Bond Yields Continue To Move Higher

Bond Investors are telling us that they are no longer worried about Deflation as they continue to demand an increased premium in yields to defend against future inflation.

German 10 year yields, after hitting close to 0% in April, have moved back to 1% (the highest level since Sept. 2014):

• US 10 year yields have moved up to close to 2.5%
• Canadian 10 year yields are above 1.9%.

These are significant moves. 

Globally, central banks have been aggressively using stimulative monetary policies to fight the potential for deflation and this has begun to work and global bond market participants are building this in to their outlooks.

Bond Markets Lead All Other Markets, so we need to pay attention.

Higher long term interest rates will have a dampening effect on the global economy, which has been struggling to achieve higher levels of growth:

Q1 2015 saw a marked (worse than expected) slowdown in GDP growth (especially i n North America and the Euro Area:

• US = -.7%
• Euro Area = .4%
• Canada = -.1%
• Japan = 1.0%
• Australia = .9%
• China = 1.3%

Expectations are for a stronger 2nd half of 2015 for the global economy, lead by the US.

To date, Q2 2015 data has shown mixed results:

Employment is growing, but the consumer and business sectors are not convinced and continue to hold back.

Bond Market Volatility, which at the moment is at record highs, will likely not encourage the consumer as mortgage rates rise and other costs of borrowing start to move higher.

Next week (beginning Tuesday, with an announcement on Wednesday at 2pm) Th US Federal Reserve's Federal Open Market Committee (FOMC) will meet to discuss the next steps for monetary policy. 

It is widely expected by financial market participants, that they will not begin to raise interest rates until September.

Bond Market volatility will certainly be a topic of discussion at the meeting.

When Clients Get "Burned" By An Advisor 

...who does not take the serious responsibility to have their best interests in mind (because all that the advisor could think about was the "sale" or the "commission") 

I find it abhorrent.

When those reluctant folks come to me (urged to do so by long-standing clients) because they still need to find a way to plan an investment strategy to accomplish their financial goals, there is inevitably "baggage" and trust-issues that have to be overcome.

Unfortunately, I am not a "slick" salesperson with all the answers. 

Just a very experienced "risk manager" with a desire to help.

So for all of you out there looking for something different and better, I offer a repeat of the blog that I wrote early in April when I officially embarked on my new journey:

When I started into the world of wealth management at the turn of the century (seems weird to say that), I came from a world where I traded billions of dollars in fixed income securities and derivatives (and managing the corresponding  risk) into a world that was completely foreign to me: SALES.

At the age of 40, I was easily the oldest "trainee" in the TD Evergreen (now Waterhouse) "developing" advisor program. Me and a bunch of twenty-somethings with $$ signs in their eyes at the peak of the dot-com bubble.

All I wanted to do was to help folks wisely invest their money in the most advantageous way (best possible return for the least amount of risk taken).

Wrong for the times.

What a different world: 

1. I was required to get my Life Insurance license, because that was a big revenue generator.
2. At the time the big "sell" was Deferred Sales Charge (DSC) mutual funds: 5% upfront to the advisor and a .5% trailer fee (paid monthly).
3. There was (amongst my peers) sizeable "new issue" activity, whereby the "biggest" producers would get the biggest "allotments" to sell  the new issues (lots of dot-com stuff coming to market back then). Lots of commissions paid up front for that business. 
4. It was an advisor to the "trough" and client beware (huge conflict of interest) feeding frenzy.

Could I survive in this world wrought with all the conflicts that I ethically could not abide?

For a while it was very difficult, because I was not a sales person and so I stuck to what I knew: Fixed Income!

Boring, but at least there was a 5% yield on 10 year Government of Canada bonds!

In time however, I found a partner who had, apparently, the same ethical scruples and we set about to build a very large business (we looked after approx. 750 families with close to $400mm in assets) trying to cut costs for clients and get those reasonable long-term risk-adjusted returns.

Client service has always been, for me, the underlying key to developing sustainable trusting relationships.

In 2011, when market volatility brought back memories of 2008 to clients, I suggested a daily conference call to allow clients to have the opportunity to hear our calming thoughts apart from the noise of the media.

When things settled down, we made those calls a weekly event.

Communication with clients is key: so now I have this blog, we offer a weekly webinar, regular portfolio reviews (in person or via webinar) and regular availability for a call when a client wishes to chat.

Even with the discretionary style of investing that we do (where we don't have to ask the clients permission on each and every trade) we want our clients to be comfortable with the strategy we have developed to match their goals and objectives.

And even though they have given us this discretion based on their Wealth Forecast, risk tolerance level and Investment Policy Statement (IPS), it is communication that engenders trust and that is what we strive to do: be transparent.

