Happy Birthday High Rock Private Client (Wealth Management) Division

It is actually a bit belated, but with all that has been going on recently it actually had slipped my mind until I was asked a few questions by a prospective client this morning which I will share further along in this blog. We were supposed to celebrate with a gathering of our clients, prospective clients and friends at The Albany Club (across King Street from our office at 1 Toronto Street) yesterday evening with a special guest appearance from our friend David Rosenberg. Given the current pandemic and subsequent lock-down, the timing (planned well-before this all happened) was not so good. In hindsight, though, I would really like everyone to hear David's outlook on the current reality that we face. David's input and critical thinking was, over the last year, vital in helping us maintain a defensive strategy that has been paramount for our clients avoiding the huge swings and frightening volatility of the last couple of months. 

As of yesterday, our 60% fixed income, 40% equity clients were basically flat on the year (this is general, because every client portfolio and strategy is specifically tailored to their own situation: goals, time horizon, risk tolerance). The 40% fixed income, 60% equity clients somewhere between -2% and -4% on the year (again depending on their asset allocation mix). And, as you all should know, historical returns are not a guarantee of future performance.

So while we don't like how history has unfolded thus far in 2020, we can quietly celebrate keeping volatility to a minimum in our client portfolios, despite the crazy market swings (which, as you may have guessed, if you read my little blog regularly, are likely not over, or at least that's what we think, anyway). You can believe in the optimist's  narrative touting a "V" recovery and we sure hope that they are right! They appear to be looking beyond the recession. However, even the sometimes overly optimistic U.S Federal Reserve said yesterday that 

"the ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term".

Medium term friends, to me that is 3-5 years. So we think more of a "W" recovery. It might be best not get too comfortable in the first "V".

Back to High Rock:

Q:  When did you start High Rock?

A: Paul started High Rock in 2010 as an institutional portfolio management company, managing (sub-advising on) 4 mutual funds for Scotia Bank. We started our Private Client Division in 2015 (I bought ½ of High Rock at that time). Our bio’s are on the website highrockcapital.ca/team for further detail. We both shared a similar philosophical rationale for molding a wealth management firm that was more client focused vs. the “one size fits all” approach, specifically because we felt the former was better and different than the industry direction that is moving towards scale, favouring shareholders and commissions over client advice and service.

Q: What alternative strategies do you use besides Fixed Income and Equities?

A: We are very focused on liquidity for our clients, which allows us to maneuver quickly when we need to (and provide cash flow to clients when they need it). We have owned REIT’s in the past, but are a little skeptical of their distributions (Paul is very cash flow focused with his research on any company we own that pays income or dividends). Turned out to be a good thing as they got clobbered recently. When the time is right we may look at them again. Private Equity and other forms of real estate ownership tend to be less than liquid. I would be happy to discuss our Tactical model strategies in more detail if you wish.

Q:   I think as we navigate this economic turmoil and COVID ; It is clear we have a simple objective nothing fancy like you spoke about knowing they can sleep at night and while there are ups and downs that are beyond anyone's control but the ship is actively managed and while we may not hit homers we are often more right than wrong with singles .  Wealth management with the ideal goal would be 7-8% interest annually manage the down side and understand there is a sacrifice on the upside. 

A: Historically, 7-8% was achievable. Believe me, I would love to get back to those days. But for the near-term anyway, I would suggest that with interest rates near 0% and economic growth likely to be no better than 2% over the next few years, getting 7-8% might be fraught with higher levels of risk (that would make sleep less easy to come by). It is doable, but for my own portfolio I would not want that level of risk, so I would ask the risk question first because everything we do is about managing risk first. Return per unit of risk taken / or risk-adjusted returns. I think that once we get to the other side of Covid-19, I would be cautiously optimistic of getting back to 6-7% as inflation returns and yields move higher, but that may take a while.

Q:   We are realizing that Pooled funds may be less our appetite; not portable, less transparency and hard to be fully tax efficient 

for both our corporations and personal

A: We utilize the Separately Managed Accounts (SMA) to help harvest tax losses when they are available to offset gains. Everybody has tax strategies and we find it helpful to align ourselves with their tax professionals to ensure a seamless and synchronized strategy. It also helps us to direct client holdings to more tax efficient accounts when it is available. i.e. higher income (less tax efficient holdings) to tax free and tax deferred accounts when available.

Q:   How active are you in the portfolio ?  in changing positions/ rebalancing etc.

A: There are 3 reasons for rebalancing:

1) Cash flow in

2) Cash flow out

3) Price adjustment in holdings (that take % allocations out of the desired range).

