2019 Predictions

Most forecasters and analysts are usually pretty wrong trying to predict the outcome of the next year in financial markets: Cash (and near-cash equivalent assets, like money market funds or high interest accounts) was king in 2018. My 2018 predictions suggested that most asset classes would end the year lower as liquidity dried up on the back of interest rate increases and increased US government borrowing needs. Ray Dalio, a billionaire fund manager, Harvard educated and probably way smarter than I am, suggested (at about the same time) that anybody holding cash was going to "feel pretty stupid". But what do I know?

Most of these folks have an agenda and are out selling their agenda. I have an agenda too: trying to get the best possible risk-adjusted returns for our High Rock Private Clients, working hard to move them towards their long-term financial goals in a fiduciarily responsible manner at as low a cost as makes good sense. 

Which is why we have had an over-weight cash / underweight equities position in our global equity model for most of 2018. If you read Monday's blog or have had way too much idle time to follow this blog on a semi-regular basis, you will know that I believe that we are at the end of the economic expansion cycle and there may be more volatility to follow. What keeps me up at night is the possibility of a repeat of 2008 (see chart at the top), which if you recall saw the S&P 500 drop 53% from its 2007 highs to its 2009 lows. While I put a low probability on this happening again, I have learned in my 35 plus years of experience to never say "never". Did you see the "Miracle in Miami" last Sunday?

But more realistically, a drop to the "Bull-Trend" line of about 13% has a much greater probability of happening. The bulls will still be right if it holds that test (and there are no shortage of them talking up their positions in the media, even now). That would represent about a 22% correction from the highs, which the media would jump on to say that we were in a new "bear market", but we can ignore them.

We are itching to put our client's money back to work in the equity market, but my past experience has taught me (usually I am early to the party) that we can be a bit patient. I remember  2014  when it would have been much better to have waited until late 2015 / early 2016. Hindsight is 20/20, but, best we learn from our experiences not to make the same mistakes. I should have fought harder for my clients back then. I do now.

Will it happen in 2019? Possibly, but there are so many loose ends in the global economic, financial and political situation that it is really hard to see how it will all unfold. That is not so different from how things looked at this time last year, other than US tax reform, which everybody was so taken with. Now we will deal with the increased US deficit that this has left in its wake. Debt is still a real problem in the global economy and an economic slowdown, which we expect will happen (perhaps even a recession) because we are at or near that point in the investment cycle, could very easily exacerbate this. Higher interest rates from the US Federal reserve have been biting.

The good news is that once we get through the slowdown, or more likely during the worst of it, equity markets will bottom and there will be some excellent opportunities to take advantage of that we have not seen since late 2015 / early 2016 when risk was considerably lower and certainly much lower than it was in 2017 / 2018.

Wishing you all a very happy, healthy and prosperous new year!

Active, Passive Or A Combination?

Once you know your asset allocation strategy (at High Rock we use a Wealth Forecast, prepared by our very capable Certified Financial Planning professional to discover your goals, time horizons and risk tolerance, which allows us to understand what the best strategy should be), then you can determine how you best want to execute it.

If you are a Do It Yourself (DIY) type, or perhaps an Assemble It Yourself (AIY) type, you best have a look at Larry Bates' book Beat The Bank first, there are lots of things in there that will assist and you can figure it out for yourself. 

If you think that you can beat the market (active investing), by all means have at it. Many have tried and, for a while they may have found themselves able to pick their spots to enter and exit, but sooner or later they fail, miserably.

Even the so called "experts" who manage the mutual funds that so many Canadians pay so dearly for (seriously friends, 2.5% MER?), with all the requisite degrees and training have serious difficulty in matching their benchmark index (of which they are expected to beat in order to justify their huge fees).

Last stat I saw, suggested that only about 20% are able to beat their benchmark target. It could well be lower this year!

Nonetheless, if you think it is daunting, as many do, and you do get rattled by market volatility, which may or may not invite you to question your entire strategy, there is some room for looking for and taking guidance from the pro's.

If your pro tells you that they can out-perform the market, you know that about 80% of them are telling you a tall tale. Remember, they also have to tell you (absolutely required by the regulators) that past performance is not a guarantee of future returns. There is a reason for that!

So there is a great reason to take a more passive approach, buy easy to understand, low MER, index Exchange Traded Funds (ETF's).

If you are starting out with a big chunk of cash, popping it into a bunch of ETF's may be a good idea, but if you are like me, you may not want to do it all at once. After 35 years in the trading/risk and investment business, I have come to recognize that there are times that buying makes good sense (usually when everyone else is selling and scared) and there are times when it does not (when everyone is throwing caution to the wind and complacent about risk).

