Scott will often show both the Canadian and US yield curves on our weekly webinars (highrockcapital.ca/current-edition-of-the-weekly-webinar.html).
By way of background, the bond yield curve is comprised of 2yr bonds out to 30yr bonds. The shorter bonds respond and reflect monetary policy more than the longer bonds. That is to say, when the central bank is raising very short term rates (overnight rates), the 2yr bond yield is likely to rise much more than the 30yr bond yield. The 30yr bond yield really is only affected by one thing: inflation. Inflation is the #1 enemy of long bonds. Anyone who thinks that bond yields are low only because the Fed has been buying bonds during their Quantitative Easing over the past number of years, should read my blog on Tuesday (highrockcapital.ca/pauls-blog/fed-balance-sheet-reduction). There you will see that bond yields actually moved higher when the Fed started buying bonds and then proceeded to move lower when the Fed ended their bond buying programs. The exact opposite of what you would have thought, eh? Budget deficits, shutting down the government, elections, hurricanes, nuclear war...the only thing that really matters to long bonds is...inflation, or lack thereof.
That being the case, the yield curve (30yr yields minus 2yr yields) has been a good predictor of past recessions. The reason being is that the yield curve tends to flatten (30yr yields drop and/or 2yr yields rise) when the central bank starts hiking rates. And the central bank hiking rates usually brings on a recession, in and of itself. Also, if the Fed is hiking rates to combat inflation, then 30yr bonds feel like the Fed is "getting ahead of the inflation curve" so it doesn't rear it's ugly head.
So what does the 2-30 yield curve tell us today? Chart below with the yellow line being the 30yr minus the 2yr yield and the white and shaded areas are past US recessions:
Note a two things:
I might as well explain why this dynamic exists. It really goes back to inflation being the enemy of long bonds. Right now, the lack of inflation is producing questions for all of these PhD's at the Fed. With all the monetary (and fiscal stimulus) they have put into the system over the past (almost) 10 years, how on earth could inflation not be rearing it's ugly head? The answer is probably for a separate blog but it has something to do with employment gains that have been made and the spectacularly low Unemployment (UE) rate which now sits at 4.4% (remember in 2012 when former Fed Chair Bernanke said he would automatically raise rates when the UE rate hit 6.5% or something stupid like that? And that was when the US rate was 7.7%). Well here we sit at 4.4% and they have barely raised rates. Why? Simple...the quality of those job gains that has driven down the US rate to the low-4's is, well, crappy at best. Lots of low-paying jobs like retail sales, servers in the food/beverage industry, part-time vs full-time, etc. So no wage gain pressure and wage pressure is what really drives inflation...you make more, you spend more.
The economy is going thru a seismic structural change where old rules (like the Taylor Rule which states where overnight rates should be vs full employment) simply don't hold any more. In fact, a few regional Fed Presidents stated yesterday that they are confused as to why inflation is not resurrecting at this stage. The Fed has been dead wrong. (And remember, a PhD in Economics gets to be called "doctor" but if he/she is wrong, no one dies. No big deal...just the global economy hanging in the balance).
So what will happen? The Fed will probably hike rates further but at a very measured pace due to their confusion on inflation, amongst other reasons. As for the longer end of the yield curve (30yrs), the yield will likely continue to fall for two reasons: 1) there is no inflation to erode purchasing power and 2) 30yr bonds will start to believe, rightly, that the Fed rate hikes are premature and will start a recession, at some point.
But before we start talking too much about a recession, the curve needs to flatten a fair bit more. Unless the old rules no longer apply and the new rules surprise everyone. Remember, the bond market is almost always right and leads all other markets. We pay attention to it, that is for sure.
The US Federal Reserve Open Market Committee (the FOMC; the decision-making body of the US central bank) meets today and gives us results of their two-day meeting tomorrow at 2pm. The FOMC has been talking for most of the year that they would start the unwinding their $4.5 trillion balance sheet (up from $800 billion before the 2008 crisis). This unwinding would initially be in the form of not re-investing coupons they receive on the bonds they own.
StatsCan just reported our Canadian jobs report this morning at 8:30am. The country produced about the number of jobs Bay St Economists had expected at 22,200 new jobs. The Unemployment rate fell from 6.3% to 6.2%. On the surface, about as expected and all good.
Beneath the surface, the quality of those jobs gains were not so stellar. Of the 22,200 new jobs created, +110,400 of them were Part Time (PT) while Full Time (FT) saw a healthy retraction of -88,100. The reason why it is so important to differentiate between FT and PT jobs is that FT jobs offer more security and a better annuity for the worker which leaves that FT worker feeling more confident about their earnings stream and more willing to spend. PT employees do not feel that same sense of confidence - they are unsure about many things like, how many hours work they will get, whether they will be terminated tomorrow, etc. We call this "the quality of the job gains".
