2016 Theme #8:

We Are In A Low Return Environment

For those of you who follow our client weekly webinar

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

you will know that we have a series of 8 themes which we have been following for this calendar year. We touch on this particular one from time to time because with slow economic growth, low inflation and meagre year over year earnings growth (negative for 5 consecutive quarters), we think that investors are placing too much emphasis on the stock market in an attempt to squeeze out what historically has been a pretty decent return on average and this puts them in a higher risk category.

We also disclaim (each week) that historical returns are in no way a guarantee of future returns. 

Have a look at the equity benchmark returns for the last 5 years (MSCI All Country World Index):

Pretty good and steady returns until May of 2015, but the index is now really only where it was back in mid-2014 (no price appreciation, just dividends) and so the 3 year annualized total return is a relatively light 3.66% vs. the 5 year return of 8.91%. 

On the bond side of the equation:

Bonds have out-performed equities over the last 3 years.

When you look at the combined 60/40 and 40/60 returns (and allow for fee's and MER costs):

The 5 year returns have been pretty much in line with the multiple year (20-25 year) averages but the most recent returns (3 and 1 year) have been well below average because we have entered into an era of lower than average returns (i.e. A Low Return Environment)

Further, according to a Bloomberg story and a study by the investment advisory group Research Affiliates, the odds of getting a 5% or better return on a balanced 60/40 portfolio over the next 10 years are 0%.

http://www.bloomberg.com/news/articles/2016-10-26/the-next-10-years-will-be-ugly-for-your-401-k

At High Rock, with this scenario in mind we (a year and a half ago) created an additional tactical portfolio model as a compliment to the basic 60/40 (equity model/fixed income model) standard balanced portfolio models to try and find a solution to something that we saw coming. 

Sitting in a fully invested 60/40 portfolio with the low return scenario and the possibility of both asset classes moving in a correlated fashion when normally they move in a non-correlated fashion (see the separate 3 year returns above where bonds out performed equities) is a recipe for potentially significantly lower returns (and potentialy greater levels of volatility) than the average.

Time to get proactive (we have for our clients and they are nicely ahead of the benchmark returns), if you haven't already done so.

Feedback...

scott@highrockcapital.ca

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bianca@highrockcapital.ca

If Stocks Are Expensive And Bonds Are Expensive, What Do You Do?

Traditionally, a balanced portfolio, with 60% equity and 40% fixed income assets was considered to be a pretty safe way to get long-term growth over multiple years at or about a total return of 7% annually on average (but certainly not guaranteed). Some years (like 2012) may get total returns in double digits, others like last year may be pretty flat. 2008 which frightened everyone, saw negative returns of about -15% or worse, depending on the structure of your portfolio.

The growth part of the portfolio, the equity portion is where the greater risk and potential volatility is supposed to be.

The fixed income, bond portion is supposed to provide the safety cushion.

In the long-term scheme of things, this balance works (or is supposed to work) because these two asset classes are normally negatively correlated, in other words when one is rising the other is falling.

Supposedly in stronger economic conditions, equity prices rise as do corporate earnings and as interest rates rise in those same circumstances, bond yields go up (with higher inflationary expectations) and bond prices fall.

However, my friends, these are not ordinary circumstances:

1) Economies have stagnated.

2) Earnings have not been growing, although stock prices have continued to rise.

3) Central banks have been keeping interest rates low in order to stimulate economic growth, but that has had limited effect.

4) Bond yields are "artificially" low and prices are therefore artificially high.

So you have a scenario where stock prices are probably too high and bond prices are also too high.

And as we have been talking about on our weekly webinars, the normally negative correlation is now a positive correlation.

This could all shift if economies start to grow again and corporate earnings reflect that and inflation returns and bond yields normalize.

However, the risk at the moment is that this scenario which we have been waiting to play out for a few years now, is not evolving that way.

We have become dependent upon the central banks to fix it, but they can only do so much.

Now it is up to the governments to make the fixes, but they are awash in debt and have limited resources to help out.