Because all things economic are cyclical (see the above chart), there are times when stocks represent good value and times when they do not (i.e. they are expensive). Generally if stock prices (pale blue line) are at a point where they are lagging below earnings estimates for the future (dark blue line), they are of some potential value. That might be a reasonable time to get fully invested in that particular index ETF (in this case an S&P 500 ETF). If not, it might be time to wait.

Nobody who wanted to invest in 2016, wanted to wait until 2019 or 2020 to get to put money to work, so you can do some partial allocation in the meantime to a passive index (there were some opportunities available through this time period where a correction occurred and provided a better opportunity).

Point is, there is room for both passive investing and smart decisions about relative value, especially if you accumulate savings over certain time periods. If you blindly popped your money into the S&P 500 in January or August of this year, it may be quite some time before you will see it at those prices again. If you can live with that, great. However, most humans are emotional creatures, it is what gives us our humanity.

Pain is something that we find difficult to tolerate and pain is something we want to remedy very quickly. That is not good when it comes to investing and/or sticking to an investing strategy.

That is why some of us experts (Paul and myself anyway) choose to manage our money with a passive core in our portfolio, but also with some tactical and value oriented approach to it as well. We find that from a risk-adjusted perspective,  it tends to smooth out the bumps over the longer term. So that's how we invest our money and invite like minded folks to join us.

The Fleecing Of Naive Canadians Continues

RBC hits record $12.4 billion!

"The Toronto-based bank saw particularly rapid growth from it's wealth management business for the year ended Oct. 31, as the unit recorded a 23-per-cent increase in its earnings compared to fiscal 2017, rising to nearly $2.3 billion".

The wealth management business generates huge revenues garnered from managing their clients money. Mostly earned from the fees (hidden or not) that they charge their clients. A 23% increase over one year. Think about that. How have your investments fared over the last year?

As my friend Larry Bates, in his new best-seller, Beat The Bank, so succinctly puts it "Old Bay Street bosses require the vast majority of their national sales force to offer only products with high, and often hidden, fees."

For fun, lets look at the RBC balanced fund:

The value of this mutual fund is over $5 Billion (as of Oct. 31, 2018). $5 Billion of RBC client money.

As best as I can tell, over the last year, to Oct. 31, 2018 this fund has brought a return for investors of -3.8%. while at the same time charging investors in the fund 2.15% (MER).

Here is what they say about the MER (note the fine print!):

1) no sales charges (no load)

2) You don't pay expenses directly. They affect you because they reduce the funds return. (i.e. you don't get the tax deduction).

I think Larry has a point. 

"Their relentless marketing machine plays on this insecurity, bombarding Canadians with a smokescreen of complexity, bewilderment, foreboding, false salvation aimed at convincing you to:

1) Distrust yourself (you are incompetent)

2) Trust us (we will save you)"

And we pay dearly for it.

I do try to spread the message that there are equally protected alternatives for investors and they can be "Do It Yourself" (DIY), "Assemble It Yourself" (AIY), Robo (no personal service) or if you like a human being to care for you (at a very reasonable cost) and with fiduciary responsibility to you, a portfolio management firm (like High Rock), who can provide you with a plan (Wealth Forecast prepared by a Certified Financial Planning pro), an investment strategy for the long-term (you are likely going to have many years left on this planet) and guide you with regular monitoring, updating and perhaps even hand-holding through the more difficult moments so that you can stick to your plan.

Save yourselves (and help out your friends too) from the high cost, low touch world of the very profitable "Old Bay Street" banks and financial institutions. Seek out the alternatives. 

Consumer Prices And Your Wealth Goals

A key component in projecting the growth of your wealth is trying to anticipate how inflation will impact your cost of living over the course of the rest of your life:

Growth of your money (average annual return over the rest of your life) less the rate of inflation (average annual increase in the cost of living over the rest of your life) of your lifestyle expenses. 

What you consume, how much you consume and where you do your consuming are all important in getting a handle on what to expect for future cost of living increases. 

Statistics Canada tells us that the "average" household saw a 2.4% increase in its basket of goods over the last 12 months ending in October.

What you consume: (according to StatsCan) the average Canadian household consumes like this:

Transportation costs which account for about 20% of the average household's spending rose at a rate of 4%. Gasoline prices were up 12%.

Where you consume:

In Ontario, energy prices fell 2.4% following the termination of the carbon cap and trade program. Gas prices fell 4%.

However, all of this may be moot because the drop in oil prices to close to $US 50 per barrel (West Texas Intermediate crude oil) recently, if sustained could push CPI inflation lower by close to 1 full percentage point.

