Oh October!

There is a sea of red for global stock markets this month (far right column). The benchmark All Country World Index (ACWI) ETF is lower by about 10%.

If you are fully invested in a 60/40 globally diverse and  balanced portfolio and dare to look, your equity portion is likely going to be down about 6% (60% of -10%). 

Meanwhile, the 40% Fixed Income portion (as measured by the Canadian bond index (XBB) ETF is little changed:

So you are not getting much protection from bonds. 

If you have some cash / cash equivalent / short-term maturity securities (t-bills or bonds) as our High Rock portfolios have, you have spared your portfolio and yourself some duress. 

In fact, while the stock markets were falling precipitously yesterday, we were picking up some significantly cheaper assets with a little bit of that cash that is in our portfolios. Nothing huge, but just picking away at better value assets.

Interestingly, in the same month that Cannabis became legal in Canada, The Bank of Canada suggested in their October Monetary Policy report (released yesterday) that "the outlook for the global economy remains solid" and felt not only justified in raising interest rates by 1/4%, but indicated that they might be prepared to continue a more aggressive tightening of monetary policy going forward. This left some strategists / analysts wondering if the BOC folks had been enjoying some of those newly legalized treats.

As for the year of 2018 to date, as at the close yesterday, even U.S stock markets (except for the NASDAQ) went negative (far right column):

The All Country World Index (ACWI) ETF has returned a close to -5.5% return:

XBB has added about a -0.75% return:

So a fully invested 60/40 portfolio (year to date) is going to be lower by approximately -3.55% so far in 2018 (don't forget to factor in fees, if you pay them) Most portfolio managers charge between 1 -1.5%. Mutual fund MER's at about 2%, give or take and your fully invested balanced portfolio may be down between - 4.5 to -5.5%.

If it is not, it is because there is some defense built into your portfolio. That is, as they say, is a good thing.

Despite Subdued Inflation,

The Cost To Finance Your Debt Could Be Going Higher On Wednesday

Statistics Canada released their latest reading for the Consumer Price Index last Friday, which fell from 2.8% in August to 2.3% in September. Most of the move was in gasoline prices which shot up last September (2017) following hurricane Harvey, and are no longer being part of the full year equation. Transportation costs were up 3.9% over the 12 months since last September vs. the 7.2% increase recorded over the 12 months that ended in August:

Most of the modified CPI data that the Bank of Canada follows is now at or about 2%, year over year, right at their target.

But the Bank of Canada appears ready to push interest rates up by 1/4% on Wednesday, as "business prospects appear to be robust" from their most recent Business Outlook Survey and the resolution for NAFTA / USMCA takes some uncertainty out of the outlook for economic growth going forward. This despite reports of slower Canadian retail sales and wholesale trade for August.

Bank's prime lending rates are likely, then, to be pushed within a hair of 4%. If you have variable interest mortgages or lines of credit based on prime, you will be paying more to service your debt. 

If you borrow to invest, the costs are going up too. 

There is a reason that investors are selling assets (stock and bond markets are lower),  and that is that the cost to borrow to invest in those assets is rising and sellers are taking risk off the table because they no longer are comfortable borrowing against assets with falling prices. 

Leverage multiplies the losses on the way down as much as it does the gains on the way up.

Friends, when interest rates go up, pay down your debt as much as you can (and take risk off of the table). It is a simple signal and one to be taken at face value. We (at High Rock) have seen all of this before, a few times in fact. It is part of the late stages of the economic and investing cycle.

Investing vs. Gambling

Last week we met with one of our private clients who happens to be in the medical profession. She had been approached by an advisory group who was promoting an investment opportunity in "a privately held medical radioisotopes supplier and

oncology drug developer positioned at the core of a novel

and exciting development in the treatment of cancer" out of Germany.

Very exciting!

For me (and Paul), however, red flags popped up immediately!

After reading through all the material we came to the conclusion that you would at least need a PhD. in medical bio-physics to understand most of what was in the specific details. I actually have a daughter who has a Masters degree in medical bio-physics (another story for another day).

