Sorry I have not written lately but it is earning's season (when companies report their quarterly earnings and I have to go through about 50 companies) and also our year-end Audit. Boy, do I love January and February each year.
Back in the summer of 2014, I decided I was going to create a Private Client Division at High Rock. There were several reasons why I wanted to do so, but one important (and selfish) one was to manage the assets of my household, my parents and a couple of friends on a operationally efficient basis.
Up until 2015, I, like most people in the country, had my money with an Advisor (who is an old friend and a great guy). He really didn't offer advice or anything else but rather executed as I required him to. The operational obstacle was that I couldn't get corporate bonds into the various accounts I had discretion over (my household and my parents). In some cases, like investment grade corporate bonds, I could get them but the retail trader at the Bank would take 1-2% on the trade before offering me bonds. Being an Institutional Fixed Income Manager, and knowing where all these bonds trade in the Institutional market, I would never in a million years pay the "retail price" to buy those bonds. And High Yield corporate bonds were even worse! Think about losing 1-2% when you buy the bond and then another 1-2% when you want to sell the bond...that could be between 2-4% round-trip, and some of these bonds only yield 3%!!! Who the heck would knowingly do that?? Gotta love the Bank Model. So the bottom line was, I couldn't get corporate bonds into my accounts on a price-efficient basis.
Then in the fall of 2014, I talked to Scott and told him all about my plans to create this Private Client Division. It didn't take Scott long to figure out the many benefits and synergies of marrying our Institutional Portfolio Management company with our new Private Client Division.
In my opinion, we have many differentiators and value creators in our Private Client Division, but selfishly, the biggest one for me, is that I can get corporate bonds in my personal accounts with "on-the-screws pricing" whether is is a new issue or a secondary trade.
Two great examples of this came both Wednesday and today:
Now two more benefits to being a client of a Discretionary Institutional Portfolio Management company, like High Rock, are that:
Not once have I been asked "What is the single biggest advantage of High Rock's Private Client Division over the Bank/Dealer Advisor model?" Not once, but if I was, I would state, IMO (in my opinion) having access to the Over The Counter (OTC) traded corporate bond market would be right up there. To be sure, there are a lot more benefits I could highlight but, for me, this is up there because it is something that most people would not have access to anywhere else on as direct a basis. To get this kind of access to the corporate bond market, you would have to pay your Advisor a Management Fee and then he would take your money and buy funds managed by an Institutional Fixed Income Portfolio Manager (like High Rock) to manage a portfolio of bonds on your behalf. And I can assure you that the Institutional Portfolio Management company charges you a fee as well. These are called Management Expense Ratios (MER's). They are those hidden or embedded fees people have sort of heard about but really don't understand. Sound like you are paying 2x? You would be if that was the path you chose. And if you had 50% of your portfolio in Fixed Income, then you would be paying 2x on 50% of your portfolio...you do the math.
I have an old family friend who is an extremely successful, sophisticated investor and is also a client. One year ago, to the week I believe, we were sitting across the street in a coffee shop talking about how the market was getting hammered so badly and oil was hitting U$26/barrell. He said he was buying all kinds of oil and gas stocks to which I said, "Hey if you are buying the stocks which are quite risky, why not buy the bonds which are yielding 10-20%?" I told him I had access to all these bonds by virtue of the funds we manage for BNS. He listened, bought into the idea in about one hour, put money in a separate account and I purchased some select high yield bonds for him (this was a one-off, risky portfolio that was suitable for this individual but was not suitable for the average investor). He did well and I think if you asked him today, he would tell you that access to said bonds is a huge benefit to High Rock Private Client Division.
Again, I must admit that, although I have the Chinese Renminbi (Yuan) on my Bloomberg screen, I don't focus on it every day. Today, however, was a day I thought I would at least glance at it. This blog is not easy to write and I am sure won't be easy to read and understand but here it is anyway. Lots of cause and effect in this blog.