It has been a long 15 years (since the turn of the century) to get here, but I have learned a great deal in that 15 years and I am excited to have this new platform to encompass all that I have learned and let our clients benefit from it.

Today is webinar day, we do our live webinar at 4:15 pm, but will post a recorded version (for those who can't attend the live one) on our website following:

www,highrockcapital.ca

Global Diversification

Perspective: The MSCI World Equity Index is composed of:

• US = 57%
• Japan = 9%
• UK = 8%
• France = 4%
• Switzerland = 4%
• Canada = 3.5%
• Germany = 3.5%
• Australia = 2.6%

So when we focus on US markets, we are focused on the largest (by a significant margin):

Our equity models try to incorporate this global diversity (although, when fully invested, we may likely be a little overweight in Canada because of our proximity to some of the companies that we like to watch). However, we do try to guard against an overly "home country bias".

So what is going on in some of these markets?

The World Index:

• Made highs on May 18th at 77.35 and has been correcting since. Currently at 74.73, this is a correction of approx. 3.4%. 
• Trend-line support at approx. 73.50-60 is important: if it falls below this level, it may encourage more selling and lower prices.

US:

• S&P 500 moved further below trend-line support on Friday after the Employment Data was released.
• We would expect to see some buying support at or about 2040-50 and below that at 1970-80.
• Respectively, corrections of 4.5% and/or 7.7%.

Japan:

• Japanese equity prices remain close to their highs and until selling emerges, the up-trend remains. Buying support at the trend-line at 19870 is important for the trend to remain intact.

UK:

• UK equity prices have broken down through the up-trend support level and have corrected approx. 4.5% from the highs. Next buying support level at 6700 would represent a 6% correction.

France:

• The CAC 40 has also broken down through the up-trend line support, currently a correction of 7.3% from the highs.

Also:

• The Swiss market has corrected by 9% from its highs.
• the German DAX is down 10%.

Closer to home:

• The TSX has also slipped below, its trend-line and will look for buying support near 14,600.

• Australia has corrected by 7.5%

Summary:

Markets in Europe and the UK are correcting, significantly, but only beginning to (at this point) in North America.

Japan has not yet begun to correct, Australia has also been correcting significantly.

We have remained (and still do) cautious about adding money to equity markets in our client portfolios and this strategy has been working.

We shall remain cautious, expecting that North America will follow the trend lower and ultimately Japan will as well.

www.highrockcapital.ca

Employment Data Day

First and foremost, this is just one month's (May's) data. 

In the greater scheme of things, while financial markets will focus on how this may impact direction in the short-term (today's trading), we tend to look for what the long-term implications are: what the underlying trend suggests for the North American economy and ultimately the global economy and how this may impact the assets that we hold in our client's portfolios.

Better than expected results on both sides of the border:

In Canada, while the jobless rate held at 6.8% for the 4th consecutive month, employment grew by 59,000, mostly in the private sector (economists expected approx. +10,000):

• +44,000 in Ontario
• +31,000 in BC
• little changed in Alberta
• largest gains (20,000) for men 24-55.

Implications:

While this is a positive economic development and considerably lifts the average (30% of the last years gains came in May), we will wait to see if there are any revisions and whether next months data will continue the trend.

Meanwhile in the US:

Not only were the headline data (an increase of 280,000 non-farm payrolls) better than expected (223,000), the more important wage growth data (average hourly earnings = +.3%) were higher than expected (+.2%).

This is important because one of the last remaining data points to kick in to the recovery thus far has been wage inflation and it has given the Federal reserve breathing room for the timing of the inevitable increase in interest rates.

Certainly this could further add to bond market volatility as bond investors perceive higher future levels of inflation if this becomes a trend (higher wage growth) and will want yields to give them a greater premium over expected inflation.

Greater bond market volatility may lead to greater equity market volatility (as bond markets lead financial markets, one of our 2015 themes):

Yesterday the S&P 500 broke down through the lower end of the recent trading range (2100) and thus far this morning is trading at near the 2190 level.

If selling (profit-taking) appears as a result, this could mean that we will not see buying support until 2040 (which would be close to a 5% correction from the the highs.

With equity markets at rather expensive levels and earnings expectations for Q2 at negative levels, it would appear that the sellers might gain the upper hand through the next month or 2.

We shall monitor these developments closely as they may have some significance for our portfolio models which are positioned rather defensively (more cash than our target) at the moment.

Stay Tuned!

www.highrockcapital.ca

What's Up With The Bond Markets?

Yields!

And Volatility.

Two of my/our 2015 themes:

1. Bond Markets lead all other financial markets (might this be a prelude to increased equity market volatility?).
2. Central Bankers don't like volatility.

However, while they may not like the long-term impacts of volatility (uncertainty erodes confidence), central bankers are preparing us to expect some in the short-term as economic and financial conditions "normalize".