If bond markets fall and stock markets fall at the same time, the only place to turn (to avoid more than normal levels of volatility) are non-correlated assets (cash and cash equivalents are good non-correlated assets, among other things). 

It's worth thinking about.

The risk of greater volatility is out there and the traditional 60/40 portfolio maybe in for some turbulence.

We do have a tactical model with "other things" for our clients.

Feedback....scott@highrockcapital.ca

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bianca@highrockcapital.ca

I Get Mail!

Hi Scott,

Congratulations for your 2^nd year with High Rock. I have no doubt that you will do well as you are very passionate and dedicated to helping and providing top quality service and advice to your clients and investors.

It was quite nice to read your blog and I am carefully considering some of the analysis you make in terms of the macroeconomic trends. 

As you know it has become a trend these days for most portfolio managers to head from the advisory model to the discretionary model.

Please let me know if you have a chance to give me your honest opinion on what you prefer between the two.

Thank you for your email and your congratulations.

Our clients have all expressed wonderful compliments about how we are handling the management of their wealth and portfolio strategies.

First and foremost your question about investment advice vs. discretionary portfolio management:

It really depends on the client’s needs.

Non-discretionary investment advice requires the approval, by the client, of each and every trade. This has to come about via a portfolio review (especially for any re-balancing or adjustments to the portfolio). If you have one or two portfolio reviews per year, then that is the only time a non-discretionary portfolio can be adjusted (so the timing for those portfolio adjustments may not be appropriate).

As we have shown (with the success of our tactical model), clearly, while there is still a need for long-term core portfolio structure, there are also opportunities (buying /selling of securities) that arise which require quick and decisive portfolio changes. To do this simultaneously for all of our clients would be impossible in the old-style non-discretionary portfolio.

That is why there has been a shift to more discretionary portfolio management.

However, that is not all there is to the appropriate management of your wealth.

The discretionary portfolio strategy has to be tailored, very specifically to each client. That is why we have 3 models (Fixed Income, Global Equity and Tactical) so that after we complete a Wealth Forecast and determine your goals, risk tolerance and time horizon for achieving your goals, we then determine the structure of your portfolio with the parameters of your exposure to each model carefully determined with you. As we build a portfolio, we can be selective as to the appropriate time for buying assets to get the best possible value (this is where we utilize our over 65 years of collective experience). We then will have reviews at least every 6 months to determine whether the strategy is progressing toward your goals and if any adjustments to the strategy are required.

Certainly there is the trust factor at play: that we are buying and selling appropriate assets for your portfolio (within the agreed upon parameters), however as we are buying those same investments for our own portfolios, you can be rest-assured that we are not buying any random assets just to put them into your portfolio.

As well, you are able to see each and every security you own in your portfolio (on-line) and we are available 24/7 to explain the significance of any asset that we purchase. We will send each client a quarterly summary of their portfolio and its performance as well as a letter discussing our view of financial markets and comparative bench marks and an Independent Review Committee letter stating that our portfolios are indeed invested in the same assets as our clients.

http://www.highrockcapital.ca/uploads/3/4/2/5/34254660/hrcmi_q_3_2016_client_note.pdf

http://www.highrockcapital.ca/uploads/3/4/2/5/34254660/hrcm_3q2016_irc_note.pdf

From a client’s perspective, I can’t see how non-discretionary investment advice can be anywhere close to being as effective.

Feedback....

scott@highrockcapital.ca

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bianca@highrockcapital.ca

Tactical Approach To Balanced Investing vs. Fully-Invested ("Let It Ride") Approach

I do tend to go on about this, but as a case in point, when I see how impactful this is in a market that gets volatile, I get really excited about how we have found a way to keep a good deal of that volatility at bay.

Looking at the benchmark we use for a fully invested 60% equity and 40% fixed income balanced portfolio: blended total return of 60% ACWI and 40% XBB, the change in the 1 year total return (Bloomberg, Daily Basis) and allowing for fees and MER costs, from Sept 30 to Oct 11 was a staggering 3.54% drop with both stocks and bonds declining.

