These are the forecasts released after yesterdays Federal Reserve (FOMC) meeting. 2% GDP growth is not conducive to corporate earnings growth of 20% (which is currently built into stock prices).
Something has to give.
And now, interest rate adjustments aside, the US Federal reserve will be starting to reduce its balance sheet by $10B per month (beginning in October) and gradually increasing that amount.
What happens to the $10B (and eventually more)?
It is removed from the financial system. The US Federal Reserve will not be buying $10B of additional securities (each month) that they have been previously buying, so the financial markets have to take up the slack and buy those additional securities themselves.
Where will the $10B come from?
The most expensive assets will be sold to make room. If you own expensive assets, it is likely that their prices will start falling.
If economic growth is only going to be 2% and stock prices have built in a 20% premium (above the current expected earnings), I would argue that the 20% premium in stock prices might indeed make them expensive assets and therefore vulnerable to selling.
This is one of the reasons that we have taken a cautious position in owning over-priced equity assets in our portfolios. Tactical and disciplined investing.
Bianca and I were visiting with one of our older clients yesterday (yes, we make house calls!). She had recently moved into a lovely assisted living community because of some health issues and while she was thrilled with her new living environment and the additional care, she was, quite reasonably so, concerned about the additional costs.
We had redone her Wealth Forecast to allow for all the changes and were able to show her that there was going to be little impact on her long-term net worth (she was thrilled for her ultimate beneficiaries). Tailored, flexible Wealth Management.
"But what about the stock market?" she asked, "it doesn't look too healthy" (I'm glad she keeps an eye on things). We showed her that at the moment, her total exposure to equity markets was approximately 8% and that we had plenty of income being generated by bonds, preferred shares and cash equivalent, no MER, High Interest Savings Funds (CDIC insured) to provide her with safety and all that she might need into the future.
Folks, stocks are expensive and vulnerable and I would suggest by what the Fed is telling us we should not be complacent.
The Trudeau government is about to stick it to the entrepreneurs in favour of the workers under the guise of creating an "even" playing field (a debate which we are watching closely on behalf of our clients who have small corporations).
The Bank of Canada, whose mandate is to fight inflation (which at the moment remains minimal), is sticking it to the indebted household with higher interest rates.
The housing market is on the verge of cracking.
Is the "perfect storm" developing?
And this is just in Canada.
I am biased, to a degree, as a small business owner, but I take risks with my (and my families) money to invest in and build a business.
With all due respect to the hard working Canadians who do their jobs, day in and day out for large corporations or a government agency, they just don't have the same risks as we small business owners have. In that alone, the playing field is already uneven.
Small business drives the Canadian economy, it should be encouraged, not discouraged, if you take away the tax advantages, you take away the desire for the entrepreneurs to take risk. If you take that away, then you lose a powerful economic force.
That is the risk that the Trudeau government is taking. Unfortunately the downside (slowing economic growth) affects everyone.
Throw in higher interest rates and the rising cost of borrowing that the Bank of Canada is pushing on us with yet another record household debt to income level as of the end of Q2 ($168 of debt per $100 of income per household) and there is a recipe for further economic slowing. The stronger $C is also adding to this issue.
Finally, add in the fact that the housing market (which is now somewhere in the vicinity of 20% of Canadian GDP) is showing signs of strain with new foreign buyer rules and higher borrowing costs and it becomes a very cloudy outlook for this country.
The US economy is looking a bit shaky after today's retail sales data for August (what happened to "back to school" buying?).
Need I mention North Korea (nuclear war risk), again?
Even Warren Buffet is accumulating cash:
And parallels are being drawn to 1987:
Be careful what you wish for Mssrs. Trudeau and Morneau!
If you have never had a close look under the hood of the self-regulating, Investment Industry Regulatory Organization of Canada, it is certainly worth taking the time (and there are some really interesting stories under what I call the "bad advisors" section under Enforcement Notices.
I do check there, from time to time, just to see who has done what to whom, so I can shake my head in wonder.
Here is a good one:
A Vancouver couple, aged 63 and 64 receive a million dollar plus inheritance, have had no previous investing experience and hook up with a Financial Advisor with the intention of investing to generate income for their retirement and the desire to leave the principal to their children.