Then there was the very long list of risks involved (which at p.13 of 20, after all the positive stuff, they did get to):

"The Fund is subject to a variety of risk factors, including reliance on a limited number of suppliers of raw material (also see below “Supply Chain Risks”), limited number of suitable nuclear reactors for the processing of its core products (also see below “Supply Chain Risks”), the result of its clinical trial(s), the protection of its intellectual property, the development of competing technologies, execution of its growth strategy, reliance on key personnel and potential lack of liquidity events, as well as economic conditions, epidemiological condition, government regulations, market risks, acquisition risks, credit risks, uninsured losses, debt financing, foreign currency and interest rate risks and secured financing. An investment in X has higher risk that typically cannot be valued by normal fundamental criteria. An investment in X may result in material loss. There is no assurance that this investment will be successful and you should discuss the suitability of this investment for you with your own professional advisors. No advance tax ruling has been sought or obtained in respect of the Fund. Tax laws and the Canada Revenue Agency’s administrative policies and assessing practices may change over time, and it is possible that the Canada Revenue Agency may disagree with the tax positions adopted by the Fund from time to time."

Yikes!

We also know from experience that many of these early development situations require lots of new cash to continue through to the eventual (hopefully it gets there) point of driving positive cash flow back into the company.

We have seen many situations where a new company may have to raise more capital three, four or more times just to get them to the starting point. In the meantime your early investment continues to get watered down to the point where you just hope you can get some or part of your money back. But you have to wait because there is no liquidity.

You may get lucky, but the odds are pretty much like buying lottery tickets (each of these types of investments being equal to one lottery ticket): the more you buy, the better are your chances, but you may need fifty before you hit one.

That my friends, for most of us, is just pure rolling of the dice. If you have very deep pockets (or even some deep insight), you may one day cash in, but for those of us with just our retirement savings to work with and families dependent on us for the future, we have to take way less risk as we work toward our goals.

As Paul quite succinctly put to me after looking at this "opportunity" closely: "In summary, not in this universe, or the next, would I invest $20,000 (or even $2500) in something like this. I would rather donate the money to a charitable cause I believed in more than this."

Our goals. We need to keep sight of our goals.

Back to our medical professional client whose immediate goals are tied to providing a healthy and active home life for  her children with a decent education and then her eventual retirement as she winds down her career.

Blowing up in a get-rich-quick scheme would put a hefty dent in the progress toward her goals. Oh and by the way, the advisor selling this "opportunity" was going to get paid a cozy 5% up front for his troubles. "Up front" in the investment advice world means that once you, the buyer, are deemed suitable (for the risk), and sold on the deal, there is, at least in the Canadian investment industry, no fiduciary responsibility put on the advisor beyond the initial sale.

You are on your own. With all the risk.

Getting to your goals is not going to come from a quick and easy deal, it is going to come from a long process of patient saving and investing with the stewardship from those (like us at High Rock) that understand risk, understand your goals, create a disciplined strategy for getting to those goals, try to keep your costs as low as possible, provide regular reviews of your progress and have the legal fiduciary responsibility to ensure that you are protected along the way.

It takes a long-term perspective: our client in this case, has another 50 years or so to spend and survive on this planet  and she needs a long-term plan to take her to her goals.

Volatile Stocks And No Help From Bonds

For the year to date, 2018, the All Country World Index (ACWI) ETF ($US) is down by -1.5%. So if you have a globally diverse portfolio (and don't forget the ACWI has a little more than 50% U.S. companies), all of a sudden things are not looking so good (the S&P 500 is positive by about 4.9%, so far this year).

If you are fully invested in a balanced 60% equity portfolio, you are going to be down on the year at the moment, by about -0.90% (-1.5% X 60%) in the equity portion.

Your bond portfolio (the other 40%, if you are fully invested), if we use the Canadian Bond Index ETF (XBB) is also lower:

Year to date, 2018, it is lower by -1.16%, so your bond portion, which traditionally is supposed to balance things out (equities down / bonds up), is not helping. The 40% bond portion of the 60/40 is lower by about -0.46%.

Put them together and you have a fully invested portfolio that is lower on the year so far by about -1.36%. Time to call your advisor and find out how you stand. Likely, she / he will not be calling you!

If you have an over-exposure to Canadian equities, which is called the "home country bias", that is likely going to push you further into the red as the S&P TSX is lower by close to -2.5% this year, so far.

So my friends, being fully invested this year, so far has not been friendly to a traditionally balanced portfolio.

If you are stuck in mutual funds, add an additional 2% MER or so on top of that and it really starts to get negative.

Having some exposure to cash equivalent High Interest Savings funds at or about 1.6% (annual interest) certainly helps take out the sting of negative portfolio performance. If you have some U.S. short-term Treasury notes at or about 2.5% (as we do at High Rock Private Client), it helps take a little more of the sting out.