I wonder if China is between a rock and a hard place as they balance out the desire to have a weak currency (helps their exports) with their desire to maintain and attract all that capital that we hear is flowing (or used to flow) to the Vancouver housing market. They need capital inflows for investment to keep the economy growing at the huge clip it grows at (~7% GDP).
I will show and explain this chart first and then explain why they may be between a rock and a hard place and how that may affect us here in North America.
The yellow line are Estimated Chinese Capital Flows (on the LHS) and the white line is the US$ vs Offshore Chinese Renminbi (yuan on RHS) (the higher the white line goes, the stronger the US$ is and the weaker the yuan is).
Let's start at the left side of the chart. Note that in the Fall 2015, Chinese Capital Flows (yellow line) starting turning very negative (big Outflows of capital...not good for re-investment in the economy).
But the Chinese authorities (the People's Bank of China (PBOC)..(ya, like the average Chinese person has any say about anything to do with the PBOC!) need to maintain an artificially weak currency for their export machine as you can see in late 2015 and early 2016 with the yuan getting weaker (white line up) while capital continues to flow out.
By Jan 2016, the PBOC react to the capital outflows and tightened monetary conditions a bit so as to stem those capital outflows (anyone remember how global risk assets like stock markets responded to this tightening in Jan/Feb 2016?? Wasn't so good). You can see how the yuan got stronger from 6.7 to 6.5 as a result and capital flows started improving immediately and significantly. But that didn't last and the yuan continued to weaken right into the end of 2016.
Now look at the rest of 2016. They kept monetary policy accommodative enough so as to continue weakening the yuan up to the top/right of the chart (7.00 area/US$).
But also look what is starting to happen to capital flows again...they are turning more negative (more outflows) which we know to be bad for re-investment in the economy...which we know to be bad for China's GDP. And we know that, in the past, the PBOC has tightened up monetary conditions to help strengthen the yuan to help improve capital flows...and we know this tightening was not good a year ago for risk assets around the globe (Jan and Feb 2016 the S&P 500 was -1.6% and -5% respectively).
So if China's GDP matters to the rest of the world, this all matters to us here. Damned if they do, damned if they don't.
Not sure how the PBOC balance the yuan with the capital outflows but I think we should keep an eye on it more often now.
I have written a bit lately about what a Crowded Trade is (highrockcapital.ca/pauls-blog/yesterday-was-a-telling-day) and here (highrockcapital.ca/pauls-blog/the-usand-the-fed). The basic premise behind a Crowded Trade is the following:
You get the picture...
Such is the current case with the US Treasury (government) bond market (along with the Canadian government bond market too).
I have shown this chart a few weeks ago but here it is again. This is the CFTC CBT (chicago Board of Trade) 10-Year US Treasury Notes Non-Commercial Short Contracts/Futures Only. Effectively, it shows the "short" positions in the market for 10yr treasury bond futures held by "non-commercial" holders (commercial are real companies that need to hedge up interest rate risk while non-commercial are...speculators like hedge funds). Have a look at the record short position:
Does anyone reading this know anyone who doesn't think interest rates are going higher? Clearly a lot of hedge funds think rates are going higher which is why they are sitting with this record short position (shorts would benefit if prices drop and rates go higher).
And given we lean more to the contrarian side than the masses, we bought some 10yr government of Canada bonds last week. We paid $97.71 for them (red arrow). Didn't quite get the bottom, but close. They have popped up nicely to $98.92. Not bad for a government bond in one week. The green channel just may get broken here if shorts run in to buy to cover in their short positions. And if they break to the upside, we will look at technical retracement targets along with our fundamental view and the flow we see at the time. Have a look at this 10yr government of Canada bond chart:
As an old friend and prospective client said to me last night, "so you have three models of which you call one of them Tactical but really everything you do in managing the portfolio is tactical, right?" Truer words have never been spoken.
After 30 years of doing this, I am not about to have a buy and hold portfolio for my household and, given we manage our client portfolios exactly the same as our own portfolios, our clients will benefit from our experience/expertise and overall tactical approach.
