Central Banks (and BOC) Singing A Different Tune On Rates ?

When the Bank of Canada's senior staff (Poloz, Wilkins and Patterson) started talking about the possibility of raising rates through the "stop light ahead, apply brakes now" metaphor, it really didn't make much sense because their mandate is price stability (keeping inflation at or about their 2% target) and inflation is running at 1.3% and is not forecast to accelerate at any great speed.

A great number of financial market participants and economists were equally surprised.

It seemed like a fairly abrupt about-face.

Alas, it has become more clear now that more central bankers have joined the party (at a conference in Portugal), but consumer price inflation does not appear to be their concern as much as asset price inflation: stocks, bonds and in Canada (because the SP/TSX is basically flat 6 months into this year) house prices.

At what cost to the Canadian, US and European economies will the central banks be willing to allow these rate increases (there is now about a 67% probability assigned to a July 12th 1/4% increase in Canada) to make their mark?

I think that the downside economic risks are a great deal larger than the more optimistic Bank of Canada may be visualizing. Given their history of forecasting (see my blog The Gloves Are Off  for a brief history of the BOC's recent forecasting prowess).

Either that or the 33% who don't expect a July rate increase (the more prudent call in my opinion, but what do I know?) hope that the Bank of Canada will be more cautious. It is a tough call.

Without inflation, short-term rate increases will make the yield curve flatter, eventually, because longer term bond investors will not demand as high a risk premium and longer dated maturities will either hold their current yields or yields will fall. 

In any event, flatter yield curves are harbingers of recession. So if the Bank of Canada is wrong (and they raise rates), it won't be pretty.

Risk And Your Cost Of Living

Last Friday Stats Can reported that our cost of living rose by 1.3% over the 1 year period from last May. As we all know, we don't all necessarily fit into the "basket" of consumer goods that they prescribe to the average Canadian family, but it certainly helps us to make some assumptions. If we look closely at what prices of what goods /services were higher or lower and in what regions (because where you live certainly impacts your cost of living), we can get a reasonable understanding of what the correct assumption might be for extrapolating our cost of living into the future.

When we create our client Wealth Forecast's, we need to make this assumption and it cannot be taken lightly because of the significance of how we see your cost of living growing over a longer term time horizon (and it is why we follow this inflation measurement so closely). Remember, one of our key objectives and the reason we take risk in investing is to outperform the rate of (our own) cost of living (and grow the real purchasing power of our hard earned $). The risk-free (where you are taking no risk at all) rate of return sits at about 1/2% (90 day t-bill), so to get better than inflation returns, we need (at the moment) to get better than 1.5%, which means we need to take risk. The Wealth Forecast allows us to determine how much risk we need to take. Without that, just investing for the sake of investing becomes gambling. A large portion of investors (and many of their advisors), just do not understand how much risk they are taking. We do. 

Over the last 5 years, the 1 year moving average for total Canadian CPI has been 1.3%. If you live in a major city, like Toronto or Vancouver, you can likely add another 1/2% -1%.

The 5 year benchmark 60% equity / 40% fixed income (buy and hold) portfolio (60% ACWI ETF / 40% XBB ETF) has returned approx 8%, before fees and taxes.

Take off fees and taxes and it leaves you something in the vicinity of 5% to 5.5% growth. From a conservative perspective, you should be about 2.5% ahead of your cost of living.

Over the last 3 years however, the benchmark 60/40 portfolio has returned only about 4.7% (after fees), so the "real return" of your portfolio may not even be ahead of inflation over this period (even though the 1 year 60/40 return has been closer to 14% after fees).

This is why we focus on the longer-term, because we need to understand the impact of all of the forces that affect your real return over time relative to what your goals are. 

Slow global economic growth (and lower total returns) over the last few years has impacted portfolio growth more than it has impacted inflation and is one of the reasons that investors have tried to find better returns, but exposed themselves to excess risk.

Are you comfortable with your level of risk (do you know what it is)?

We will discuss this and other issues that are impacting the management of our clients wealth on our weekly webinar today. The recorded version will be published at or about 5pm EDT.

Trust Issues

So the bank that I have trusted to do my banking: held my chequing / savings accounts and lines of credit (personal and business accounts) for the past 35 years has fallen into the "there is never just one cockroach" category: "RBC faces scrutiny following report of excess investor fees"

Am I surprised? Not really. We as Canadians throw way too much trust into these vaunted institutions that we believe to be so safe, secure and truly have our best interests at heart (mostly because that is what their advertising convinces us that they do).

It is however just selling.