The volatility in the prices of energy and food from month to month forces the Bank of Canada to try to come up with formulas for a less volatile "core" CPI number which they monitor for policy making (interest rate setting) purposes:

For our client Wealth Forecasting, we make the assumption (unless we adjust it to meet a clients very specific requirement) that inflation will likely grow at a rate of 2.5% into the future.

In our equation for the growth of their / your money, the average annual return over the rest of our clients lifetime needs to exceed 2.5%.

The risk-free rate of return (a 90 day Government of Canada T-bill) will get you bout 1.7% (at the wholesale level, before fees and taxes) at the moment. That will not get you ahead of the annual cost of living increase.

In order to beat that annual increase in your cost of living, you are going to need to take risk.

How much risk?

Enough to beat your inflated cost of living, but not too much to jeopardize the integrity of your investments.

You can try to do it yourself (DIY) or as Larry Bates will suggest in his very important new book Beat The Bank, assemble it yourself (AIY), or you can look to the experts in risk management, but make sure that you are fully aware of the costs that you are having to pay.

What you need to be aware of is that any risk that we take may bring about potential swings in the short-term value of your investments (as current financial markets are creating at the moment). Those, however, will be more than offset in future years as your investments grow (and they will) as long as you can maximize the return per unit of risk that you take.

Most importantly, make a plan and stick to it. Exiting your plan because of some short-term volatility is a sure way to never achieve your goals.

And, as is always the case, past performance is no guarantee of future returns, but at High Rock we work darn hard to get the best possible risk-adjusted returns at a very modest cost over the long-term. A good way forward to achieving your wealth goals.

Remember Bitcoin?

About a year ago I wrote a blog entitled "Too Much Money Chasing Too Few Assets". At the time Bitcoin was breaking up through the $US 10,000 mark. About 3 weeks later it hit $US 20,000. Today it is testing the $US 5,000 level.

I wrote that blog after some conversations with clients and some prospective clients who so very much wanted to participate in the latest "get rich quick" scheme.

In my blog I wrote: "It will end when it ends and there will be plenty of tears and lost fortunes". I have not had many conversations about bitcoin lately, but I have had plenty of conversations about portfolio performance.

My business partner Paul Tepsich and I started High Rock Private Client as a way to grow our own money and be able to have full control over the risk factors (managing it with all our of our many years of collective experience) associated with investing with as little cost as possible. We also thought it would be  unique to offer this same opportunity to like-minded investors. Needless to say, unlike many advisors who are just selling funds and structured product to get paid a commission (and I sadly see this so very often), we own the exact same assets as our clients do (although it may be in different allocations in conjunction with various our goals, time horizons and risk tolerance levels).

When we are afraid of high and rising risk (as we were at this time last year, per my blog), we are going to be practicing what we preach: defense.

I was a goalie for 51 years before hanging up my pads (2 years ago), defense is built in to my DNA.

Chasing returns by buying expensive assets because they are high and rising in price is an emotional reaction driving a desire to participate and not get left behind no matter how short a period of time those returns might last.

2018 has been a classic example:

In January, a wave of "throw caution to the wind" buying enveloped the US and global stock markets. Huge volatility, the likes we had not seen since 2015 and early 2016 erupted in February and again in October, pretty much wiping out any gains and from a global scale pushed stocks to levels not seen since mid 2017.

Bond markets were re-priced lower as interest rates rose and balanced portfolios were left mostly in the red, a deeper, darker red for those who, unlike us defensive minded investors, were "fully-invested".

From that same late November 2017 blog: "The big problem, of course, is that when asset bubbles burst (and they will) all risk assets become more closely correlated. That means that selling of risk assets intensifies across the board: as assets get sold to pay for the loses on other assets".

Well my friends, bubbles are bursting and liquidity is drying up. With less liquidity, there is less money available to push prices higher and all the folks and corporations who have borrowed to invest need to pay down their debts because the cost of borrowing against falling asset prices has become a losing trade and they have to sell assets to do it.

This will (and may already be happening) transcend into the housing market too. Anecdotally, if you look around Toronto, I don't think I have ever seen more open houses in the month of November before. 

If you own risk assets, there is more selling to come, so prepare yourselves. If you have debt against these risk assets (leverage) pay it down as much as possible or get rid of it completely.

Paul and my portfolios (and all of High Rock's Private clients for that matter) are positioned defensively because that is how we believe it is most prudent to be as we near the end of the economic expansion cycle.

And Bitcoin? We never liked it and never owned it and refused to get caught up in the hype. We didn't get caught up in the January stock melt-up hype either. We use the hyped-up markets to sell into (especially when new, fully-invested clients jump on board) and raise our levels of cash equivalent holdings for future buying at lower price and value points, which we know will come eventually and which we shall patiently wait for.