Past performance is no guarantee of future performance for any particular security or overall portfolio.
I noticed something interesting last week and must admit that this is not something I follow like a hawk on a daily basis.
What I noticed was that US Treasury Inflation-Protected Securities (TIPS) or Inflation-Index bonds, have not been doing very well lately. I especially noted this in the 5yr TIPS market where yields are almost back to pre-election levels. Weird, shouldn't they be going higher if inflation (expectations) is likely??
The way these bonds work are that when inflation or inflation expectations rise, the value of these bonds rise because they track and protect against inflation by being "linked" to inflation itself.
By now, we are all mostly aware of what the new Administration is trying to do...IE...reflate the US economy. With that, stocks rose and bonds, especially longer-dated bonds (30 years) fell. Remember, inflation (expectations) is the enemy of government bonds, especially long bonds. And that did happen through Nov and Dec.
But lately, since mid December's high yields, US bonds have not been able to make new highs. That is Observation #1. Maybe it is because as I wrote last week here: highrockcapital.ca/pauls-blog/the-usand-the-fed that US Treasury Bonds are a "crowded trade" with everyone in the world looking for higher rates being driven by Trump's reflation and the Fed wanting to raise rates.
And then, as I started this post saying, I noticed that something didn't add up in the TIPS market. 5 year TIPS are almost back to pre-election levels. Observation #2. If inflation is really going to be a problem from here, shouldn't TIPS bonds be on fire? The fact they aren't is a bullish sign for government bonds.
And add to that, the correlation between the S&P 500 and 10yr US Treasuries has moved back to it's more normal inverse correlation (means that if stocks get hit, bonds should rise in price) (Second Chart). Observation #3
So here is the 5 year TIPS chart:
And here is the S&P 500 vs 10yr Treasury Bond correlation chart. Remember, the higher (green shaded area and where the white arrow is on the right) it gets, the more we expect bonds to move in the opposite direction of stocks (which adds a natural hedge to our portfolio):
So, by looking at the TIPS market, we can draw some conclusions about inflation (expectations), government bonds/yields and even stocks.
At High Rock, we talk about "Research" but it is what we do with this research that really matters. Because of our 3 Observations, we put the research to work and re-purchased some of our 10yr Government of Canada bonds that we sold in September 2016. Actionable Research.
And remember, bonds lead all other asset classes so what we see going on in the bond market can affect other asset classes.
Yesterday, a client-friend and I, attended National Bank's 7th Annual Energy Conference in Toronto. We sat in on two panel presentations, one on oil and one on gas, and then two 1-1 meetings with the respective CEO's and CFO's of the two companies. These types of conferences, but especially the 1-1 meetings, are an incredibly important part of the fundamental research I do here at High Rock. It gives us a chance to ask more pointed questions about parts of their business.
Given it is Friday, I think I will throw in some humour on this topic. Back in about 2002, when I was at MER, we hosted a similar Energy Conference in Calgary where we invited Institutional Accounts (big pension funds, life cos and asset management firms, like High Rock) to the event to meet with company management teams. I remember sitting at a dinner beside some CEO from an oil producing company and the conversation centered around personal investments. When it was suggested that the CEO think of diversifying his personal wealth a little bit from 100% of it sitting in the stock of his oil company, he said, "son, around here, if I want diversification from oil, I'll just go and buy a natural gas producer". True story. Calgary is a town of hard-a$$ gamblers.
Anyway, a few themes came up yesterday, one which I will share with you.
Canadian Exploration and Production (E+P) Oil/Gas company stocks have been getting hammered the past month, even as oil (WTI) has been going up.
Chart first. Here is the Blackrock iShares XEG which is an Exchange Traded Fund (ETF) filled with Canadian E+P (mostly) companies vs the price of oil in North America (WTI). SU, CNQ and ECA represent about 50% of the entire ETF. XEG is the white line and WTI is the orange line. This chart goes back over the last 6 months but note the gap over the past month of January?
