Double, Double Toil And Trouble

Fire Burn and Cauldron Bubble (with apologies to William Shakespeare).

Just in time for Halloween: The UBS Global Real Estate Bubble Index ranked Vancouver as #4 in the world.

https://www.agefi.com/uploads/media/UBS_Global_Real_Estate_Bubble_Index_Study.pdf

Almost simultaneously, Canada Mortgage and Housing Corporation (CMHC) issued a report warning that home prices are now outstripping fundamentals in 11 of 15 major markets and that four cities: Toronto, Regina, Winnipeg and Saskatoon, face serious headwinds because of high prices and a surge in the supply of new homes under construction.

https://www03.cmhc-schl.gc.ca/catalog/productDetail.cfm?lang=en&cat=192&itm=1&fr=1446209268142

And, the CNN Fear and Greed Index has jumped from "extreme" fear to greed in just one month.

http://money.cnn.com/data/fear-and-greed/

Low interest rates for long periods of time can push asset prices to very expensive levels.

Trick or Treat?

The Fed Remains Positive On The Economy

So, apparently, a December interest rate increase remains an option:

 In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

(more here)

http://www.federalreserve.gov/newsevents/press/monetary/20151028a.htm

Meanwhile the US Commerce Department announced the most recent data on 3rd quarter GDP which came in at an annualized 1.5% (vs. an expected 1.7%).

On a year over year basis, which smooths out the quarter to quarter volatility, this is a 2% rate of growth.

Hardly robust, but "moderate" according to the Fed.

Inflation readings continue to show below target readings, so the key data will be the impact on employment.

The first Q4 indication will come on November 6th's Employment Situation Report. While the data is often revised significantly, there will be a great deal of focus on it by financial markets as the Fed has stated that:

The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

Currently, it is expected that Non-Farm Payrolls grew at 177,000 in October. 

The debate will be if this actually represents "improvement".

Speculation at the moment is that anything better than 150,000 is "improvement".

In the interim, regardless of what the Fed does, global economic conditions are not improving, earnings are declining and expected to decline further.

Caution is warranted.

Who Is Buying Stocks and Why?

With almost 7 years of extraordinarily low interest rates, equity markets have enjoyed a long run-up in prices. 

Ever wondered who the big buyers are?

According to the table below (courtesy of BofA Merrill Lynch Global Research), It is corporations, buying back their own stock. Also known as "share buy-backs".

(click on the table to enlarge)

Instead of using cheap money on the back of easy monetary policy to increase capital expenditure spending on future growth, corporations (in aggregate) have been using it to push their share prices higher.

Back in 2009, when equity markets were hitting the bottom after the financial crisis, this may have been a good strategy because share prices were cheap.

However, in recent years, equity prices have increasingly become more expensive:

So why are corporations focused more on share price than future growth?

CEO's are incentivized to increase their share price. 

Shareholders are happy to see the prices rise, so they are not going to complain.

However, this is all done within the focus of the short-term, true share value is not being driven by growth. There is no long-term benefit to the corporation and for that matter no benefit to economic growth.

Those who question the ability of quantitative easing in the long run have a good argument. Economies cannot grow unless the businesses that support that economy invest in growth.

Share buy-backs are not an investment in growth.

This will not end well.

Prelude To The Fed's Decision

The US Federal Open Market Committee meets today and tomorrow and will announce any changes at 2pm on Wednesday.

The "Fed" wants to begin the normalization of interest rates, but for all intents and purposes they cannot.

The Fed's mandate: promoting maximum employment, stable prices and moderate long-term interest rates.

Earlier in the year, the Fed chose not to raise interest rates because Q1 economic growth suffered a significant slowing. While they put this off to "temporary" factors, their outlook for the 2nd half of 2015 was for improved economic circumstances and they anticipated at least 1 interest rate increase in 2015.

US Q2 economic growth came in at a much better than expected 3.9% annualized rate of growth. 

