Updated: High Rock Sponsored Olympian Darren Gardner (Parallel Snowboard) Races On Friday (CBC 7:27 EST)
Qualifying , Finals on Friday
More on Darren.
We are all very excited and proud of Darren and hope that you might get a chance to cheer him on!
Good luck Darren!!
Last Friday (Feb. 9), the S&P 500 hit a level (2532), which was almost 12% lower than the Jan. 26 high at 2873. This brought one measure of value, the Price to Earnings (P/E) ratio for 12 month forward looking earnings (earnings growth for 2018 is expected to be about 18% taking new US tax reform into account) down close to the 5 year average near 16 times
(see last Saturday's blog for the chart on this).
Our risk models turned green at this point and our orders for investing recently added client cash saw many of their target prices met and we bought equity assets for our clients and ourselves (because we invest in the same assets as our clients).
Volatility created value (risk levels fell with falling stock prices) and we were able to take advantage of it. Buy and hold strategies were basically stuck on the sidelines.
Yesterday, after about an 8% increase in the S&P 500, risk levels rising again and the 12 month forward P/E values rising to over 17 times, we took some of that risk off of the table. Who can argue with an 8% profit over one week?
The point being is that we were hard at work, monitoring our risk metrics because that is how we mange money, by risk. If stock markets go higher, we will continue to take risk off of the table.
If, as we suspect, there will be more volatility as central banks draw liquidity out of the global financial system as they gradually reduce quantitative easing (and institutions are forced to sell assets), there will be more opportunity to find better value as prices settle at more realistic levels.
One of our more attentive clients sent me this market letter mid-week: The Advent of a Cynical Bubble by market strategist James Montier (worth a look for sure), which interestingly invokes the musical chairs metaphor which I often use, but the week of Feb. 5-9 was certainly an excellent example. Needless to say, last week (on much lighter volumes) brought back the overdone "buy the dip" crowd, pushing market prices back to levels that are less-realistic.
This push and pull of buyers and sellers could keep volatility relevant for some time to come, especially if the reality of lower levels of liquidity brings greater institutional selling into fewer and fewer "buy the dip" types who are running out of juice.
For our clients, we will monitor all the goings on and continue to do the work of buying value opportunities which enable us, over longer periods of time to reduce risk and portfolio volatility.
In the mean-time, the buy and hold crowd will watch their portfolios swing erraticaly in value, while we build it in ours.
Stocks are about 9% off of their highs and down a little over 2.5% on the year (ACWI ETF converted to $C). If you bought stocks after October 2017, you are offside. Bonds are down too, the Canadian Bond Index ETF (XBB) is lower (year to date) by about 1.7%.
A fully invested 60% equity, 40% fixed income portfolio, based on those two ETF's is lower by a little over 2% so far this year.
With an increased allocation of cash of 20-30%, you likely could have saved about .50% or about $2,500 on a $500,000 portfolio since January 1.
Dennis Gartman, long-time market commentator and trader suggested on BNN that market tops are made of volatile moves as those we have seen over the last couple of weeks and that we may have begun a bear market (in stocks).
Prominent economist Mohamed El-Erian suggests that it is unsettling and that as I suggested above that diversification is not working. However, he does say that it could put markets on a firmer footing:
"Although it is painful in the short-term, this correction could underpin healthier markets in the longer term. It reminds participants of the importance of respecting, and better pricing, volatility and liquidity. And, with improving actual and prospective growth, the sell-off can be part of a transition from liquidity-driven valuations to ones built on better economic and corporate conditions, thereby narrowing the gap between elevated asset prices and fundamentals -- and the concern for future financial stability that comes with such a gap. "
More here: https://www.bloomberg.com/view/articles/2018-02-09/10-things-to-know-about-the-stock-market-selloff
What I know is that stocks got a lot cheaper relative to earnings and that is a key fundamental that we (at High Rock) have been monitoring for sometime: VALUE
And another thing that I know is that I would rather have cash in my portfolio so that I can grab some bargains when I see them. So I do. So do Paul and Bianca. So do all of our clients, because we manage our personal money in exactly the same way as we manage our client's money.
We manage risk first. When risk is high, we accumulate cash. We do not chase returns. When prices come down to more reasonable levels we look for value.
Is there better value now? Certainly, at least by the above chart it has not been this good since 2016. Will values get better? Maybe. But it sure is nice to have options for buying into better value.
If you have a fully invested buy and hold strategy you are going to just have to sit and wait it out.
What kind of work is a buy and hold strategy advisor doing at this time? Not looking for bargains. Perhaps advising his / her clients to "sit tight". Very strategic!
