What's Working So Far This Year?

Defence!

January was a difficult month for financial markets and despite some technical buying on Friday (short-covering on the back of the Bank Of Japan's move to negative interest rates), the All Country World (equity) Index (ACWI) was down about 5%.

The Canadian Bond Index was basically flat over the month, which leaves the Benchmark 60% equity (ACWI) and 40% fixed income (XBB) portfolio with a negative return of - 3%.

Depending on the model structure, a High Rock portfolio of similar composition was down -1 to -1.5%. Nobody likes a loss, at anytime, but we have worked tirelessly to find solutions to mitigate the volatility: overweight cash and a little overweight Canadian equities (TSX was down a little less than 1.5% in January) and underweight US equities (S&P 500 was down a little more than 5% in January).

We are also a little over-weight in Government of Canada bonds (relative to Investment Grade, Corporate bonds).

A more conservative mix benchmark of 40% equity (ACWI) and 60% fixed income (XBB), had a negative return of about -2%.

Depending on the model structure, a High Rock portfolio of similar composition was basically flat (no growth, but no loss). 

We (at High Rock) have taken a defensive stance since April of last year and those of you who know me from my former gig, also know me as a more conservative investor, fearful of over-valued assets and mindful and patient to wait for market corrections to purchase assets at better values (and that it can take a long time to build a solid portfolio).

If you take the goalie out of the net, you are vulnerable! (yes that is me in the photo at the top, in the 2009 Baycrest Proam fundraiser for Alzheimer's research) I live, breathe and play defence (goal)!

Here is what one thankful client wrote (after having seen the plunge in equity markets):

Thanks so much, Scott.  I feel better now.  I am so glad that you are handling my money.  I really do not know much, at all, about the best way to handle my money. 

If you would like to receive this bog directly to your in-box, please email:

bianca@highrockcapital.ca

also...

Tuesday is webinar day at Hgih Rock, at 4:15 we will hold a live call for our clients and post the recorded version on our website at:

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

We will discuss current economic events, our thoughts on those and their implications for financial markets and our portfolio models.

Re-visiting The Themes For 2016

We are coming to the end of January (already?), so lets take a look at our themes for 2016 and see what has happened or changed so far:

1) Volatility and Uncertainty (no change)

• I probably don't need to dwell on this, but volatility is up and will remain so until we get a better handle on the global economic picture and all the various influences on it (and there are many).

2) The US Economy (soft and getting softer)

• The domestic economy continues (for the time being) to carry the whole economy.
• Labour markets improved throughout 2015.
• Consumers (70% of the US economy) remain confident, although that does not appear to be being translated to retail spending:

• Consumers are saving, not spending.
• The strong $US and the weak global economy, especially in China and emerging economies has been negatively impacting the export economy and manufacturing data continue to be soft.
• Looking backward, Q4 2015 GDP is not expected to be anywhere close to what was expected in early 2015.
• Official data on this will be released tomorrow.

• Looking forward:

3) Commodity Prices (more uncertainty):

• There is serious concern over the massive debt that has been amassed as interest rates have remained low for such a long period of time (especially in the energy sector) and that low oil prices will make servicing that debt extremely difficult as it is expected that supply and demand factors will continue to put downward pressure on them.
• This situation not only impacts North American producers but Emerging economies who have built their economies around oil and do not have the monetary reserves to sustain their debt levels, hence a greater potential for default.

• It has been suggested that this scenario could possibly drag the US economy into recession, but one of the sharpest of economic thinkers, Mohamed El-Erian only puts this at a 30% probability.

4) Diverging Monetary Policies (even more uncertainty):

• The US Federal Reserve raised rates in December and are expected to do so again in March (tightening monetary policy), still promoting a rather optimistic view. However, yesterday's meeting and policy statement revealed concern over the global situation.
• Meanwhile in Europe, Japan and China there are expectations of further easing of monetary policy.
• Obviously, this creates uncertainty as to who has the greatest understanding of current economic conditions and that uncertainty transcends into financial markets:
• Liquidity dries up and volatility rises.

5) Geo-political concerns (rather quiet on the headlines at the moment, but lurking):

• Middle East
• Russia
• UK exit from the European Union
• Greece
• North Korea
• Global terrorism
• US political gridlock (Donald Trump ?)