However, the headwinds from the global economic slowdown lead by developments in China and emerging markets and a strong $US have put US growth expectation's for Q3 to a much slower 1.7% rate of growth.

Last week the European Central Bank hinted at the potential for further "extraordinary" monetary policy measures in December and the following day the Peoples Bank of China cut deposit and lending rates as well as reduced reserve requirements. All of this is intended to counter the current state of the global economy.

The Bank of England, Bank of Japan and Bank of Canada have all held monetary policy steady, but acknowledged the risks of a slowing global economy.

Global debt levels are 3X what they were in 2008.

Bond Markets have discounted a "no Fed rate increases" scenario until 2016.  

Equity markets rallied last week on the back of the ECB and Bank of China news.

If the Fed were to increase rates tomorrow, volatility would skyrocket.

I don't think that is going to be something that the Fed wants to see. Basically, their hands are tied. So the probability of a rate increase tomorrow is low.

We will discuss this and other financial market and wealth management issues in more detail on our weekly webinar today.

The recorded version should be available at 5pm (or thereabouts) at

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

How Much Do I Need?

One of the most common questions that we get when we talk to clients about the current state of their wealth management plan is:

"How much money do I need to retire comfortably?"

As always, an excellent question, but dependent on so many things.

How we build a "Wealth Forecast" is contingent on a number of factors:

1) We need to understand our spending habits now and how these spending habits will translate into future spending .

2) There are plenty of reasons that spending habits can/will change in the future, so we might rationalize this away as an unkown variable, however if we want to live comfortably in the future, we need to understand what "comfortable" costs now.

3) Then we need to build in an assumption about the change of the cost of that comfortable lifestyle in the future. This is the "inflation factor".

4) We will be spending differently on a number of things as we retire: less on children and education (hopefully), more on some of the lifestyle goals that we had set out to achieve.

5) We will also have to plan for the possibility of unexpected costs.

Another important reason to get a handle on our current lifestyle costs is to be able to evaluate our savings potential.

Current after-tax income - current spending = savings.

Compounding is a powerful force as your current savings / investments generate annual returns and in turn become part of the growth process of your net worth.

Commonly known as the "Rule of 72" whereby your savings will double over a ten year period if you can achieve an average annual return of 7% (after fees and taxes).

If you can add annual savings to the equation, the growth curve will steepen with time.

If we extrapolate this curve out to 30 or 40 years, it will continue to steepen at a more dramatic pace.

For you younger folks, this can be extraordinary, if you can find the discipline to save.

Here is where the "forecasting" comes in to play:

You can estimate your savings to your proposed "retirement" date or the time when you wish to start drawing on your savings for your lifestyle needs and then determine your lifestyle spending needs from that point forward. From that, you can calculate how long your money will last.

If the forecast indicates that you will outlast your money (depending on your estimated length of life), you will need to make adjustments (save more / spend less).

If your money will outlast you, then you may have to do some estate planning.

We do a great deal of this forecasting and while it can never be "bang on" accurate, it certainly helps us to be able to make some of the important decisions and visualize the impact of those decisions.

We can create various scenarios to make comparisons.

If you plan to make a major purchase (house, condo, vacation home), it can show you how it will impact your net worth and retirement plan.

It can also help you determine when you can rely less on employment income and more on your savings for your lifestyle needs.

It allows you to get a glimpse into the future, monitor the progress and make adjustments when necessary.

It will show you how much you are going to need.

www.highrockcapital.ca

Central Bankers React To Weak Global Economy

Yesterday European Central Bank (ECB) president Mario Draghi stated in his post- meeting press-conference that:

"the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting, when the new Eurosystem staff macroeconomic projections will be available. The Governing Council is willing and able to act by using all the instruments available within its mandate if warranted in order to maintain an appropriate degree of monetary accommodation"

The equity and bond markets liked that. Possibly more cheap money to chase expensive assets with and scare the "bears" out of the market. 

This morning, to further entice the sceptics the Peoples Bank Of China (PBOC) cut its lending and deposit rates by 1/4% and lowered reserve requirements by 1/2%.