The shareholders are the folks at the top of the priority list, revenues and earnings (from fees, etc.) take precedence, while client service (a cost of doing business) remains vulnerable to economies of scale and cost cutting.

Not at High Rock. We have no shareholders to report to, we report only to our clients. Our signed Voluntary Code of Conduct for the Stewardship of your Wealth is our guarantee that our clients get precedence.

We do not sell. As anyone who knows me will attest to, I am a lousy salesperson: no slick pitch, no "pressure to close". If it makes sense to build a good working relationship, then we shall work together, but I won't chase you down to sign you up.

I might call you up to re-connect (now that I no longer have a non-solicitation issue), but I only want you to know what it is that I have been putting my efforts towards for the last couple of years: a better way for you to get your money growing and at the same time, taking a lot less risk.

I may suggest that your current advice channel is being a bit complacent about risk, likely painting a pretty picture about the state of markets and returns over the last year. The returns over the last year will mean nothing if they are not captured before the pending equity market correction, your bond portfolio will likely not be in a position to give you the protection that you need. Correlations are changing.

That's what our clients pay us to look after: their protection.

Some RBC clients were overpaying, apparently. I wonder how well they were being looked after?

At High Rock we are trying to change the way that people think about who looks after their money and why and what you get for the fees that you pay: individual attention specific to your goals, fee transparency above the regulatory requirement experienced portfolio management, lots of two-way communication and plenty of sleep at night. All in all, a better client experience.

Join us!

Thank You Vancouver Friends!

I really was not prepared for the outpouring of support that I received from old friends, some whom I have not spoken to in a couple of years, I was truly touched. 

Further, it was a great chance to unwind a few of the non-truths that have sprouted while I was under my period of non-solicitation:

For the record: High Rock Capital Management Inc. is not a "mutual fund company" and we do not sell mutual funds.

We are a separately incorporated  portfolio management company who has 2 divisions: One division, what we refer to as the "Institutional Division" manages (sub-advises) very successfully, I may add, on a number of funds for Scotia Managed Companies. 

Scotia Managed Companies, a division of Scotiabank has been recently sold to Marquest Asset Management where we will continue to grow and evolve our fund management services in line with our level of highly regarded expertise.

Our "Private Client Division" manages money for our private clients on a Separately Managed Accounts basis (where your accounts are held at Raymond James Custodial Services for your safety and each individual security that you own is in your account, protected under the Canadian Investor Protection Fund).

We do not pool our clients money.

There are great synergies between our institutional division and our private client division that allow us to trade more inexpensively and pass those lower costs (and investments that are not available to retail investors) on to our private clients (lower fees). We have a nice brief "Introductory Webinar" that out-lines this and a number of other essentials.

Importantly, High Rock is and I am licensed under the Ontario, BC, Alberta, Saskatchewan (and soon to be Manitoba and PEI) securities commissions. 

My licensing under IIROC was not removed / suspended, it was not necessary with the updated licensing with the other securities commissions and was simply not renewed as it was not necessary.

As my licensing is in good standing: OSC Registrant Search

Hopefully, that will dispel that particular rumour!

Our focus for our private clients is on risk and the return per unit of risk taken. What concerns me most (gleaned from some Vancouver conversations) is that many with whom I have had the chance to talk to, just have not clearly and fully been told about the level of risk in their portfolios. In fact, it appears to be just glazed over as if it does not matter at all (a balanced portfolio will inevitably be just fine). 

Well Paul and I, with our vast level of experience will argue that it is just not that simple and it has been great to sit and watch the reaction to those folks to whom we can impart our knowledge. 

So far, a most excellent journey!
So looking forward to more of the same today!

And ... I do have a couple of open time slots for a coffee, adult beverage or jaunt around the sea wall if you would like to rekindle our friendship! Let me know!

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Looking Forward To Sunny Vancouver

In an effort to stay current with our more distant clients and bring a personal touch to our message, I get to visit one of the most beautiful cities in the world tomorrow through Friday. I am thrilled to be able to say that High Rock is truly a Canadian company with clients from coast to coast (I will be on the east coast in August).

As you regular readers know, we are passionate about looking after our clients and their families and always put them first (Our Voluntary Code of Conduct for the Stewardship of Your Wealth).

This means that from time to time we need to see these folks face to face, if for no other reason than to just say hi. Knowing and understanding our clients and their goals is more than just numbers on paper. In so many of our client relationships we have multiple generations of grandparents, parents and their kids and there is lots of inter-generational interest to see them all succeed.