6) Bond Markets:

• Yield curves are flattening: investors / traders are selling expensive risky assets and buying safe government bonds.

7) Equity Markets Remain Expensive

• Earnings growth is declining: 

• 10 year average price to earnings ratio at 14.2 times remains below the current 12 month forward expectation of 14.9 times, although well below the peak near 17 times.
• There is better value now, but economic uncertainty may continue to put earnings growth at risk.
• Investors are (finally) becoming uncomfortable with over-valued assets.

8) We Are In A Low Return Environment

• Equity markets are down by about 8% so far this year.
• Bond markets are up slightly.
• After 6 years of above average growth we must now endure below average growth that will bring us back to average growth.
• This may last well into 2016 and possibly into 2017.
• Overweight cash as a defensive asset remains prudent, but there will come a time when that cash can be put to work and we will remain vigilant for that time.

Stay tuned!

If you would like to recieve this email directly to your inbox, please email:

bianca@highrockcapital.ca

Mind Boggling!

When a new client transfers their exisitng portfolio into our care, it never ceases to amaze me what I will find.

We might live in Canada, but Canada represents only about 3-4% of world capital markets. Having a 5-10% weighting in Canadian equities might be acceptable. But a 50% plus weighting? That is not a properly diversified portfolio and "yikes!" to have to endure a year like 2015 where Canadian equity assets were one of the worst performers.

I will not even begin to list the junior oil and gas and mining stuff that the former advisor stuffed in there likely to capture some "new issue" commissions.

Only 15% fixed income assets and less than 5% in government bonds? That is not balance my friends. In times of high levels of volatility, this is a portfolio that is going on the wild ride.

DSC (deferred sales charge) mutual funds. Advisor gets 5% up front (no cost to the client, yet) and an MER (management expense ratio) of 2.5% (advisor gets a trailer of .5%). The conflict of interest here is extraordinary! I cannot believe that these still exist. Oh and if you want to get out of them before the 7 year penalty period...this is where it "costs" the client.

This was not a portfolio put together by someone who truly cared about the client.

Broad diversification, balance among asset classes in a fee based account with a full understanding of any third party management costs and respect for your long-term goals and objectives is the sign of an advisor who cares.

Ask yourself, does your advisor really care?

What has she / he done for you lately?

If you would like to receive this blog directly to your inbox, please email 

bianca@highrockcapital.ca

A Client Writes:

Last week High Rock Capital Management sent its quarterly reports out to clients.

And, as we always ask for, received feedback:

"Good work and good calls. Only place I did not get slaughtered..."

Balance, diversity, an underweighting of equities, fewer preferred shares and an overweighting of cash (as we have preached since last May) has been beneficial for portfolios.

Today is webinar Tuesday and as we do each week, we will talk about all the pertinent financial news, our views and address how we see the global economy impacting financial markets and our model portfolios for our clients.

Feel free to tune in to the recorded version at

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

which should be posted at or about 5pm EDT.

Oversold Financial Markets Are Settling, 

Now What?

As the major focus has been on oil prices and specifically the impact of  the new supply as Iran comes on stream, short-term traders (computer generated and not) have pushed volatility levels on financial markets higher playing on the fear of investors. Interestingly, not enough panic (or capitulation) yet to drive volatility to last August's levels.

After the Bank Of Canada's "wait and see" approach was revealed on Wednesday, yesterday, The European Central Bank suggested more Quantitative Easing for March and traders decided to use that as the catalyst to buy in short positions.

Oil is higher about 12.5% off of its lows, the Canadian dollar is back above $0.70 US and as it stands at the moment, the S&P 500 is approximately 4.5% off of its lows.

  The Bank of Canada remains rather optimistic about the second half of 2016  (they were rather optimistic about the second half of 2015 at this time last year) but their track record has not been stellar. They keep pointing south and hoping that the optimism of the US Federal Reserve will play itself out.

While all this is going on, behind the scenes, the US jobless claims numbers are creeping higher:

Historically, declining jobless claims have been correlated with rising stock prices, but now that jobless claims are rising?

This is also data that may make the Fed less optimistic about the US economy in 2016.