Friends, central banks do not take these actions in a strong and strengthening economy.

Low economic growth = low inflation = low interest rates.

Low interest rates = lower currency value (devaluation) = better exports.

However, lower currencies = stronger $US

And this hurts US economic growth.

Low economic growth = low earnings.

If, as is the case (on an aggregate basis), earnings are falling, 

true share value should, in fact, be doing the same.

The fact that cheap money is driving share prices higher is counter to the fundamentals.

When the cold water of reality is splashed on the faces of traders and investors, the elastic is going to snap back. Personally, I don't want to be holding that elastic when it happens, because it is going to hurt.

In the meantime, the happy buyers are falling over themselves to buy equities and we shall have to prepare ourselves to watch patiently from the sidelines for this to play itself out.

With more cheap money, also expect borrowing to increase and debt levels to rise further. 

To take a note from our weekly webinar that we recorded last Tuesday:

• In the 1980's, it took $4 of debt to get $1 of additional GDP.
• In the early 2000's, it took $10 of debt to get $1 of additional GDP.
• Now, it takes $20 of debt to get $1 of additional GDP.

Basically now, there are record amounts of debt that is working significantly less efficiently.

Economic growth is going to take a lot longer to return. That is why central bankers are lowering their expectations and further stimulating their economies.

Still Optimistic At The Bank Of Canada

From yesterdays press release:

"Global economic growth has been a little weaker than expected this year, but the dynamics pointing to a pickup in 2016 and 2017 remain largely intact."

more here:

http://static.bankofcanada.ca/uploads/pdf/fad-press-release-2015-10-21.pdf

However, if you keep reading... there are some potential issues that could become problematic:

Once again, pinning Canadian economic hopes on the US economy:

"In the United States, the economy is expected to continue growing at a solid pace with particular strength in private domestic demand, which is important for Canadian exports."

And the Canadian consumer:

"Household spending continues to underpin economic activity and is expected to grow at a moderate pace over the projection period."

But what is the consumer / houshold using to spend?

Record levels of debt. Global debt levels have increased 3 fold over the last year. Canadians are no exception. Oh and the new Canadian Government wants to now join the debt / deficit party.

Lemmings to the cliff?

 "Meanwhile, as financial vulnerabilities in the household sector continue to edge higher, risks to financial stability are evolving as expected."

OK folks, this basically says that risks to financial stability are increasing, but as expected? Do they have a strategy for what happens if this "risk" continues to "evolve" at possibibly unexpected levels?

Not so optimistic to me.

Meanwhile the tone being used at most other developed economy central banks is one of "concern" over low economic growth and low inflation brought on by developments in China and other emerging economies.

Not to sound overly alarmist, but central bankers in North America were apparently caught by surprise in 2008 too.

The US Federal Open Market Committee (The Fed) meets next Tuesday and Wednesday, let's see what they might have to say.

The Myth Of Needing To Be "Fully Invested"

As an advisor / portfolio manager we often end up in discussions with clients about holding "cash" (or cash equivalents) in a portfolio.

There are a few important reasons for this:

1) Cash Flow: 

a) depending on anyone's individual circumstances, cash may be needed for lifestyle needs and to avoid being "forced" to sell an asset at an inopportune time, cash is good to have for this purpose.

b) as savings are added to a portfolio, it is important not to be "fooled" into necessarily putting that money to work immediately, but to be patient for reasonable opportunities.

2) Strategy:

There are those who might debate the idea of trying to "time the market" and academic studies show, that over longer periods of time, market-timing (tactical) strategies (picking tops and bottoms for asset prices) under-perform.

However, there can also be good economic reasons for increasing the weighting of cash in a balanced and diversified portfolio.

Cash is an asset. It is a defensive asset.

When prices of growth assets are in decline (deflating), cash is an asset that will hold its value and provide a haven of safety, protecting our capital.

