On the back of last week's blog (highrockcapital.ca/pauls-blog/coiled-up-like-a-cobra), here is an update on the coiled-up nature of the US Equity Market (at least the Dow):
Still in this flag type formation waiting for a breakout.
And if you are not reading this from FLA or CA or, some other sunny, warm and dry location, you will note that the two trend lines are in Christmas colours...because that is what it feels like in Ontario right now. If you're reading this from a better place...stay there!
When I worked at Merrill Lynch as a junior bond trader in the early 90's, I had a boss who was, without doubt, the best trader in the firm, and went on to become one of the best traders in the world at that time (in my humble opinion).
Back then, he was the most intense guy I had ever met in my life and was extremely demanding and unnerving to work for but, he was also principled, extremely fair and the best mentor one could have ever asked for if you wanted to learn how to really manage risk in the capital markets. I wouldn't have traded working for him for anything.
One day, when I must have felt extremely confident in my view of the market and was on a hot streak trading up a storm, I remember said boss saying to me, "look at you - all coiled up like a cobra and ready to bite the a$$ off of a bear". Words I will not forget.
Coiled up like a cobra is what the Dow is right now. Ready for a breakout:
What we are looking at on the Dow is really the past three months on this six month chart.
We can draw a line (white on the top) from the late January high and move it down to the right. As you can see, the highs seem to hit that white line with amazing consistency. You will also note that each time the highs hit the white line, the highs were not as high (lower highs) creating that downward sloping white line.
On the bottom, we can see a red line (horizontal) that joins up the lows over the past couple of months.
Also on the bottom, you will see the 200 day moving average in blue which seems to have acted as a support level at least over the past couple of weeks.
I am not much of a "technician" or "chartist" but I think those folks call these types of formations "flags" or "pennants" or something like that. To be honest, I have no idea what it is called technically but I do know that the market is coiled up like a cobra and poised for a breakout. Jesse Livermore (Reminiscences of a Stock Operator) would wait in this range and do nothing but then buy the market if it breaks out of this formation to the upside and sell it short or at least sell some long positions if it breaks to the downside.
Watch and wait..then pounce.
Here is the update for March 2018 for the City of Toronto real estate market for the categories of: Detached, Semi-detached and Condo Apartments. (mom=month over month and yoy=year over year).
Active Listings - 1,642, +13% mom and +66% yoy
New Listings - 1,473, +30% mom and -23% yoy
Sales - 706 units, +35% mom and -42% yoy
Avg Price - $1,293,903, +1% mom and -17% yoy
Months Supply (Active Listings/Sales) - 2.3 (down from peak of 3.5 in July)
Active Listings - 236, -4% mom and +36% yoy
New Listings - 308, +26% mom and -29% yoy
Sales - 236 units, +62% mom and -29% yoy
Avg Price - $1,032,358, +5% mom and -5% yoy
Months Supply - 1.0 (down from a peak of 2.6 in July)
Active Listings - 1,854, +5% mom and +34% yoy
New Listings - 2,225, +32% mom and -22% yoy
Sales - 1,573 units, +38% mom and -32% yoy
Avg Price - $590,184, +3% mom and +7% yoy
Months Supply - 1.2 (down from a peak of 2.0 in July)
It will be interesting to look at all of this data over the next three months as some big numbers will start to roll off. For instance, the Avg Sales Price for Detached and Semis peaked in April 2017 so the yoy will start to look better. It will also be interesting to see how the new mortgage qualifying rules (B20) affect the really important Spring buying/selling season.
For now, it appears that the market is coming into balance with a decent tilt continuing to favour the lower priced type of housing (condos).
As most of you will now know, this was a particularly rough week for equity markets around the world.
Trade war fears, Facebook and the Mueller investigation seemed to be the kindling that ignited a bit of a fire. I won't get into opinions on free/fair trade, Facebook or the Mueller investigation but when it comes to an overbought (US Equity) market, it doesn't really matter what the end result is that you think might come to fruition...it is shoot (sell) now and ask questions later.