Clearly, lower equity prices have brought them closer to being of better value based on projected earnings, the 10 year price to earnings ratio average for the S&P 500 is 14.2 times. When the market settles this week, the 12 month forward projected price to earnings ratio is going to be quite close to that number.

So is it time to buy yet (to get some of that better value)?

Perhaps. 

However with the global economic situation showing no signs of pulling out of the current malaise (IMF earlier this week lowered global growth targets and so also did the Bank of Canada) and the US economy seemingly unable to provide the impetus and under-performing on many levels, there could be further reductions to forecasted earnings, so it is likely prudent to remain cautious.

And so we shall.

Stay tuned.

If you would like to receive this blog directly to your email, please email:

bianca@highrockcapital.ca

The International Monetary Fund (IMF) Cut Its World Growth Outlook

The global economy will expand 3.4% this year, down from a projected 3.6% in October. Growth for 2017 has been revised to 3.6% from 3.8%.

According to the report: There are important risks to the outlook, which are particularly prominent for emerging market and developing economies and could stall global recovery.

These risks relate mostly to the ongoing adjustments of the global economy, namely China’s rebalancing, lower commodity prices, and the prospects for the progressive increase in interest rates in the United States. They include the following possibilities:

• A sharper-than-expected slowdown in China, which could bring more international spillovers through trade, commodity prices, and waning confidence.

• A further appreciation of the dollar and tighter global financing conditions which could raise vulnerabilities in emerging markets, possibly creating adverse effects on corporate balance sheets and raising funding challenges for those with high dollar exposures.

• A sudden bout of global risk aversion, regardless of the trigger, could lead to sharp further depreciations and possible financial strains in vulnerable emerging market economies.

• An escalation of ongoing geopolitical tensions in a number of regions, which could affect confidence and disrupt global trade, financial flows, and tourism. New economic or political shocks in countries currently in economic distress which could also derail the projected pickup in activity.

Commodity markets pose two-sided risks. On the downside, further declines in commodity prices would worsen the outlook for already-fragile commodity producers, and widening yields on energy sector debt threaten a broader tightening of credit conditions.

On the upside, the recent decline in oil prices may provide a stronger boost to demand in oil importers, including through consumers’ possible perception that prices will remain lower for longer.

“All in all, there is a lot of uncertainty out there, and I think that contributes to the volatility,” said IMF chief economist Obstfeld. “We may be in for a bumpy ride this year, especially in the emerging and developing world,” he said.

More on this and plenty of other things to discuss today on our weekly webinar.

We will post the recorded version at or about 5pm (EDT) on our website:

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

So feel free to tune in!!

A Reader Question: When Will Equities No Longer Be Expensive?

An excellent question, not an easy answer.

I /we have been trying to tell anyone who would listen for some time now (especially last April, May, June, July... December) that low interest rates had given investors a sense of complacency. Many said: even if the Fed raises rates, what is a quarter of one percent?

What we always stressed were the underlying fundamentals: prices of shares were not representative of earnings (or company value) and that as long as companies preferred to buy back there own shares, they were not investing in long-term earnings growth, they were pushing the price of their shares higher to satisfy investors / shareholders.

Investors are very happy when share prices go up, but when they start to go down, not so much and they lose patience quickly.

So, to get to the question at hand:

The simple answer is: either when earnings start to rise or when prices come down to a more reasonable level (or a combination of both).

Lately analysts have been continuing to lower their earnings estimates, but if all goes as expected we will likely see a 3rd quarter of declining earnings growth because revenue growth has been on the decline for all of 2015.

In picture format, when the green dotted line (prices) reaches the blue solid line (earnings), that would be neutral. As the green dotted line as been above the blue line since 2013, equity prices have remained expensive over that period. At the time, many told us that it was justified and that earnings would catch up as the economy picked up and resisted the idea of caution. Some of those were at the same time, rather vocal about the overvalued housing market. In my former job I was out-voted on my caution. So I got a new job (where I own half the company) where my caution was appreciated and where our (my business partner, Paul and my) money is invested in the same models as our clients.

The ratio of share prices to expected earnings (over the next 12 months) reached a peak of a little over 17 times in May of 2015. Very expensive, but has fallen recently as equity prices have fallen to closer to 15. At the moment, the 10 year average is near 14. So based on that metric, we have still some room to the downside. Back in 2011, the green dotted line was actually below the blue solid line and equity prices were cheap.

