The Trust Equation

From the CFA Institute's 2018 Report: 

The Next Generation Of Trust

"CFA Institute is the global association of investment professionals that sets the standard for professional excellence and credentials. The organization is a champion for ethical behavior in investment markets and a respected source of knowledge in the global financial community. The end goal: to create an environment where investors' interests come first, markets function and economies grow."

As a portfolio management firm High Rock's Voluntary Code of Conduct specifically refers to our being "governed by the CFA Institutes Code of Ethics and Standards of Professional Conduct" (Paul has been a CFA charter holder since 1991)

As we all know, Trust takes a leap of faith. We are required to show credibility to begin to establish that trust: 

"Credibility, which is dependent on track record and experience, provides investors with confidence that the investment professional or organization is professionally accredited to provide the required service successfully." 

At High Rock, we have a team of professionals with the highest levels of professional accreditation as well as decades of experience through many tumultuous market conditions (all the way back to and including including 1987's crash). Something to consider in all the crazy volatility we are experiencing now and likely for some time to come into the future:

"Professionalism is more subjective and much harder to assess. Professionalism factors include competency and subject matter knowledge, and values such as putting clients' interests first, empathy, and demonstrating a fiduciary mindset."

"Brand is also becoming a more important method of establishing credibility, and is increasingly a proxy for trust."

I would argue that currently we are seeing an increase in examples where brand trust is being breached. 

Without a national brand (although we have clients all across Canada), High Rock has to work significantly harder than the big, branded organizations to earn and build trust. So that is what we do. 

"Conclusion: The investment industry is competitive and changing quickly, but investor trust remains a foundational element for success. The good news is that actions and tools exist to increase trust. By knowing investors' goals and fears, investment professionals can serve them better and provide more customized products and solutions."

Friends, the days of the "one size fits all" type of investing portfolios are drawing to a close. It is time to explore the alternatives. Customized solutions to your Wealth and Portfolio Management needs are here. Low cost, full-service and fiduciarily responsible.

Want To Know Where Stocks Are Headed? Follow The Bonds.

Bond markets lead financial markets. The yield spread (difference) between 2 year government bonds and 30 year government bonds and the direction it is moving in are key to the flow of money in the bond market:

The gold line is the spread differential. As 2 year yields rise (because the central bank is raising rates) and 30 year yields rise less, the gold line moves from upper left to lower right on the chart. That is because bond investors are less worried about long-term inflation and move money into longer dated bond investments. Quite simply, they are less concerned about inflation because the higher short-term yields are expected to slow economic growth and lower the potential for inflation.

Recessions (the blue shaded areas) occur, historically, after the yield spread hits zero or goes negative. We call this a flat yield curve (at zero) or inverted (when spreads are negative).

The US yield curve has flattened from a 4.00% spread in 2011 to close to its lowest level since at about 0.80% now.

The US Federal Reserve is expected to raise rates by another 1/2 to 3/4% this year. That should just about flatten the yield curve to zero.

Stock markets don't like recessions. It has taken a bit of time, but it appears that, given all the volatility happening now,  some of the smarter stock market participants are starting to get the hint.

S&P 500 In gold, recessions in blue. Yikes! I am afraid of heights!

In Canada, after Statistics Canada announced inflation for the year Mar. 2017 to Feb. 2018 had jumped to 2.2% (mostly as a result of increased gas prices, again), the bond yield curve moved to its lowest point since 2010, a little less than 1/2% from a flat yield curve. Probably one more quarter point increase from the Bank of Canada.

I read a blog the other day where the advice giver was urging her clients to remain calm.

If stocks retreat just 20%, a fully invested portfolio of 60% equity and 40% fixed income is going to give up 12% in the equity portion.

I'd rather be more tactical about it myself (being less exposed to equities with some buying power when markets hit their lows), a little less painful and a lot more calming, to say nothing of getting more invested with better value.