These can be ongoing and tend to be client specific (which is why we also prefer SMA accounts).

Changing positions is tactical and we will do so when we get what we consider to be a good opportunity. For example: We took Global Equity Model positions to under-weight in 2018, added some back in early 2019 (perhaps not enough though) and further reduced in 2019 (profit-taking), simply because markets looked expensive. As markets fell in 2020 we started to add some back, gradually. Yesterday we started to sell (we will sell more if markets continue higher). Taking advantage of volatility is one way to add alpha (earn our fees).

Q:  How many different iterations of portfolios exist — I recall you talking about a bespoke approach and the returns of I believe your portfolio from the presentation  typical of the  avg high rock client ?

A: We have three basic models (and some “special opportunity” models for more sophisticated clients): Fixed Income, Global Equity, Tactical. I would be happy to go into greater detail on a call. But each client family, (RESP’s and children over 18 have their own strategies) has an allocation of the 3 basic models. The structure of that allocation is based on a combination of the client families goals, time horizon and risk tolerance as set out in a Wealth Forecast and then strategized in an Investment Policy Statement (IPS) that we advise on and determine in conjunction with you. These are target ranges that give us some latitude for tactically building and managing the portfolio. Paul has the greatest weighting in the Tactical model at 25% (which he runs). I am set up at 40% Fixed Income, 45% Global Equity (which we manage mostly from a macro perspective) and 15% Tactical.

I love what I do!

Won't Get Fooled Again?

With apologies to The Who.

Risk tolerance. 

If your investment portfolio dropped 20% or possibly more and you were feeling quite nauseous back on March 23, you may want to use this opportunity to take a quick look under the hood (ask your advisor to send you an updated portfolio return summary) and ask yourself if you can stand another bout of that?

If you can, read no further.

If you can't and are thinking about the big risk inherent in "re-opening" the global economy, then perhaps it is time to give it some thought.

I am hopeful, but only cautiously optimistic. Think about it, the economy suffered a vicious sudden stop. Pretty much everything shut-down. There is no switch-click that will just turn it back on again so that it resumes growth (which had already been slowing before the pandemic and lock-down took hold). This re-start will be gradual and fraught with the possibility of another sudden stop. 

Clearly, the mood of the consumer is going to be somewhat skeptical, for some time to come. The only thing that gets the above table anywhere close to normal is if testing and ultimately a vaccine is available for everyone. 

Stock markets, however, appear to have a different perspective. The S&P 500 is up close to 30% from the March 23 lows. Historically, that would be considered a couple of good years.

Let's once again look at the fundamentals: 

Earnings estimates are crashing and expected to continue to show negative growth into 2021:

 If stock prices are rising and earnings are tumbling, anyone want to take a wild guess as to what is happening to the ratio of prices to earnings?

Yup, spiking back to the February highs, higher in fact. Remember what happens next?

What this tells me is that risk is also spiking, as it did in January and February. If your portfolio has too much risk and your tolerance for it is not there, it's a good time to make some adjustments.

High Rock Private Clients remain underweight equity and overweight cash equivalents, unless of course you are a daring millennial (we do have some young folks as clients with very long time horizons) who is comfortable with the risk.

If you need cash flow for retirement purposes over the next few years, think long and hard.

Inflation's Sting May Return (But Not Quite Yet)

$8 Trillion!

From our friend David Rosenberg this morning: "Why aren't markets getting hit even more (as in equities)? ... Governments around the world have stimulated so much, that's why. Just on the fiscal side alone, not including all the incursions by central banks alone to influence and support risk-asset prices, the global stimulus has come to an astounding $8 trillion."

This is going to make the Bank of Canada's inflation projections (as I suggested in Tuesdays blog) go squirrelly!

From the BOC's April Monetary Policy Report:

"The weak economic outlook will weigh on inflation. Because of severe and adverse effects of the pandemic, there is considerable uncertainty around the outlook for inflation. Determining the impact of the economic contraction on future inflation is difficult because both supply and demand are falling. There will also likely be technical challenges to measuring inflation during the containment period."

Gas and other energy related prices have fallen precipitously, especially those pertaining to transportation and travel (hotel costs too). Likely food and medical prices have risen on scarcity and perhaps delivery costs, although with folks no longer dining out, that could be a wash.

But, what happens when the recovery comes (and how sustainable it might be)? All that stimulus sloshing around is going to impact the value of our money. Already it can be seen in the little watched (anymore) money supply numbers:

Back in the late 1970's / early 1980's when inflation was peaking at 9% annually (only those of us over 60 likely remember this era) this was a key data point and we currency, money market and bond traders waited for the weekly reports in order to assess the central bank's next likely interest rate move in their raging battle against inflation. Higher levels of money supply in the system were considered inflationary, prompting expectations of central bank tightening of monetary policy (higher interest rates).