So, it is possible to see prices fall to levels where equities will be cheap if the economy does not grow enough to allow revenues and earnings to grow and investors lose confidence.

Certainly corporations are going to have to do a better job of thinking and acting to facilitate long-term growth to re-establish investor confidence. Share buy-backs using low cost funding (borrowing at low interest rates) is now going to add risk to those who lent them the money for those share buy-backs (and that could possibly exacerbate the situation).

We (investors / traders) have become an impatient bunch, always looking to make money fast and looking for instant gratification. When the short-term runs out, we become frightened at how volatile things become.

So, the answer to the question, ultimately, is: when we finally grasp the understanding that it takes time to build a solid economy and regain true confidence, that is when stock prices will achieve levels of reasonable relative value and volatility will subside.

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bianca@highrockcapital.ca

I Didn't Write This

But my business partner, Paul Tepsich did and I think it is worth repeating....

http://highrockcapital.ca/pauls-blog.html

Our lead theme for 2016 was volatility... and we got it good.

More tomorrow!

S&P 500 Testing Key Support

More selling as lots of "talking heads" hit the airwaves with negative prognostications. Of course this means that they have already established their short positions and now are happy to talk to the emotions of regular investors.

On the S&P 500 Daily chart, the short-term technical picture is pretty clear: the range from last August's lows is being tested. If it holds there may be some short-term buying support that enters the market, if it does not, then we will be into the next phase of the down-trend which will likely bring in further selling.

This could take us back to test the 1750-1800 level which marks the up-trend established in 2009.

Stay tuned!

If you would be interested in having this blog sent directly to your email inbox, please email 

bianca@highrockcapital.ca

Webinar Tuesday

Busy day of webinar prep today, feel free to tune in to the recorded version after 5pm:

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

or for your reading pleasure check out the High Rock "Market Views for 2016" on our website at

http://www.highrockcapital.ca/market-views.html

2nd Opinion?

I received a referral last week for an investor who wanted a second opinion on her current portfolio. She stressed that she was quite comfortable with her current advisor but wanted to double check to make sure that her asset allocation was appropriate and that she was not paying too much in fees. 

Her current advisor likes to use managed mutual funds.

Of course I said that I would be happy to help (because I really enjoy this part of my work: helping folks figure out how to maximize their returns, limit their risk and keep their costs low). However, I said that in order to do a proper assessment of her current situation, it would be important for me to have a greater understanding of what she was trying to accomplish with her investments and how that merged with her current financial situation.

So we have sent her a Wealth Forecast questionnaire which helps us to get a greater understanding of her current financial status. With that information and an understanding of what her goals and objectives are (as well as her tolerance for risk), we will create a forecast that will help us determine what her appropriate investment strategy (asset allocation) will be. When we review her current portfolio, we will have the appropriate information to determine if our proposed asset allocation aligns with what she currently has.

The Wealth Forecast (prepared by our Certified Financial Planner Professional) also will help her get a sense of how time and compounding will grow her wealth and what she can expect her retirement to look like and help determine if their might be a need for further estate planning. We look at the forecast as a "working model" that allows us to make adjustments as changes occur in a person (or family's) circumstances and allows us to determine if changes need to be made in their portfolio strategy.

In other words, to give her a proper second opinion, we need to have a good deal more information. This can require a little more effort on her part, but I said that there is no obligation to continue to work with us unless over the course of the assessment, we prove to be worthy of her business (our fees equal the satisfaction of having confidence in our service offering which might prove to be a better deal for her). 

I thought it would be interesting to follow the process and progress of our analysis on this blog and report back on the results. (Of course, we will, as always, give our prospective client complete confidentiality).

So stay tuned!

(if you would like to receive this blog directly to your email, please contact bianca@highrockcapital.ca)

Strong Employment Data Creates More Uncertainty

The headline employment numbers looked pretty good for both the US and Canadian economies for December:

US non-farm payrolls jumped 292,000, well above the expected 200,000. The gain was led by professional and business services (+73,000) which is considered a leading component for future hiring. As well, there were upward revisions of 50,000 to previous months. Unemployment remained at 5.0% as the labour force participation rate moved off of its lows to 62.6% (from 62.5%).