So here is how the 3 Major US Indices ended the week:
And in Canada, the TSX faired marginally better at -> -3.1% (in C$ terms).
European Indices ranged from -2.5% to -5.0% (in EUR terms).
Asian Indices were much the same in the -3.5% to -4.3% (in US$ terms).
And two snapshots on the Dow. One is the short-term YTD showing the technical breakdown we witnessed this week:
And the following longer-term chart that shows Retracement Targets (from an Italian mathematician, Sr Fibonacci) from the Nov 2016 lows when Trump took office until the late Jan 2018 highs when the market got wobbly. These retracement targets help us a lot with entry/ exit points so we do look at them. Note the upper-green line at 23,280 was pretty much the stopping point for the early Feb 2018 rout (this represents a 38.2% retracement of the entire Trump rally...a temporary stopping point was seen). This was precisely the level we did some buying in early Feb and this was the reason why. But as you saw in chart 1 above, we broke down again this week. Sure we stopped at that same retracement level today but it is highly likely that over the next couple of weeks, the market will re-energize itself (move higher) before another move lower and a test of that 50% retracement level which is shown by the blue line at 22,250. We will wait for that level (1,000pts lower than today's close) before buying any US stocks. This level of 22,250 would represent about a -16% drop from the all-time highs set in late Jan 2018.
And you may ask how we "remain calm" during periods like this? (Those who know me will probably tell you that I am seldom "calm"...but you pay me to be in a perpetual state of "non-calmness" so that you yourself can remain calm). Well, first of all, we are sitting on >20% cash (and newer clients are closer to 40-50% cash), which is obviously very defensive and protective. Two, we took some profits just days later on what we bought in early Feb 2018 at the most recent lows. Three, we own a healthy weight in government bonds (and investment grade corporate bonds) which act as a nice cushion during rough periods in the equity market as money pours into bonds ("flight to quality" it is called). And finally, we own some non-correlated assets based on proprietary regression analysis on risk-adjusted returns. Disciplined Investing.
At High Rock, we focus on managing risk, first and foremost, and returns are the result of well-managed risk. This requires a heck-of-a-lot more experience, knowledge, skill and focus than a typical buy and hold type strategy where your Advisor, after weeks like this, says, "don't worry, it will bounce back". Really? If they knew that, then they wouldn't be working for a living. We are Tactical in everything we do.
Note - Past performance is no guarantee of future performance.
Source - Bloomberg
I promised at the end of yesterday's blog to talk about why I think it somewhat economically foolish for the cities of Toronto and Vancouver to, independently of all other parts of our great country, push away foreign capital. Here's why and this is not just economic theory - it is a reality.
In an open/flexible/floating currency system (like almost all of the developed world), there is a system to track how money flows in and out of a country. This Balance of Payments is comprised of two types of "accounts" on the federal government's books: the Current Account and the Capital Account. The Current Account tracks goods and services that are bought and sold with other nations (commonly referred to as "trade surpluses and deficits" but they do include services too, not just hard goods). The Capital Account on the other hand tracks capital flows between residents and non-residents (things like investments, loans and yes, real estate).
The economic theory/reality is that there must be Current Account/Capital Account Parity. That is to say, if a country runs a Current Account Deficit, it must run an equal Capital Account Surplus to offset that Current Account Deficit. The two must "balance" out at the end the day.
And according to studies like that of the CIA World Factbook 2017, here are the top countries running Current Account Surpluses (those exporting more goods/services than they import):
Interesting. So for countries like the USA and Canada, which run high Current Account deficits, there is an equal and offsetting requirement for them to run Capital Account Surpluses. That is to say that they need to attract foreign capital each and every day to fund that Current Account Deficit.
And how do you attract capital to fund your Current Account Deficit? You keep interest rates high (Note German 10yr bonds yield .64% while US 10yr bonds yield 2.89%), you create incentives for foreign investors to invest in your country and yes, you allow those foreigners to buy real estate. Any readers own a place in FLA?