The goals for the grandparents are usually somewhat different from those of the parents, but for the children especially, there is not only a huge potential to learn early about saving, but what really is the kicker is the compounding curve and the time factor. It doesn't take much, just a bit of patience and commitment:

We call it the "Aha!" moment, when the young 20 something gets a look at this. Just a little bit of regular saving and you are on your way.

So I will travel to visit our clients (and a few who have expressed an interest in learning about how we are different and better and want to become clients and I would also be happy to include any Vancouver readers into my schedule if you have not already asked) to work to truly understand their goals and how we might best help their families continue to prosper.

See you all soon!

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A Recession Is Inevitable

The Question Is When?

Historically, when the yield spread (difference in yields) between the 2 year US Government Bond yield (gold line) and the 10 year (green line) and 30 year (purple line) narrow close to 0, a recession has followed.

If inflation remains below 2% and slower than expected economic growth suggests that it will remain that way for some time into the future, bond investors will continue to buy longer-term bonds because they will not require the inflation "premium" that they would otherwise want to have as protection from future inflation. Long-term bond prices will rise and yields will move lower (see Paul's Blog from June 14th).

At the same time, the US Federal Reserve (the "Fed") is anticipating that lower unemployment numbers will soon push wages higher which will help drive inflation higher and justify their interest rate increases (which will push the 2 year bond yield higher).

In essence, this will push the yield spread narrower.

So if the Fed is correct and higher wages evolve (although until now lower unemployment has not generated much in the way of wage inflation), bond investors may need to reverse course, which would push longer-term bond yields higher and put the odds of a recession back to later, rather than sooner. 

At the moment however, bond investors, recently whipped in two directions because the so-called "Trump Trade" or "Reflation Trade" bandwagon, that traders jumped on after the election, sputtered and went the other way (i.e. the inflation premium was built-in and then rather quickly taken out). The spread differential between the 2 year bond yield and 30 year bond yield has come all the way back to pre-election levels:

After that differential reached a little over 200 basis points (or 2%), it has come back to below 150 basis points (or 1.5%). If the Fed tightens by 1/4% 2 more times, this spread will narrow to less than 100 basis points (if inflation expectations remain the same for bond investors) or more if the economy slows further.

The Fed owns a lot of bonds (purchased during 3 rounds of Quantitative Easing) that they want to sell to reduce the size of their balance sheet, but they have made that quite clear and bond investors have had time to build that outlook into their expectations.

So it is down to trying to determine who is right on inflation (and economic growth): The historically over-optimistic US central bank (trying to keep consumers confident and spending) or bond investors.

The thing about bond investors is that it is their money that is at risk, so being wrong is an expensive proposition. 

Central bankers are, by and large, economists (pretty smart ones at that) but with no real "skin in the game", other than their reputation (which time always repairs). 

We also know that economy's are cyclical and after 8 years this economic cycle is getting long in the tooth. All the anticipated goodies hoped for from the Trump administration are taking some time to come to fruition and when they finally (if, as and when) do get initiated, there will be some lag time before they have the desired impact.

It may just be in time to help pull the US into the next economic cycle, but first, the current one has to end. 

The question is: when? 

The answer is: stay tuned.

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The Gloves Are Off!

Last week I wrote about the Capital Economics conference that I attended on June 5 where they suggested that the next move by the Bank of Canada may be to cut rates by 1/4%.

Yesterday, Carolyn Wilkins, Senior Deputy Governor of The Bank of Canada (in a speech given at the Asper School of Business in Winnipeg) stated that "Monetary policy actions influence financial conditions and economic decisions right away but can take as long as two years to have their full effect on inflation. To ensure that inflation gets back to target on a sustainable basis, we must consider not only current economic conditions but also how they will evolve". 

Here is the part that got bond and currency traders all fired up yesterday: "If you saw a stop light ahead, you would begin letting up on the gas to slow down smoothly. (Really? When I drive, what I witness is not so predictable).

The kicker: "You do not want to have to slam on the brakes at the last second". Down went bond prices, up went bond yields and the C$!, with traders taking it that this meant some kind of immediate tightening of monetary policy was now being put into play.

Just for fun, I thought it might be interesting to have a look back at the last couple of years of headlines from the BOC's quarterly Monetary Policy Reports:

"Economic growth in Canada is expected to average 2.1% in 2015 and 2.4% in 2016 with a return to full capacity around the end of 2016".

This coincided with a cut in the Bank Rate to 1% from 1.25%.