You see friends, you can sit in a fully invested, globally diverse and balanced portfolio and ride the swings of volatility or you can find subtle ways of limiting the swings and have ammunition to utilize lower prices as they occur. The advisor types that tell you to remain calm while they sit and watch these swings in your portfolio and distract you with other issues are not really working so hard to earn their fees. Same with the "Robo" world.

On the other hand, those managers that are preparing your portfolio to deal with greater levels of volatility by adjusting the portfolio mix are definitely earning their fees and it will come out as such with better long-term performance over time.

Less downside, more potential upside, smaller swings in portfolio value and better risk-adjusted returns over the long haul. That my friends is what will get you to your goals.

Trump, Higher Rates, U.S. Stocks

Yesterday U.S. President Trump told the press that he thinks that the U.S. Federal Reserve is raising rates too fast. He may be right.

On Monday, the International Monetary Fund (IMF) lowered its outlook for the global economy in its World Economic Outlook: 

Note the expectations for global growth in Advanced Economies (red line) as it declines beyond 2018. 

According to the IMF: "Global growth is forecast at 3.7% for 2018-19, 0.2% point below the April 2018 WEO projection, and is set to soften over the medium term. Global financial conditions are expected to tighten as monetary policy normalizes; the trade measures implemented since April will weigh on activity in 2019 and beyond; US fiscal policy will subtract momentum starting in 2020; and China will slow, reflecting weaker credit growth and rising trade barriers."

Financial conditions are expected to tighten as monetary policy normalizes: that means higher interest rates. The ones that Trump is not happy about.

Higher interest rates will draw liquidity out of the financial system and much of the stimulus that has driven U.S. stock prices higher over the past several years will no longer be there. In order to raise liquidity, institutions both public and private will need to sell assets. Likely they will start by selling the most expensive assets that they own. Those may happen to be U.S. stocks.

President Trump has frequently used the U.S. stock market as the gauge for his policy success, so he obviously does not want to see the U.S. stock market fall, as that would, in his way of thinking, paint his policies in a bad light.

As we have said (ad nauseum) this (higher interest rates and monetary policy tightening) is very typical of the late stages of economic expansion and usually at about this time, the U.S. Federal Reserve pushes a little too hard on the proverbial "brakes". This may be what president Trump is referring too. 

They pushed a little too hard in 2007, before that in 2000, 1989 and 1980. In fact every recession begins with the Fed raising rates.

The IMF forecast is taking this into consideration as well and that the recent bump (from tax reform) in U.S. fiscal stimulus will come to its end.

Time to make sure that your portfolio is prepared to withstand what the post-expansion phase of the economic cycle may have in store. High Rock Private Client portfolios have been prepared.

"By failing to prepare, you are preparing to fail" - Benjamin Franklin

Political Positioning And Headlines = Noise

The new NAFTA, now called the USMCA (United States Mexico Canada Agreement) agreed upon at the last minute late yesterday will bring a sigh of relief (at least temporarily) for the Canadian economy and the C$. U.S. president Trump will claim a victory, although other than a change in name there are relatively modest changes to the agreement. Better, however, than the alternative of no deal.

Despite a slightly better than expected July (that was months ago, but we don't seem to be able to put economic data together more quickly in this country) GDP reading, there are still multiple concerns facing the Canadian economy: primarily how to be more tax competitive with the U.S. and retain important businesses that are motivated to move south.

The Bank of Canada may now believe it has room to raise interest rates by another 1/4%. That will make the debt-heavy household and the housing market pause for reflection.

The "reality TV" show that is U.S. politics captured many last week and this is far from over. Up next will be the U.S. mid-term elections and the results could be telling: a better Democratic showing in congress and / or the senate may cause further upheaval.

In the meantime, behind the noise, the most recent economic data in the U.S. shows some mild slowing:

Further, U.S. debt and deficits are rising as are interest rates and recent consumer spending (with household debt at record highs) may likely be feeling it.

The reality of it all is that, as I have suggested on numerous occasions over the last few months, the economic expansion cycle is, as they inevitably all do, drawing to its end. The timing is not exactly specific, but it is best to prepare for its eventuality.

Expect more noise on the political and global trade front in the time being, but we will be closely watching what is happening behind all this and as a result how best to position our and our private client's investments to minimize the impact of potential volatility and maximize opportunities for long-term growth.