That is the way we like to invest our personal portfolio's and we sleep well at night. We started High Rock's Private Client Division to offer the same to those who wished a better alternative (than just waiting it out).

Meanwhile, keep an eye on the bond spreads.

"Retail Banking Sales Culture May Raise Risks For Consumers" (Financial Consumer Agency Of Canada)

https://www.canada.ca/en/financial-consumer-agency/news/2018/03/retail-banking-sales-culture-may-raise-risks-for-consumers.html

There it is friends: the institutions that you have come to believe in and put your trust in are relentlessly trying to take advantage of you.

"Retail banking culture is predominantly focused on selling products and services, increasing the risk that consumers' interests are not always given the appropriate priority"

The culture of growing the bottom line with fees and commissions on the backs of their clients wealth is very simply, a conflict of interest. 

When the independent financial advice firm where I worked (as a branch manager and advisor) from 2005 to 2011 was taken over by a bank, we (myself and my colleagues) went from a client-first culture to a shareholder-first culture: were told in no uncertain terms that the shareholder out-ranked the client. Of course: client fees went directly to the bottom line and eventually to the dividends paid out to shareholders and the CEO was rewarded when the share price of the bank went up.

for example:

https://www.newswire.ca/news-releases/national-bank-reports-its-results-for-the-first-quarter-of-2018-675383613.html

Wealth Management:

• Net income totalled $120 million in the first quarter of 2018, a 21% increase from $99 million in the same quarter of 2017.
• The 2018 first-quarter total revenues amounted to $441 million compared to $397 million in the same quarter of 2017, a $44 million or 11% increase driven by growth in net interest income and in fee-based revenues.

If the conflict of interest here is not obvious, I am not sure what is. 

Fiduciary responsibility to clients cannot be present when the clients interests are not put first and foremost. 

At High Rock we have a Voluntary Code of Conduct that very specifically outlines our dedication to our clients interests. You will not find this in the culture that is outlined in the Financial Consumer Agency of Canada's report.

Every week we see the "aha!" moment when a new client signs on and experiences the vast difference in culture that we offer. We are not commissioned salespeople, we are a portfolio management company with expertise in financial planning, wealth and portfolio management. 

Of course we charge a fee, but we would challenge that our fees are at the low end of the spectrum and they are absolutely transparent. 

We have exactly the same safety features (Canadian Investor Protection Fund, CIPF, through our Raymond James Correspondent Services custodian) that you would have with a bank.

As I say over and over again, there is an alternative to the traditional bank investment advice offering and we (my business partners Paul and Bianca) think that what we offer is head and shoulders above the rest: low cost, fiduciarily responsible, personal and family wealth and portfolio management with high levels of service and communication.

Nothing to lose, all to gain.

US Economy Raging?

"The economy is raging, at an all time high, and is set to get even better" according to President Trump.

This morning, US retail sales, as reported by the Commerce Department, notched their third consecutive month to month decline:

https://www.bloomberg.com/news/articles/2018-03-14/u-s-retail-sales-unexpectedly-fall-for-third-straight-month

In the US, interest rates are rising and it is widely expected that they will be increased by another 1/4% next Wednesday following the US Federal Reserve's Federal Open Market Committee (FOMC) meeting to determine the course of monetary policy (and possibly another 2 or 3 times in 2018).

It is required of these folks to do this "in accordance with its mandate from congress to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy".

As we mentioned on our weekly video, the US economy is pretty close to full employment at 4.1% (latest data from last Friday).

Historically, just before a recession (blue shaded area), unemployment reaches its lowest point (top of the economic cycle). When it starts to move higher, intersects with the 3 year average and passes through it, a recession usually begins.

A client, obviously with way too much time on her/his hands (humour) actually watched our weekly video and asked for the "narrative" behind the statistical correlation, so here goes: 

This situation tends to happen as a response to the US Fed raising interest rates, which is intended to slow the economy (and the prospect for future inflation) and which historically has lifted the unemployment rate.