So what is so bad about running Current Account deficits? Well, for starters, you need to keep interest rates high to attract capital and high interest rates put a bit of a stranglehold on economic growth. It also means you are beholden to foreign capital flows (Saudi Arabia, China and Japan are all massive holders of US Treasury bonds which helps fund the US's Current Account deficit).
In the USA, we are seeing the Trump Administration follow through on their campaign promise to "bring back manufacturing jobs to the USA". It is highly unlikely that Trump is going to go out and say he wants to shrink the Current Account Deficit but, in fact, that is exactly what he is trying to accomplish. Last week, we had a well-read client ask about the US$ going into free-fall. If Trump has success over the next 3 years in shrinking the Current Account deficit in the USA, there is the potential that the Capital Account surplus will shrink as well which may mean the need to attract foreign capital will lessen. Not sure it will lead to a free-fall of the US$ but it could maintain its recent weakness.
In Canada, we are in much the same boat as the USA. We run a very stout Current Account deficit so we need to equalize that every day with a Capital Account surplus. Again, this balance of payments situation means we need to attract in foreign capital every day. So I find it rather stunning that the mayors of the two largest cities in our country, unilaterally, decide to push that much-needed foreign capital away (or at least attempt to). Any idea how that affects our country's balance of payments on the whole? We need that foreign capital. And I do realize there is a question that some foreign money (the press talks a lot about Chinese investors) may be buying houses with ill-gotten gains but it is the responsibility of the Canadian Real Estate Board to vet all foreign buyers and report to FINTRAC (watchdog for anti-money laundering). Wouldn't it be better to properly vet the money rather than refuse it? Can you imagine if you simply were not allowed to buy a house in the State of Florida? (I could go on about relative value in the global residential real estate market, the principles of property ownership in a democratic society etc, but this is about the economic reality of Current Account/Capital Account parity).
Anyway, this is the reality of the state of our natural and constant demand for foreign capital in Canada.
The title may seem odd so let me explain. First I will give a recap of the February data (apologies if I missed Jan but I have been jammed at work) for the City of Toronto's real estate market and then I will make a comment about the Royal Bank of Canada (and its CEO's most recent comments). I wrote much more extensively about the Canadian housing market last June which you can read here: highrockcapital.ca/pauls-blog/archives/06-2017
Here is the recap for February's data. Remember, we are only looking at the City of Toronto (not the GTA) and only for Detached, Semis and Condos. YOY (year over year) and MOM (month over month) are reflected.
Active Listings - 1,453, +14% mom, +121% yoy
New Listings - 1,134, +36% mom, +2% yoy
Sales - 524, +39% mom, -34% yoy
Avg Sales Price - $1,282,240, 0% mom, -19% yoy
Months Supply - 2.8 months, -18% mom, +235% yoy
Active Listings - 247, +13% mom, +101% yoy
New Listings - 244, +31% mom, -4% yoy
Sales - 146, +55% mom, -27% yoy
Avg Sales Price - $985,902, +5% mom, -9% yoy
Months Supply - 1.7 months, -27% mom, +174% yoy
Active Listings - 1,767, +7% mom, +36% yoy
New Listings - 1,687, +12% mom, -10% yoy
Sales - 1,142, +27% mom, -30% yoy
Avg Sales Price - $570,276 +5% mom, +11% yoy
Months Supply - 1.5 months, -16% mom, +94% yoy
As you can see, the trend continues for demand to back the lowest-cost type of housing (condos and, to a lesser degree, semis). The fact of the matter is that new OSFI Mortgage Qualification rules (B-20) are having a bit of an affect on the amount of housing buyers can afford. If you want to own a house, but can only afford a condo, given how you qualify under B-20, then a condo you buy. Also, demographically speaking, the two largest buckets of people are millenials and baby boomers and both create demand for condos - millennials because that is all they qualify for and baby boomers because they want to down-size (and take out some cash to retire).
I still think that over a longer period of time than 2-5 years that detached houses are where the real value is. As the city grows (110,000 immigrants into the GTA each year) the supply will come from condos while detached housing is locked up. It's all about land value and what will soon be scarcity value. Condo Supply vs Detached Demand.