From a piece by Jonathan Chevreau in The Financial Post: "The magic number for retirement savings is $756,000, according to a poll of Canadians" and "while that is the average amount individual Canadians believe they'll need to amass, up to 90 per cent don't have a formal plan on how to get there."
I can tell you that everybody we (High Rock Private Client) work with has a formal plan. We call it a Wealth Forecast. In fact we will not build a portfolio strategy without one (and it is prepared by our Certified Financial Planning professional). As experts in wealth and portfolio management, we would never presume that a "one size fits all" mix of assets (stocks and bonds) is correct for everybody, something that separates us from the standard of many financial and robo-advisors.
Not only do we prepare a plan up front, there is no obligation to work with us if you don't like the plan and the accompanying strategy (or us for that matter). We know that you not only need a starting point, but regular monitoring and updating to keep the plan current. The starting point and projected net worth forecast is not worth the paper it is written on, if it is not re-visited at least one or two times per year. Life is dynamic and change happens on many fronts and that needs to be reflected in your plan.
Everybody's goals are different and the path to achieving them is different. The average amount of dollars suggested in the above mentioned article is just a number. It does not tell you the lifestyle associated with that number. That lifestyle is purely personal: where you live, how you live, what activities you choose for retirement are yours to determine.
We can tell you if they are realistic.
We can also tell you how you are going to get there.
We cannot predict the short-term swings in the value of investment assets in financial markets. We can, with our ability to manage risk, predetermine a long-term goal for the growth of your financial net worth: focusing on protecting your capital first and then getting the long-term average annual rate of return you require to meet your objectives for the future, while at the same time keeping the risk we need to take to get it at the lowest level as is possible.
As I have stressed in many of my previous blogs, risk is always going to be necessary to stay ahead of inflation. At the moment, the current and future expectations of the rate of inflation (or annual increase in your cost of living) can be open to a wide debate. In all likelihood, however, it is rising.
This all has to be built into your plan.
Problem is, you need to take the steps to get that plan created and executed. We are happy to help you get going, but you have to want it first.
Yesterday, volatility (in stock markets) jumped to levels not seen since September of 2016 (pre-election) and before that, all the way back to 2012.
Clearly, that was not as much fun (for many) as those folks in the photo are having. The computer generated "algo" trading jumped in mid-afternoon, just in time to fill all the "stop-loss" orders at pre 2018 prices. That manifestation took about 10 minutes or less to drop the Dow Jones Industrial Average by about 800 points. The swings may get more violent before volatility eases up.
But, despite some buying that followed, the technical damage has been done to the market.
Investors who borrow to invest (which is at record levels per the chart above) now face margin calls that require them to put up more cash against their purchases as prices have declined so significantly. In other words they are going to have to sell something to raise cash. That selling could exacerbate the current volatility.
Further, all the buying done in January is "offside". Those investors are going to be very nervous.
Human behaviour (behavioural finance) becomes pretty important in these instances. We humans hate losses. So much so, that we tend to want to sit on a bad situation and hope that it gets better. We are very patient to wait for losing positions to at least get back to even. In all likelihood this could "trap" all those investors who were late to the party and will sit and wait until they can no longer take the pain.
Even if there is new buying into the correcting markets, there is now likely going to be good selling, if and when markets get back to January levels as those investors who bought in January get an exit opportunity.
We have probably seen the highs, at least for some time to come.
** A note to clients reading this blog: While you are not completely immune from the devastation wreaking havoc on stock investors (unless your exposure to equities is zero), you are limited to your exposure because we have been and are under-weight the equity asset class, so the impact is minimal.
I have reached out to a number of you directly, but feel free to get in touch to discuss your situation specifically, if you wish.
What is wrong with this picture?
There is a common myth propagated by those who promote the ownership of the equity asset class (or stocks) that a strong economy will drive corporate earnings, which in turn should drive stock prices (generally) higher.
But over the last nine years or so, that story has been sold to everyone who will listen (would-be investors mostly) by the investment community who, by the way, have a lot of vested interest in seeing a rising stock market. Even the more appropriate "fee-based" financial advisors who offer a balanced approach (but usually leaning more aggressively toward stocks) reap the rewards when higher stock prices drive portfolio values higher.
And prices have been driven higher and higher (with the hype) bringing the value of those prices into question (because economic growth has not).
As long as they are able to keep you invested, the advice community get paid their commissions. If the portfolio values rise, they get paid a little more. So they all want you to be "fully" invested at all times. That is what pays for their Mercedes', downtown condos and country homes. They sell you the idea that you need to be fully invested all the time.
The investment community gets real nervous when the real world begins to interfere with their cozy lifestyle and rush about telling everybody to "hang in there" when they see that the state of their happy world starts to come under pressure.