Certainly there was lots of volatility 1 year ago, which added to the wild swing. However, when we compared that to an actual client portfolio, structured with our models and significantly lighter on equity (for all of the reasons that we think we should be: http://www.highrockcapital.ca/current-edition-of-the-weekly-webinar.html) than our standard target, there is a considerable reduction in volatility from one week to the next:

The client portfolio dropped from a 1 year return of 7.95% (after fees and costs) to 6.56%, a drop of 1.39%. Close to 40% less volatility over the same period of time and still well ahead of the benchmark return.

This is what we mean by stronger risk adjusted returns and it was what we work so hard to achieve.

Less risk, better than benchmark returns, lower volatility (keeping more of the growth when markets are giving it back).

Over the next week or so, our clients will be receiving their quarterly reports for the 3rd quarter. It was a good quarter for equity markets and we were light on our equity holdings, but we still managed to out-perform (the blended benchmark on a balanced portfolio), despite our more defensive stance.

When markets get more volatile (as we suspect they will), we (the managing partners at High Rock) and our clients will be able to hold on to those gains better than a fully invested portfolio.

That excites me!

Like being the underdog baseball club and sweeping the division series!

(well, perhaps not quite that exciting)

Thank You Readers!

I began writing this blog in January 2015 because I thought that I might be able to offer an out of the mainstream perspective to the world of wealth management, portfolio strategy, financial markets and global economics. 

I eat, drink and breathe this stuff 24/7 (except, perhaps when I have been on the ice, which as a goaltender, demands total focus or the team playing in front of me may not be so thrilled but may also explain my "defensive" nature).  

To be totally upfront, it is a way to stay in front of our clients as well (because, for those interested or on the financial literacy "learning curve", it is hopefully helpful and relevant) and from the feedback I get, it appears to be appreciated.

My opinions are developed from over 35 years of trading, risk management and assisting families with building appropriate investment strategies to ensure that they achieve their long term goals.

I have learned a great deal in that time and I have also learned that not everything is as it may appear or others want you to believe. Behind most mainstream investment advice is a sale whereby the seller will financially benefit from their own advice. I like to think that over the years, I can sniff out those who have ulterior motives, but unfortunately, it is not an exact science.

At High Rock, we are building a business that we hope offers a new type of transparency, where we are only trying to sell our experience. Our clients (old and new) are a testament to that and obviously, they appreciate it and they trust us.

Trust is a difficult thing these days and it should be. In the investment industry where there are many levels of financial literacy, many at the client level are without even the rudimentary elements: 

We had to gently tell an elderly woman (for whom we offered a wealth forecast free of charge, with no obligation) that she would likely run out of cash next year. She has no interest in selling her home or her cottage. Emotionally attached to both, she stated outright that she was not prepared to do so. She also had outstanding credit card debt that was on a card administered by the same bank where she held her RRIF (Registered Retirement Income Fund). Nobody at that institution had picked up on the fact that she was paying outrageous interest rates on the credit card debt and earning (after fees and costs) virtually nothing on her RRIF.

Do we want her as a client?

Of course. Will she have to pay us a fee? Yup (otherwise we wouldn't be in this business for long). However, we would also help her manage her affairs to ensure that her net worth (well over $1,000,000) was providing her with the best possible lifestyle that she could have (and definitely at a lower net cost than she was paying her bank!) and working harder at getting her better and prudent risk-adjusted returns (in her investment strategy) than she was getting from her current mutual funds. That is a decision that she will now have to make, better sooner than later, but only she can make that decision based on the various scenarios that we presented to her. Sadly, she might wait too long because it is an emotionally difficult decision.

It pains me to see how people get taken advantage of because they put such faith in financial institutions (where, by the way, I have spent a reasonable part of my career) that have been around for such a long time that they get  automatic trust when they actually can do such a horrible job (and folks who do not know any better get taken advantage of).