In a balanced portfolio, it will cushion the total decline of the combination of other declining assets.

When asset prices are expensive (an argument which we currently believe to be true), it is prudent to increase our cash weightings (even if it is temporary).

What would you rather have? 

A money market fund earning 1.0% (or perhaps a t-bill at .25%) or an index ETF that has fallen 5%? (just for a simple comparison).

Global debt levels have increased 3 fold over the past 10 years!

Goldman Sacks put the number at $50 trillion in a report released on October 12 called: 

"Welcome To The 3rd Wave Of The Financial Crisis"

This wave is characterised by rock-bottom commodities prices, stalling growth in China and other emerging-markets economies, and low global inflation, Goldman Sachs analysts led by Peter Oppenheimer said in a big-picture note.

This triple whammy has its roots in the response to the first two waves of crisis — the banking collapse and European sovereign-debt crisis — and it is all part of the so-called debt supercycle of the past few decades.

But with bond yields in real terms close to zero, and policy rates at historical lows, this extraordinary combination of events has raised concerns about the sustainability of the financial returns on a forward-looking basis, particularly if deflationary forces continue to develop.

If this is in fact the case, we think that it might be prudent to increase our weighting of cash.

It's Going To Be No Easy Task

Managing Canada in the context of the global economy is going to be a major challenge for the new government. The world is much changed since the last time that the Liberal's held power.

Canadians have come to enjoy one of the best standards of living in the world. While the net worth of the US "middle class" has been stuck over the last 10 years, the Canadian "middle class" has continued to move forward to catch up and ever so slightly surpass the US.

The domestic economy, however, is vulnerable to the high levels of household debt that has evolved with the record low interest rates and is in a precarious spot.

With global demand for Canadian commodities slipping as the global economy stalls and the Bank of Canada scratching its head as to what happens (and what monetary policy initiatives should follow) next, there is a great deal of uncertainty that "middle class" Canadians may not  be completely aware of.

What Canadians have done is vote for change, but they may not necessarily realize exactly how high the stakes are. At risk is our very decent standard of living, which, up until now has been on an upward trajectory.

The new Liberal government will not only have the challenge of protecting those gains, but also allowing the Canadian standard of living to continue its growth path.

Lots to discuss on our weekly webinar today!

We will be recording the "live" version at / or about 3pm today to allow for the 4pm start of the Blue Jays vs. Royals game 4.

The recorded version will be posted on our website shortly after.

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

We Are Blessed To Live In Canada

We should not take it for granted.

It is far from perfect and depending upon your perspective, it may never get there. Those who have become Canadians more recently (and especially those who have come from horrible circumstances) may have the greatest appreciation for our country.

We who have been here longer probably complain more.

Many try to rationalize away their right to vote, decrying the futility, but we all have the same ability to influence the outcome and we should make sure that we exercise that democratic right.

Politicians (both the party leaders and the constituent in my riding) and their goals may be questionable and objectionable and sometimes the choices are limited, but we should not let this dissuade us from voting, even if it is the best of bad choices.

I have a simple formula for making my choice:

I list my priorities, in order, then try to find which party platforms best suit those priorities.

My family's well-being (and future well-being) is always at the top of the list and there are many sub-priorities that fall under this heading, both long-term and short-term in nature.

I would never assume to try and influence anybody's personal choices.

It is arrogance in the highest form to try and impose my beliefs on anybody else.

It is weakness in the highest form to let others influence your beliefs.

We all owe it to ourselves to make our own decisions based on what our priorities are.

As a country or as a community, we have all obliged ourselves to co-exist within the context of what the majority wants, but if we collectively decide that they no longer (or never did) share our interests, then we also have the ability to vote for change.

Is it time for change?

I can't tell you that. 

Decide for yourselves.

But exercise your right to vote for the person or party that you think will take our beloved country in the direction that suits you best.

and..... GO GO BLUE JAYS!

Trust

We had a nice gathering of clients and friends last evening to celebrate the successful launch of our High Rock Capital Management Private Client Division. 