Nothing overly demanding, the kind of thing thatwe see on a regular basis.
The advisor sets them up initially with margin accounts, which should always raise a red or yellow flag, but these folks trusted this fellow and followed his advice. They stated objectives that were 50% low risk and 50% low to medium risk.
8 months later, the advisor, likely wondering how he was going to generate more revenue from these unsuspecting clients (because in the investment industry you are paid a greater per cent of the fees and commissions you generate when you attain certain revenue targets, called "the grid"), had them adjust their objectives to moderate growth (medium risk), increased short-term trading (medium to high risk) and speculative (high risk). Definitely more warning flags.
You can read all of the gory details in the above report, but basically it appears that the advisor began to use margin (borrowed money) to trade in some junior Canadian resources stocks (probably suggesting great gains to be had).
Great gains were not had. In fact it appears that great losses were had, to the tune of $700,000!
So much for protecting the principle.
In the end the advisor was fined $45,000.
I am not certain (because I could not find any other details and if there was a settlement, it was likely not made public) but hopefully there was a civil suit that followed. Even then, the likelihood of getting all of that money back (after legal contingency fees, etc.) is limited. even more likely is that it is still in the system, so many years later. The big company lawyers know how to drag it out.
You do not recover from a breach of trust like that.
A portfolio manager (not regulated by IIROC, but by the more stringent Ontario or other provincial Securities Commission) has a fiduciary duty to protect you from that kind of financial abuse.
The investment industry has an enormous conflict of interest and bank and investment firms (self-regulated under IIROC) simply do not offer fiduciary responsibility to their clients. Advisors are paid based on the fees and commissions that they generate. That is, for the most part, the investment industry's motivation. I have seen it first hand.
That is why we started the High Rock Private Client Division, to offer an alternative that is different and better (and probably costs less and provides a very strong personal service commitment). I am never too busy to come to visit you, if you need to see me, face to face, no matter where you live in the country.
Fiduciary duty (safety), low cost, high level of service, not driven by revenue goals, but by doing right by our clients: It is possible and we are doing it.
wo quick 1/4% rate hikes to stall the potential inflationary impact of strong GDP growth in the first half of 2017 (when inflation and the future expectations thereof are currently non-existent) is driving the value of the $C higher (by more than 12% vs. the $U in the last 5 months) and the value of your globally diverse, balanced portfolio lower.
Let's use the All Country World (equity) Index ETF (ACWI) in $C terms (which your consolidated portfolio is ultimately denominated in) as our proxy:
Total return (per the above chart) has added about 12.5% over the last year. If you have 60% of your fully invested portfolio in global equities, that would be impacting your portfolio positively by about 7.5%.
If you have the other 40% in Canadian bonds, let's use the Canadian Bond Index ETF (XBB) as our fixed income proxy:
Total return over the last year is a negative 2.75% (lots of red there). If your fully invested portfolio is 40% fixed income, that would be impacting your portfolio by a - 1.1%.
Therefore, your total portfolio return, before fees would be only up by about 6.4%.
This is pretty simplistic, but enough to draw comparisons as to how your own portfolio's have been performing over the last year (remember to include fees and costs). Ask your advisor. If they don't know, exactly, they are either hiding something or they just don't know what your risk profile is.
If you have had tactically less exposure to the $U, bonds and / or international equities, then you may have faired better.
At High Rock, we manage risk first (and we know exactly what each clients risk profile is). We have been tactical about our various exposures because we don't think that historical correlations are offering the same protection as they used to.
The Bank of Canada has seen to that recently.
Even if you have been over-exposed to Canadian equity assets (see Paul's blog today) you will not have benefited from Canada's recent run up of GDP.
Markets are scrambling for answers and knee jerk reactions are creating all sorts of volatility.
As we have been wishing all of our friends who are in the path of these wild hurricanes: Stay safe!
We regularly tell our clients and anyone else who might listen that all is not necessarily as it may seem. That is because we manage risk first and foremost. So we are always questioning mainstream thinking, looking in the crevices for things that may not look significant, but could blow up to be big issues.
We are not alone, even a voting member of the US Federal Reserve is questioning the stance of his colleagues.
