It Is Truly An Honour To Have Canada's Business News Network Want My Opinon

"Hey Scott, Michelle here from BNNB. Hope you've been well! I'm currently compiling a web piece on how the U.S. rate cut could impact Canadians and gathering all the different angles on it. Can you send me a blurb (as soon as you can) on how the rate cut might affect Canadian equities?"

OK Michelle, always happy to offer my humble opinions. But first a warning: they may be somewhat contrarian. I am not one to be drawn in to the conventional hype. There are so many advisors out there that will spin a positive perspective just to convince Canadian investors to continue their gamble on equity markets (i.e. that lower interest rates support equity market prices). Optimism sells. Risk management, on the other hand is boring. If you want excitement... what is the slogan for the casino in Niagra? (but you know that the odds always favour the casino). I always choose boring. Because in the long run, it works. Multiple yawns are now accepted.

Back in June 2018 as guest host on BNNB's "The Street", I told Paul Bagnell and any one who would listen (or was tuning in) that the economic and investing cycle that began in 2009 with the end of the "great recession" was long in the tooth and that we (at High Rock) were taking equity assets off of the table (reducing our exposure in our Global Equity model to underweight equities and overweight cash). That is the essence of being discretionary portfolio managers: our fiduciary responsibility to our clients transcends the selling required by non-discretionary advisors (to earn their commissions).

So even if clients were enthused by the new highs in equity markets at the time (and the positive impact on their portfolio values), we believed that reducing exposure to expensive risk assets (because, again, we are boring and manage risk first) was prudent. I said to Paul, on the show, that we did not advise clients to reduce risk. We just did it for them.

Low and behold, the fall (September through December) was not kind to most asset classes, especially following the U.S. Federal Reserve's December decision to raise rates. Volatility in equity markets jumped and those with reduced exposure (to equities) were subject to significantly less emotional duress than those who were fully invested.

Sorry Michelle, that was for a little context. Fast forward to now. The global economic environment is deteriorating, that cannot be argued. Everything economic is cyclical: always has been, always will be into the future. We are just about (if not already) at the end of the economic cycle. Trump administration tax cuts may have prolonged it a little in the U.S., but it is inevitably just a brief blip. Trump administration trade policies are going to negate all the positives (if there was truly any at all) from tax cuts.

So the Fed took a conservative approach and and took out an insurance policy by cutting rates 1/4%, which was fully telegraphed and expected. The Fed remains upbeat on U.S. economic prospects which prompted Fed Chair Powell to suggest this might be a "one and done" situation.

As we can all see in the above, "one and done" is not a common occurrence. I am going to go out on a limb and suggest that history will likely repeat and that there are plenty of rate cuts to come. As my good friend and trading mentor (from my bond trading days) Dennis Gartman has always said: when the Fed starts on a policy course, it is always longer and deeper than anyone initially anticipates. Our other good friend and out-spoken economist David Rosenberg (who has been predicting a recession later this year or in early 2020) thinks that ultimately the Fed Funds rate will go back to 0% in time.

Is that good for stock markets? At the moment, in a nutshell, no. There is plenty of scary and fast water to flow under the proverbial bridge that could cause a significant amount of erosion of confidence in both businesses and consumers. When they lose confidence, they postpone investment and spending plans. It is already happening (see my blog from Monday) in business confidence. When that transfers to consumers because they start to see their jobs disappear, that will be trouble.

Canada will not be immune. Sure, the last few months have seen a pickup in economic activity, but if Canada's largest trading partner stumbles economically, there will not be much to keep us all from being impacted. The Real Estate sector, which has been a huge support to the domestic economy in Canada is going to be vulnerable and so will the financial institutions (banks and mortgage companies) that have significant exposure to it. Exports of goods and materials, a big part of Canada's economy, continue to be exposed to the global trade uncertainties. Non-cyclical sectors like technology and health care will provide some safety as will the traditional "defensive" sectors like consumer staples and utilities. But remember, when traders and investors decide to sell, all risk assets (especially equities) will have a correlation of 1, which means that they are all going down in unison until value hunters start to look for bargains.

As I said in Monday's effort, passive investors need to just sit tight. Active and tactical investors (and managers) should already have some (more than normal) cash and cash equivalent balances to be ready to be put to work. The cycle will evolve, scaring the stuffing out of many, but it is important not to let emotion rule your decision making. In the end, time is on your side. Just breath through the next six to nine months and try not to look too closely at your statements when they role in.

Finding Value

On Friday, the U.S. Bureau of Economic Analysis announced that in the second quarter of 2019, GDP grew at 2.1% (a bit higher than the expected 1.8%). Government spending (U.S. deficit is now at about 3/4 of a $ trillion, on track for over a $ trillion through fiscal 2019) rose at a 5% annualized pace. The consumer was also a factor, with a 4.3% annualized growth rate (after a couple of light quarters in Q4 2018 and Q1 2019). Interestingly, the consumer was borrowing and drawing down savings (following the example set by the government), because incomes only grew at a 2.5% rate.

The rest of the economy (business capex spending, non-residential investing, housing, inventory accumulation and net-exports) declined at a rate of -12.1%. Our friend, economist  David Rosenberg called this report "lopsided", commenting that you would have to go back 13 years to see something similar :"This report, contrary to conventional wisdom, was the furthest thing from being universally robust".

With 10 year U.S. treasury notes yielding just above 2%, bond markets might agree.

And heading into this weeks U.S. Federal Reserve (FOMC) interest rate announcement, probabilities of a 1/4% cut are 75% and 25% for a 1/2% cut. So, the Fed is obviously worried about the economy. (source: CME Group):

Meanwhile in stock markets:

With 44% of S&P 500 companies reporting Q2 earnings, the estimated and actual blended results are showing another negative quarter (-2.6%).