So readers, thank you for "listening" and hopefully understanding (and keep asking questions). Financial literacy is not an exciting topic at the cocktail party or the dinner table, but people do need to know that there is a new and better way to guard against being taken advantage of and it is not a huge leap to contemplate a well-constructed plan. So talk it up!

Feedback...

scott@highrockcapital.ca

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bianca@highrockcapital.ca

US Recession Watch: Unemployment Rises To 5%

The US "Non-Farm Payroll" data is the headline number that is the focus of most of the media and financial market participants. Today we learned that 156,000 additional folks were employed in September. They are referring to it as the "Goldilocks" report.
 

In Canada, there were an additional 67,000 people employed in the same month. Relatively speaking, that is a fairly significant rise in Canadian employment.

As I do each month, I remind all my friends that one month's data (especially the employment data) must be taken in context of the longer term trend because these numbers are subject to many and potentially significant revisions.

So we focus on the 12 month moving average (purple line)

to give us a "smoothed-out" view of the trend, which has continued to show slowing employment growth in the US over the last year.

And

In Canada the 12 month moving average (green line) has pretty much been moving sideways over the last year.

However, what we have spent time focusing on is the US Unemployment Rate, the 3 year historical moving average and the significance of their converging lines as a predictor of US recessions:

The rate of decline of the 3 year moving average (fairly steep) looks to intersect with the actual employment rate (which has been steady / rising over the last few months) in the next few months. The increase in the US unemployment rate to 5% in September (from 4.9% in August) adds credence to our thinking that a recession is not far off.

You will likely not see this in the media headlines. Perhaps not exactly what "Goldilocks" might imply.

The timeline lines up with the US election, the uncertainty surrounding it and the statistic that a recession has followed 5 of the last 11 elections (regardless of the politics of the new president).

As we have stated before (and I mentioned in my interview on BNN a few weeks back), we think that this is reason enough to be defensive when investing our and our clients money. 

Add in the higher possibility of a US interest rate increase in December (based on CME group's Fed Fund Futures probability of 60%)

http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html

And... the recession scenario becomes even more likely.

I met a great number of happy clients on Wednesday night at our annual client event. Makes me think that we are doing something right (above benchmark returns with significantly less risk than the benchmark).

Feedback...

scott@highrockcapital.ca)

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bianca@highrockcapital.ca

If you want to learn a little bit more about High Rock:

http://www.highrockcapital.ca/private-client-division.html

So Excited To See All Of Our Friends Tonight!

It is not too late (if you forgot to RSVP, or the invite went to your junk mail), if you wish to join us just give us a call. There are a few spots left.

Last year we ( at High Rock) celebrated a new beginning for investors who wanted an alternative to high cost / low service investment / financial advice.

This year with growth of over 100%, we get to celebrate with our clients our success in getting our message across: 

Paul and I wanted to create a platform on which to be able to manage our own household money as efficiently and effectively as possible, without having the "middlemen" continuously taking their cut (fees and costs). Some of our efficiencies come from the $100mm that we manage for Scotiabank. 

Once we had this set up, we also wanted to be able to do this for our friends,  family and those who believed in our way of investing: core balance, with a tactical twist that would enable us to efficiently reduce risk while at the same time maximize our returns within that lower risk framework. We have certainly accomplished that.

Reducing costs should not and does not necessarily have to come with a trade off of reduced service. All of our clients know that their life goals and the time horizon for achieving those goals are our number one priority.

We visited clients earlier this week who had a family issue that had made them re-think their plans for the future and our first response to them was: let's have a look at your Wealth Forecast and build in a few more scenarios before we make any decisions. Then we can crunch the numbers and look at it and make any strategical changes to your portfolio that become necessary. 

They were very thankful (lots of big hugs), as if this was something that we were going out of our way to do. I said to them in response: "guys, this is what we love to do: to make sure that what you need, to have a happy and comfortable life, is our first priority".

So tonight we are celebrating our bold new adventure to continue to try to adjust the way people think about how they receive their financial services.

