions."

More here:

http://www.bankofcanada.ca/wp-content/uploads/2015/07/mpr-2015-07-15.pdf

I think that it is fairly telling that the dependence on the US to contribute to Canada's economic growth is not living up to expectations thus far (and as a result the bank rate has been cut).

Meanwhile, south of the border, in her testimony to Congress , Chairwoman of the US Federal Reserve, Janet Yellen, does continue to believe that "eventually" the pick-up in employment will transition to more consumer activity and stronger economic growth.

However, while we hope that all the smart minds that are putting forward these positive/upbeat forecasts are correct, we are a little skeptical (see yesterdays blog and/or the High Rock webinar for more detail, following yesterdays report on US June and May retail sales).

We believe that, at the moment,  there is a structural shift happening in the nature of the consumer who is reluctant to spend: the Baby Boom cohort is saving as they head toward retirement. The Millennial cohort (now the largest) does not have the money to spend.

This may impact the outlook for US economic growth because the consumer represents approximately 2/3 of the economy.

At the moment, we do not believe that this scenario (of downside economic risk attributable to the consumer) is being considered enough (or talked about) as part of the forecast.

On a global scale, the Euro area is recovering (but slowly and the focus on Greece has not been a helpful stimulant). China is not consuming exports as they once had been (as growth slows there while they transition through structural economic changes), impacting the Australian and Canadian resource sectors.

As BOC Governor Poloz implied at his press conference this morning, the economic cross-winds are complex. He was significantly more positive in January, that the downturn would be short-lived.

For both central bankers (Poloz and Yellen), they continue to focus on a more robust economic future, but their track record is a little suspect at the moment. As governor Poloz intimated this morning when asked about his previous forecast, hindsight is 20/20.

I would suggest that behind the scenes there are greater concerns than are being discussed in the public forum, despite the image being portrayed of "greater transparency".

That's why the BOC cut the Bank Rate by 1/4%.

So our investment strategy currently incorporates a less than robust economic outlook, for the US, Canada and the global economy in general.

www.highrockcapital.ca

The US Consumer Is 2/3 Of The US Economy:

They Are Confident, But They Are Not Spending

And this has been one of our new and on-going themes (apologies for the repetition) regarding the current state of the US economy: 

Baby Boomers are saving for retirement, Millennial's just don't (yet) have money to spend.

• US June Retail Sales data declined by .3% (May's data was revised down to plus 1% from plus 1.2%).
• Excluding Auto's and Gas, the decline was .2% (and May's data was revised down from plus .7% to plus .5%).

When the consumer doesn't spend, inventories sit on the shelves (cars sit on the dealer lots) and producers have to cut back on production.

In the meantime, sellers offer incentive discounts to move their excess inventories and this eventually falls to the "bottom line".

The bottom line is earnings and we have also been hitting on another recurring theme that without earnings growth, regardless of how low interest rates may be, stock prices can not go up.

Earnings have not been growing and expectations for future earnings will likely get revised down. 

The basic fundamentals can only be ignored for so long.

The S&P 500 is tired (because there are no new catalysts to take it higher) and buyers are not willing to buy at these (relatively expensive) levels, other than short-term traders covering short positions after the Greek solution.

As the wise market analyst Dennis Gartman often states: 

"It takes buying to make a market go up and just a lack of buying to make it go down".

The US Federal Reserve will give pause to think about this number and it could certainly delay the expected September increase in interest rates.

Tomorrow, the Bank Of Canada will announce its decision on monetary policy and interest rates.

Stay tuned.

And don't forget to check out our weekly webinar, broadcast live at 4:15 every Tuesday and recorded and posted on our website:

http://www.highrockcapital.ca/current-edition-of-the-weekly-webinar.html

Where we discuss wealth management, the global economy,  financial markets and the strategic positioning of our portfolio models.

Today, live from Pointe Au Baril on the north eastern shore of the beautiful Georgian Bay.

The Proverbial Greek "Can" Has Been Kicked Down The Road Once Again

They sure made it seem like a "nail-biter", but as we had suggested (June 24 blog) the Euro needs the weakness that Greece gives it for the purposes of euro area exporting countries' economic recovery (cheap Euro makes export prices more attractive).

Assuming all the necessary parliamentary ratification takes place, hopefully we can put this to bed for a while and move on with more important matters and our 2015 themes:

Expect The Unexpected.

• Canadian Labour Force data announced last Friday showed little change.
• June showed gains of 65,000 in full-time work, offset by losses of 71,000 in part-time work.
• Provincially employment fell in Quebec and New Brunswick and increased in BC and Newfoundland
• Public sector employment increased, self-employment and private sector employment were little changed.

On Tap for this week:

 

BOC bank rate announcement on Wednesday: it's 50-50 among the experts for a 1/4% rate cut.

• I would suggest the BOC plays wait and see on future economic data, given that the core inflation rate is close to target.