ECB president Draghi did that yesterday.

German government bond yields have been rising rapidly since hitting lows close to 0% (10 year yield) in April and earlier this morning came close to hitting 1%. Shorter-term yields had visited negative interest rate territory as deflation became a greater a concern and as the ECB continued buying bonds in its on-going Quantitative Easing program. 

Recent economic data out of the Euro area, however has shown improving economic circumstances and a return to higher levels of inflation.

As bond investors adjust their expectations for future inflation, they demand higher yields and this is causing greater degrees of volatility in bond markets:

Interestingly, the International Monetary Fund (IMF) lowered its 2015 economic growth expectations for the US Economy this morning (from 3.1% to 2.5%) , suggesting that the US Federal Reserve should hold off on beginning to raise interest rates until the first half of 2016. 

This comes on the back of the OECD report yesterday (see yesterday's blog).

This touches on another couple of our 2015 themes:

• That stronger US growth will lead the global economy in the 2nd half of 2015 (or will it?).
• That it is expected that the US Federal Reserve will begin raising interest rates in September of 2015 (or not?).

And our "grand theme"  (that throws all expected outcomes out of the window):

Expect the Unexpected!!

Tomorrow is "Employment Data Day" in the US and Canada...

Stay tuned!

www.highrockcapital.ca

OECD Report Sees "Extraordinary Risks" That Could Have "Potentially Big Effects"

In its report released today the Organization for Economic Cooperation and Development suggests slower global economic growth in the future as business investment is not accelerating and the consumer is reluctant to spend (something that we have been discussing in this blog on an ongoing basis):

more here:

http://www.oecd.org/eco/outlook/Economic-Outlook-97-General-assessment.pdf

However, buried in the heart of the report (p 37, 38) and what caught my eye are some "extraordinary risk factors that are not taken into account in the projections that could have potentially big effects"

Yikes!!

As Risk Managers then, we need to be especially attentive:

• Negative yields on Government bonds (or where they are not negative as in Canada or the US, the "term premium" or real return after inflation is taken into consideration, is negative).
• In the Euro Area and US, spreads between high yield and government bonds (difference between high risk and low risk yields) implies "sustained investor risk appetite". In other words investors are chasing returns and taking on greater risk than perhaps they should.
• Equity prices have reached record highs in many OECD countries. The "assessment of value is inherently challenging". Our on-going theme is that stocks are expensive.

"An abrupt and simultaneous resolution of these excesses could disrupt financial markets seriously and have considerable negative implication for the real economy, if accompanied by large losses for investors, reduced risk tolerance and higher uncertainty."

"These signs of excesses in financial markets, and hence risks of corrections, are particularly uncomfortable as ongoing changes in the structure of financial markets could amplify shocks."

"Indeed, the amplitude of price movements has recently increased in some markets . Higher volatility in bond markets may reflect longer-term trends related to automation and prevalence of high-frequency trading"). 

"Also, ongoing changes in bank regulation to reduce risk taking could discourage banks from acting as market makers, increasing volatility . "

We continue to advise caution!

www.highrockcapital.ca

Copper As A Leading Indicator For The Global Economy:

At the beginning of May, Copper prices jumped, threatening to break out of a 4 year bear market, but stalled at the down-trend line just below $3.00 and have fallen since, leaving the down-trend from 2011 intact:

Broadly speaking, this looks (for the moment) to be a disappointing development, but coincides with the most recent economic data which shows global economic growth to be stalling.

One of my "Themes" for 2015, is that the US economy, which contracted in the 1st quarter of 2015, is expected to pull the global economy along in the 2nd half of the year.

However, data for the 2nd Quarter, thus far, is yet to impress:

Earnings Expectations (for the S&P 500), a key fundamental for stock prices, are expected to show declines in of 4.4% in Q2 and .6% in Q3, but a rebound of 4.8% in Q4.

The consumer in the US represents close to 2/3 of the economy and of late the consumer has not been participating and consumer sentiment has been slipping. Is this, as the US federal reserve believes, a temporary situation or are we seeing a more fundamental shift as Baby Boomer's become more frugal heading toward retirement and Millenial's have different spending and consumption habits?

This morning, the US Personal Income and Spending data for April revealed a consumer who continues to save, income grew by .4% and spending was unchanged.

On the Inflation front, the Fed's key core PCE price index year to year change (target 2%) fell from 1.4% to 1.2%. Clearly, the fed has time on its side as far as the need to begin the normalization of interest rates and this may put the expected September interest rate increase onto less certain ground.

Expect the Unexpected!

No blog post tomorrow morning, but feel free to tune in to our weekly webinar, the recorded version will be posted tomorrow evening at:

www.highrockcapital.ca