Now onto the Royal Bank (RBC). I have show this before but for different reasons...just sort of ironic that the CEO of RBC made a comment yesterday at a speech in NYC about how foreigners are using Canadian houses as a "piggy bank". More on that in a minute and maybe even more tomorrow. For today, I want to show the Total Return of the City of Toronto Detached and Condo Housing market (Avg Sales Price) for the past 20 years and compare that to the RBC stock over the same period ending Feb 28, 2018. Keep in mind that on the housing side, the price appreciation does not show all of the costs of running the property (utilities, insurance, property taxes, renovations, etc), all of which can add significant value to a house over 20 years but, to be fair, it also does not take into account that if you did not own your own house, you would have to rent. And the RBC stock includes dividends paid by RBC and re-invested back into RBC stock.
Detached - Feb 28, 1998 at $225,000 to Feb 28, 2018 at $1,282,240 for a 20 year compound annual return (CAGR) of 9.1% or a Total Return of 470% (again, this excludes any renos over 20 years which would dramatically change the CAGR, even if we added rent back).
Condos - Feb 28, 1998 at $124,000 to Feb 28, 2018 at $570,275 for a 20 year CAGR of 7.9% and a Total Return of 357%.
RBC Stock - Feb 28, 1998 at $49.39 (adjusted for splits) to Feb 28, 2018 at $101.09 for a 20 year CAGR of 12% and a Total Return of 874%.
So, Mr McKay (RBC President/CEO), why is it that the City of Toronto housing market is so expensive?
What really gets me is this notion that our housing market in Canada is all being driven by foreign money (and the assumption that most/all of that foreign money is from ill-gotten gains...maybe some is, I am not privy but the real estate boards across the country are supposed to have Anti Money Laundering systems in place, as we do as an asset management firm. And anecdotally, I can say that there is no foreign money in my neighbourhood and that new neighbours moving in are all domestic families. I will have more to say on this notion of foreign capital tomorrow and it will be purely from an economic perspective.
For now, there is your snapshot of the state of the housing market and just one relative value gut-check on two separate asset classes and how they have performed over the past 20 years.
When a group of stocks (sector) or an asset (Bitcoin) goes through the roof, we usually take a few inbound emails from clients asking if we own them or if we are going to participate in them. Canadian marijuana stocks were one such group where we were questioned.
My answer over the past six months or so has been "we only invest in cash flowing companies". That is to say, when investing in corporate bonds and equities, what we are really buying is a stream of cash flows. There are many ways of valuing what that stream is worth (the tricky part) but investing in businesses that have zero cash flow adds a second derivative...ie...will the business even survive? Marijuana stocks certainly fall into this category. Heck, the federal bill has yet to pass through the Senate and receive Royal Assent as of yet (I would be pretty sure that will happen however).
I must admit that I haven't spent time looking at the sector from a fundamental research perspective (and may never) but I do have some close associates who have. Their conclusion over the past month or so has not been a positive one, that is for sure (it pays to have smart associates to share research with).
And, as usual, right they were. I have been watching from afar and have noted that some of these stocks have sold off a fair bit. Today, I thought I would look at what they have done in general over the past month. A quick look at the Canadian Marijuana Index of 24 Canadian Marijuana public stocks reveals the following chart:
The peak was Jan 9th at a value of 1,045 and today it is at 615.5. That is a 59% Decline in value over about 7 weeks. Killer for a portfolio if an investor had a large weight to the sector. To be sure, I have no idea if this thing will pop right back up. It very well may but a 59% cut is a big move.
What is driving this massive decline? An educated guess might put forth the following:
And the bottom line is - Scott and I are investing our own money exactly the same as our client money. We are doing so prudently and with the proper fiduciary duty that we owe ourselves, our families who we invest for and, most importantly, our clients. Sure it would have been nice to have made some dough on the way up on these marijuana stocks but we see that as gambling, not investing and it could, arguably, violate our fiduciary duty to our clients.
