Stocks For Sale

Sorry for the busy chart. In a nutshell, after the current sell-off (perhaps the 15% drop from the recent highs might be a bit more than just a sell-off?) from the beginning of 2018 the S&P 500 (light blue) is up about a grand total of only 4% (was up 24% a week or so ago). Funny how all the debate over value plays itself out in time? Looks like the "wussies" (those who would not take the bait) from 2019 are ruling the day. 

And so are the conservative bond investors, with XBB (Canadian bond index ETF, green on the chart above) better by almost 7.5% (add on the annual income of about 2.5% for a total return in the vicinity of 12.5% or thereabouts).

As one of the so called "wussies", apparently, it appears that good judgement is, as it does in time, being rendered appropriate. That is, not getting caught up in the hype that the stock market "cheerleaders", bloggers and over-confident (see my blog on the subject) sellers of financial products who were doing a whole bunch of "carnival barking" until very recently.

As it always does, value returns (from over-value).

Our good friend David Rosenberg, a very seasoned economist (and former Merrill Lynch colleague of both mine and Paul's) and now running his own operation (Rosenberg Research, a global independent economic research and strategy firm) has also withstood his share of punches received along the way. He had this to say in his morning:

"The fact that the futures market has already priced in 90% odds of two rate cuts now by year-end hasn't exactly offered up much solace for the equity markets, which remain in freefall even with these revised Fed expectations towards an easier stance."

"The Fed is surely going to be cutting rates, and aggressively, but this time the impact won't help the problem because the problem wasn't caused by the Fed, as was the case in other periods"

"The bottom line here is that the virus has gone global, it is disrupting global supply chains and curtailing consumer demand everywhere. The economic turndown will cause financial pain because so much of the world, the corporate world, is awash in debt. And the impairment to cash flows will cause defaults and delinquencies to escalate".

"And we know in recessions, we get a 25% profits plunge and 5-point P/E multiple point compression. We are likely going to see all of last years's post -Powell-pivot rally erased. Goldman Sachs now projects no earnings growth at all this year and even that will be optimistic. But even if they are correct, the forward P/E on true reported earnings is over 22x even after this last correction, which is still above the historical norm of 16x. And remember, mean-reversion means you go through the mean. This alone would take the S&P 500 down to 2200."

As I write, the S&P 500 is trading at 2930 and trading fast. That would take us down another 24%. Yikes!

We have been putting some cash back to work at today's prices, picking up considerably better value than existed even in June and September of 2019 or even January and October of 2018.

There is, as usual, lots of debate as to how this will all play itself out (Coronavirus, U.S. election, recession). As usual, some may take us to task for being relatively conservative (some young guns, new to the idea of a recession hurting stock markets, think the S&P 500 will still hit 3500 this year). However, our jobs are to protect our and our High Rock Private Clients capital and get us growth over the long-term to see us to our collective end goals and that is what we shall continue to strive to do.

We will likely keep some powder dry in case the Rosenberg scenario plays out. His caution on the economy through 2019 has certainly played out.

Portfolio Shock Absorbers

The main objective of long-term portfolio strategy for our High Rock Private Clients is capital preservation and portfolio growth to meet long-term goals. These may evolve over 20 to 40 year time frames (see yesterdays blog: scotts-blog/another-client-ready-to-retire-or-re-wire-ahead-of-schedule)  which will cover a number of economic and market cycles. Our challenge is to manage the risk inherent in these cycles to maximize the opportunities and mitigate, as best as is possible the downside impact.

Day to day market swings and volatility over these long periods matter only in so far as it impacts the recovery period and slows the long-term ability for growth.

Nonetheless, we closely monitor our client portfolios to see how they respond to market shocks in an ongoing effort to understand how they impact our portfolio risk management.

Yesterdays market activity certainly had some interesting price activity:

The S&P 500 shed 3.35% (which dropped it back to a little under flat on the year). Our risk measure, a full standard deviation (from the mean) move, is about 11% for this index. In the last quarter of 2018, if you recall, this index dropped about 1 1/2 standard deviations.