We are going to start to need to keep an eye on this again because of the potential for it to sneak up on us. Central banks money printing presses are running on overdrive.

History tells us that after recessions, inflation will inevitably return and become the next worry. The last thing highly indebted economies need is a surge in interest rates to combat the upward inflationary pressures. Bond and fixed income investors will demand inflation premiums to be built into yields if they perceive erosion of purchasing power in the future. The big debt load put on governments who will be borrowing to finance the $8 trillion in stimulus will also add to long term interest rate increases. The market will determine the level of interest rates, but it would have implications for mortgage rates too, as they are set off of what happens in bond markets. 

If safer investments provide a better return than riskier stocks, where will aging investors feel more comfortable? 

It is also going to challenge the central banks whose mandates are based on controlling inflation (the value of their currency).

How this plays out is far from certain, but it could have significant consequences for all of our collective Wealth Forecasts should we have to ramp up our assumptions surrounding our annual cost of living increases.

Who Would Have "Thunk" It?!

We actually have a client, someone quite knowledgeable in the world of alternative energy who predicted (in our conversation a few years back) that oil prices would go to zero at some point in time in the future (he also owns gold because he is a little skeptical on the value attached to fiat currency) . I am not sure that he saw what happened in the oil futures market yesterday coming, necessarily, and the reason for it, but... if you are right, you are right (regardless of the "why"). I can't help but think of the Clampett's and Ewing's and all the other TV oil shows and movies that might not have seen this eventuality!

How do prices get negative?

In the futures markets, where commodity producers can hedge their prices and commodity buyers can make purchases to avoid the uncertainty that price movement brings (and speculators can do either if they see a chance to get in the middle and make some $), few ever expect to actually take delivery of the actual product. They either buy / sell an offsetting contract (to cancel the original) or "roll" the contract into the next future expiration date. A kind of musical chairs, if you will. For a pretty good explanation in relatively easy terminology read: There’s Nowhere to Put the Oil.

With oil demand off some 30%, on the back of the coronavirus pandemic and subsequent lockdowns, the expiration of the May contract got a little tricky. Perhaps some airline who suddenly realized that the were not going to be able to roll their futures contracts (airlines would need a natural hedge against rising fuel prices in normal times, to estimate costs, etc.) and feared having to take delivery with nowhere to put the oil and were scrambling to get rid of their contracts, hitting any bid in sight, even bids that had a negative price. Which translates into, "here take a free barrel of oil and I will also give you $40 to take it off my hands, 'cause I have nowhere to put it!"

Anybody have an empty swimming pool?

If only we could lock in future gas prices on the back of that!

The Bank of Canada's inflation projections just went a bit squirrelly too.

The point here is, we are in unprecedented times. Anybody who says that they see how this whole pandemic situation is going to play out has been participating in some of the 17% increase in marijuana sales since the lock-down began.

There will be a "new" normal, but what that is remains to be seen. If the oil price fiasco is representative, we are going to be in for a wild ride.

Hang on!

Once Again, I Am (Apparently) Missing Something?

We own stocks and equity ETF's in our High Rock Private Client portfolios for long-term growth with capital appreciation and dividend income. So we naturally expect that, in time,  higher stock prices (as a larger group) will give us returns that grow our money. When stock prices rise and portfolio values grow, we (and our clients who check regularly) are happy. We have a natural desire to see this working. 

When it happens outside the realm of reality, it frightens us, because it sets up a greater potential for near-term disappointment and we know that when investors become disappointed and / or frightened, their patience for waiting for the long-term runs a little thin. The last thing we want is for our clients to abandon their long-term plans because they get scared out of their investments in the equity market.

One of the fundamentals around stock ownership (among a number of other valuation metrics) is based on earnings expectations relative to the price of the stock. We call this the forward price to earnings (P/E) ratio (chart above). 

When stocks are cheap (representing value), the P/E ratio falls as it did in 2008 to below 9. As the P/E ratio rises, it signals that stocks are getting expensive. It peaked at 19 in late January / early February (highest level since the financial crisis) as stock prices made new highs while earnings expectations were falling. 

For us, that period (Oct. 2019 to Jan. 2020) signaled that there was way too much risk attached to owning equity assets. When the coronavirus pandemic began, P/E ratios fell to a relatively attractive 13. Last week  P/E's jumped to about 17.5. as stock prices rose and earnings forecasts plunged.

