The Big Dilemma

A balanced, globally diversified portfolio has not been living up to its supposed (dubiously promised by many an advisor without the regulatory required discalimer that past performance is not a promise of future growth) 7% annual average return recently. Global equity markets (we use the All Country World Index ETF, ACWI as our proxy. This ETF is composed of about 50% US equity and 50% the rest of the world equity) have returned about 3% in price appreciation (capital growth) over the last approximately 2.5 years. Quick math tells me annual average return = 1.2%. Add in the distribution / dividend income of about 2.0% annually and the average annual total return becomes somewhere in the vicinity of 3.2%. All of this with a very generous bounce off the March 2020 lows.

Do the same with the Canadian Bond index ETF, XBB, with an annual average price appreciation of 3.2% (8% over the last 2.5 years) and annual distributions of about about 2.7% give you about a 5.9% annualized real return.

If your balance is 60% equity and 40% fixed income, you should be getting in the vicinity of 4.25% total return, before any fees. Not the 7% promised (if it was), I would say. 

If you had REITS  (-7.5%) (see Paul's recent blog on these) and Preferred shares (-27%) over the same time period in your mix, then you would likely be getting somewhat less (although the reasonable distributions in both might offset some of the negative price depreciation). With interest rates at or near zero, rate reset preferred shares are not likely going up any time soon and as they get reset, the distributions / dividends will fall too.

The problem is that everybody is fixated on the stock markets to get them these better than average returns and are scrambling to try to trade fundamentally very expensive (and risky) assets in order to "beat" the benchmarks. And as a result have created a casino out of the stock market. If you are a gambler, have at it.

If you are a long-term visioned portfolio manager who is focused on risk-adjusted returns over longer periods of time, stocks are too risky to be fully invested in (even 60% in a balanced portfolio).

The reality of a recession is that there will not be any economic growth to drive spending and earnings in any significant manner. That is why buying stocks at current levels (or even levels a few % lower) is fraught with risk.

The U.S. Federal Reserve ("Don't Fight The Fed") and all the central banks that have been adding liquidity are falsely driving prices of stocks to levels where they fundamentally have no business being (which means they are not likely over any longer time frame going to stay there, see 2002 and 2008). We all want our stock holdings to appreciate (even us under-invested types), but when they go up on a hope and a prayer (or a gamble), well that becomes a recipe for potential disaster (again). Older investors have shown a tendency to get out of the stock market altogether after experiencing big drops: a recent Wall Street Journal article quoting a Fidelity Investments study suggesting that about 1/3 of investors 65 or older sold all of their stocks between February and May of this year. 

It may be a good market for day trading (plenty of volatility), but as we tell the folks who ask us why we were not picking the bottoms or the tops: we don't have the ability to see the future and hind-sight is 20/20! We don't day trade and we don't gamble with our own money, so why would we do so with our clients money. Especially when they trust us to help steward their wealth over longer periods of time (i.e. to the end of their days and on to their beneficiaries).

So what do you do?

Generate income. Interest on bonds (in Paul, we have one of the best Canadian corporate bond traders / portfolio managers in the country at High Rock). Our higher yielding corporate bond portfolio generates over 7.0% in interest income (cash yield) on an annual basis at the moment. Even in our balanced portfolios we are earning between 3 and 4% in interest and dividend income alone. That means that you can take a lot less risk chasing capital appreciation in the stock market to get your annual returns up. 

If you are retired or retiring and you want cash flow from your portfolio for your lifestyle expenses, why take unnecessary risk?

Friends, we are in very unusual times, but we may be in one serious recession that could take a very long time to climb out of. A lot longer than some of the more optimistic folks are suggesting. The headlines may look positive, but a hard look behind the scenes (of the headline data) reveals some disturbing economic reality. Even the Fed sees a protracted period of low growth (i.e. not getting back to 2019 levels until well into 2022).

Chasing stock market returns could be disastrous, if you don't have a long time horizon to enable you to recover.