XEG is basically trading where it was in mid-November, which was before OPEC did it's thing Nov 30th and WTI was trading at $46. Today, WTI is at $53.50.
What gives? After yesterday, I think there are three possible reasons why this gap has opened up:
I think there are some specific opportunities out there because of this gap that has opened up over the past month but we need to move with a note of caution. Standing in front of a freight train (the large seller) can be tricky because, we never know when he/she is done.
I want to write a little bit about the US$ but, given the US Federal Reserve Board's Open Market Committee just released their decision on the fate of the overnight lending rate (Fed Funds) at 2pm today, perhaps I will start with the Fed.
Bottom line - no change with Fed Funds set at .75% (upper end with .50% being the lower end). The decision to leave Fed Funds unchanged was unanimous amongst Board voters. Other comments: economy warrants only gradual rate hikes, survey-based inflation expectations are little changed, near-term risks to outlook roughly balanced, inflation to rise to 2% over medium term (their goal is 2% and we are at 1.7% currently), market-based inflation gauges remain low, yada, yada, yada.
To sum it up - appears to be as expected on both the rate decision as well as the comments. If anything, I would read this as ever so slightly "dovish" (meaning that they may not raise rates any faster than last planned, which had them calling for three rate hikes in 2017). Maybe, just maybe, they don;t even raise them three times?
As for the US$, it has been on a tear since last summer. As you can see from the chart below, it rallied strongly up through the fall and went ballistic after the election (for all of the reasons we have written about like Scott just did this morning..."reflation" with the expectation of higher rates which draws investors into the US$ as it becomes a slightly higher yielding currency).
Interestingly though, as you can see on the far-right side of the chart, the US$ trade-weighted Index (DXY on Bloomberg and the most common measurement of the US$) has spent the entire month of January falling. From it's highest to it's lowest level in Jan/17, it is -4.2%. Why is it dropping if the whole world knows/thinks rates will rise and attract buyers of US$?
How about because the US$ is a very "crowded trade". As I wrote last week here: highrockcapital.ca/pauls-blog/yesterday-was-a-telling-day we talked about how either overly "long" or overy "short" positions can affect the trading of any given security. And the US$ is overly long and has been for some time. Check out the non-Commercial Long Positions (non-commercial are often seen as "hedge fund types") on the US$:
Whether they are hedge funds or not, a security can often just get too long (or short) and require a breather, at a minimum, before moving either higher or lower.
One other lesson I have learned over 30 years of trading and managing money is the following quote from Merrill Lynch's former Chief Stock Market Analyst, Bob Farrell:
"When all the experts and forecasts agree – something else is going to happen"
“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”
Now I normally don't put much/any credence into what some Analyst-types say about valuation, market levels, trade ideas etc for the simple truth in that they are not managing money, just making recommendations or offering advice. I would rather hear the arguments from someone who is actually managing money and has their $*&@^ on the line. However, in Farrell's case, it is simply a general quote and an observation. He had ten of these now-famous quotes.
And this quote just may apply to US interest rates and the US$. Think about it - there are very few people in the world who think interest rates will not go up and that the US$ will actually go down. If everyone is set up for rising rates and a rising US$, Farrell would argue that the opposite should happen. Markets tend to take the "path of least resistance" meaning that, if it gets harder for a market, like the US$, to go higher, then it stops going higher and starts going lower...path of least resistance is lower.
My sense is that most of the damage in US interest rates (gov't bonds) has already happened and that most of the buying in the US$ has already happened.
And for micro anecdotal evidence that this is actually happening, since I started writing this at 2:05pm Feb 1st until right now at 2:50pm, 10yr US Treasury bonds have rallied or dropped in yield from 2.52% to 2.46% and the US$ DXY Index has gone from 100.02 to 99.57. Interesting.
Just a small part of the reason why we decided Monday to buy back some of our government bond exposure that we had sold down in early Sept/16. Lessons learned from 30 years of actually making these decisions (and plenty of mistakes too).