Mainstream thinking, at the moment is that central banks, facing economic growth (and as I mentioned yesterday, most of the data on GDP growth is more than 2 months old now) are erring toward the tightening (or reducing the easing) of monetary policy.
This is being done in the face of a wide variety of potential economic, geo-political and environmental shocks that could completely turn economic growth upside down.
Need I name them all?
In Canada, the housing market has gone pear shaped and the 10% rise in the $C will make exports more expensive and imports cheaper and should work to drive GDP growth lower.
In the U.S. the cycle is in its late stages, employment is close to full, but doesn't appear to have a whole lot of growth momentum (and wages are not growing). The Trump administration is mired in politics (and not getting much of anything accomplished) at the moment and climatically induced hurricanes are ravaging (or about to ravage) its southern coastline. The sabre-rattling with North Korea and Trump's stance on protectionism and anti-immigration policies further cloud the picture.
The wild card, of course, has been the reluctance of inflation and inflationary expectations to take hold, which under normal circumstances should follow economic strength.
But that is not happening.
Central banks (especially the Bank of Canada) are adamant that inflation will re-appear. However, for that to happen, you need to have expectations for inflation increasing and for that to happen, you need to see wage growth. It is not happening in Canada and it is not happening in the US, or anywhere in the world, for that matter.
Bond investors are telling us that by not demanding additional premiums (higher yields) in longer dated maturities, that they are not expecting any major inflation surge either.
We know and are at no loss to tell those who may listen, that bond markets are way bigger than stock markets and lead all other asset classes (in direction):
So have a look at what they are telling us:
Bond yields are falling. Stocks look vulnerable.
Do you fully understand your risk profile? If you are fully invested, 60% equity, you are vulnerable. That's why a more tactical approach works. It helps to reduce risk.
Thanks for the fine intro Pres. Trump!
1) In our fair country, with the big GDP numbers (the last 4 quarters worth anyway, which are all historical and ended on June 30, that would be 2 months ago) we have the Bank of Canada offering up its decision on the course of monetary policy and interest rates tomorrow.
In a country as indebted as ours, this is not insignificant. The household debt service ratio at about 14.5%, rather subdued (again as of June 30), will start to feel it after two 1/4% interest rate increases (if they do raise the Bank Rate again tomorrow) and will have a nasty impact on the highly leveraged Canadian households already feeling the sting from the housing market slide.
2) Tax changes are coming, according to an article in today's Globe and Mail by the Finance Minister himself:
If you are going to be impacted (especially those of you with professional corporations), you might want to start thinking about your strategy going forward. We can help you with that.
South of the border, they have lots of issues in front of them as Pres. Trump alluded to:
1) Another game of "debt ceiling roulette" and the Trumpian threat to shut down the government.
2) NAFTA negotiations are ongoing, but the early talk is that it is not going so swimmingly:
Again from the Globe and Mail:
3) And it seems that Trump's message to North Korea has not had much impact and the political rhetoric has escalated further.
We shall discuss all of this and more on ourclient weekly webinar today. We shall post the recorded version on our website at or about 5pm EDT.
Feel free to have a listen!
Spend a couple of hours with Stan Buell, head of the Small Investors Protection Association (SIPA) (which I did today at Charlottetown's The Brickhouse Kitchen And Bar) and listen to a few of the stories he has accumulated from his days helping the many abused investors who have lost millions to just plain bad advisors and it won't take you long to start thinking about who is in control of your money.
These people (the bad advisors) were apparently trustworthy, in some cases, vice presidents with large, apparently safe, banks and investment firms under the ever watchful eye of the self-regulating Investment Industry Regulatory Organization of Canada (IIROC).
Over our lobster mac and cheese and seafood chowder (both to die for, if you enjoy the type of catch that the local folks brought in that morning) we wondered why it was that the people who put their trust in these various scoundrels were so easily taken.
Certainly, the institutions backing them were a good part of the reason. The scary part was that even though, in many cases, investors did get some (definitely not all, after lawyer contingency fees, settlements, etc.) of their money back, the banks fought for years to protect these bad advisors (and themselves). So, in the case of one situation, after fighting 10 years over a couple of million dollars, the retired plaintiff got some of his money back and passed away 4 years later. Not a happy story.
Friends, I have in many past blogs tried to discuss the necessity of making certain that your adviser is fiduciarily responsible, but both Stan and I have come to the realization that many do not even understand what that means.
We think that we have to break it down into more understandable terms:
If and when your advisor sells you an investment (ETF, stock, bond, mutual fund), it is her / his responsibility to make certain that, at that moment in time, it is suitable for you (the Know Your Client rule).
Beyond that, it is no longer his / her responsibility. You own it, you are responsible. Period. She / he is not. If that investment, somewhere down the road becomes unsuitable, it is not their responsibility to tell you to sell it. If they are good, they should, but as they are not legally accountable (i.e. they have no fiduciary responsibility), you are rolling the dice. It is all on you to monitor and research. Do you have the time and the expertise for that?
Did they advise you to use margin (use debt) to purchase that investment?
Uh Oh! More warning signals.
Stan spends his valuable time fighting the good fight, trying to get the governments to recognize how the self-regulating organizations have an extreme conflict of interest and are not interested in forcing their members to provide a fiduciary duty.
Have you seen the latest big bank profit results?
The Wealth Management arms of these institutions are recording record revenues. I guess the pressured sales tactics as reported by CBC Go Public Investigation into Big Banks are working.
At least the bank shareholders must be happy. What about unsuspecting clients?
As a portfolio management company (like High Rock) registered with the Ontario or other provincial securities commission, we have a fiduciary (legal) responsibility to monitor and protect our clients' portfolios. That is why we are so very focused on risk. You, as a trusting investor, have to make certain that you are dealing with advisers who have a fiduciary responsibility to you.
We (the smaller but likely more responsible money managers) do not have the resources to compete with the advertising powerhouses of the financial industry (that allude to safety and security that may in actual fact be, in many cases, a myth), so we need to rely on continuing to tell the stories that Stan tells.
So have a look at the SIPA website and pass it on and help Stan tell his stories and get the message out there. Think about it. What if you were to lose everything to a rogue advisor? What would you do?
You may be richer than you think, but you may not be as protected as you think!
My answer is always: "it depends".
Basically, it is not about the amount of your investable assets, we won't draw that line.
It is more about the fit: If you are a young investor and a good saver (that will all come out in the Wealth Forecast) and have a long-term,wealth building goal and understand that wealth is not created instantaneously (i.e. via gambling), but is a gradual building process, you will be a good fit.
We have a host of multi-generational families in our (High Rock) care (including our own children and grandchildren) and a broad cross-section of clients that give us the experience of preparing investing strategies for lots of folks from many walks of life.
We try to limit ETF MER costs to our clients by using actual securities in our Fixed Income and Tactical models, but will use ETF's in our Global Equity model, but always with an eye to keeping MER costs to a minimum.
At the moment, MER costs for the majority of our clients are approximately 0.03% to 0.06% (of the total portfolio, depending on how fully invested you are) in a balanced 60% equity / 40% fixed income style of portfolio.
If you are in a fully invested 60/40 ETF portfolio, by comparison, you are probably paying an additional 0.30% to 0.50% (or more) on top of whatever your advisor is charging you. Have you investigated what your ETF MER costs are? It is important (especially in the low return environment we have been in for the last few years), you definitely should research this. If your advisor isn't forthcoming (they should be able to provide exact details, not just approximate data) that is a definite warning flag.
In our smaller client portfolios, where we can't get securities (usually bonds) in smaller denominations, we will have to use bond ETF's and that will add to the portfolio's MER cost, but we will always be completely transparent about the MER costs and do our best to keep them as low as possible.
So smaller portfolios may have some additional MER costs, but our level of service and commitment to you should more than compensate.
If we are the right fit.
The "fit" works both ways: we need to be the right fit for you and you need to be the right fit for us.
But unlike many investment advisory practices at banks and large financial institutions, you don't get shuffled to a lower tier of service and investment options if you are a smaller client.
Our discretionary management (you still have separately managed accounts, SMA, held at our custodian, RJCS, as opposed to a pooled fund) allows us to buy and sell securities simultaneously for every client: there is no discrimination or priority as to size when it comes to trading.
So our big clients are happy and our smaller clients are happy.
Everybody has a plan tailored to their specific goals and a matching portfolio strategy.
There is a new low-cost, fiduciarily responsible alternative to the old school, expensive, big bank or investment dealer style of growing your money with the service and care (risk management) that you will not get at a robo-advisor and High Rock (recognized by the Small Investors Protection Association, SIPA, as a "new breed") is leading the way forward.
In my world, boring is good.
A slow, steady, gradual, low volatility, predictable rate of growth is a good thing.
Now, of course, we are competing with those that want to tell you that you have to do something and you have to do it now or you will miss out on the big opportunity that awaits you!
They are selling excitement!
It's easy to buy excitement because it is entertainment and we all know that we want to be entertained!
Speaking of which, I just finished season 1 of Dwayne Johnson as Financial Advisor Spencer Strasmore:
Or perhaps even more exciting is Jason Bateman as Financial Advisor Marty Byrde:
Now these guys sell excitement (comedy and drama)!
They even talk it up like a few financial advisors I have witnessed in my past, you know: "grab the opportunity now" (and other standard financial advice cliches) kind of stuff.
But, alas, the real world is not like that (not the one that I know anyway).
Here it comes, you may be thinking, he's going to say something about planning...
You are correct. How boring is that?
So many folks don't have a plan. You need to have a plan before you can take advantage of any exciting "opportunity" because you need to be able to figure out how that opportunity is going to fit into your future.
But its August, its the summer, its just not the right time.
Ok, so should we wait until September? If you have kids, then that is such a good time because you won't be running around with back to school issues? Perhaps October? Maybe after Thanksgiving, or November, such a boring month! Not December, way too busy. January? Yes, to start the new year!
And before you know it another 6 months passes on by and there is no plan.
Obviously that little lecture is not for High Rockclients, because they all have plans and are well on their way to having their portfolios built, achieving their goals and getting a wonderful nights sleep (that is where boring is very helpful) in a methodical, disciplined way.
If you think that gambling is exciting, then you should take a trip to Vegas (but keep in mind that the "house" has the odds stacked heavily in its favour).
If you want to be a steward of your families financial future, then you are going to have to get a plan together.
Be fearful of the exciting sales pitch. Go with the boring folks, who talk about how managing risk (and cost) is their biggest priority.
John Maynard Keynes : "When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill done".
I did not come up with this on my own, but had help from James Mackintosh of The Wall Street Journal.
Nonetheless, following up on, in what we would consider to be a time of high risk (last Wednesday's blog), volatility spiked last Thursday as the political rhetoric between the US and North Korea heated up and slipped lower on Friday, yesterday and further today as it cooled down:
Traders and speculators (gamblers) have been whipped into a frenzy. They like volatility because it frightens the retail (individual investor) and they are keen to take advantage of those that get frightened by the wild market swings.
The problem, at these late stages of the economic cycle, is that investing (finding value in an asset for the purposes of receiving a future income stream or appreciation in that value), has little to do with what is transpiring in the stock market.
Reasonable value has long been taken out of stock markets (sometime in 2013) and expected future (12 month forward) prices, relative to earnings earnings are trading at about 17.5 times. Well above the 10 year average of 14 times (24% above).
In fact, with earnings over the next 12 months expected to grow at a rate of about 6.5% and the the price to earnings ratio 24% over its average, earnings would have to grow by an additional 30% to just meet the 10 year average P/E ratio.
In an economy that is growing at barely 2%, that is not likely going to happen.
Another of our metrics of value: Enterprise Value to EBITDA (Earnings before Interest, Tax, Depreciation and Amortization) is at its highest levels since the dot com bubble.
With value out of the equity market in general, it is left to the gamblers to play the trading game to try to find a way to continue to build momentum for stocks to move higher.
Earnings growth is better now, but it was non-existent in 2015 and 2016, yet stock prices continued to rise. Now there is some residual growth, but it is not booming, just catching up.
The new Trump administration gave hope and hype at the beginning of the year, but that is so far a bust.
Hope and hype and pretty mediocre earnings have fed the emotions of the buyers so far this year, but stocks are expensive and in the end they will return to the mean (average) values as all things do, eventually. Buying stocks at these levels would likely be less than prudent.
We will talk about this and other things financial, economic and wealth management related on our (new format, dialogue version) weekly client webinar today. The recorded version will be posted on our website (after 5pm EDT). Feel free to tune in!
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist