US Fed Sees Slower Growth

In about as bold a statement as you are ever likely to get from the Fed (because they will never suggest a recession is pending), yesterday (following their scheduled FOMC meeting) they announced downward revisions to their economic projections for 2019 and 2020.

Currently, per the chart above, Q1 GDP (based on data released so far this year) is expected to show extremely sluggish growth, not far from the zero line. So in as optimistic a tone as possible the press release stated that "growth of economic activity has slowed from its solid rate in the fourth quarter".

The Fed will always opt out of using language that might be detrimental to the confidence of consumers and businesses because as they become less confident of the future, consumers will postpone spending plans and businesses will hold off on capital investment. If the central bank has a frightening message, this could inevitably become a tipping point.

The Bank of Canada is no different. 

Bond market participants are pretty seasoned at reading between the lines and the benchmark US government 10 year bond yield dropped by almost 10 basis points. The Canada 10 year yield dropped by about 6 basis points. Clearly, bond markets are anticipating slower growth, lower inflation and lower interest rates in the future.

Stock market participants may also be getting the message: after a failed attempt to make higher prices post Fed announcement, stocks closed lower on the day. As of this writing, they appear to be lower again in overseas trading this morning.

If you haven't had a chance to read Paul's blog from last week: "One of these Markets is Wrong", have a peek.

Our thesis is and has been (ad nauseam) that stocks are a very expensive proposition: with slower economic growth, earnings are expected to fall. Yesterday FedEx reported lower than expected earnings and forecast the same for the near-future. If FedEx is not a window on modern day consumer activity, I am not sure what is. The consumer is about 2/3 of the US economy.

And stock prices (light blue line) are not reflecting this:

Value lies somewhere below the  dark blue line (as we saw in December).

As value investors at High Rock, we are not interested in being fully invested in our global equity model. While we did do some buying in December, we have recently been selling into the rally (didn't quite catch the highs, but close enough). We shall buy again when a slowing economy takes hold and offers up more value.

Until then we can enjoy the fact that we have exposure to alternative assets (high yield bonds and one of the top HY managers in the country in Paul) that pay us well (interest income) to hold them while we wait.

Reminder... don't forget to take a couple of minutes to help us with our reader's survey.

Hands Up And Be Counted!

We write our blogs on a regular basis expounding on the things that matter to us and attempting to discuss the topics that we think will help our readers 1) improve their financial literacy and 2) get a sense of what we are thinking (our bias) in the complex world of financial planning, investment strategy and risk management. However, it is time to ask you, our readers, what matters to you and where you sit on the learning curve. 

We are pretty certain we know where our clients (who read our blogs) sit on this spectrum (because they do give us feedback from time to time), and of course you (our clients) are invited to participate. Also for the other folks who tune in as well, we want to be able to determine what matters most to you and where we might be able to help you get further advanced along the curve.

We thought it appropriate as High Rock Private Client turns 4.

If you wish to take the 3-5 minutes to fill out our quick little survey (click this link), there is a comment box at the end and you have the option to sign up for a draw prize (to be drawn by our Independent Review Committee, Wychcrest Compliance Services) as a way to thank you for participating.

In advance, Paul, Bianca and I thank you for taking the time!

High Rock Private Client Turns 4

"People have no idea of what they are paying. It's a shame". Said founder Paul Tepsich to Barry Critchley back in 2014 in a Financial Post article titled "High Rock Capital Management Leads The Charge On Fee Disclosure".

Although, High Rock stands for more than just fee disclosure. High Rock stands for a new vision in the world of wealth and portfolio management: what Larry Bates refers to in his book, Beat The Bank as "New Bay Street": where not only does the true cost of investing become transparent, but non-conflicted fiduciary duty in portfolio management rules the day. 

How are "Old Bay Street" advisors conflicted? Simply by being agents who collect commissions from their big bank and financial services employers and / or mutual fund companies on the generation of revenue from their clients.

"Old Bay Street" advisors are rewarded on their ability to "gather" assets and generate fees from those assets. The emphasis is on "building a book" of gathered client assets and finding the most profitable way to extract a living on the commissions generated and in the end, sell the book of business to become further enriched. Often the client is just a dollar sign for generating revenue and treated as such (spending time with existing clients is costly, when you can be out gathering more of them). How many investors get to talk directly to the person managing their money? Do you get to talk to the person whose name is on the advisory practice?

High Rock Private Client was started to take this in a different direction entirely, making the focus on putting client's interests first. Early in 2017 we created and each signed a Voluntary Code of Conduct that ensures this throughout the process of planning (Wealth Forecast) and investment management and the continued monitoring, review and strategy updates.

We are owners, but also employees, who are paid a salary. There are no bonuses paid for generating revenue. If we grow our business, it is because we are doing right by our clients. High Rock Private Client has grown by over 300% in assets under management since our inception. So we must be doing something right.

We also invest in the exact Same securities: bonds, stocks and ETF's that our clients are invested in and provide a quarterly report from an Independent Review Committee (IRC) to our clients to ensure that we are adhering to our principles. With our Institutional Division, we have the ability to get preferred, wholesale pricing on our bond purchases (bulk trades) which we can pass directly on to our clients, something that Paul had been frustrated by in his attempts to buy bonds at reasonable prices into his "Old Bay Street" accounts and partly inspired him to want to create High Rock's Private Client division.

Truly, the client is High Rock's first priority.

I know that my blog readership is mostly a partisan crowd and that for the most part I am preaching to the choir. However, there is a growing alternative to the old ways and it is in everyone's best interest to seek it out, whether you are a Do It Yourself (DIY) investor or not, there are better options available for investors than what was / still is a captive group who are afraid to seek out an alternative (away from "Old Bay Street") that they can trust.

Central Banks Take Center Stage (Again!)