If you want your money manager to "gamble" your hard-earned after-tax (and tax rates don't look like they are going down after yesterday's Federal Budget) dollars then I would suggest you: a) go to Vegas and/or b) find a Broker at Canaccord who is way smarter at gambling on marijuana stocks than I am.
If you want your money manager to create a well-diversified portfolio by using an investment process that has been in place for decades, attempts to create superior risk-adjusted returns, allows you and your family to sleep at night and, ultimately, over time, meet your future financial goals, then High Rock might be right for you. If so, give us a call...you have nothing to lose and maybe something to gain.
NB - Past performance is no guarantee of future performance.
I was asked to give some comments to a Bloomberg journalist last week on my views on the state of the energy markets in Canada. Good timing as I have written about it before and most recently as Feb 15th (highrockcapital.ca/pauls-blog/taking-stock).
Here is the link to the Bloomberg/Globe article I was (mis) quoted in: www.theglobeandmail.com/globe-investor/investment-ideas/investors-bail-on-landlocked-canadian-oil-as-pipeline-woes-deepen/article38047446/
A couple of corrections to the article:
And I do not disagree with what the other Portfolio Manager said in this article. I do however disagree with what the federal government says in the article...these pipelines are not going to get built in time for hydrocarbons to still be relevant. There will be way too many special interest groups who will oppose pipelines (and rail) as a form of transporting hydrocarbons out of Western Canada.
There has obviously been a lot of volatility the past two weeks in all capital markets so I thought I might take just a moment to look at the stock market returns around the world (in C$, although it looks pretty much the same in U$) on a year-to-date (YTD) basis.
I have shown this page (taken from Bloomberg) before in a blog back in Sept/17: highrockcapital.ca/pauls-blog/things-i-wonder-about-my-shortest-blog-ever and today will be the same...short.
Without delay, here are some major stock market indices around the world with their return (excluding dividends so not Total Return) for the YTD and in C$ in the last column on the right side:
Notice anything here? You don't need a CFA to find the outlier. That's right, the Canadian stock market is fairly deep in the red after only 6 weeks. The question of "why" is one I will answer with very little detail:
Here at High Rock, we have continued to limit our exposure to Canadian oil and gas stocks even in the face of what look like cheap/tempting valuations. Disciplined Investing. We are also being extremely selective with our Canadian equity investing in other industry sectors as well for fear that overall economic damage is being done that could lead to real economic weakness, which will continue to lead to further economic pain in Canadian stocks.
More red, less green is not what we are looking for.
I am terribly uncreative with titles on blogs but this may be one of my best (sad as it is).
Expanding on Scott's blog on Tues Jan 30th (highrockcapital.ca/scotts-blog/big-drop-in-stock-market-and-uptick-in-volatility-should-you-be-worried) I thought I would show a chart of the Dow on a daily basis so it is easier to see. Below is the Dow for the past four days (Monday Jan 29th thru to today).
On the far left, Monday represented the all-time high (until we make another all-time high because that is what US stocks do at least on a weekly, if not daily, basis!!) but Tuesday saw a big "gap" down where the Dow fell upwards of ~400 points during the day. And what Scott was referring to in his blog was whether or not the market will be able to "fill in that gap".
It is not uncommon for any market to "retrace" or partially fill in big gaps after big gap down days. So here we are on the second/third day after Tuesday's big gap down day. As you can see above, yesterday the market attempted right at the open to fill in that gap. Didn't quite fill it in but did so partially. And today it has tried again hitting about the same high as Wednesday but again not able (so far) to fill in the gap.
Filling in the gap is important because it demonstrates the strength of the overall market. And if you go back and look at Scott's longer-term chart, you will see that this is the biggest gap down we have had over the past six months. And if you look back even further, you will find this is the biggest gap down we have had since before the Great Recession (it is hard to see on a chart but I did look) other than a small (much smaller than this past week) gap down in May 2017.
So that is why it so important to see, at these high levels and after such enormous strength, if US stocks can "stabilize" at these slightly lower levels, recharge and shoot up higher and fill the gap. Or are they tired and the market has run out of buyers. Time will tell but we will mind the gap each day.