It was a great chance to chat with clients who had been working with me for years and some who were brand new.

We had some lovely wine tasting provided by Chris Mclean of Rogers and Company, the "Ferrari" of wine importers and distributors in the Toronto area (with special thanks to Dan Cook who set that up for us). Chris gave us some great discussion on the geographical, geological and ultimately the flavourful reasoning for his selections. 

Emerging Canadian artist Donna Chudnow kindly added plenty of colour to the evening with a wonderful display of a great cross-section of her work. 

One of our sponsored athletes, Miranda Tomenson, was also on hand to talk about her journey from being 23rd (and 3rd Canadian) woman to cross the finish line in the 2013, 1/2 Ironman World Championship, through an almost career ending knee injury in 2014 and back to world-class status for the 2016 season and her dream of competing at the Ironman World Championships (and finishing in the top 10) in Hawaii in 2018.

The Blue Jays were at the top of most conversations and the exciting time that it had become for the city of Toronto and Canada as a whole.

One of our more shrewd clients made a call to purchase playoff tickets well before the Blue Jays clinched and they were on hand to share their stories of Wednesday's game 5, emotionally charged, victory.

The mood in the room was positive and this in light of some financial markets that had been less so. In fact we had just finished sending out client 3rd quarter reports and in the words of one client: "Breaking even never looked so good!".

But with almost everyone I chatted with over the course of the evening, there was one underlying theme: Trust.

"We Trust you".

That is one very heavy responsibility, but one we accept and absolutely respect.

As I once read: Trust takes a long time to earn, seconds to break and an eternity to repair.

We take that very seriously.

So thanks to all of our clients for joining us last evening to celebrate, share your thoughts, your feedback and your trust.

http://www.highrockcapital.ca/about-high-rock.html

Exciting Times For Toronto Blue Jays Fans

Boom! Jose's home run drives the Blue Jays to Kansas City for the ALCS.

Not so exciting times for the US Economy however, as it appears that slower than expected September retail sales and lower than expected inflation reports further indicate that the US is importing the global economic slowdown.

It was hoped that the US economy would lead the global economy through the 3rd and 4th quarters of 2015, but this hope appears to be fading. 

Chinese and emerging economy weakness inclusive of currency weakness and US$ strength is exporting deflationary pressures into the US economy.

China is also at the heart of a commodities downturn that’s further weakening prices around the world. The slowdown in the No. 2 economy is colliding with increased supply resulting from efforts in the past decade by global mining and energy companies to boost production to meet what had seemed to be insatiable demand.

     Meantime, China’s investment binge since the 2008 crisis has created overcapacity in capital-intensive sectors from cars to commercial buildings. And its August decision to let the yuan depreciate means less demand for foreign products and even cheaper shipments abroad if further currency weakness ensues.

This is making the US Federal Reserve's decision on beginning the normalization of interest rates even more difficult.

Meanwhile, Industrial production in the Eurozone rose only 0.9% year over year in August, slowing from a downwardly revised 1.7% in the previous month.

3rd Quarter earnings reports are front and centre over the next month and expectations remain negative for both this earnings season and for the 4th Quarter as well.

Based on the slowing economic growth and negative earnings, we just can't get excited about the outlook for equity markets.

So for a much more positive experience for the next few weeks, stick with cheering on the Blue Jays!!

Live From Washington DC:

(that's me at the US Federal Reserve! Notice how it is not crawling with tourists!)

I am surrounded by economists and central bankers this (Canadian Thanksgiving) weekend in Washington as it is the 57th annual meeting of The National Association of Business Economists where the Theme is "North America's Place In A Changing World Economy", exploring the "tectonic forces" shaping the world economy: demographic shifts, political change, technological advances, deeper trade linkages and environmental stress which are pressing businesses to rapidly evolve and stressing governments, all in the context of a sub par recovery from the Great Recession. I am joined here in Washington by none other than Bank Of Canada Governor Stephen Poloz who will be addressing the conference today.

