RRSP Myths And Misconceptions

If you have a financial plan, then you will not be fretting about the deadline because you will already have (or have not) made your contribution.

If you don't have a plan, best get on it. But don't come to us now, Bianca (our Certified Financial Planning, CFP, professional) will kill me, she is already dealing with a bunch of last minute issues.

1) You are not "buying" an RRSP. You are contributing to your RRSP account. The contribution you make can be invested in a number of different assets. If your bank advisor tries to sell you anything, run away. Or better yet, seek out Larry Bates' best selling book Beat The Bank.

2) If you are doing it last minute (you have 4 days left), go to where you already have an account open and make your deposit/contribution to get your tax deduction. You can leave it in cash for the moment (i.e. you don't have to "buy" anything or even invest it in anything immediately). When you have determined (if you come to High Rock, Bianca will be willing and able to get you started, but after the March 1 deadline is past), via your plan, what the best strategy is for investing the cash and when.

 3) You can find out how much room you have by checking your 2017 CRA notice assessment (or go online here).

4) The folks at Questrade did a recent survey that turned up some interesting tidbits, have a peak: it still blows us away at how misleading the big banks and investing institutions can be and what passes for a their attempts at pushing their versions of financial literacy on the unsuspecting public.

5) Most important of these is that you can transfer your RRSP simply and easily without any tax consequences. For example, if you like Bianca's plan for you and want High Rock to manage your RRSP investment strategy (with fiduciary responsibility), we simply prepare and have you sign a form that authorizes Raymond James (our custodian for client accounts) to transfer your account to your new or pre-existing RRSP (that is under High Rock management). The institution that, at that particular moment, holds the RRSP is then legally obliged to send it (unless they can convince you to change your mind, and they may well try with all sorts of methods and tricks, believe me I have heard it all: right down to the besmirching of my character! The nerve of some advisors!) within 10 business days. They may charge a "transfer-out" fee, but we always reimburse our clients for those. You don't even have to have that uncomfortable conversation with your former advisor (as per the Questrade adds you may have seen on the TV).

6) According to the Questrade survey: 2/3 of Canadians tend to either choose a mutual fund or a savings account to use as their RRSP investment vehicle. Yikes! There are so many other, less expensive or more advantageous ways to invest. 

There are alternatives to the banks! And like High Rock, they are less costly, offer high caliber service (in High Rock's case including financial planning that may other-wise cost $2,000 and up with a fee for service planner) and fiduciary responsibility, well beyond what you can get from your bank / financial institution.

We need to talk it up out there friends!

(Bianca gets a big assist for this blog!)

False Sense Of Security In Equity Markets

While the economic data continue to point to a global economic slowing and possibly a recession, global stock markets (above chart is the All Country World Index ETF) have had a resounding start to 2019.

Why?

The meltdown of stock markets in December of 2018 not only put fear into investors who liquidated equity mutual funds in record numbers, but also into central bankers. The US Federal Reserve did a quick about-face in their interest rate policy commentary (from tightening of monetary policy to a neutral stance) in a heartbeat. Other central bankers around the world were quick to follow and it filled investors with a sense of hope, enough so that they bought back in to equity markets. However, the volumes of trade have been underwhelming, which is one reason to render caution. Although it appears on the surface to be a catalyst, central bank mandates do not include stock prices, only the levels of inflation/deflation and in the US, the level of employment (which at the moment hardly warrants easier monetary policy).

An eye-opening decline in US retail sales in December (released on  February 14th due to the US government shutdown) caused big revisions in US Q4 GDP:

In the current stock market mentality, this is looked upon as a positive, because it further removes any concerns that the US Federal Reserve will go back to raising interest rates.

But, the bond market, which historically leads all other financial markets, is now warning us of the slowing future economic situation (lower yields, higher prices):

Needless to say this has been great for our balanced portfolios that have seen an almost full retracement (depending on your allocations) of the damage imposed on portfolio values in the final quarter of 2018 (bond prices higher and stock prices higher).

History will tell us that this is not the normal correlation between stocks and bonds and that at some point this situation will re-adjust.

Expecting further deterioration in the global economic picture (per the bond markets) and no real easing (yet) from central banks (as it has just all been an aural soothing for stock market investors thus far: all talk and no action),  and if, as expected, the earnings picture continues to deteriorate (with a slowing economy), there will not be much for stock investors to be so confident about.

Volatility is not over, in fact we suspect that December was a preview of what is to come further down the road. Volatility will bring value, in time. Patience will reward those who are cautious.

Stock Prices And Earnings

We invest in stocks to participate in the growth (and dividend income) of the companies who's shares we own. Earnings growth is a key component to any company's future value. As we who spend our time monitoring this kind of stuff (to determine if there is value in ownership at current share prices) are want to do, we are inherently more interested in what is in store down the road as opposed to what is already historical information, because we want to build a sensible case for buying whether it be now or at some future point in time.

So we cast about in the available data to attempt to come up with some reasonable way to determine relative value. 

In the chart above, the dark blue line represents the expected future (12 months) earnings per share of the companies that make up the S&P 500 index. The lighter blue line is the composite of the companies' share prices.

Back in the after-math of the 2007-2009 recession, shell-shocked investors, somewhat reticent to take on the risky ownership of stocks again, had to be convinced that earnings growth could be sustained, so there was more of a "show me first" mentality: earnings had to lead share prices higher. Bravery was rewarded with some pretty decent returns until 2015.

As is the normal human reaction, those who joined the party well after it was in full swing (with many advisors shouting the rally cry of 7% returns for balanced portfolios as a layup, without the required disclaimer that past returns were no guarantee of future growth), created a buying spree from mid 2014 that drove share prices past the expected future earnings (light blue line intersects and overtakes the dark blue line), rendering share prices rather expensive on a relative basis. 

Late in 2015 a realization of over-valuation brought about a correction of share prices and a return to relative value. The light blue line fell back to the dark blue line then and again in early 2016 and with it all those portfolios that had been late to the party, suffered.

Donald Trump came to the rescue with promises of tax reform, infrastructure spending and deregulation and stock prices took off in 2017. 

The problem? Stock prices just built in too much good news and stayed expensive relative to earnings. Earnings did jump higher in early 2018 (as tax reform gave them a temporary boost), but stock prices stayed well ahead with investors believing that it would all go on forever! Not so with the drop in share prices in December back to reasonable value.

Now we are seeing earnings growth expectations rolling over (dark blue line turning down inside the red circle on the chart above) and below:

But share prices have bounced back to lofty (relative to earnings) levels. Which means that buyers are still active. Until they are not. History will tell us that what is expensive will not remain so for very long.

What We Worry About

On Tuesday's monthly High Rock video for our private clients, we discussed the probability that we put on a test of the long-term bull-market trend line that extends back to 2009. We also talked about what happens if not enough buying emerges to provide support for that trend line. We feel that this justifies an under-weight equity / over-weight cash equivalent (low risk) position in our global equity model.

Many more passive oriented advice givers might suggest that this in the longer-term outlook is just short-term noise. I cannot argue too much with that view, because after all, our view is also longer-term for all of our clients (and ourselves) because, on average, our financial plans (at High Rock, we call them Wealth Forecasts), which are crucial for determining asset allocation strategy, extend between 20 and 40 years into the future.

We just feel that being fully invested, at this late stage of the economic cycle is going to put some short-term pressure on the portfolio. December 2018 was the worst month for stocks since 1931. January 2019 was the best month for stocks since 1987. The very astute David Rosenberg constantly reminds us of what happened following the great January 1987: October of 1987, "Black Monday" (for those of you too young to remember, it was a big stock market crash of some 22%).

Are we 100% certain of this pull-back in stocks? No. Otherwise we would be 100% in cash equivalents in our global equity model. But the economic evidence for a slowing or even a recession around the globe is mounting, daily. It would be highly unlikely to have a recession without some downward pressure on corporate earnings, which does not bode well for stock markets (despite whatever position central bankers take).  Higher interest rates on record amounts of global debt are already taking their toll with more expensive costs for servicing that debt. So we are comfortable taking a prudent approach to the holdings in our portfolios.

If you are fully invested in a passive ETF portfolio, you will survive the next recession: even through the financial crisis of 2008, most balanced portfolios returned to positive performance within a year and a half if left untouched. If you can live with the negative portfolio performance until we get through the next recession, stay the course.

However, our clients pay us (but only slightly more than a robo-advice portfolio manager) to get them better than the benchmark index returns and certainly better risk-adjusted returns (return per unit of risk taken). So we need to be constantly looking for better than passive investing opportunities.

Having cash equivalent assets allows us to take advantage of these potential opportunities that our experience tells us will happen (eventually), if we are patient. 

But we also worry about investors who are paying fees (either in a fee-based account or worse, in a collection of expensive mutual funds) for passive portfolios that are fully invested, because while markets may go down, you will still be paying fees to your advisor and / or mutual fund manager (MER). That means a longer recovery period.

If our High Rock portfolios go down, as they did in December, they bounce back more quickly: they were higher at the end of January than they were at the beginning of December. They did not go down as far as a fully invested, passive portfolio in December, so they recovered faster in January, even though stock markets did not get all the way back to neutral. 

When our portfolios go lower with the next tests of buying support, we will have buying power. When they get more fully invested with lower priced assets, the recovery will be significantly quicker than the passive portfolio. So we will earn our fees (which passive advisors will just sit back and collect).

This is the value that we add. Part passive (what remains invested), part active (what is now cash equivalent). Earning our fees. In the long-term this will put our portfolios ahead of the completely passive portfolios, if you value our experience and expertise (and our Wealth Forecasting, inclusive in our fees, but with a value of between $2,000 - $3,500 which a fee for service financial planner would charge).

The point being, that, if you have a passive portfolio, why are you paying for it?

U.S. Unemployment Rate And Recessions

Today's release of the U.S. employment situation by the Bureau of Labor Statistics revealed a bigger than expected jump in the widely watched Non-farm payroll report of 304,000 new jobs registered in January. Buried deep in the report was a significant downward revision of December's number by 90,000 (from 312,000 to 222,000). This is just a reminder that this monthly data can be subject to big swings and should likely not be considered as important as they are sometimes made out to be.

Nonetheless, what we watch more closely is the unemployment rate, which moved higher, to 4%. It was influenced, slightly, by the U.S. government shutdown. However, what is important, as I have pointed out many times in past blogs, is that the when 36 month moving average (gold line in the above chart) and the actual rate of unemployment (white line) intersect, it has historically signaled recession (blue area). The gap there has narrowed now to 0.3% as the unemployment rate has risen in both the December and January reports.

This is clearly the end of the economic expansion cycle that began in 2009 and we should all be prepared for slowing of economic growth on a global scale.

Normally, when the U.S Federal Reserve changes its bias from tightening monetary policy (raising interest rates) to easing monetary policy (lowering interest rates) there is about a six month lag to the beginning of a recession. The Fed has clearly changed its bias (as of this week). Synchronize your watches and keep an eye on the U.S. unemployment rate for the next couple of months. Caution rules.