There is a better way, you just need to have the courage and make the effort to go out and find it. It will be worth your while and that is something that I can personally guarantee.

Feedback...

scott@highrockcapital.ca

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bianca@highrockcapital.ca

Fed's Vice Chair Dudley: " Some Economists Are Concerned That The Risk Of A Recession Is Increasing"

We have been on record since late April suggesting that there was a rising risk of a US recession. But, this is the first time we have seen a Fed official publicly acknowledge it. 

At the same time, Cleveland Fed President Mester (and a voting member of the Federal Open Market Committee who makes the ultimate decision) thinks that a November rate increase should be considered.

The Fed has continued to publicly maintain a more optimistic view of the US economy, as they indicated in their most recent press release following their September 21 meeting, where they decided to hold interest rates at current levels. They do this to give the general public (those who pay attention to this stuff) a higher degree of confidence.

We continue to suggest that for an economy to grow, the consumer and businesses must be confident before they make the decisions to increase spending and longer-term investment.

We maintain that behind the scenes, the Fed is trying to balance their optimism with all the concerns that continue to keep them from raising interest rates (even though they, or at least some are anxious to normalize them) as they lowered expectations for 2016 growth to 1.8% from 2%.

I would suggest that the outcome of the US election and the uncertainty surrounding that is driving decision making at the Fed.

The latest data show that the consumer has eased up on spending, and non-residential structures investment has stalled dropping Q3 GDP expectations to 2.2%.

Today is Webinar Tuesday at High Rock, we will talk about this, the global economy and portfolio strategy and performance (which we continue to provide for our clients, despite our defensive posture) with our clients. We will post the recorded version on our website at about 5pm EDT (well before the Blue Jays vs. Orioles 8pm EDT starting time). So feel free to tune in: http://www.highrockcapital.ca/current-edition-of-the-weekly-webinar.html

Making Sense Of Share Prices

The S&P 500 started the 3rd quarter at about 2100 and finished at 2168, up a little over 3%.

Analyst estimates for 3rd quarter earnings per share (for S&P 500 companies) began the quarter at 30.65 and the most recent estimate revisions have lowered those expectations to 29.75, down about 2.5%:

So, fundamentally, for those who buy stocks to be able to participate in a future stream of earnings (which is ultimately what you want to be able to do when you invest in a company), it does not look to me like this relationship is something that is moving in the right direction. In fact, to me, it looks as though it is moving in the wrong direction (which has been happening since 2014, by the way).

The argument from the other side of the "who cares, buy anyway" camp is that you need to get growth and you should buy for the dividend yield.

If earnings are not going to increase, are dividends at risk? Perhaps.

Is that a risk that an investor should be taking?

Not to our way of thinking.

Further, US economic growth, expected at the beginning of the quarter to rebound to better than 3.5%, is now estimated to come in at an annualized growth rate of 2.4%:

This is happening because the consumer, who drove a good portion of 2nd quarter GDP growth has not followed through as expected in the 3rd quarter and business investment remains a negative force.

As I have said on many occasions, uncertainty (and now the US election is driving uncertainty levels) is rising and consumers and businesses, when they are not confident in the future will postpone economic decision making: reducing spending and investment in longer-term productivity. 

As share prices rise (for perhaps technical reasons, like low interest rates and fixed income yields), without the fundamental support of earnings growth, the risk that they may fall back to more reasonable values becomes greater.

Needless to say, we have not been convinced by higher share prices that they are a good (long-term) investment at the moment. In fact, we would say that the rationalization for share ownership continues to fade as share prices go higher (and earnings do not support them).

Tomorrow is Webinar Tuesday at High Rock, we will talk about this, the global economy and portfolio strategy and performance (which we continue to provide for our clients, despite our defensive posture) with our clients. We will post the recorded version on our website at about 5pm EDT (well before the Blue Jays vs. Orioles 8pm EDT starting time). So feel free to tune in: http://www.highrockcapital.ca/current-edition-of-the-weekly-webinar.html