In the current debt-laden (record household debt) economy, rising interest rates will increase the amount of money required to service that debt and give the consumer less purchasing power. The consumer is 2/3 of the US economy. Three months of declining retail sales may just be telling us about the state of 2/3 of the US economy (especially in light of the purported benefit of the US tax cut). When the consumer stops spending, inventories rise and businesses have to slow production. This increases the potential for layoffs and the possibility that unemployment rates will start to rise. Add in what also might be an unwanted impact (more unemployment) of protectionist trade policy. So we circle back to the history of unemployment rates and recessions.

As portfolio managers, we have to make some determinations as to how best allocate assets to our clients (and our) respective portfolios. We try to use a number these indicators of the state of the economy to get a handle on where we are in the economic cycle and by virtue of that, which assets might be vulnerable.

Historically, stock markets don't like recessions. As stocks have become relatively expensive over the last couple of years, they are likely to be more vulnerable, especially at this late stage of the cycle. That would indicate to us, as portfolio managers, that despite the emotionally charged equity market environment, being fully invested in equity assets may not be especially prudent.

As for the latest on the US economy in the 1st quarter of 2018 (following today's retail sales data): Growth  is expected to be only +1.9%

Raging? I don't think so.

The Case For Other (Non-Correlated) Assets

Despite the fact that stocks (especially US stocks) have been in a bull market since 2009, we were reminded in the first week of February that, as an asset class, there is vulnerability to the potential of severe price swings.

If they can go up dramatically, they can also go down dramatically. Some folks are willing to take on that kind of risk, but others are not so comfortable when they look at their portfolio give up 5 or 6% over the course of a week.

And there may be more of it to come:

A 40% correction according to the co-President of JP Morgan: 
https://www.bloomberg.com/news/articles/2018-03-08/jpmorgan-s-pinto-sees-40-percent-correction-in-equity-markets

As human beings we are conditioned to be very happy as long as things are going positively. When it turns and goes in the other direction, we tend to not be so thrilled. Some folks look at their portfolios daily, which is akin to driving with your nose pressed against the windshield, but they just can't help themselves.

Certainly it is good to have equity assets for growth purposes, but a balanced portfolio (with other asset classes) that are not correlated with equities will help alleviate the potential for the sleepless nights that accompany stock market volatility and the inevitable down-turn (markets just don't always go in one direction, they cycle, it is just natural).

So being a little less dependent on equities may be a necessity if you are going to want to continue to get growth when the downturn comes. It may have already begun.

The historically natural offset to high risk equity assets has been to balance them with a collection of high quality government and corporate (investment grade bonds). However, low interest rates have made those correlations less and less realistic (especially as inflation concerns, which erode the value of bonds, are climbing).

We at High Rock have found some alternatives over the last couple of years (because, surprise! we think that stocks are expensive) in other non-correlated assets for our clients: a collection of Canadian High Yield bonds that have had a better than 14% average annual return over the last couple of years, with less than half of the risk associated with stocks and an opportunity in preferred shares that brought a one year return of better than 20%. All of our clients have participated in these in some manner, depending on the structure of their asset allocation strategy (based on their goals as set out in their Wealth Forecasts).

And, no surprise, our client portfolios did not experience the heart-wrenching swings of traditionally balanced portfolios in that crazy first week of February.

Always remember that past performance does not guarantee future results, but at High Rock we work darn hard to provide our clients with the best possible risk-adjusted returns.

When stocks are sliding, you are going to want to have some other opportunities to rely on. When traditional bond assets don't provide it, what are you going to do to continue get growth?

Financial Advice Or Portfolio Management?

There Is A Big Difference, Did You Know?

Most of it lies in the obligation that the advisor owes to the client:

The Investment Industry Regulatory Organization of Canada requires the advisors under its registration (a Registered Represenatative) to provide a "duty of care" to their clients. 