Uncertainty comes with the lack of inflation seen in wage growth which was unchanged in December (expected to be higher by .2%)

So as we try to determine how this will influence future US Federal Reserve interest rate policy (which has a dual mandate to facilitate maximum employment and price stability), it raises the question as to when will inflation (which remains well below the Fed's and other central bank targets) begin to turn higher?

The US Federal Reserve governors have suggested that inflation will eventually return to target levels (although there is little sign of this at the moment) and they also see the likelihood of 4 interest rate increases through 2016. 

Other central banks want to keep their monetary policies stimulative, the US Fed wants to reduce stimulus.

We financial market participants have coined the term for this as "Diverging Monetary Policies" (see my blog from Wednesday of this week for the Themes for 2016 http://www.highrockcapital.ca/scotts-blog.html). 

As the US Fed raises interest rates, they will drain liquidity from the monetary system. This will only add to the potential for greater volatility in asset prices (and 2016 has only just begun!). 

So a stronger economy is not necessarily an antidote for the equity markets. You don't buy an economy, you buy assets.

If asset prices are under duress (volatility) then you are less likely to be comfortable buying those assets. Investors may postpone asset purchases in this case and buying support may not contain market prices until they get to more attractive and more comfortable levels. If owners of assets perceive that prices in the future are likely to go lower, then they may be more inclined to sell in the near term. 

Simple economics: more sellers than buyers means prices are heading lower.

Volatility creates uncertainty and uncertainty creates volatility.

Volatility is on the rise and until there is more certainty and comfort, volatility will continue.

(if you would like to receive this blog directly to your email, please contact bianca@highrockcapital.ca)

Good Morning Volatility!

(With apologies to the late Robin Williams!)

Buyers of over-priced equity markets have taken an extended vacation in the New Year (so far) as this morning finds plenty more sellers than buyers in the overnight session.

The Shanghai Composite is lower by 7%.

The S&P 500 is expected to open over 40 points lower than where it closed last evening.

After failing to make new highs in the August to November up-move and not getting the much hoped for "Santa Clause" rally into year end, traders are less positive as we start the new year.

Selling pressure will now look to test buying support at lower levels: key support on the daily chart comes at just below the 1900 level which links the lows of October 2014  and the lows of August / September 2015. If this support does not hold, longer term investors (who have been enticed into the market by low interest rates, chasing over-priced equity market returns) will likely start to lose hope and more selling may enter the market.

On the weekly chart, the trend line back to the beginning of  the long-term trend in 2009 would be the next support at 1750.

From the peak in May at 2135 to support at 1890, the correction would be about 11.5%. At 1750, the correction would be about 18%.

We have, for a long while, been recommending a more prudent and defensive strategy (which we have been utilizing in our portfolios): over-weight cash, for better buying opportunities.

Stay tuned!

(if you would like to receive this blog directly to your email, please contact bianca@highrockcapital.ca)

Themes For 2016

On yesterdays High Rock weekly webinar  (http://www.highrockcapital.ca/current-edition-of-the-weekly-webinar.html)

we announced our key themes for 2016. I thought I might share those with you today:

1) Volatility will continue to create uncertainty

or 

Uncertainty will continue to create volatility.

However one wishes to look at it, uncertainty about what to expect in the future forces decision makers to postpone economic decisions and that negatively impacts economic growth.

2) Can the US Economy Survive The Global Economy (and China)?

Is the Federal Reserve's optimistic outlook on the US economy and its expectations of raising interest rates possibly 4 times through 2016 realistic? Recent data certainly suggest that the final quarter of 2015 will come in well below initial forecasts based on continuing slow growth in the manufacturing sector.

Will the slowing of the global economy be an anchor that drags the domestic economy down? China will be the wild card. Thus far the US consumer's buying of automobiles (financed at low interest rates) and dining out at restaurants has been fueling domestic economic growth, but can this continue, especially if US interest rates rise further?