On a more global scale, the benchmark that we use to compare to our Global Equity Model performance, the All Country World Index (ACWI) ETF fell by about 3.5%. That brings it to a -2% for 2020 thus far.

Higher risk (less diversified) assets like those in our Tactical Model (Canadian small and mid-size company bonds and stocks) have a much smaller correlation to the broader equity markets, but for the most part, they, at this juncture, appear to have fared better. The TSX was down only about 1.5% yesterday. For 2020, the TSX is up by almost 3%.

On an interesting note, Paul's portfolio (High Rock founder and portfolio manager) who has the largest allocation to the Tactical Model (and less to Global Equity, more to Fixed Income), was lower by 0.3% yesterday and is higher by 2.8% year to date.

We all (at High Rock) have the same assets, our allocations of those assets are a function of our individually tailored portfolios and our goals as identified in our Wealth Forecasts.

My portfolio, a somewhat more mainstream balanced allocation (derivation of "60/40"):

Dipped yesterday by 0.8%. 2020 so far is about +0.8%. This matches many of our 60/40-type balanced (and fully invested) portfolio client performances.

Our Benchmark for the Canadian bond index is the XBB ETF.

Yesterday it was higher (with lower bond yields) as investors moved to safer assets by about 0.25%. On the year so far though, XBB is up by 3.4%.

Needless to say, our clients who have a larger weight in our Fixed Income Model (more conservative allocation) fared relatively well yesterday, down between 0.25 and 0.35%. Year to date, they are higher by 1-1.3%, on average (helping Paul's portfolio too).

Preferred Shares, an asset class that we are not so comfortable with, especially if they are rate reset preferred's (my portfolio only has about a 3% allocation to preferred shares), did not provide any shock absorbtion yesterday. In fact the ETF CPD was down 1% and the other ETF, DXP was down  about 2%.

I should also add that our portfolios have exposure to $US that helps mitigate the downside on days like yesterday when there is a move to the safety of the $US, although at year end 2019 this position worked against our  2019 portfolio performance.

Of course, it is only one day, and our true focus is on the long-term, however, we do need to constantly monitor and be aware of what these shocks do to our portfolios to properly prepare them for when the bigger, longer lasting and more destabilizing ones (larger standard deviation moves) occur.

Another Client Ready To Retire 

(Or "Re-wire") Ahead Of Schedule!

The excitement was palpable as we reviewed the updated Wealth Forecast and previewed the latest scenario: moving retirement up by four years. Not without one of these two folks still carrying a healthy degree of skepticism, but the new numbers we presented to them did not disappoint. It's not a full-on, we are going off golfing, feet up kind of retirement, but as these clients so appropriately suggested, it is a "re-wiring". No more commute downtown everyday, no more 5am alarm clock, no more walking back in the door at 6:30pm, but taking more control over a work-life balance at a significantly lower level of stress. Call it a graceful exit.

Client's of mine for close to 20 years (in a number of phases of my wealth management career). Two recessions (maybe another one on the horizon), never having shot the lights out (by taking too much risk, chasing out-of-reach returns), but taking the boring route of adding to savings when possible and maintaining a balanced approach to investing, while putting the focus on what they were good at: nurturing their family and pursing their own successful careers.

I love this part of my job. Bianca loves this part of her job!

More importantly, it gives me a soapbox to stand on and tell the rest of the world that our methodology works. The doubters think that they have to have stock market-like returns, year in and year out, to get to their goals. Perhaps they do because their goals are unrealistic.

However, the gamble of chasing stock markets can and may put your goals at risk. After peaking in 2001, it took the NASDAQ about 15 years to get back to that very peak. 

With current stock markets at levels that beg the fundamental question of true value:

Ask yourself, if you had to buy stocks, where do you want to be buying them? With Price to Earnings ratios at 10-15 or 20-25? Forget "multiple expansion", where is there less risk?

30 year bond yields are at record lows, we have to pay attention to what that is telling us.

I think it is clear that the Coronavirus is throwing a lot of uncertainty at us.

I think it is also clear that the current political situation in North America and around the globe is tenuous and fraught with potential twists and turns that can and may have potential destabilizing risk.