Why do stock prices rise if the fundamentals are not strong enough to support those prices? 

There are lots of varied opinions on that topic, but the more positive stock trader / investor / advisor / cheerleader looks to the central banks to be the back-stop if stock markets should go into sell mode, thereby providing a floor for stock prices. We saw it as the U.S. Federal Reserve provided QE through the 2009 to 2015 period and again in early 2019 by cutting interest rates.

With the sudden shock to the global economy provided by the coronavirus and the efforts to curtail it, central banks have once again become the stock market support system.

The end result is a stock market that is further removed from its underlying fundamentals: earnings expectations are plummeting, while stock prices are rising (or no longer falling, depending on your context). That distortion (of reality) means there is increased risk inherent in the ownership of the equity market asset class. Risk of another seriously nerve-wracking decline.

The economic news is grim. If you have not seen the Bank of Canada's Monetary Policy Report released yesterday, you may want to have a look, it is not pretty, but it is the current reality:

"Measures required to control the spread of COVID-19 have caused a severe reduction in economic activity. The sudden closure of many businesses and the sharp fall in trade have prompted major disruptions to global supply chains. The resulting increase in unemployment has been unprecedented and has contributed to a drop in income. This, combined with elevated indebtedness and the abrupt deterioration in business and household confidence, is weighing heavily on a wide range of economic activities. A sharp contraction in the global economy in the first half of the year is unavoidable."

And we know, from it's past economic reports, that the Bank of Canada tends to paint a more positive perspective of the outlook so as to not frighten the general population too much.

Our friend, economist, strategist and great critical thinker David Rosenberg (of Rosenberg Research) had this to say:

"The market bulls have been saying for a while now that the stimulus from the government is going to stop this recession in its tracks, a recession that had already been priced in, and now time to price in the recovery. Or at least, look through the downturn and focus on "normalized" earnings. From my lens, it is tough to identify what is "normalized" when the future will be anything but "normal"."

What will be the "new" normal? Financially and economically speaking, a very long path to get consumers and businesses back to a level where they are able to generate enough income to comfortably re-start spending and hiring. 

Don't forget that all this current government spending will eventually have to be paid for. Initially governments will have to issue bonds to cover the payouts, more bonds could push longer term interest rates higher.

To finance the debt and deficits look out for tax increases. 

With all the fiscal and monetary stimulus, any recovery could be fraught with inflationary pressures.

The "new" normal will be significantly different than whatever we had when we entered the 20's (all those roaring 20's New Years Eve party's that the millennials got up to might have been a bit of an omen).

In the "new" normal what will be the evolution of any party? dancing / contact? concerts? sporting events? Will we need to present our certificates of COVID-19 testing and vaccination?

Lots to speculate on, but certainly not anything that we might have expected as we began the year.

Time to manage our expectations about the future. Including our investments. I am cautiously optimistic that we will find our way, but don't fall in with the camp selling a quick bounce-back solution.

Nothing Like A Crisis To Help Reset Your Goals (or Get Them Started)

https://www.nytimes.com/interactive/2020/04/11/business/economy/coronavirus-us-economy-spending.html

Not sure if this really fits exactly, but in some way we are likely all having to endure the Five Stages Of Loss as we progress through the lock-down: loss of some income, perhaps, temporary loss of employment, hopefully not the loss of a loved one. Closer to my world, maybe loss by way of the decline in value of your investment portfolio and / or your net worth. The latter is what we classify as an "unrealized loss", i.e. if you don't need to sell and don't, that loss may, over a longer period of time resolve itself. However, it doesn't mean that, if you have looked at the value of your portfolio, you didn't experience that nausea and light-headedness that comes with a shock (especially back in late March as the markets hit bottom):

1) Denial : I am amazed by some of the other blogger / journalist / advice giver (and cheerleader) responses to the initial shock (and I have heard and read a lot). Likely because it is not their future that has just become a big blur (or maybe it is?). Not so much empathy and a heck of a lot of finger pointing at all the other influences (other than bad portfolio management choices prior to the coronavirus crash).

2) Anger: Certainly many of us have seen portfolio melt-down's in the past (2008-09), but when you are 11 years further on the path to your retirement and the folks that look after your money have not taken that into consideration (one size fits all?) and your portfolio is down 20% (fortunately not the experience for High Rock Private Clients with tailored portfolios), one might be permitted to be a wee bit frustrated with the lack of attention to your detail.

3) Bargaining (struggling to find meaning): who has not had that "why do I even bother" thought cross their minds? Or the other one: "I could have just stuck my money in a GIC". It is never easy to learn that our risk tolerance is not quite what we thought it might be when we see a 20% decline in our portfolios in a 2 week period. 