Also:

• US Retail Sales data for June on Tuesday will challenge our theme that the consumer is becoming less of a factor in the US economy (expected to have grown by .3%).
• China will announce its GDP data for Q2 (expected at a 6.9% annualized growth rate).
• More inflation data for Canada, the US and the Euro area as the week progresses.
• More S&P 500 company Q2 earnings: 42 companies will report. Of the 26 that reported last week, 16 beat the mean estimate.

www.highrockcapital.ca

Why Canadian High Yield Bonds Belong In A Balanced and Diversified Portfolio

Yes, I have a bias when I write this blog, because I own  part of an asset management company that specializes in Canadian High Yield bonds.

However, long before I became involved as a partner at High Rock, I was helping families build balanced and diversified portfolios and came to the realization that in a low return environment, this particular asset class could add an excellent stream of income and also (if the portfolio of high yield securities is well managed) be an important source of strong risk-adjusted returns.

click on the chart to enlarge.

Clearly, the chart shows that, in general, Canadian High Yield bonds represent a better investment than many other asset classes for the relatively low risk and reasonable return (but, as with any asset class, should be only part of a balanced strategy).

Why does it need to be well managed?

High Yield, by definition means that the debt rating agencies have rated these issues as lower than "investment grade", BB or lower (in the cast of most rating agencies), likely because there is increased risk associated with the particular company who has issued the bonds. In turn, the increased risk means that investors want higher yields as protection.

As a result, there is plenty of expertise and due diligence that is required:

• Understanding the complexity of the covenants of the securities (capable of reading through the legal document or indenture).
• Regular monitoring of financial reports and developments within the companies.
• Knowing when the risk profile changes (having an ear to the market) and requires an adjustment of the holdings (selling companies that present potential problems).
• It is also important to know how to best execute the trades in the "over-the-counter" (OTC) market.
• Proper diversification across many issuers (industry sectors) to ensure that one problem company will not significantly impact the total portfolio of holdings.

Also, most of these issues are not available to individual (non-accredited) investors and are only available in a fund format.

click on the chart to enlarge.

The above table lays out the fact that Canadian High Yield is an asset class unto itself and can be utilized to broaden portfolio diversification.

Also important, this is an asset class that is not necessarily interest rate sensitive and when interest rates start to rise, it is because the economy is strong and that is favourable for the High Yield sector.

A strong economy will mean growth opportunities and the greater potential for a rating upgrade that can offer potential capital appreciation.

All in all, sound arguments for further diversifying a portfolio with Canadian High Yield bonds.

The charts are better at :

http://www.highrockcapital.ca/scotts-blog.html

74% Of Non-Retired Canadians Are Worried About Out-Living Their Money.

A recently released Angus Reid study on Retirement in Canada found that "financial worries loom large" for retired Canadians (48%) but especially for those still working (74%).

more here:

http://angusreid.org/retirement-in-canada/

If you are worried, then you need to do a Wealth Forecast.

A Wealth Forecast will help you determine whether you will have enough money in retirement (and, if you wish, what money you may have left to pass on to family, charity, etc.).

A Wealth Forecast will assist you in planning your financial future. It will project, for you, how your financial lives will unfold and determine, long in advance, what your retirement will look like.

If you don't like how it appears, you can make adjustments (now) in order to be able to enhance your life in retirement.

This is truly a worthy exercise to give you peace of mind when it comes to planning how you want your future to unfold and  allows you to develop a strategy now to ensure that you meet your goals.

Of course the world we all live in is dynamic and there are always many moving and changing parts. So a Wealth Forecast has to have flexibility and needs to be monitored and updated regularly.

It is also important to have an expert providing you with the guidance needed to put this all together.

Importantly, a Wealth Forecast should not be a tool for the sale of a product (mutual funds or insurance) it should incorporated into your long-term wealth management process. 

Being anxious about having enough money in retirement does not have to be an ongoing part of your life . I have never seen anyone walk away from a Wealth Forecast not feeling better, having been given a glimpse of their future with a tool that puts them in the proverbial drivers seat.

It is, in fact, a great sense of relief.

www.highrockcapital.ca

Uh Oh China !

This is not pretty.

• In 4 weeks (since reaching their high's), Chinese equity prices on the SSE composite are down 32%.
• Lower interest rates, easier access to margin, suspension of IPO's and suspension of trading of a large percentage of companies has failed to stem the sell-off.
• Tuesday represented the largest day of margin selling in its history.
• Foreign investors are selling at a record pace.

Also, as investors face margin calls (to pay back borrowed money used to purchase stocks) they are being forced to sell other assets.

Commodity markets in China traded to their daily down limits in metals and agriculture.

Is Real Estate the next asset to be sold?

And on a global scale, investors are moving away from risk:

• Japanese equity markets traded down by 3%.
• Australian equity markets down 2%.
• US equity futures were down by close to 1%.
• US 10 year bond yields fell by .05% as investors continue to move to safety (pushing prices up and yields lower).

Add in the Greek uncertainty and there is real potential for a perfect storm to develop. 

We have been cautious for some time now (underweight equity assets) and continue to be inclined to remain that way until we get a better sense of how the dust will settle.

www.highrockcapital.ca

Behind The Greek Headlines: 

Commodity Prices Are Falling

Copper:

We often look at Copper as a proxy for future global economic growth.