On April 15, 2015 the MPR headline was: "Real GDP in Canada is expected to grow by 1.9% in 2015 and 2.5% in 2016 and by 2.0% in 2017.

Then on July 15, 2015: "Economic growth in Canada is projected to average just over 1% in 2015 and about 2.5% in 2016 and 2017."

2015 GDP growth expectations went from 2.1% to 1.0% in just six months.

And they cut the Bank Rate by another 1/4%.

Fast forward to January 2016: "Growth in Canada's economy is expected to reach 1.4% this year (2016) and accelerate to 2.4% in 2017."

So, the pattern has been somewhat overly optimistic growth and inflation targets that over time gradually get revised lower and lower again. There have been plenty of "stop lights" in the distance, but they keep turning green (apparently) and the "gas" pedal has been pushed a little harder. 

The latest Monetary Policy Report headline: April, 2017: "Canada's economy to grow by 2.5% this year and just below 2% in 2018 and 2019."

Stay tuned for the July report, should be a "barn burner"!

For you floating rate borrowers out there, I would suggest sticking to the plan, if short-term rates are going up (IE if GDP and inflation targets are met, which has not been the case over the past couple of years), it will likely not happen until 2018 (six months to a year away and probably not by more than 1/4 to 1/2%). Bond / Currency traders might be a little restless at the moment (not much to do since the great short-covering rally slapped them around a little) and who knows how the housing market is all going to shake out.

Today is Webinar Tuesday (4:15pm EDT, live, for clients) at High Rock, or feel free to tune in at or about 5pm EDT for the recorded version where we will talk about this and any other important developments in the global economy, financial markets and the world of wealth management.

Giving A Little Back To the Community

I grew up learning the importance of trying to assist those who were experiencing challenges in life, regardless of the root cause. Getting them back on their feet, so that they could be making their contribution to the community, was the most important goal, regardless of politics or religious issues.

A couple of years ago I came across a group that was doing just that. 

"New Circles Community Services is a not-for -profit, grass roots agency that builds strong and caring communities by providing basic necessities to those living in poverty. They provide much needed clothing, social programs and skill building opportunities to individuals living on a low income, many of whom are newcomers to Canada."

"Their core mission is to ensure that local families struggling with poverty can meet their basic need for adequate clothing."

But "clothing is just the beginning". They know how to build strong and caring communities that provide programs to help them integrate socially and economically into the community.

My wife Mary and I have assisted in the sorting room, attended graduations of some of their trainees (very moving because you can see the sense of accomplishment as these young people re-enter the world with newly attained skills) and have been able to witness first hand the wonderful work done by founder Cindy Blakely and her staff including Executive Director Alykhan Suleman, Diana Gibbs, Virginia Trotter and Andrea McGavin. 

On Monday, May 29th, High Rock Capital sponsored a hole and entered a foursome in the 5th annual New Circles' Golf Classic where they were able to raise a record high $70,000. I was proud to have in our group, Olympian Maxine Armstrong, Mary Tomenson and hockey legend Jim Lye (we played together on the same championship team in 1981, but I had not seen him since then!).  Jim won the men's longest drive competition, although Maxine's drive on the same hole was longer! Jim's daughter Joey plays softball for Team Canada.

We had a lovely and enjoyable day, but more importantly we were able to help New Circles raise money so that they could continue to do their great work in our community!

US Fed To Hike 3 More Times In 2017

So says Capital Economics' Chief US Economist, Paul Ashworth. More key take-away's from yesterday's Capital Economics Annual Conference:

Monetary Policy (US):

• Another 0.75% of tightening this year.
• Fed Funds rate 1.50% to 1.75% by end of 2017.
• Rate to peak at 2.75 to 3% in 2019 H1 (first half).
• Balance sheet normalization to begin "later this year".

Trump Agenda:

• Tax reform will be modest and delayed until next year.
• Congress also needs to deal with 2018 budget (by Oct.) and debt ceiling (by Aug.).
• White House progress hampered by scandal and incompetence.

Conclusions:

• Economy is set to grow at a decent pace this year.
• Federal reserve to raise rates faster than many expect.
• Tax reform still more likely than not.
• Another recession is coming, the question is when?

With a caveat on the recession date: Paul Ashworth said 2019 with tax reform, 2nd half of 2018 without it.

Interestingly, there was little mention of the record amounts of US household debt, which with three 1/4% interest rate increases, should have an impact on the consumer with an increasing cost to servicing their debt.

My take was that they (Capital Economics) expect that the consumer will remain capable of spending by saving less: with improving household wealth (housing price increases and equity market strength) as well as further job growth expected to lead to higher incomes (but not yet, in the most recent data, anyway).