But stocks are making new highs again, leaving Price to Earnings (P/E) valuations (what we might call the fundamental importance of stock ownership) stretched at 17.1 times (and well above the 10 year average of 14.8 times):

The dividend yield on the S&P 500 is currently at 1.86%.

10 year US. treasury note yield is 2.05%.

10 year Canadian government bond yield is 1.46%.

Cash equivalent (HISA) is approx. 1.9%.

The Canadian high yield fund that High Rock manages for Scotia Bank (AHY.un) has paid distributions of $.44 (trailing 12 months, F class) and with the NAV at 7.75, that comes to an annualized yield of approximately 5.6%. Our clients have access to a similar HY strategy in their portfolios (without the MER, that brings it close to a 7.75% yield). This is not at all  intended to be a solicitation, merely an example. Investors should consult with their advisors to ensure that this is an appropriate investment for your portfolio.

If the economy is slowing (which appears to be the case), how do you want to be positioned?

Do you want to be vulnerable to risk assets (stocks) that could conceivably drop 12% (about 1 standard deviation from the mean) or more? That makes the dividend somewhat less than relevant, should that situation materialize.

Or, might you wish to be less vulnerable (less than fully invested in equity markets) and have a portion paying you to wait it out and perhaps take advantage of the 12% move lower in equity markets (if/when that should occur)?

Passive strategy proponents will tell you to stay fully invested. Managed strategy proponents will tell you to be less invested.

There is room for both. Patient, value-oriented investors will inevitably out-last momentum traders. Time is on your side.

Your Journey to Wealth And Financial Independence

The path to financial independence can follow many routes: 

I had the great pleasure to have worked with a wonderful couple a number of years back who were able to successfully find a way to live rather intelligently and build their wealth quite quickly so that they could retire from their rather stress-filled  jobs at the age of 31. They have just released a book about their journey: Quit Like A Millionaire. A refreshingly simple, but very disciplined approach to accumulating wealth. It was a thrill to watch their portfolio hit that $1,000,000 mark and experience their out-right joy when they gave their notices.

Of course, theirs may not likely be the lifestyle for most folks, but the message is clear. If you set your priorities and make a plan and stick to it, you will get the results you want.

Our High Rock Private Clients are a widely diverse group ranging in age (working, retired, grandparents, parents and children, grandchildren), investing sophistication, career path, lifestyle and where they have chosen to reside (full and part-time).

The one thing that they all have in common is a picture of the future (not necessarily the same picture) like the one above. The one above is for what I like to refer to as a "poster" family.

 A family who started out with me not long after I began my career in the Family Wealth Management world (now almost 20 years ago!) with a home, a mortgage, RRSP's, RESP's (3 kids) and dreams of retirement before 65. They are now only a couple of years away and have knocked the proverbial ball out of the park. We have been through the "great recession" and financial market meltdown together and the combination of good saving (when possible, because there are always struggles) and diversity of assets (including a whole life insurance policy) has seen them through.

But speaking of pictures of the future!

How about this one for a 20-something? With 65 or so years of potential compounding to go? Look at what compounding can do just to a TFSA if you start early enough!

The point is that you just have to create the plan and follow it. Adjust it as circumstances require: there will be frustrating years when financial markets do not cooperate (like 2018), but over longer periods of time, those years will be small blips on the path to financial success. 

History has shown us that for every below-average investing year, there will likely be 5 or 6 above average years (including the financial crisis, in which most balanced portfolios fully recovered after a year and a half or so, depending on the asset allocation strategy). It is important not to be frightened away by a poor investing year, just as it is important not to be drawn to a sales pitch waving a new "shiny object" at you that promises a "get-rich-quick" opportunity.

It is nice to be able to choose your path, whether it be retiring at 31 or 65. A little bit of discipline goes a long way.

And, as always, past returns are no guarantee of future growth, but at High Rock, we work darn hard to provide the best possible risk-adjusted returns for our clients, with a disciplined, low cost (i.e. keeping more of your money in your pocket) approach.

U.S. / Canada: Different Economic Outlook? Not Likely

Fed Chairman Jerome Powell has (apparently) indicated a willingness to cut interest rates at the next FOMC meeting on July 31. In his testimony to the U.S. House of Representatives today he testified that: 

"Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy. These concerns may have contributed to the drop in business confidence in some recent surveys and may have started to show through to incoming data."

Remember that the Fed is "data dependent".

Meanwhile, on our home turf, in its interest rate decision today, the Bank of Canada suggested that things economic in Canada were improving:

"Recent data show the Canadian economy is returning to potential growth. However, the outlook is clouded by persistent trade tensions. Taken together, the degree of accommodation being provided by the current policy interest rate remains appropriate."

So why is the U.S. ready to cut rates and Canada is not?

Consumers appear to be  confident (at the moment): 

The Bank of Canada may be particularly encouraged by the recent bounce-back for Canadian consumer confidence (dotted line). This appears to be in line with better wages and salaries data for April in Canada (although that seems quite a while back):

Perhaps there has been some political interference south of our border?

We should all worry if the independence of a central bank is compromised. But Chairman Powell (in his testimony)said he would not leave his post if asked to. 

Still, stock markets appear to be emboldened by economic weakness and lower interest rates, despite expectations of much slower earnings growth:

And clearly significantly less liquidity to prop up prices as the Fed has been tightening (shrinking the Monetary Base) since 2016:

So even if the Fed does cut rates, stocks seem to be well ahead of themselves.