4) Depression: It can truly be emotionally exhausting and debilitating if you see your future vanishing before your eyes (even if it is not, really): "I guess I will just have to wait it out and hope for something better" type thinking. Clearly not a happy time. Many of us are filled with a certain paralysis (helplessness), not feeling up to doing anything to get some forward momentum.

5) Acceptance: Finally, perhaps with counselling and / or coaching, there comes some hope. If you have a plan, perhaps it becomes time to re-visit and adjust it (time horizons, risk tolerance and re-balancing). If you don't have a plan, maybe time to get on it.

First, set / adjust your (new) goals. Studies show that people who set goals accomplish more, achieve greater success and accumulate greater wealth than people who don't.

Goal setting is a job. It takes time and effort. For some, goal setting can be threatening. For me, I find it inspiring: I have a target to shoot for and can adjust my behaviours to align them with the things I need to do to get to my goals.

Always ask yourself: "is what I am doing right now moving me closer to or farther away from my goals?"

As my coach (Greg Wood at Sandler Training) implores me: set your goals out on a "life line" with key dates and accomplishments. At High Rock we set our financial goals out in a Wealth Forecast, which projects out to the (estimated) end of our time here on this planet and we follow them and monitor them and adjust strategy as is required. 

Certainly, given all that is happening now and the likelihood of a whole new "normal" in the future, there is no time like the present to get your goals and the strategy required adjusted to achieve them, in order.

Where do you want to be in 10 years? 20 years? 30 years? or more. 

"One final thought: Some people struggle with committing to their goals and writing them down because they fear failure or success, or they fear that their goals may change. Those feelings are normal, but they should not stop you from completing your lifestyle design. Just because you write it down today doesn't mean you can't change it tomorrow, should a better option come along or you change your mind. However, not having a plan is the surest path to failure." (Sandler Training)

Plan to succeed!

The Recession Has Begun

 The Recession Will End

As I have mentioned in numerous past blogs, historically recessions begin when the current unemployment rate (blue line above) breaks up through the 36 month moving average (red line above). So, no surprise to anyone (I hope), with last Friday's unemployment data (and more to come) the next recession has begun.

Perhaps have a read of David Rosenberg's article in the Financial Post : "Recovery Looms, But You will Have To Wait For It"

As you may well know, David and my High Rock business partner Paul worked together at Merrill Lynch. We subscribe to David's research. During the time when the stock market cheerleaders were getting shrill about the never-ending upside potential for stocks, David was warning us that behind the scenes, things just did not look that good because we were in the very late stages of the economic cycle (and that there were plenty of underlying issues that might come to the forefront should the economy get stressed).

And we did pay attention. David took lots of heat, but stood his ground. We did too.

Now we need to start looking forward.

"A recession has not been averted, but a potential disaster has been. Counterparties now know that there is an entity with deep pockets that will ensure payment to lenders, landlords and suppliers. Most businesses will be allowed to stay alive, which means there will be jobs waiting for workers who have been forced to stay at home because of the coronavirus. This policy response is just about as good and well-thought out as can be under the circumstances".

As we mentioned to our clients on our High Rock monthly video last week, this will not be a "V" shaped recovery. More likely a "U" shape or as David suggests a "W". But there will be a recovery, in time, as there has been through history. Everything economic is cyclical: cycles begin and end and begin again.

Determining the duration is going to be a little more difficult and will depend on many things:

1) First and foremost will be achieving the levels of confidence that will allow businesses and consumers to return to the economy and begin to invest and spend again.

2) Economic growth, profitability and earnings will follow, but it will take time (more than many want, hope for and think).

3) Don't count on stock buybacks to be a factor anytime soon.

4) Expect some dividends to be cut, especially for companies that take bailout money.

5) Balance sheet deleveraging will further constrain short-term growth.

6) As in 2011, some after-shocks mostly from corporate and government debt loads, will also reverberate through the global economy.

7) The retiring baby boom generation will not invest as aggressively as they may have in the past, in fact they will continue to be drawing down investments and savings. They will also have less to spend (with stocks down 25%) and more to be worried about (their health).

8) Shell-shocked Millennial's will become more conservative with their money and savings.

9) The political environment may shift significantly away from the current populism after its major failure to safekeep the health and well-being of the population. Capitalism may take a hit as things geo-political move leftward. 

10) To pay for the huge fiscal stimulus, expect corporate and personal taxes to rise to pay for it all.

We will get to the other side. Be patient however.