Wednesday, December 6, 2017

Bank of Canada Recognizes Risk Is High


As we suggested on our High Rock weekly client video, the Bank of Canada kept rates unchanged today.

"The global economy is evolving largely as expected in the Bank's October Monetary Policy Report (MPR). In the United States, growth in the third quarter was stronger than forecast but is still expected to moderate in the months ahead. Growth has firmed in other advanced economies. Meanwhile oil prices have moved higher and financial conditions have eased. The global outlook remains subject to considerable uncertainty, notably about geopolitical developments and trade policies."

Currency traders who were hoping for a different outcome after last Friday's employment report are abandoning their C$ bets (for now):



Uncertainties remain foremost in BOC decision making: NAFTA, Brexit, North Korea, the Middle East and a more aggressive US foreign policy are at the forefront of their radar screen and while optimistic (still) they are choosing to err on the side of caution.

Seems to make good sense. Investors should take note. The risks in financial markets are high and have been rising.

In US equity markets, price to earnings ratios are a good 23% above their 10 year average on a 12 month forward looking basis and that already has an expected 10% increase in earnings built in (for the next 12 months).

Every time we have a new client transfer in, I feel such a great sense of relief to be taking risk off of the table for them. They must feel the same way because we have seen an increase in Assets Under Management (new clients) this year by about 40%.

Bond markets are telling us something: yield curves are flattening and at the risk of becoming rather repetitious, flattening yield curves tell us of what is to come:



A flattening yield curve (the decline in the gold line) means that short term rates are rising and longer term rates are either rising less, remaining neutral or falling. Investors want the safety of long bonds, even in a low interest rate environment. The blue areas are times of recession (in the US) and you can clearly see the historical significance of what follows the declining gold line: the ensuing blue area.

In Canada the yield curve is doing this:



The spread between the 2 year and 30 year bonds has flattened to about 0.65%, the lowest since 2007.

Clearly, while not mentioning it, the Bank of Canada is aware and watching closely (so they are not raising short term rates today, which would push this flattening further).

We (Paul and I) have been trading and / or managing wealth through turmoil in 1987, 1998, 2001 and 2008, so we have a little bit of experience with these things.

What I see a lot of these days are portfolios with way too much risk relative to the signals coming from forward looking indicators (as opposed to backward looking economic data).

Want to know if you have too much risk in your investment strategy?

scott@highrockcapital.ca


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