I will let the experts debate the possible outcomes, but I would suggest that herein lies some pretty significant risk that may be impactful on future consumer spending (US consumer is 2/3 of the US economy) and US economic growth outside of the political issues. 

As always, our job for our clients (at High Rock) is to identify risk, assess it and build investing strategies around it. That is not something you will get with a "buy and hold" or "Robo" portfolio structure. 

All this and more to be discussed on our weekly client webinar today, the recorded version which we will post on our (High Rock) website at or about 5pm EDT.

Bank Of Canada May Cut Rates in Q4

So says Senior Canada Economist, David Madani of Capital Economics, one of the leading independent economic research companies in the world.

The most important word is "independent".

Regardless of what you are told, bank and other investment company research cannot be truly independent because they have an agenda (a bias based on their relationship with / to their readers). Even the Bank of Canada tries to put a positive touch on their press releases to avoid frightening their clients (the good folks of Canada). 

I spent this morning at the Capital Economics Annual Conference entitled Stumbling or soaring? Global growth in the age of populism: David Madani sees a 20-40% correction in the Canadian housing market which could trim Canadian GDP by about 1-2 percentage points (that would be a stumble, I would imagine).

The Bank of Canada would likely never issue as bold an outlook as that for fear of shaking Canadians confidence in their housing market (and confidence is important to keep consumers spending and businesses investing, even though households have been spending well above their means).

But somebody needs to suggest (and likely it will come from an economist who has no particular "ax to grind" other than putting his reputation out there) that a little reality might need be brought into the housing price conversation. This (Madani's forecast) may be a pretty heavy dose of reality.

Unfortunately, lower short-term interest rates may only encourage borrowers to build more debt. Debt that is continuing to pile up at record levels. That may be tough for the BOC to swallow, but it may also be their only option if Canadian GDP starts to shift lower and takes inflation lower with it.

Being globally diversified from an investment strategy perspective (and holding assets in $US) will be essential should this scenario unfold.

And the housing price issue is only one concern.We also have to consider the uncertainties surrounding the re-negotiation of NAFTA and the BOC worries over the possibility of greater protectionist policies from our biggest trading partner to the south. 2/3 of Canada's economy is dependent on trade.

The outlook may just be less than rosy.

Add that to a possible recession in the US in 2018 if the Trump Administration doesn't get tax reform (as planned) accomplished, according to the Capital Economics forecast.

We'll have that discussion here (and on our weekly client webinar) tomorrow.

US Employment / Unemployment Data: 

Bond Prices Up, Stock Prices Up 
And Risk Up Too

Non-farm payrolls in the US grew at a slower than expected rate in May with pretty significant downward revisions to the previous reports from March and April. As I say each month (to those who will listen and / or care) these numbers are always subject to potential revisions, so we need to focus on the longer term trend, which is to slowing employment since early 2015 (red line on the chart).

One rather important question that emanates from all of this data is whether this will change the US Federal Reserve's decision to raise interest rates on June 15th.

The answer is that it likely will not.

But bond markets (see the gold line of the chart above) are telling us that the economy may not be strong enough to handle interest rate increases. Certainly one reason (as we discuss each week on our client webinars)  may be because US households have amassed record amounts of debt again (higher than back in 2008) and having to service that debt with higher interest costs will impact consumer spending (2/3 of the US economy).

And wages (according to today's data) are only growing at a meager 2.5% annually.

We know that bond markets lead all financial markets, but the stock market is, for the moment, ignoring the risk signals being sent by the bond market (see the white line on the chart comparing stock prices and bond yields above). 

Why?  

Because there is so much liquidity in the global financial system (see my blog from May 23 on this topic or for another, somewhat more respected opinion, read Dr. Mohamed El-Erian on Bloomberg).

As we (at High Rock) have been suggesting to our clients and anyone else who will listen, the correlations between stocks and bonds are no longer as reliable as they have been in the past and that a more tactical approach to investing will be necessary in order to avoid larger potential risk and big swings in volatility in your investing portfolio.

Dr. El-Erian refers to it as "changing the way that you are taking risk". Passive "buy and hold" investors (index ETF's are all the rage now) need to take care, you may have quite a great deal more risk in your portfolios than you fully appreciate and many financial advisor's don't / won't see it either.

Being complacent because your equity portfolios have done reasonably well (and every month your statements appear to show growth) is not the answer. Unfortunately, many will have to find out the hard way.

But it doesn't have to be the case.