We are in this for the long-term and will not be emotionally driven by short-term phenomena.

Make a plan and stick with it.

The Power Of Compounding And Your TFSA

If you have contributed the maximum allowable amounts to your TFSA (and you were born in 1991 or before), that would amount to $57,500 over the last 10 years (i.e. since 2009). On average, just $5,750 per year (although there were varying allowable maximum contribution limits for different years). If you were able to get a 4.5% average annual return (after fees) over this period, you could very well have have something that resembles $70-75,000 in value there. The future value of a $5,700 per year contribution over 10 years with a rate of 4.5% = $73,194.72.

As in the chart above, if you contribute the max (at the moment) $5,500 per year over the next 10 years and are able to get that 4.5% annual return, the future value jumps to $184,295.64.

20 years (2038) = $356,831.98

30 years (2048) = $624,775.64

And for you younger folks (and this is why you start doing this as soon as you possibly can):

40 Years (2058) = $1,040,883.95

50 Years (2068) = $1,687,087.43

If you were born in 1991 (or before) and have not thought about a TFSA, you can still get started with any part of the so far maximum allowable $57,500 and jump into the compounding fray. 

The numbers won't look quite as good as those above, but the future value of $57,500, with $5,500 per year ($458.33 per month) contributions at 4.5% per year is:

10 Years = $159,922.23

20 Years = $318,980.81

30 Years = $565,993.93

40 Years = $949,597.74

50 Years = $1,545,322.74

Parents, teachers, mentors it is a fantastic way to encourage your charges to build wealth. Wealth that will grow and compound without the imposition of any taxes, which is why the longer you have it in your TFSA, the greater the growth will be.

When we do our client Wealth Forecasts, the TFSA becomes the best growing account in the plan over time, for that very reason.

Make a plan, stick to the plan and away you go. 

Need help?

http://highrockcapital.ca/index.html

U.S. Mid-terms Out Of The Way

What's Next?

Global equity markets have clawed back from their October lows. We can expect to see some relief buying (upper gold circle on the above chart) in the near-term, which will be well received by investors who watched their portfolios take the big tumble. It could very well take us to the end of the year for those who use that time frame to mark their annual portfolio growth progress. The big equity portfolio managers will be doing their best to show something positive in what will end up being a pretty lackluster year.

The U.S. Federal Reserve will likely raise rates another 1/4% in December. This will once again reduce liquidity in the financial system and push debt service costs even higher,  further slowing the U.S. and global economy. So one should not get too comfortable with slightly better equity prices and prepare themselves for a rough first half of 2019 on that front (a re-test of buying support to the lower gold circle or even the long-term bull trend-line on the chart).

We at High Rock do our best to keep our personal politics in check for investing purposes (politically agnostic) so that we can take a less emotional perspective of the current economic environment. 

That being said, bond markets might now worry less about any further U.S. fiscal stimulus with the Democrats having control of the House of Representatives and doing their utmost to keep President Trump in check.

There is still an ever increasing deficit from the tax cuts to fund because tax receipts are not keeping up with spending outflows  despite the economic growth of the 2nd and 3rd quarters. The 4th quarter looks like it is going to come in somewhere between 2.5% - 3.0% annualized GDP growth (at the moment).

That will lower inflationary expectations and bond investors will likely demand less of a premium for longer-dated maturities, taking the yield curve back to a flatter position. The 2 year to 30 year spread differential has narrowed by 5 basis points (from .50% to .45%) already this morning.

This may spell some temporary relief for fully invested 60/40 balanced investors, but it is likely only temporary. Fully invested in equity portfolios are likely going to run into some turbulence again in the new year.

Cash or cash equivalent investments (and under-weight equity positions) are going to take some of the sting out of further equity market volatility in 2019 as will some broader diversification into other non-correlated asset classes.

At High Rock we specialize in Canadian High Yield Bonds (C$HY) and my business partner and colleague Paul Tepsich may well be one of Canada's foremost portfolio managers in this asset class. All of our High Rock Private Clients have some exposure to C$HY for purposes of diversity and it has been one of the best performing asset classes through 2018.

On a risk-adjusted return basis (return per unit of risk) it has been one of the top asset classes over the last 10 years and unlike government or corporate investment grade bonds has little if any correlation to interest rates:

Diversity (and until we get to the next economic cycle), a reduced exposure to equity markets and perhaps more cash equivalent assets in their place are going to save you some soul searching and nail biting and help you sleep better at night.

As always, past performance is not a guarantee of future returns. Although at High Rock we work darn hard to get our clients the best possible risk-adjusted returns over multiple years.