Interestingly today, we saw PT jobs gain by the second most in the past 30 years at +110,400 vs the highest at +136,300 in July 2010 (according to Bloomberg and StatsCan). Not a good sign - we would always want to see strong FT gains, not strong PT gains. PT job gains below:
And FT job losses at -88,100 for August were the third largest over the past thirty years. The only two other times the Canadian economy lost that many FT jobs over the past thirty years was in Feb 2009 when it lost -120,100 FT jobs and in July 2010 when it lost -145,100 FT jobs. FT jobs below:
And speaking of the quality of jobs produced, higher paid sectors like manufacturing and resources showed declines. Peeling back the layers and looking at the quality of jobs is important but we also do need to keep in mind that one month does not make a trend.
As for the market's response after the release, the C$ has weakened off a little bit. It has been on fire since the Bank of Canada raised interest rates on Wednesday morning, all through yesterday and even overnight, however, after this report, it appears to be flat to slightly weaker. The Loonie is probably due for a breather but it is really being driven by two things: 1) the US$ is getting pounded lower against every currency as Fed officials have been talking more dovish (not wanting to raise rates) over the past month and 2) the Canadian economy has been strong and the Bank of Canada clearly wants or wanted to remove some of the stimulus they put in place when oil hit $26/bbl. They have raised interest rates 2X in less than two months and higher interest rates drives buyers of the currency because they get paid more to hold it as rates rise.
Also, we and some of our business colleagues are having a hard time reconciling just why the US$ is so weak given we could be on the precipice of a (nuclear) war. Normally, the US$ would see capital flow to it for safety reasons during times of war but, right now, it appears the market does not really think war is imminent or a reality. The market seems more concerned with the Fed talking more dovish about not hiking rates further.
Expect the Unexpected. The path to least resistance, maybe not today or tomorrow, would be to a stronger US$. We are not hoping for war but certainly are preparing our portfolios for it, especially when the portfolio protection is relatively cheap.
I am having a hard time reconciling the fact that if the Canadian economy is so darn strong with annual GDP at 4.3% in June, that the Bank of Canada has been forced to respond and raise rates twice (.25% each time) in less than two months - how is it that the Canadian stock market (S&P/TSX) is the only stock market in the developed (and undeveloped) world that is red (down) on a nominal (not including dividends) basis for the year to date?
See below and I probably don't need to tell you which one is the S&P/TSX:
Either the Canadian economy cracks under the pressure of higher rates and the stock market is right in predicting future economic weakness OR the stock market is cheap and will play catch-up to the economy. Still wondering.
The Toronto Real Estate Board (TREB) just released their statistics for the month of August.
I wrote a pretty comprehensive four-part series on the City of Toronto real estate market back in late June which you can read here (highrockcapital.ca/pauls-blog/city-of-toronto-housing-introduction-and-part-1-of-a-4-part-series). Note that this is for the City-proper, not the GTA.
I won't go into much detail today on August's numbers but there are glimmers of hope(at least in spots) which I will highlight in the three most popular housing types for the City: Detached, Semi-Detached and Condo Apartments.
Conclusion - Detached (higher priced) housing still needs to find it's bottom. First time buyers are likely not going to be able to afford a $3mm+ house in Rosedale no matter what the various levels of government do to intervene, but these first time buyers do have a shot at owning a semi or condo and today's data show that that is where the demand is. Over the longer term, I stick to my thesis that detached housing will increase the gap over semis and condos as there will be no further supply of detached and continued supply of condos.
When we formed our Private Client division over two-and-a-half years ago, we wanted to do something unique in our ability to display trust. Our answer was to form an Independent Review Committee (IRC).
By way of background, all prospectus-based funds (mutual funds, closed-end funds, ETF's) all have to have an IRC of at least 3 members. The closed-end fund we manage in our Institutional division (AHY.un) for Scotiabank has an IRC. I meet with the IRC of that fund at least four times per year. The IRC is responsible for all compliance matters on that fund and, most-importantly, they need to ensure that the fund (and the Portfolio Manager managing the fund...High Rock) is managing the portfolio exactly within the confines of what the prospectus states. That is to say, we are not permitted to stray outside of the restrictions stated in the prospectus. So to ensure that, the IRC pours over the portfolio, checks all the numbers and grills me about certain positions, etc. It is a very important role they play to ensure compliance at all times.
