"Hope For The Best, Prepare For The Worst"

That was a classic line that my canoeing partner would shout to me as we entered the white water on our paddling adventure down the great Missinaibi River of Northern Ontario (eventually flowing into James Bay, via the mighty Moose River) in 1980. It has stuck with me throughout my career managing risk (which began shortly thereafter) and in life and other subsequent canoeing adventures .

Yesterday, Federal Reserve Chairman Powell suggested the same: "

A text from my former canoeing partner this morning: "Ha! Chair Powell is listening".

The news on the economic front is not good. If the normally optimistic (they always want to inject a vision of economic confidence) U.S. Federal Reserve is planning for the worst, I think that anybody who takes risk (whether on their own or with the help of a professional) in financial markets, to grow their investments, ought to heed these words. 

When I think of the word "Hope", it reminds me of all the possible outcomes that I wish I had control over, but don't, so I am reduced to hoping. So while the overly optimistic stock market cheerleaders are hoping that they will convince more unsuspecting buyers to throw caution to the wind and jump in to the feeding frenzy (FOMO and TINA) for which there is a named

From the

And for emphasis, the Q2 US GDP (-32.9%) announcement was released this morning. It is more than just "white water" turbulence, it is indeed a waterfall. Add to that, that 1.43 million Americans filed unemployment claims in the week ending July 25 and the Q3 GDP data are beginning to look pretty soft. Covid-19 is definitely impacting the outlook. 

Once again, with persistent unemployment, consumer's (which account for about 2/3 of U.S. economic growth and slightly less in Canada) will not be driving economic growth.

The unemployed cannot borrow (banks will not lend to them) at record low interest rates. So regardless of how investors perceive the Fed's ability to back-stop financial markets and /or economic growth, they cannot force lending to those who are not creditworthy (unemployed). When the period of mortgage deferrals ends (1 in 5 Canadians have been utilizing this), there may be some reckoning for overly indebted households, putting further pressure on banks and the housing market.

The current state of the stock market these days (currently decoupled from economic reality) is tending to be driven by the need for instant gratification (day trading / gambling), which could, as traders become more anxious about a lack of upside momentum (valuations are very stretched), bring about an exodus that may in turn bring about a return to reality and a focus on the medium term that the Fed has suggested is fraught with uncertainty.

For this, we shall be prepared.

Different and Better

Paul and I started our High Rock journey together with one very specific goal in mind: we wanted to create a unique wealth and investment management company that would give our clients a better experience than they would get with the larger more traditional investment advice operations.

1) Tailored portfolio management based on your specific end goals.

2) Fiduciary duty, with no conflicts of interest. 

We are not paid in commissions or by mutual fund trailer fees as a function of "gathering" assets (like most advisors). We earn a salary. If High Rock is successful (i.e. we do a good job for our clients) we can receive dividends based on our ownership of the company. 

We own the exact same investments as our clients (although the % allocation might be different, depending on our respective investment strategies).

3) Our fees are completely transparent (and tax deductible in your non-registered accounts).

As is often the case, I was chatting with a new prospective client the other day who, while trusting his former advisor to do the right thing, had uncovered the fact that there had been some serious "gouging" on fees and costs over the past several years. A shame because those costs, compounded over time can add up significantly.

The first High Rock blog that I ever penned way back in April of 2015 was about this very subject: What Are You Paying For Financial Advice?

 4) We manage risk first: all our investments have a certain level of risk and this risk is quantified (based on historical price movements over time, known in statistical circles as a standard deviation). Through this we can determine what risk any client portfolio is carrying and determine its vulnerability to a major downside move (like the one that we experienced last March) and adjust it accordingly, if necessary. We can also determine how our portfolios perform on a return per unit of risk taken measurement:

Over time, our client in the above chart has earned a return per unit of risk taken over the last 7 3/4 years better than any of the associated benchmarks. If you are not our client, has your advisor ever shown you your return per unit of risk taken? This is in fact different. And better!

As you all know, but may not necessarily get told, past performance is not a guarantee of future returns. However, at High Rock (as all of our existing clients know and recently experienced) we work darn hard to make sure that we do get the best possible risk-adjusted returns as we can.