Most of that falls under the "know your client" rule. In essence this means that an advisor, when they sell you a stock, bond, Mutual Fund or ETF (and they are selling it to you, so they are in fact salespeople) must be able to determine if the investment is suitable for you. That is the extent of it. Once you own it, the responsibility shifts to you, the buyer / owner of that investment.

If that investment should become unsuitable at anytime following the sale of it to you, ultimately the advisor can avoid responsibility for the sale of that investment by claiming that it was suitable when you bought it.

That is something that can be a pretty horrible experience for you if you get blindsided.

A portfolio manager, who has discretion over the portfolio of the investments that she/he purchases on your behalf, has a much deeper level of responsibility. They have a legal fiduciary duty to make sure that the investments you own continue to be suitable. That is a very big difference.

A portfolio strategy, therefore, must be based very specifically on your personal goals, timelines and ability or desire to take risk and how much risk is relevant for you.

More importantly, this requires regular monitoring and review of your circumstances and strategic adjustments should they be required.

Equally important, especially for us at High Rock, is that we have no conflicts of interest: we invest our money in the exact same assets as our clients and we are not commissioned salespeople. So we always put our clients interests first, ahead of our own.

A portfolio manager may not necessarily be licensed under IIROC. In fact, from my own personal experience, it is considerably more difficult to become a licensed portfolio manager under the Ontario (or other provincial) Securities Commission than it was under IIROC. 

Click on this link: https://www.securities-administrators.ca/nrs/nrsFirmSearchResults.aspx?mode=QS&type=F&firm=High+Rock+Capital

The real question becomes (now that you are aware of the difference): Why would you want less, if you can have more? Especially if it doesn't cost more. In fact, I think that you will find with High Rock, we are comparatively cheaper than most advisors and other portfolio managers (relative to the level of service and competence that you get).

Something to think about.

A Tough Month For Global Stock Markets

And It Is Not likely The End Of It

All Red (negative) for the month of February (on the right above, circled in blue). We have not seen that since the beginning of 2016.

So where do we go from here? 

More selling than buying, with some huge swings in prices in relatively short periods of time, has lifted volatility levels. Technically, the inability of the market to return to its highs will mean that traders will likely experiment with price exploration and discovery to the downside (barring any significant development to the contrary) until they find the levels that buyers are comfortable with. Last time it was at around 2530 to 2550 on the S&P 500 (200 day moving average).

Higher volatility, historically, can signal the end of one trend and the beginning of the next. Until that yellow line in the above chart is breached by more buying than selling, the short-term price trend will be to lower highs and lower lows and better value for making purchases. 

The smart money will likely be patient to see what develops.

Fundamentally, US stock prices have way outperformed the economy for the last 8 or 9 or years (as a result of easy monetary policy and excess liquidity in the financial system).

And that has made valuations (Price to Earnings Ratios) expensive.

Either stocks need to get cheaper or the economy (and earnings) needs to accelerate, alot. Even GDP growth of 3% will not push the economy up to the lofty levels where stocks have gone. 2018 earnings have already built in an 18% growth rate into 12 month forward looking P/E ratios (above) .

The latest US data suggest that tax reform has boosted US incomes and consumer confidence, but in January the consumer was not buying, especially durable goods. As I suggested in my blog on Tuesday, the specter of rising interest rates may just be beginning to take its toll on very debt burdened households. 

Higher employment costs may also come in to play in the earnings equation (revenues minus increased costs). Something that will need to be monitored.

While stocks were looking for buying support through February, bouncing all over the place with the increased volatility (and ending significantly lower on the month), High Rock Private Client portfolios were flat to slightly higher, but not experiencing anywhere close to as much volatility.

And always remember that past performance is no guarantee of future returns. However, at High Rock we work darn hard to get the best possible risk-adjusted returns over the long term for our clients (and ourselves)!