But, our clients still have to retire / rewire and if we can help them get there on or ahead of schedule, managing the risks and keeping the stewardship of their wealth on track, then our methodology, in spite of the skeptics, is working. If our aforementioned clients had stepped away from the plan we built for them or deviated significantly away from our designed strategy because of recessions or over-valued markets, wanted to chase returns and throw risk management out the window, then they might not be where they are today.

Consumer Prices And Your Cost Of Living

Statistics Canada just announced the most recent Consumer Price Index (CPI) data for January increased at 2.4% from Jan. 2019.

Why does that matter to you?

If your cost of living increases by 2.4% (which is going to vary from household to household, depending on what you consume, how much you consume and where you consume it) then that is going to erode your purchasing power (which is what drives your comfortable lifestyle).

In other words, in order to continue your comfortable lifestyle, you best be growing your money by a rate that is better than 2.4% (if, in fact that is your annual cost of living increase), after fees and taxes. For the purposes of our High Rock Private Client Wealth Forecast's, we assume a 2.5% annual cost of living increase (the long-term average increase for CPI in Canada is about 2%), unless our client wants to plug in their own specific number, which of course makes the Wealth Forecast much more accurate. It is an extremely important part of the plan. An increasing cost of living by more than the growth of your savings/investments could erode your comfortable lifestyle and put you at risk of running out of money.

With the risk-free rate of return (before fees and taxes) sitting at or about 1.6% (a 90 day Govt. of Canada T-bill), the likely after fees and taxes return is closer to 1% (or less).

If you want to get better than the annual increase in your cost of living, you need to take risk. How much risk can only be determined by creating a forward looking plan, like our Wealth Forecasts, to determine how and what kind of portfolio growth (and investment strategy) you need and ultimately how much risk you need to take. When we say that we manage risk first, that is what we mean. Taking too much risk can also put your Wealth Forecast (and your future comfortable lifestyle) in jeopardy. So we find the appropriate balance. Maybe it is 60 / 40, maybe not. Every client family has different circumstances and therefore their strategy should be unique to them. Definitely not a "one size fits all" approach.

Do you drive alot? If so, the recent data would suggest that the 11.2% (year to year, i.e. Jan 2019 to Jan. 2020) increase in gas prices would be impactful (if you are driving a gas powered vehicle, of course). Fresh tomatoes cost 10.8% more and all fresh vegetables were more costly by about 5%, driving all food prices up by 3.2%. Non-alcoholic beverages cost 5% more, but alcohol, tobacco and recreational cannabis only cost 0.5% more. And those are just national averages, not considering the "where" you consume variable.

The point being is that your annual cost of living increase is an enormously important factor in your need for the growth of your money. It also will determine the amount of risk you need to take to grow it to get that comfortable lifestyle that you want to last through to the end of your days as well as possibly pass on any inheritance to those you may think are deserving.

Chasing investment returns and portfolio growth without taking all these important inputs into consideration could be a potential recipe for disaster. Make sure that you have the right folks guiding you along the way.

Over-confidence

Continuing within the theme of behavioral finance, which has become more and more relevant with all of the many variables being thrown at us portfolio managers these days as we try to deal with all of the new naratives (economic and political) being presented to us on an almost daily basis.

One of the great difficulties is determining which are true and which are false (or perhaps, "alternative truths").

In my Sunday blog, I alluded to a situation where expectations of somewhat unrealistic returns occurs because there is a belief that what has been over the last few years (stock market resilience) will continue on into the future indefinitely. That is where the narrative of "company earnings don't matter to stock markets, just central bank liquidity" resides. On yesterdays High Rock monthly video, we also brought up the story of a client who, in the violence of the plunge in stock markets in 2018, became so unglued as to request that their portfolio be moved to 100% cash. Clearly, both these situations involve(d) levels of confidence in their views that are / were off the charts (i.e. not considering the risks of either being overly invested in stocks or not invested at all, relative to their long-term goals).

Another Nobel prize winning economist, Daniel Kahneman, professor emeritus of psychology and public affairs at Princeton University's Woodrow Wilson School and who, in 2015, was listed as the seventh most influential economist in the world by The Economist has this to say:

Video link click here

People, he claims, are pulled in opposite directions: they have an aversion to loss, but are optimistic. Loss aversion and over-confidence work in opposite directions.