In early May Copper made an effort to test the long-term down-trend from early 2011 (high of 4.57) and failed to break through to the upside (near 2.95). Subsequently it has fallen to within reach of it's December lows at 2.46.

If this is an indication for the direction of the global economy, it certainly does not bode well.

Oil:

After a steep drop in the 2nd half of 2014 (from over $100), Oil plummeted to near $44.00 early in the year.

A subsequent bounce saw prices hit close to $62 and had since traded in a narrow range until yesterday which saw a breakdown, below the range, to lower prices near $52.

If this trend to lower prices continues to test the lows (at $44), there could be further significant repercussions for the global economy.

Add this uncertainty to the current uncertainty surrounding Greece and throw in the debacle in the Chinese equity market and we are looking into a gathering potential deflationary storm.

Bond Markets have been responding as 10 year US government bonds have dropped close to .25%  over the last few days.

As I mentioned yesterday, uncertainty forces market participants to move from riskier assets to safer assets. 

And there is plenty of uncertainty swirling around at the moment.

More Uncertainty

Uncertainty undermines confidence.

• The Greek economic crisis will draw the attention of many and decisions on future economic decision making will be postponed until there is further clarity.
• At the moment, both Germany and Greece have backed themselves into their respective corners, so there is limited understanding as to what happens next (although we might expect Germany to soften its stance in an effort to keep the Euro weak).
• At the same time, Chinese equity markets are highly unstable (down 27% since June 12) and while the Chinese government (suspended IPO's) and central bank ( lowered interest rates) are trying to engender stability, it is not clear how this will end.
• US economic data is not bouncing back from it's Q1 downturn as hoped for (yet) and inflation (specifically wage growth) has not turned higher as desired, so many are re-forecasting the next move by the US Federal Reserve (now to December or even early 2016).
• In Canada it has been suggested that the economy has actually slipped into recession (2 consecutive quarters of negative economic growth). 

In times of uncertainty, financial market participants will move from riskier assets to safer assets:

• Good quality bonds (government bonds) will be purchased (for safety) pushing prices higher and yields lower.
• $US will be bought.
• Money will flow into cash.
• Equity assets will be sold, emerging markets sold the most.
• Overly aggressive portfolios will suffer from higher levels of volatility.
• Portfolios with diversity and balance will suffer the least.

www.highrockcapital.ca

A BOC Rate Cut Should Be Good For Canadian Equities

Earlier this week (while we were all watching the Greek situation unfold) Canadian GDP for April was released and while this actually came to pass a couple of months ago, a whole slew of economists who follow the Canadian story have begun to make their calls on the possibility of a July 15 Bank Of Canada Rate cut (by 1/4%) and the potential for a recession (2 quarters of negative GDP growth) has even been mentioned.

more here:

http://business.financialpost.com/news/economy/bank-of-canada-july-rate-cut-back-on-the-table-after-gdp-shocker-economists-say

and here:

http://business.financialpost.com/investing/canada-is-already-in-a-recession-says-bank-of-america-and-the-loonie-is-set-to-get-hammered?__lsa=4ddb-7c92

Looking at all the equity markets on a global scale and how they react to central bank interest rate cuts and other measures of monetary stimulus, I would have to say that this (a cut in the bank rate in Canada) should probably be taken as a positive for Canadian equity markets.

Interestingly, 

• The S&P TSX , year to date, is up a few points, but basically unchanged (1/4% easing occurred in January and possibly another 1/4% coming in July).
• The S&P 500 is also only up a few points (possible interest rate increase coming in the US in September or December).
• The Euro Stoxx 50 is up 10% (and The European Central Bank has been easing aggressively since January).
• The Nikkei 225 is up more than 17% (and the Bank Of Japan has been easing aggressively).

I think I like the odds of the S&P TSX to beat the S&P 500 this year.

Just sayin'.

www.highrockcapital.ca

US Employment Data Is Not About The Headline Number

US June Non-Farm Payrolls rose (close to the expected level of  230,000) to 223,000. The unemployment rate fell to 5.3%.

However:

• May's data was revised down from 280,000 to 254,000.
• More importantly, the participation rate fell to the lowest level since 1977 at 62.6%.

Most Importantly:

• Average Hourly Earnings were unchanged (expected +.2%) and May's number was revised lower, from +.3% to +.2%).

This is not a sign of a strong (and strengthening economy) because it leaves consumers with potentially less spending power and the US economy is dependent on the consumer for 2/3 of its input. We believe that there is a fundamental shift in consumer attitudes occurring, whereby Baby Boomers are spending less and the largest cohort, The Millennial's have less to spend.

With low inflation and no sign of wage growth, the Fed has even more breathing room (on its timetable for raising interest rates) and certainly does not want to raise rates on an economy that is still not inflating to the degree that it wishes. 

If consumers don't spend, inventories build, manufacturers lower production and earnings fall. That is ultimately not good  for equity prices.

Further, a study (released in April) by the LIS (Luxembourg Income Study Database) show that the American Middle Class is losing its status as the wealthiest middle class in the world.

click on the chart to enlarge, but....look closely at the Canadian situation (top left)

That is the good news here: Canada is catching up!

Happy Canada Day!

www.highrockcapital.ca