5) Our custodian, Raymond James Correspondent Services, holds our client accounts (and the assets in them) and with that gives you all the protections that you would get at any major financial institution: Canadian Investor Protection Fund (CIPF)  

If you are not a client and would like to investigate further, let me know: scott@highrockcapital.ca

Our existing clients have been introducing us to some of their less than happy friends and family who have not had such good experiences with their investments of late.

We started out on this journey to make a difference. I and obviously our clients (who are sending us new introductions) think we have done a fine job of doing so!

Our Covid postponed 5th Anniversary event with special guest speaker and renowned economic and market strategist David Rosenberg will be now held as a Zoom meeting. Let me know if you would like to attend.

Money Is Cheap. Stocks Are Expensive.

As our friend David Rosenberg so succinctly put it in his morning commentary yesterday : "This is all momentum, speculation and liquidity. Fundamentals were thrown out months ago".

Meanwhile, the supply of money in the system (M2) has grown by about 25% since March:

What is an investor to do?

Beware the over-confident, upbeat advice to throw caution to the wind and jump in. Yes, a Covid-19 vaccine appears to be garnering front page headlines, offering us plenty of hope for the future, but read beyond the headlines and the experts are offering up all kinds of cautions about the early stages of trials.

Even if a vaccine is available in early 2021, there is plenty of fast flowing water tearing at the proverbial supports beneath that bridge:

1) The economy bounced back some in May and June from record lows, but unemployment remains rampant and Covid-19 new cases have been going in the wrong direction recently, which will no doubt have a not so hopeful impact on the economic recovery. Ask yourselves this: how comfortable are you dining indoors at a restaurant? Flying? Taking a cruise? Those who were employed in those industries are not coming back to work soon.

Conversing with retired clients yesterday: they are not travelling or dining out (unless it is out of doors and very Covid safe) and lo and behold, their bank accounts are growing. Savings are up. 

Perhaps see the Bloomberg article titled: At Least $1 Trillion is needed to avert U.S. Economic Disaster.

2) But what does it matter if the Fed keeps pumping money into the system? Well it matters when the momentum and speculator type buyers start to wonder when it might be best to cash in their chips (gamblers and day-traders), 'cause the cautious crowd won't (count me in) likely be buying it until they feel a better sense of value. Value matters over the long run. Earnings matter and earnings are a function of economic growth, which in turn is contingent on consumer and business confidence. An unemployed consumer is not going to be so confident. The supply of money in the system will not help the travel and hospitality industries (and retail shops) hiring plans if they are struggling to stay solvent (and how long can they hold out?).

3) The politics of an election year are going to be ramped-up as we head into November. With the sitting president trailing in the polls, expect some desperation moves to possibly un-nerve us cautious types. Looking "strong" on China relations seems to be the current focus of attention, distracting away from pandemic response and civil unrest that have not been kind to him in the polls and betting odds.

Perhaps read David Rosenberg's What Happens If The Democrats Sweep?

4) And finally, there is the debt question: Today's debt binge is tomorrows liability and that liability may put a serious choke-hold on economic growth in the future.

Caution does not sell like optimism and we all want to stay positive, but ask our retired clients who rely on their investment portfolios for their livelihood, they are thrilled with their portfolio performance so far this year.

What's Keeping You Up At Night?

I can certainly tell you one thing that keeps me up at night and that is the age old question: Am I doing the right thing for my clients? Because, if I am, then, generally, the world order (or at least that which I can control) is in good standing (pandemics, politics, economics and idiots / cov-idiots aside).

Every year a company called Capgemini Research Institute puts out a something called the World Wealth Report, which is basically a survey of the world's High Net Worth (HNW) folks and what it is that is most pressing to them and how Wealth Managers are responding to meet their needs.

Here is how they define High Net Worth (and what kind of returns those folks have been able to achieve. CAGR = Compound Annual Growth Rate):

Clearly, 2020 has (and they do address this in the report) added some interesting new dimensions to returns.