Confidence sells. That is why BMO's Brian Belski (Chief Investment Strategist) tells BNN/Bloomberg that he sees 10 more years of bull markets. They want your business and they want you to believe! BNN /Bloomberg wants you to believe too, because it keeps you tuned in. Excitement!

But Prof. Kahneman says he wouldn't want a financial advisor who was an optimist. (read: is a salesperson).

Why? Investment advice is not supposed to be exciting. It is supposed to be well thought out long-term planning that will get you to your ultimate financial goals. Rolling the dice with all your money in any stock index fund or ETF is nothing other than gambling. And we know the "house" always wins when it comes to gambling.

As I will always say: "why take risk that you don't have to?". Over-confidence may blind you from a proper assessment of risk.

Again, to reiterate from Sunday's blog: beware the agenda of the super confident, in their perspective lurks a boat-load of unaccounted for risk.

At High Rock, at least for our own portfolios and a good majority of our client's portfolios, we manage risk first. We prepare a Wealth Forecast from which we develop a long-term strategy. That strategy is always flexible, subject to review as circumstances change. Circumstances may include an increase in tolerance to risk. However, we will always present our informed opinions in order to properly coach and counsel client risk.

We are also held to the CFA Institute standard of suitability as per our Voluntary Code of Conduct which in its intent holds us accountable for ensuring that a client's portfolio is suitable for a client's financial situation.

Stepping Away From The Fray!

It is always refreshing to take a step back from the day to day push and pull of financial markets to try and re-frame your perspective. A couple of weeks away has hopefully helped me get a broader view of the big picture in the world of Wealth Management where I hang my hat. Of course we can never truly be "away" in my world. Looking after clients is always a 24/7, 52 weeks of the year kind of responsibility. However, looking on from a greater distance can open your eyes a little wider.

I did spend a little time thinking about "Irrational Exuberance",  a term coined by former U.S. Federal Reserve Chairman Alan Greenspan back in the 1990's. It was subsequently the title of a book by Nobel prize winning economist Robert Shiller:

"In explaining the origin and attributes of speculative bubbles, the author persuasively examines the structural factors - politics, technology and demography - underlying them, the cultural factors reinforcing them and the psychological factors driving market behaviour." 

Speculative bubbles, he insists, are very real, the result of the "combined effect of indifferent thinking by millions of people... motivated substantially by their own emotions, random attentions, and perceptions of conventional wisdom."

Which of course begs the question: is it my job to attempt to bring rational thought to a client who has no sense of risk, even if it might mean that she/he may otherwise move to a bank advisor or other (with no fiduciary responsibility) who will make promises that are dubious at best and just move her/his money into their in-house "growth" funds. My moral compass tells me that I must live true to my own sense of what is right.

These are the difficulties we face as portfolio managers in the late stages of a bull-market: too many years of above average returns impacting emotions. Behavioural finance will coin this as "recency bias", where human emotion takes over and we simply expect what has been happening for the last couple of years to automatically continue well into the future.

It makes for a difficult conversation when we know that there will come a reckoning in which we, with a fiduciary duty to our clients, must protect them. Should we let our client's take on unreasonable risk just to keep them as clients?

Prof. Shiller's latest work is titled Narrative Economics where he explains that we are victims of a set of narratives or stories where "Adherence is probably even worse when it comes to following advice from more controversial economic pundits or financial planners. But where does advice end and speculation begin? And how do we distinguish informed speculation from confabulation or fiction? The slope is slippery. Ultimately, a story's contagion rate is unaffected by its underlying truth. A contagious story is one that quickly grabs the attention of and makes an impression on another person, whether that story is true or not."

Something to consider in the world of financial media and investment blogging / social media. As I have said on many occasions in the past, beware the writer's agenda and motivation.

On the plane, on my way home, I came across this analogy for current market sentiment from a usually middle of the road economic commentator:

Ready to get back into the fray, armed with my updated level of knowledge of the psychology of markets and the ongoing battle to bring the best possible me to the management of our clients and our own collective wealth.