But in our Private Client division, we do not manage "funds". We manage all of our private client assets in Separately Managed Accounts (SMA). That is to say, each client has it's own account(s) and, although we do trades in their accounts, they own the securities in their accounts at all times. Managing client money on an SMA basis has many benefits but most notably it is way cheaper for the client and they also have complete transparency of the securities in their account at all times.
Now because we do not manage funds in our Private Client division but rather on an SMA basis, we are not obligated by the Ontario Securities Commission to have an IRC. However, we wanted to go the extra mile and do something no one else in the country has done...we formed an IRC for our Private SMA Clients. (We believe we are the only Portfolio Management company in the country, managing money on an SMA basis, to have formed an IRC...unique indeed).
So without further ado, here is Jonathan Heymann from Wychcrest Compliance services, in his capacity as our IRC, to help explain in more detail what he does on a quarterly basis for the sole benefit of our Private Clients:
If ever a client, or a prospective client, would like to speak to Jonathan at Wychcrest Compliance Services and get more detail about his role as our IRC and what makes High Rock different than the Investment Advisor community, please contact us and we will put you in touch with Jonathan directly.
Scott wrote a great blog this morning on how most in the wealth management business want to sell you on the next big opportunity. Read it here if you haven't: highrockcapital.ca/scotts-blog/in-a-world-that-demands-instant-gratification-its-hard-to-sell-boring.
I thought I would add a bit to his blog on "opportunities". We really don't sell anything at High Rock, other than to act as the stewards of your family's wealth and our internal capabilities and experience to manage that wealth within the asset management firm that is High Rock.
When Scott used the term "opportunities" though, it immediately rang a bell because I was just looking at the performance of one of our sophisticated clients on a year to date (ytd) and since inception basis. This was a client we provided a "solution" to for an investing need they had.
This idea of providing a solution actually started as a theme for another sophisticated client back in February 2016. This client (call him Client A) and I were sitting across the street at Lavazza in the King Eddy having coffee (I am there at the same table 2-3 times per week with various folks sharing ideas/research etc) and discussing investable themes when a lightbulb went off in my tiny head. He told me what he was doing at the time and I suggested that he round out his theme with my light bulb idea. We had been discussing for two hours and I said, "hey, why don't we buy a portfolio of Canadian High Yield Energy bonds?". This seemed to be a great solution and add-on to what he was investing in on his own so off to work I went and created a highly concentrated portfolio in some high yield energy bonds I knew quite well. Now keep in mind, this was not me selling him an "opportunity" but him requesting a "solution" to round out his theme.
With Client A's approval, we did talk to a few other existing clients whose Wealth Forecasts provided for the ability to utilize such a portfolio as a solution for their overall needs. We did term this High Rock Opportunity Model I when we were talking to people. Keep in mind that it was called an "Opportunity Model" but it was meant for existing clients and meant to provide a solution...not gather in more assets by promising the next big thing. No, this was a very specific solution and, in the end, Client A was the only direct participant in Opportunity Model I...fair to say, it takes certain risk-tolerance and a high level of sophistication to invest in only 5 Canadian High Yield Energy bonds when every single one of those bonds was for sale! And remember, all of our clients participated in this investment theme as 3 of the 5 Energy bonds were bought in our Tactical Model so if you were invested with us in January 2016, you got a nice lift on your portfolio over that cup of coffee I had with him in February. (I don't actually drink coffee but rather tea).
I won't tell you what Client A was/is up on that portfolio but suffice to say the solution/opportunity worked out better than expected and that Client A had the best performance of any High Rock client across 2016 by a wide margin.
On to solution number two - High Rock Opportunity Model II. We have another highly sophisticated client (Client B) who came to me last July 2016. He said he wanted to put X$ into the beaten down Preferred Share market. Now I wouldn't have described myself as a Preferred Share expert a year ago. I told Client B that I would need to do a fair bit of work/research first. Not my style to call myself an "expert" in anything, not even High Yield, but I would say that by October 2016 I became intimately knowledgeable on the true drivers of the Pref Share market. In fact, two weeks ago I was on a Horizon's Pref ETF presentation webinar call. I thought I would hear what this PM at their sub-advisor had to say about the Pref market. Seemed like a nice guy but seriously lacking in-depth research on the true drivers of the Pref market. Maybe he was "dumbing it down" for the Investment Advisors who were on the call? Either way, I was not impressed when they only took emailed questions on the call and they wouldn't address the two more complex ones I submitted. A marketing guy from Horizon's called me after the webinar and when he found out we didn't own any of his Pref ETF, he basically hung up on me. I felt like asking "why on earth would we own your ETF when we know exactly which Prefs to buy and we can save ourselves and our clients the MER?"