3) Commodity Prices

Inflation targets are the mandate of all central banks, and commodity prices have been driving inflation down and therefore forcing the hands of central banks to be more stimulative (other than the US Federal Reserve). Will supply continue to outweigh demand to keep prices low? Cyclical economic history suggests that supply will adjust to lower demand and that eventually, demand will pick up to outweigh supply when the economic growth starts to pick up. Is this part of the 2016 scenario? At the moment, it is hard to see this, but as 2016 progresses, it may in fact become more of a realistic expectation.

4) Central Bank Monetary Policy Divergence

Back to the US Federal reserves plans to raise rates, possibly 4 times in 2016 while other central banks are more inclined to continue stimulative monetary policies. This only adds to the uncertainty, so circle back to number 1.

5) Geo-political Tensions

It appears that these are on the rise: not only terrorism raising its ugly head, but also escalation of Middle East issues and the concerns as to whether the UK will exit the European Union and whether Greece will survive in the Euro. Add North Korea to the list with its apparent successful test of a Hydrogen Bomb earlier today. More uncertainty.

6) Bond Markets Will Lead Other Financial Markets

Nothing new here: Bond markets are bigger and smarter than most other financial markets: High Yield bonds turned lower early last year, equity markets followed in August. Government bond markets got volatile in July, equity markets followed in August. So keep a close eye on the bond markets for further clues.

7) Equity Markets Remain Expensive

If you follow this blog regularly, this will be no surprise (at least I am consistent).

We follow a number of metrics that give us clues to the value of equities (fundamental) and what is influencing short-term trading (technical). Low interest rates have forced investors into equity markets driving prices to unrealistic levels. We are off of the highs from last May, but still have some correcting to do before we get close to more realistic value levels.

8) We Will Continue To Be In A Low Return Environment

...Until economic growth improves, corporate revenues and earnings growth improves, inflation rises and interest rates rise.

Adjust your expectations accordingly.

Happy New Year!!

I have had a couple of weeks to compile a whole list of pertinent topics as I monitored all the end of 2015, beginning of 2016 media output.

Bloomberg suggested that 2015 was "the year that nothing worked".

The All Country World Index (the equity index which we benchmark ourselves against) total return (inclusive of dividends paid by constituent companies) dropped by approximately 2%.

The Canadian Bond Index (fixed income bench mark) total return (including interest paid / accrued) added approximately 3.25%.

Therefore the benchmark for a fully invested portfolio of 60% equity, 40% fixed income, (not adjusted for currency) would have had pretty much no growth at all. If you were able to get anything in the plus column (total portfolio return before fees), then you were ahead of the benchmark. 

If you are (for example) a paying 1% fee (don't forget to include hidden third party management fees in your own cost evaluation), then you would have to have had at least a 1% positive return in order to have a break even year.

If your portfolio was skewed to a greater degree of fixed income, perhaps 60%, then the benchmark would have returned a 1% rate of growth. 

If you were fortunate to have part of your international equity portfolio hedged or in fact part held in $US, then you could have seen a significant improvement over the benchmark as the $US was higher by close to 20% over the course of the year.

I have always held that it is important to have part of a portfolio held in $US because in times of greater volatility, the $US becomes a safe haven and while risk asset prices may fall more buying of $US will push the price higher and can offset lower asset prices. 

As we suggested often through my blog and our weekly webinars over the course of 2015, we have entered into a "low-return" environment.

Slow global economic growth, declining corporate revenue and earnings growth, low inflation (especially from low commodity prices) and low interest rates will likely continue to put pressure on risk asset prices (equities and high yield bonds) over the course of at least the first half of 2016 (and perhaps longer).

For the time being, expect higher levels of volatility as the US Federal Reserve has taken a divergent monetary policy (tightening, by raising interest rates and draining liquidity from the monetary system) from most other central banks in the world.

Therefore, having larger cash balances than normal and less risk assets in a portfolio could be a prudent stance for the time being.

Of course, we also need to remember that it is important to take a long-term perspective and not to get caught up in the year to year data. 

We should not make significant adjustments to our long-term strategies on the back of a difficult year or 2. The key to a successful financial plan is to stick to it, making minor adjustments as is necessary (when to put new cash to work, for example), but sticking to the basics of balance and diversity.

Tomorrow is the first High Rock client webinar of 2016 and we will cover some of our key successes for our portfolio models from 2015 and some of our objectives for 2016.

Feel free to tune in to our recorded version which will be posted at or about 5pm at

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