U.S. Mid-terms Out Of The Way

What's Next?

Global equity markets have clawed back from their October lows. We can expect to see some relief buying (upper gold circle on the above chart) in the near-term, which will be well received by investors who watched their portfolios take the big tumble. It could very well take us to the end of the year for those who use that time frame to mark their annual portfolio growth progress. The big equity portfolio managers will be doing their best to show something positive in what will end up being a pretty lackluster year.

The U.S. Federal Reserve will likely raise rates another 1/4% in December. This will once again reduce liquidity in the financial system and push debt service costs even higher,  further slowing the U.S. and global economy. So one should not get too comfortable with slightly better equity prices and prepare themselves for a rough first half of 2019 on that front (a re-test of buying support to the lower gold circle or even the long-term bull trend-line on the chart).

We at High Rock do our best to keep our personal politics in check for investing purposes (politically agnostic) so that we can take a less emotional perspective of the current economic environment. 

That being said, bond markets might now worry less about any further U.S. fiscal stimulus with the Democrats having control of the House of Representatives and doing their utmost to keep President Trump in check.

There is still an ever increasing deficit from the tax cuts to fund because tax receipts are not keeping up with spending outflows  despite the economic growth of the 2nd and 3rd quarters. The 4th quarter looks like it is going to come in somewhere between 2.5% - 3.0% annualized GDP growth (at the moment).

That will lower inflationary expectations and bond investors will likely demand less of a premium for longer-dated maturities, taking the yield curve back to a flatter position. The 2 year to 30 year spread differential has narrowed by 5 basis points (from .50% to .45%) already this morning.

This may spell some temporary relief for fully invested 60/40 balanced investors, but it is likely only temporary. Fully invested in equity portfolios are likely going to run into some turbulence again in the new year.

Cash or cash equivalent investments (and under-weight equity positions) are going to take some of the sting out of further equity market volatility in 2019 as will some broader diversification into other non-correlated asset classes.

At High Rock we specialize in Canadian High Yield Bonds (C$HY) and my business partner and colleague Paul Tepsich may well be one of Canada's foremost portfolio managers in this asset class. All of our High Rock Private Clients have some exposure to C$HY for purposes of diversity and it has been one of the best performing asset classes through 2018.

On a risk-adjusted return basis (return per unit of risk) it has been one of the top asset classes over the last 10 years and unlike government or corporate investment grade bonds has little if any correlation to interest rates:

Diversity (and until we get to the next economic cycle), a reduced exposure to equity markets and perhaps more cash equivalent assets in their place are going to save you some soul searching and nail biting and help you sleep better at night.

As always, past performance is not a guarantee of future returns. Although at High Rock we work darn hard to get our clients the best possible risk-adjusted returns over multiple years.