He comes to Washington from Lima, Peru where he addressed a meeting of the Institute of International Finance:  saying that "financial stability issues add a new dimension of risk to the many uncertainties that are already present in the conduct of monetary policy".

more here:

http://www.bankofcanada.ca/2015/10/integrating-financial-stability-into-monetary-policy-10102015/

"the reality is that central banks have to cope with tremendous uncertainty regarding financial stability issues"

Repeat: tremendous uncertainty!

So the institutions that we are counting on to lead us out of the "wilderness" are facing tremendous uncertainty.

Financial market participants are buying equities and commodities in joyous rapture over the last week while central bankers are questioning the very basis of monetary policy and how it is to be implemented with maximum efficiency (which they really have not figured out yet).

At the same meeting in Peru, US Federal Reserve Vice Chairman Stanley Fischer reiterated the Fed's desire to begin to raise interest rates, but added an interesting caveat: 

"However, that is an expectation, not a commitment. Both the timing of the first rate increase and any subsequent adjustments to the federal funds rate target will depend critically on future developments in the economy. "

"For example, it is conceivable that inflation may rise more slowly or rapidly than we currently anticipate. Should such developments occur, we would adjust the stance of policy in response".

In other words, they are just not sure.

Meanwhile 3rd and 4th quarter earnings expectations continue to be adjusted downward now anticipating negative earnings growth for Q4.

Tune in for a more detailed discussion of these and other investing and wealth management issues on our weekly webinar tomorrow.

We should have a recorded version available on our website by approx. 5pm

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

Let's go Blue Jays!!

Taking A Longer-Term Perspective

Back at the beginning of the year I laid out a few themes for readers and at High Rock we Incorporated those themes into our weekly webinar when we began that series in April.

I have never been one to fall into the trap of economic and market predictions because I know that when you look back at the record of most economists and portfolio managers, there are few who get it right.

Hence the theme to "Expect The Unexpected", because in all likelihood those who make those calls are going to be wrong.

 On Tuesday the International Monetary Fund (and there is no shortage of really smart folks in their ranks) lowered there expectations for the global economy (which means that their original estimates were wrong).

click on this table to enlarge it and if you want more info go to:

http://www.imf.org/external/pubs/ft/survey/so/2015/RES100615A.htm 

The point being, that no matter how smart the experts are (or think they are), there are a great deal of forces at work in the global economy beyond the scope of the economic models.

One thing that we do know however, is that the science of human behaviour is significantly altering the economic landscape.

There has been an enormous shift in the mentality of consumers, producers and investors as they have learned to deal with the repercussions of the 2008 financial crisis and "great" recession.

In fact, it may be more of a result of what happened as information technology took hold at the turn of the century. 

There is a growing sense of immediacy, a general impatience where results have to be achieved in a significantly shorter time horizon.

So short-term outcomes take priority over long-term objectives.

Investors monitor their portfolios daily, CEO's need to get their share prices higher to hold off the shareholder activists and capital moves from one asset to another in search of quick profits.

No wonder there is so much uncertainty in the global economy.

Uncertainty forces decision makers to hold off on making economic decisions: consumers don't consume, producers don't produce, economic growth slows.

Central banks don't like the uncertainty and because they are limited in their ability to affect global economic development to monetary stimulus programs that may or may not be effective if that additional money is not put to work in the economy (but used for share buy-backs to fuel upward share price movement). Then they become reduced to making positive commentary ("cheerleading") to inspire the economic decision makers to get off of the fence.

The US Federal Reserve has been talking about a stronger US economy in the 2nd half of the year, but recent economic data shows that it is not happening according to their outlook. If the latest IMF forecast is worth its salt, the uncertainties are getting bigger not lessening.

Inflation will return when economic growth drives commodity prices higher. 

Economic growth will return when investors start to take a longer-term perspective.

Until then, low economic growth, low commodity prices, low inflation, low interest rates and low earnings mean low investment returns.