Interestingly, here is how they allocate their assets:

I am always intrigued by the "cash and cash equivalents" allocation because it is a constant conversation point with clients. For some it indicates to them that they are not fully invested. Fully invested can be strategic, but as we do remind our clients, if your total portfolio is growing at a CAGR of 6% (or any growth number for that matter), so is the cash  and cash equivalent component as a function of the total portfolio. Each allocation to a specific asset class adds to the strategic aspects of portfolio balance: fixed income provides cash flow (and at times some capital growth) which can be drawn on (for lifestyle needs) or re-invested; equity assets provide capital growth (and some dividend income) and cash and cash equivalents provide protection (defensively) because they add stability (especially in times of high volatility) and cash flow availability when other asset prices may be at points where selling them is not strategic or tactical.

Together, all these components and individual holdings work in conjunction (diversification and balance) to provide a strategic allocation and perhaps, at times offset (hedge) to create balance and risk control. Good portfolio managers understand how all these pieces fit into the portfolio puzzle and that is how risk is managed. Trying to analyze (and debate the efficiency) of each component transaction separately in a portfolio is destined to be a conversation in futility as re-balancing, i.e. buying and selling of various assets (an absolutely paramount part of portfolio management), becomes strategic and tactical too.

Another interesting aspect of the breakdown of High Net Worth assets is the diversification aspect. Notice that risk is mitigated by equity ownership being limited to approximately 30% (or slightly more or less). To me this indicates that there is less of a tendency to "gamble" by parking too much net worth in any higher risk situation. 

If we can make the assumption that most HNW folks do not need to gamble, then perhaps we can also assume that they are stewarding their wealth rather than trying to "get rich quick".

When I hear about and see the resurgence of "day-trading" it does make me pause and consider that it is likely not something that the HNW crowd is into. HNW folks strike me as those who might take a pass on a fad.

So if what keeps you up at night is wondering whether you are doing the right thing to build or preserve your wealth (meet your long term financial goals and objectives), perhaps take some lead from the HNW crowd, as they have obviously had some success in doing so.

Boom!

Certainly this was not unexpected, but the reality of seeing it explode puts the newly revised Canadian budget deficit ($343.2B) into a rather harsh perspective. Yes, this has mitigated economic devastation from the coronavirus pandemic and most agree that it was necessary (perhaps there might be debate on the degree, but we can let the political process sort that out).

What we as Canadian taxpayers need to understand is how we are all going to be paying for it in the future. It will not be pretty. It is guaranteed that your personal income taxes are not going down.

Strong economic growth that might normally drive government revenues is not going to be with us for years. That is going to cause a bit of a conundrum. An optimistic return to pre-2020 growth levels by the end of 2021 still puts the deficit at a whopping almost 50% of GDP all this with an unemployment rate of 7.8%. You have to wonder how these numbers all match up. There is no doubt that with unemployment at 7.8%, households will be stretched even more than they were at close to record levels before the crisis. 

The domestic economy will not be bouncing back in a hurry and from the looks of things globally, neither will the export economy.

So, how will the Canadian government gather revenues to manage the surging deficit?

Taxing the wealthy. Who are the wealthy? The owners of property. If there are revenues to be harvested (surely the middle class will already be under enormous financial strain and unable to contribute), they will come in the form of taxes on things that the wealthy own (or owned) and have made profit on. That would, my friends, be called capital gains. Currently capital gains are taxed at 50% (vs. income which is taxed at 100%). There should be no question that this rate of taxation which is lower to encourage risk-taking, will be now at risk.

If one of the major benefits to owning stocks is reduced and stocks are already trading at high valuations (already high risk in owning this asset class), that is going to further elevate the risk inherent in stock ownership.

My friends, if there is no net economic growth from 2019 to the end of 2021 (or perhaps longer), expecting returns from your investments to give you anything better is a fantasy. If they are to be taxed less favourably, that is going to be an added burden.

We all want growth in our portfolios, but we have to manage our expectations, certainly over the shorter term. The longer-term will allow a return to better economic conditions and real growth in the economy and investment portfolios, but in the interim be very, very careful about chasing mythical (unrealistic, overly optimistic) returns that are fraught with ever increasing levels of risk.

At High Rock, we always manage risk first. And by virtue of that, over the longer-term, we have out-performed all the comparative indexes on a return per unit of risk taken basis.

There are plenty of challenges ahead: economic, planning, investing. There will be difficult times. Make good choices. Manage your exposure to risk. Flatten your risk curve.