The European Central Bank (ECB) surprised financial markets this morning with an easing of monetary policy: stating that interest rates would stay at 0% at least until the end of the year (longer than the original plan) and would initiate a new series of long-term business loans (TLTRO) that would add liquidity to the European financial system.

Yesterday the Bank of Canada left it's monetary policy unchanged (the overnight rate at 1.75%), despite admitting that: "Recent data suggest that the global economy has been more pronounced and widespread than the Bank had forecast in its January Monetary Policy Report (MPR)". About the Canadian economy: "After growing at a pace of 1.8% in 2018, it now appears that the economy will be weaker in the first half of 2019 than the bank projected in January."

Interestingly, yesterday as well, the Organization for Economic Co-operation and Development (OECD), lowered its global forecast and dropped Canada's 2019 GDP expectations from 1.8% annual growth to 1.5%. They lowered the Eurozone economy from 1.8% to 1.0%.

Compare this picture:

With the Canadian situation (at the top).

Interest rates in the Eurozone are already at zero. Inflation in the Eurozone (February data) is at 1.5%. Inflation in Canada is running at 1.4% (January data), but the BOC measures of core inflation are running near 1.8-1.9%.

The BOC also stated yesterday that: "Governing Council judges that the outlook continues to warrant a policy interest rate that is below its neutral range."

I did message the BOC Twitter feed (@bankofcanada) asking for a broader explanation of what actually was "neutral". My @JSTomenson feed received no reply. However, in their fairly recent efforts to reach the average Canadian household on their level, they did release this (via their Twitter feed): "Price Check: Inflation In Canada".

"Of course, the Bank doesn't respond to every movement in inflation or focus on prices that move around a lot", perhaps a reference to the drop to a total CPI report of a 1.4% annual increase in January from the 2.0% December number. 

"The Bank focuses on changes that are more widespread and persistent".

When they started raising rates back in the summer of 2017, the BOC used the analogy of "putting their foot on the brakes before the light changed to red" or something of that nature (see my blog: Higher Borrowing Costs = Big Risk For Bank of Canada)

Clearly, the Canadian economy has been slowing since then and the expectations of higher inflation have not taken us much above the 2% level of the BOC's core inflation data.

So what, exactly is the BOC's "neutral" rate of interest that should be indicative of an economy with "neutral" growth and "neutral" inflation?

I might be so bold as to suggest that they are somewhat high on their estimate of "neutral" interest rates and without some action more than an acknowledgement that their economic growth estimates were too strong (as in some more aggressive monetary easing like the ECB just announced, i.e. an interest rate cut), the downside risk to the Canadian economy will likely be elevated.

Interesting that the BOC was quick to change to an aggressive tightening of policy back in 2017, but remains less aggressive to go the other way, when it is clear that the Canadian economy is in some trouble, loan delinquency is rising (higher debt servicing costs for Canadians) and the global economy is not helping.

Bond Yields And Recessions

Question from a former colleague: "you're a bond guy, where's that inverted yield curve?". This is from someone who thinks the S&P 500 will hit 3500 before the next recession (that is a 25% move higher from where we are today), so we shall call him / her a stock bull.  Financial markets are far from an exact science, so some can extrapolate more positive signals from the current economic and investing environment. That is what makes markets: those with a more positive outlook are the buyers, those with a less positive outlook are the sellers. On any given day, more buyers than sellers will drive prices higher (and vice versa), that is what makes markets work. 

We can debate value (in stocks) all day, but...

First, lets look at the chart above: the recent history of the 2 (gold), 10 (green) and 30 (purple) year US bond yields. When there is a widening between those lines, the yield curve is normal (positive sloping). However, when the US Federal Reserve embarks on a tightening of monetary policy (raising interest rates), the 2 year yield rises at a significantly faster pace than the 10 or 30 year yield. We "bond guys" call this a flattening of the yield curve (red arrow). When 2 year yields rise above the 10 and 30 year yields, it is referred to as an "inversion". Historically, this flattening of the yield curve is followed by a recession (but it does not necessarily have to invert), usually because the US Fed raises rates at a pace that is too fast for the economy to handle (some refer to that as a "policy mistake"). It appears that historically, the Fed has made a bunch of these "policy mistakes". Odds are that it is not going to be any different this time. As I like to put a probability on events occurring (nothing is ever certain), lets say its between 60-70% that we are staring a recession in the face. In which case, I (and we at High Rock) should conduct my/our investing strategy accordingly. Stocks don't historically do well in recessions.

Has the most recent tightening been too much for the economy to handle? US personal income and spending in December were dramatically lower and put lots of slowing pressure on the US economy. Remember, the US consumer is about 2/3 of the economy. Q4 GDP slowed to a 2.4% annualized pace (from 3.3% in Q3). The early call for Q1 2019 is for something below 1.5% annualized growth. The Fed has "paused" the tightening process. Is it too late? Perhaps. The rest of the global economy has also been stalling and that is not helping. The impact of a US-China trade deal is too far away to be of significant consequence in the near-term.

Closer to home, the Bank of Canada started "putting the brakes" on the Canadian economy back in the summer of 2017 (raising interest rates and flattening the Canadian yield curve). Last quarter, the Canadian economy barely grew at all. Economic forecasting can be tough. However, it would appear that the downside risks to the economy grew to be bigger than the BOC anticipated. Interest rates are too high and impacting highly indebted households (not the first time I have brought this to my readers collective attention): So...

1) Household spending slows and the housing market softens

2) Non-residential business investment continues to fall

3)Export and import volumes edge down

If you want to be bullish on stocks heading into this environment, knock yourself out (those in my camp are happy to have buyers to sell to). I / we (at High Rock) are not so positive (and remain purposefully cautious and prudent with our and our clients hard earned savings).