A good portfolio manager (very different in many ways from a Financial / Investment Advisor, because they have a legal fiduciary responsibility to always put their client's interests first, before their own: i.e. the way that they are paid), on the other hand, manages risk. That means that they are avoiding over-priced assets and always searching for value opportunities with which to invest on behalf of their clients (which also means that they have more work to do). They don't buckle under the pressure of "the flavour of the day", especially when it is not justified. For a short period of time, like when tech and telecom drove stock markets to ridiculous levels in 2000-2001, their wisdom might be questioned, but in the end it is ultimately the long-term that will tell the tale.
Sometimes you do have to adjust your strategy. We did.
I was once what you would now call a Financial Advisor, but I didn't like the methodology that was being used. So, I evolved. The world evolves with time. Old fashioned ideas get replaced by new and updated ideas and methods. It is never easy leading the change. Often it draws criticism from those whose old fashioned methods are challenged and re-fashioned.
If you don't think that stocks are expensive, then prepare yourself for a fairly significant adjustment in the value of your portfolio, while you ride out the storm.
If you want to take advantage of the opportunities that will become available as volatility rises, then maybe it is time for a second look at your current strategy.
Right now cash (and / or cash equivalent securities) is the only place that you might avoid the price declines in both stocks and bonds. We (at High Rock) have championed the rationale for a more tactical investing strategy which allows us to move to a more defensive strategy when we are uncomfortable with owning expensive assets. Cash (and cash equivalents) are defensive assets.
Sometimes, being defensive becomes an enormous advantage. The correlations between stocks and bonds are expected to balance each other out in traditionally balanced portfolios. We have argued for quite sometime that those traditional correlations are not so dependable any more with asset prices being as lofty as they have been.
That is certainly the case at the moment.
Stocks (gold line) are falling, bond yields (white line) are rising (prices falling), and the correlation (green at the bottom) is moving to 1 (which is 100% correlated), which completely defeats the fully invested stock/bond balance. That is a double whammy to the downside of a fully invested (very little cash on hand) portfolio.
The upside of having some cash on hand is the ability to be able to buy these newly discounted assets at better prices.
This is certainly good news for our clients.
If stock buyers are full up on their recent purchases (which drove that asset class to some record prices), there will not be much ammunition left to to do much buying on the way down (see Paul's blog from yesterday), so those discounts may come fast and furious.
The good news for bond holders is that eventually the exodus from stocks will likely put some buying pressure on higher quality bonds as the money moves to safer assets out of riskier assets, so the correlation move to 1 will start to go back the other way. But, between now and then expect your fully invested, balanced portfolios to give back some of their recent growth.
The good news is that, if you have some $US assets, the $US usually becomes a desired currency for safety, so that may take some of the sting out. If you have some $US assets.
Bitcoin? Well that has not been a good place to hide. See my blog from Nov. 29 http://highrockcapital.ca/scotts-blog/too-much-money-chasing-too-few-assets.
Right now my friends, cash is a great asset to give you some peace of mind. Enjoy!
Absolutely you should be worried. Especially if you are over-weight equities in your portfolio. See that gap between the most recent drop (today) and yesterday? If that gap remains (i.e. the Dow Jones Industrial Average is unable to see buying enough to drive it to fill the gap any time soon), then stocks are headed lower. That means that longer term stock owners will be looking for selling (profit-taking) opportunities. We have been telling anyone who will listen that we have thought and continue to think that stocks are expensive on a number of metrics (see our most recent Weekly High Rock Video).
The selling pressure is coming from simple re-balancing of portfolios. If you have continued to be long equity assets through the run-up in prices, then you have automatically become over-weight.
Big money managers who do monthly re-balancing are turning into big sellers because they have become over-weight, simply on the increase in prices.
I just saw, on a business channel, the head of a wealth management operation of a bank tell us viewers not to worry.
Well, I would suggest that would depend on whether your portfolio has been properly re-balanced or not.
We run a report weekly to stay on top of how balanced our client portfolios are (part of the being nimble that is a benefit of working with a small money manager) relative to the allocation targets in their Investment Policy statement.
Is volatility making a comeback?
Probably too soon to tell. It depends on what kind of follow-through selling or buying materializes over the next few trading days. Normally after a period of below average volatility, there is eventually a spike higher. Lately, those spikes have not seen much follow-through.
So you need to ask yourselves: how much do I value my sleep? If today's price action worries you, then you best get a handle on your portfolio balance or re-balance.
One thing I know is that our High Rock Private Clients do not need to lose sleep.
The Consumer Price Index rose by 1.9% in 2017. That's what we are told by Statistics Canada, based on their estimation of what the average household consumes.
As I say every time I write about this data, each household will have a different set of circumstances depending on what you consume and where you consume it.
