Bank Of Canada Didn't (But Perhaps Should Have) Cut Rates Yesterday

The Bank of Canada remains hopeful that current levels of employment and future income growth will pull the consumer out of its current doldrums (BOC April Monetary Policy Report). The consumer (consumption) accounted for about 67% of GDP growth in 2018 (see table above). For 2019, the BOC forecasts consumption growth of 0.9% and GDP of 1.2%, which looks like it is asking consumption to grow to be 75% of the Canadian economy (to offset the negatives from Housing and Business Fixed Investment).

Yet Canadian households currently (as mentioned in Tuesday's blog) are seeing their debt burdens growing at a faster rate than their incomes. Without a rate cut, it is hard to see the already stretched households carrying the Canadian economy through 2019.

The BOC says they will be "data dependent", which means that they will act if economic data should undermine their forecast.

However, their forecasts from January (above table, numbers in parentheses) have all been revised lower. It's not their fault, it is the global economy and trade uncertainty that have confounded previous attempts to forecast better times. Not to be outdone, they are still forecasting better times and not giving in to less optimistic views.

Bond markets cast their votes with a rally in the 10 year Government of Canada bond that pushed its yield back down to be close to level with the 3 month Treasury Bill. That my friends is what we call a "flat" yield curve. That happens when short-term interest rates (those which are under the control of the Bank of Canada) are pushed higher while at the same time demand for the safety of long-term bonds (on the back of economic slowing) drives yields lower.

If economic data (in the future) continue to add to demand for the safety of Government of Canada 10 year bonds, yields may in fact move lower. That, my friends, is what we refer to as an "inverted" yield curve. There has been lots of discussion around this inverted yield curve scenario (and its relevance in current times), but if it persists, it will likely be the result of further economic slowing and possibly recession. At which point the Bank of Canada will have to act to lower interest rates. So they will play the waiting game.

Long ago, on a wilderness canoeing adventure, in a discussion about what to expect from the river we were paddling on, my canoe mate turned to me and said : "Scotty, always hope for the best, but prepare for the worst". That has stuck with me for the last 40 years or thereabouts and has been my mantra for many things in life (including the management of my and other peoples money).

Certainly the Bank of Canada is hoping for the best.

We (at High Rock) shall to. But we will also be prepared for what should happen if, like their previous and rosier forecasts, they should come up a bit short of the mark.

Bank Of Canada Should (But Likely Won't) Lower Interest Rates Tomorrow

Canadian households (on average) now spend 15% of their disposable income on paying their debt obligations. From the chart above, however, it is mostly in the form of interest payments. Higher interest rates are the obvious culprit: 

Ironically, It was lower interest rates (driven by the mini-recession with the oil price collapse) in 2015 that ignited a round of borrowing that has resulted in the overburdened household. So it was the Bank of Canada encouraging borrowing (with low rates) and then raising rates in 2017 and beyond that punished those who took the bait.

Principal payments (top chart) have basically gone flat (no longer paying off the underlying debt that drives the interest payable). That might raise the question of whether it is better to buy or to rent (at this moment in time). Especially given the current state of the housing market. The hard lesson for Baby Boomers was that the big surge in demand for houses that drove prices higher in the 1980's crumpled in the early to mid 1990's as interest rates rose. Will the Millennial cohort face the same issues?

With $1.78 of debt to every $1 of income, budgets are tightening and consumers are as stretched as they ever have been. Incomes are not providing enough, growing annually at a very meager 2.2%. Not paying off principal debt will only continue to exacerbate the situation (falling house values against rising debt is a bad combination for the household balance sheet). Households need relief, the economy needs consumers, but the Bank of Canada is reticent to encourage more borrowing by lowering rates, despite an economy that is hovering on the verge of a slowdown that could easily turn recessionary.

What happens if / when the job market turns negative and some households don't have the resources to cover their debt payments?

Talk about a difficult spot to be in.

Weighing The Risks

On Monday the Bank of Canada issued its Spring 2019 Business Outlook Survey (BOS). The chart above tells the story: "suggesting a softening of business sentiment". In other words, Canadian businesses are expecting economic slowing. 

Confidence is down, which means that businesses will postpone investing until they see a better outlook. 

The Canadian consumer has been in retreat as well:

Retail sales fell steadily through January. We shall see the February data tomorrow (not sure why Stats Can cannot be more current), it is supposed to show signs of growth. 

But clearly, the Canadian consumer has been postponing purchases. At best the Canadian economy is in stall mode. No doubt the result of higher interest rates squeezing households and geo-political trade issues putting businesses on the defensive.

Slower economic growth on a global scale has (as I have stated in previous blogs) has put central banks around the world on alert: Both the Bank of Canada and US Fed stopped raising interest rates.

The big question in front of us: will it be enough?

Some stock market participants want you to grasp that as a resounding yes. The stock market "cheerleaders" have recovered their voices.

When it comes to my money, I am not convinced. I remain invested in stocks, of course (as do our High Rock private clients, who are invested in the exact same assets, although their allocations may differ according to their Wealth Forecasts). However, it will take significantly more than sentiment from stock market enthusiasts (momentum) to convince me to be more fully invested. Show me the value first, before I take the risk. 

Earnings are looking soft, with barely any expected growth over the next year and the relationship between prices and earnings over that period make stock prices (at current levels) look expensive:

Without strong economic growth, it is difficult to see how paying high stock prices is not an overly risk filled situation.

For our purposes, as stock prices rise, without economic growth, it actually makes more sense to take risk off of the table. Or find alternative asset classes that offer better risk / reward value. 

We are very fortunate, at High Rock to have one of the best portfolio managers in High Yield in the country (top performer over multiple years with the Canadian High Yield fund that we manage for Scotiabank, AHY.un ) and our ability to offer this same competency to our private clients becomes full of added value, especially when they can get access to this asset class at wholesale cost (i.e. no additional fees).

Less risk, more value. Better risk-adjusted returns over longer periods of time, without the very high potential for volatility that is inherent in stock markets.

Always able and willing to discuss this further.

How / What Do You Pay For Wealth And Portfolio Management?

To date, our reader survey has revealed some interesting data, but it is still open (if you wish to participate, click here to answer the 10 quick questions). We also must acknowledge that a good number of respondents are likely already High Rock private clients, so we are certainly happy to see that we are "preaching to the converted". 

From time to time, while following the news media and a number of other contributors/commentators from the world of personal financial matters on Twitter (you can follow me @JSTomenson, if you wish), I am baffled buy some of the things that I see and read. For example, last week I responded to a Globe and Mail financial columnist Rob Carrick question:

I responded with a reference to High Rock and got this response from another Carrick follower:

Why is that weird? We have a broad array of clients from a wide diversity of careers and professions all across Canada, some still working and saving, some now more or fully dependent on their savings for their lifestyle expenses.

Needless to say, the one common theme is that they are / were interested in saving and generally ensuring that they will have enough to live on for the rest of their lives and in many cases to leave something behind for loved ones or good causes.

Being aware of how and what you pay for this financial help (if you wish to have it) is extremely important.

I am thrilled to see that none of our readers pay via the Deferred Sales Charges (DSC) mutual fund avenue, where for many years advisors sold mutual funds with no upfront costs to the clients, while the advisors received a whopping 5% up-front commission plus a trailer fee from the mutual fund company. The clients were eventually dinged with hefty penalties when they sold those funds prior to a required 5-7 year holding period. Sometimes, advisors would churn these funds just to get another 5% commission, while the unsuspecting client paid the penalty for an early sale. Criminal. These types of funds were supposed to have been banned. Not yet.

However, I am not thrilled to see that 5 -15% of our readers are still unsure of how or what they pay. Friends, the costs of investing can set you back significantly over long periods of time. Please take the time to find out how and what you pay!

If you are not interested in going it alone (DIY), you should be able to get long-term planning, portfolio management, fiduciary duty and personal service (pretty big around tax time), including regular monitoring, at least semi-annual reviews for about 1%. Add custodial fees and ETF MER's and you get all in for about 1.25% (or thereabouts). At least you can at High Rock, despite some who may be more skeptical about what we can offer, likely because few out there can offer what we do. 

With our institutional division buying and selling in "wholesale" amounts, we can have our private clients "piggyback" off of those orders to get "wholesale" (vs. retail) prices and this helps us reduce our costs that we pass on to our clients. We also don't have big advertising overhead. If we can keep our costs down, everyone benefits.

Performance

A few weeks back, we undertook to survey our readers to get a better sense of their priorities when it comes to wealth and portfolio management. The survey is still open if you have not had the chance (10 quick questions: click here) to participate.

However, I was intrigued by the responses to this one particular question thus far and, as it is with survey's, likely  requires another follow-up survey at some point in the future just on this one particular topic.

"What is the single most important factor when deciding to allocate to a Portfolio Manager / Advisor to manage? (click one)".

To date, fees were not a priority factor. In the world where I live, where we are always trying to find cost savings for our clients, because over the long-term, annual fees and costs can eat up a significant amount of your compounding ability, I am initially, somewhat shocked.

Then again, in this world of the need for immediate gratification, I am not so shocked that some 55% put performance as the single most important factor (although the question does not stipulate performance over a given time period, so it is subject to some interpretation).

However, I am astonished (although I shouldn't be because I study Behavioural Finance) by the fact that historical returns, (despite the constant warnings and regulatory requirement to disclaim that past results are not a guarantee of future returns) are still used as a guidepost for the future. Perhaps it is consistent long-term returns averaged over multiple years vs. "the next best thing" (that has already happened), but pardon me for my skepticism.

Interestingly, performance is a relative thing: performance as compared to what? Which always begs the question of how much risk you want to take to achieve a certain performance. Less than 10% of our respondents put risk management as a priority. All the more interesting given what we saw last December, which is, in our opinion at High Rock, a warning shot of what we can expect over the next 6 months or so.

Why take more risk than you need to, just to get a performance that could disappear in a matter of a few trading days?

By mitigating the risk that High Rock Private Clients had with asset classes that are not necessarily correlated to more volatile stock markets, most clients (depending on their allocation strategy) have experienced growth that more than re-captured unrealized portfolio losses from all of 2018 in just the first three months (first quarter) of 2019.

We shall be reporting this to our clients in their regular quarterly reports, to be issued over the next week or so.

The challenge going forward, of course, is to capture that performance (and not give it back) by continuing to mitigate risk. That is the hard, behind the scenes work that goes into the managing of portfolios. That is how we earn our fees that appear not to be a priority.