So began a three month process starting with a wickedly complex Pref Share excel macro that was generously shared with me by an old friend. This macro was more complicated than any I have worked with and I needed three months to get comfortable with the drivers of valuation in the very specific part of the Pref Share market I felt exhibited the best risk-adjusted returns. What I can now tell you is that, these Pref Shares are the most complicated cash securities in the Canadian market. Investment Advisors use them as a Fixed Income proxy. Big mistake. A lot of older, retired folks lost plenty of money on certain parts of the Pref market because their Investment Advisor just didn't understand the true drivers of these things. Pref Shares are not Fixed Income! They may have a yield attached to them but make no mistake, they are Equity, more succinctly Senior Equity but, Equity nonetheless.
Again, with Client B's knowledge, I showed about four other existing clients Opportunity Model II as we felt like it would have been a good fit for them, including Client A. Alas, only Client B felt like it was the right solution. Fair enough, holding a concentrated portfolio of 9 Pref Shares isn't for everyone.
By November 2016, we began investing and quickly accumulated our target Pref Shares. We had pretty good timing as November and December performed nicely but 2017 ytd has been excellent. Again, I won't tell you what Client B is up 2017 ytd or since November 2016 but, suffice to say again, that Client B's Pref Share portfolio has the best performance of any client over that period by another wide margin (and lots more than the Horizon ETF and with no MER!). Not for everyone, but it was certainly a good solution for him.
Once again, all of our Private Clients participated to a certain degree in this trade as we sold the prefs we did own and bought the same Prefs as Client B and all at the same time and price according to our Fair Trade Allocation Policy within our Policy and Procedures Manual (ask your current Advisor if they have such a Policy...newsflash, they don't have to. High Rock is required by the OSC to have such a policy but even if it wasn't required, we would because it is the right thing to do). The Pref switch trade we did in early October 2016 has added considerable value to all of our portfolios...just a lot more to Client B due to the concentration he held.
Are we selling Opportunities? Not at all. We are providing solutions to our existing clients. Could some of our existing clients have benefited from these two Opportunity Models if they invested directly in those two Models? Sure, but we all need to be comfortable in our investments and ensure that any such solutions are specific and in keeping with our Investment Policy Statement and our Wealth Forecast. You may not go broke making money but nor do you go broke by missing opportunities.
We can't create opportunities but what I can tell you is that we have the experience, the knowledge, the access and the network to constantly search for themes that might provide solutions for our clients. In fact, I spent 2.5 hours yesterday with Client A at lunch to discuss various investing themes. And Client B is going to share a bottle of wine with me in the backyard next week to do much the same. And this morning I was at Lavazza for a one hour meeting with another asset management firm PM to discuss some investing ideas. I know what you are thinking..."he seems to go out for coffee and lunches a lot and spends evening's drinking". Coffee/tea is quick, cheap and efficient. I pack my lunch from home 21 out of 22 work days a month and eat at my desk. And I only drink wine on those weeknights when it is absolutely required...honestly.
And remember, ALL of our clients participate in these themes/solutions/opportunities so even though you may not feel like Client A or B right now, the rest of us benefit nonetheless. And when we come up with a theme/solution/opportunity, we will show you if we think it fits into your Investment Policy Statement and Wealth Forecast. If you are an existing client, and feel you have a need for a specific solution (no, we can't print money in the back room), then ask Scott or I to sit down and have a chat. We will absolutely refer to your Investment Policy Statement and Wealth Forecast as we discuss your requirements and any potential solutions.
Past performance is in no way a guarantee of future performance. This blog was meant for informational purposes only to our existing clients and not a solicitation to prospective clients.
As promised yesterday, and in advance of tomorrow's US Unemployment survey, I will show you one of Scott's favourite US recession predictors.
First of all, the US unemployment report is largely flawed in many respects. Number one, it is actually a survey of employers, not actual hires the past month. Secondly, the unemployment rate is a single number and doesn't take into account the split between full-time and part-time workers (full-time usually make more $). Also, it doesn't take into account the Labour Force Participation Rate, which right now, is near an all-time low (not a good sign).
All it's failings aside, the unemployment rate can be a good predictor of a recession.
Scott shows this chart most months when he blogs about the US unemployment data (which he will likely do tomorrow). I am only showing it today as an add-on to my blog yesterday:
Explained as follows:
Notice that every time the US unemployment rate (white line) crosses up through the downward-moving 36 month moving average, a recession begins right at that time.
As you can see in the bottom-right in the white box, today, we are still a little ways out from a possible recession. For this historical metric to work again, we need to start seeing the unemployment rate bottoming and starting to tick up while the 36 month moving average will keep going down. When they cross...beware of history.
Tomorrow 8:30am will give us another data point to watch.
Scott and I have stated in some blogs and on our weekly webinars (highrockcapital.ca/private-client-division.html) that past US recessions all started with the Federal Reserve Board hiking up their overnight Fed Funds interest rate (the rate at which commercial banks lend to each other). Usually the recessionary result is due to the fact that the Fed hiked rates prematurely.
But the question is, how long after they started hiking Fed Funds, did a recession begin? What is the lead time?
Given we think this is exactly what is happening in the US right now (and now Canada too, and to an even great extent, given our deteriorating housing market), I thought I would look at what that lead time has been over the past few recessions.
As you can see below, the Average time (in months) from when the Fed first hiked Fed Funds to when a recession started is 29 months (beige line). In blue, you can see where we are today at 18 months from their Dec 2015 hike.
If we extrapolate the average, the US would hit a recession in July 2018 (11 months from now for a total of 29 months from Dec 2015).
If we use the shortest period (1999-2001), which was only 21 months, then the US could hit a recession by Nov 2017, which is only 3 months away.
You may ask, "what on earth is going to lead to a recession? Stocks are at all-time highs". How about the Fed and the faltering economic numbers that really matter?
Note the white line a "Hard Economic Data". Hard Data has been trailing off since late last year, although it has ticked up a bit the last two weeks of July. The yellow line is "Soft Economic Data" (like surveys etc) which climbed higher right thru till March but is now coming off as well. And the green line? ...the S&P 500. Interesting chart.
Just a couple of reasons why we are investing more cautiously right now.
Remember, at High Rock, we are managing our own capital the exact same as our clients and everything we do (for all) is based on risk management and protection of capital.
Tomorrow, in advance of Friday's monthly payroll data, I will try to post another interesting comparison on the same topic.
You can't make this up.
I drove all the way to North York mid-afternoon yesterday to visit a lovely older lady (not even a client) who I have helped with on everything from buying a new vehicle through my friend who owns Performance Auto Group www.performanceautogroup.ca/ (another shameless plug for my friend) to a full-on Wealth Forecast created by Bianca only weeks after giving birth (second shameless plug in one sentence!) with multiple scenarios on selling her house, buying a condo or the status quo. Lots for her to think about.
Also, I have gone through, in detail, her existing portfolio held at a life insurance company's Broker/Dealer arm.
The contents of her "portfolio" (and I use quotes because it is NOT a portfolio) are something we see frequently when new clients transfer their existing portfolios to High Rock to work with us.
Without going into a lot of detail, this "portfolio" sits in 100% mutual funds (where all-in fees are about 2.75% vs our 1.20%) and 65% in Equities and 35% in a Balanced Fund...not even a Fixed Income Fund or a Bond to be seen. This for a 70yr old lady without the benefit of a work pension or health insurance? Sounds more like hedge fund-style concentrated risk to me. And the poor lady has no idea of the inherent risk in her portfolio. As an aside, I would have to think that if the Ontario Securities Commission (OSC) found a registered Portfolio Management company, like High Rock, had a client that age, in that financial situation and with that portfolio, they would do more than slap us on the wrist. Totally inappropriate a portfolio, at least for her. Therein lies the difference between being registered under Investment Industry Regulatory Organization of Canada (IIROC, self-regulated by the banks/dealers) where her Advisor is registered and the OSC (a gov't agency reporting to the Min of Fin of Ont), where High Rock is registered. I could go on about the differences, but that is for another post.
And the worst part is, when I told her what she was paying in fees, she tells me that she has been asking her current Advisor what she pays in fees but keeps getting the runaround from the Advisor. I couldn't believe I was hearing this so soon after just writing on the topic. I told her I just wrote a blog on this exact topic last week: (highrockcapital.ca/pauls-blog/report-on-business-article-on-fees-rob-carrick-help-my-adviser-is-blowing-smoke-on-investing-fees)
I drew out our Fee Structure infographic on the back of a piece of paper for her to see. I hoped like heck she realized just how honest and transparent High Rock is about our Fees.
And if the fact that I just wrote a blog on how Advisors avoid conversations about fees, as I am sitting on her couch in her living room, I get an email from Scott on my iPhone. I read about half of the contents of that email and just passed my phone over to her to read in it's entirety. I know Scott wants to distribute this heartfelt email from one of our clients so I won't steal his thunder...unreal timing!
As I said, you can't make this up.