Apparently it was cheaper to live in Ontario in 2017 (+1.5%) and more expensive to live in Saskatchewan (+3.4%).
Transportation, Shelter (Natural Gas prices) and Restaurant Food appear to be the key drivers of prices over 2017.
When the more volatile Food and Energy components are removed, however, the "core" rate of inflation rose at a more modest rate of 1.2%.
The Bank of Canada (Central Bank of the Year), whose sole mandate is to maintain stable prices, likes to remove the more volatile components to see how the other (less volatile) components are fairing and sees something from 1.6-1.9%.
But we all consume food and we need energy to drive and stay warm.
They do expect higher inflation in the future, but have been suggesting that for over a year now. The longer term averages for total CPI have been in the vicinity of 1.6% over the last several years.
So what is important?
For your household, the most important issue for projecting wealth is the forecast for your cost of living: income less expenses will determine your ability to save.
Growing your savings at a rate at or above the future cost of living is the only way you can maintain your purchasing power in the future (real growth).
That makes the assumption of inflating your cost of living a very major input into the forecast of your wealth. Few folks take the time to truly consider the implications of this.
Currently, you can buy a Government of Canada 90 day T-bill for about 1.2% (the interest on that is fully taxable as income at your marginal rate), which is the least risky investment possible.
But if your cost of living is rising at an annualized rate of closer to 2%, that is certainly not going to cover it. So in order to stay ahead of inflation, you need to take some risk.
How much risk do you need to take?
It depends on what annual average return you want to achieve. It is all relative: history over the last 10 or so year cycle (top to bottom and back to top of the current market/economic cycle) suggests that a portfolio balanced with a 60% diversified global equity ETF and 40% of a Canadian Bond Index ETF will give you something near 5.5%. The risk factor, the ability of this portfolio to swing up or down from its average (standard deviation from the mean), is about 5.5 as well. That means that the return per unit of risk taken is about 1. In essence you may get a year of 10% growth, but you may also have to put up with a year of 0% growth from time to time as well. We all love the former (exciting stuff), but we do not love the latter (scary stuff).
You can find ways to avoid the swing potential (volatility) by reducing the risk factor (and increasing the return per unit of risk). That is what we do at High Rock. That is why our clients pay us a fee. We manage the risk so as to (as best as is possible) avoid the swings, which over the long term will enhance portfolio growth (ultimately less portfolio downtime from which to recover).
When equity markets are rising in price, risk is also rising (risk that lower prices will follow, inevitably), risk that may not necessarily be in your best interest. Managing risk then becomes essential.
You do have to take risk to beat inflation. Taking smart risk is the only way to do so.
Sometimes I am just blown away at how little progress there has been in the way of improving financial literacy and the way financial institutions encourage investing, while at the same time finding ways to mislead a good portion of the investing public about what they are paying for and how it is paid.
If you can, read this recent Globe and Mail article: "Canadians still in the dark about investment fees despite major changes in disclosures".
"A 2017 study by Credo Consulting Inc. found that 62% of investors still think that they do not pay for the financial advice they receive".
If you can, friends, please forward this story or this blog on to someone you may know who may not be as well-informed. I try to keep those of you who allow me your precious time, as best as my limited writing skills will allow, to open up the possibility that there is more than meets the eye in the world of financial advice. Or perhaps send them to follow me on twitter @jstomenson as I do my part to encourage whoever I can reach to go and ask the tough questions of those who are providing financial advice.
I have worked for large banks and financial institutions at a high enough level to fully understand who works for whom. I asked the tough questions of senior management: "Who do you work for? The client or the shareholders?
Without hesitation, I was told it was the shareholders.
So what about the client?
The client is the source of revenue that powers earnings and profitability the funnels back to the shareholders in dividends and improved share prices.
The best way to improve earnings is to increase revenues and lower costs. What are the costs? In a wealth management division, client service is a cost. So how best to cut those costs? Reduce the service factor. So that is how the financial services business is evolving: bring in the clients, but limit their personal service (i.e. robo-advice).
I met with a prospective client last week: a very busy, career-driven, thirty-something (I would say "millenniel", much more communication-savy than me) who was blown away that I would come to her office to meet!
Service is never free. The regulators have made a lukewarm attempt to force advisors to show their clients how they are paid.
The evidence presented in the Globe and Mail article (above) tells me that there is still a great deal of naivete in the investing world (at the client level) and that the efforts to bring clarity to it has obviously not worked (so far). Furthermore, the conflict of interest of mutual fund companies paying commissions to advisors who sell their mutual funds has still not been resolved.
I need not tell you all that we started High Rock Private Client to bring clarity and transparency (above the regulatory requirement) to those who paid attention, but the conversation needs to reach far more, less-informed folks. I and they need your help.
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist