Greece will miss a 1.6B Euro payment to the IMF at midnight tonight.
+ Tsipras is "daring" the EU to kick Greece out.
+ July 5 referendum.
= Uncertainty = Volatility:
and short-term technical damage has been done to the
After opening lower, the Euro reversed to close stronger, something that we had anticipated, as the Euro without Greece should be a stronger currency.
And as money moved away from riskier assets, high quality government bonds in the US, Canada, Germany and the UK rose and 10 year yields declined by .12-.14 %.
Meanwhile, bonds in Italy, Spain and Portugal fell and 10 year yields rose by .23-.33 %.
The balanced and diversified 60% equity / 40% fixed income portfolio remains positive (by approx. 1%) year to date.
We shall continue to monitor the events as they unfold, but for the time being, heightened levels of uncertainty will continue to drive volatility.
The best protection from volatility: Balance and Diversification
We expected a Greek solution, but not this one.
The Greek people may vote to stay in the Euro in their July 5 referendum, however it will not avoid default on June 30 (when a large payment to the IMF is due).
What happens now:
This should not have an enormous impact:
Central bankers will have contingencies in place to try and stave off any contagion for other parts of Europe and as we continue to discuss, central bankers do not like volatility because it creates uncertainty.
Does this impact the US Federal Reserves decision on interest rate increases?
Possibly, however it will remain to be seen what if any consequences develop and how the Fed will respond. Likely their approach will be cautious and dependent on further developments.
We have taken a cautious approach to investing for some time, based more on value than expected or unexpected geo-political and economic developments.
We have continued to have an over-weight in cash waiting for opportunities (better prices) to develop before committing capital for long-term investing (because we expect the unexpected).
That is our nature.
Because we think that they are going to make a difference in the new consumer economy:
From a Goldman Sachs report:
The Millennial generation is the largest in US history and as they reach their prime working and spending years, their impact on the economy is going to be huge.
Millennials have come of age during a time of technological change, globalization and economic disruption. That’s given them a different set of behaviors and experiences than their parents.
They have been slower to marry and move out on their own, and have shown different attitudes to ownership that have helped spawn what’s being called a “sharing economy.”
They’re also the first generation of digital natives, and their affinity for technology helps shape how they shop. They are used to instant access to price comparisons, product information and peer reviews.
Finally, they are dedicated to wellness, devoting time and money to exercising and eating right. Their active lifestyle influences trends in everything from food and drink to fashion.
These are just some of the trends that will shape the new Millennial economy.
Born between 1980 and 2000:
Our view is/has been that there is/will be a considerable impact on consumer behaviour and ultimately on how much the consumer contributes to the US economy as this cohort evolves.
Witnesses to the 2008 housing crash and financial crisis at an impressionable age, caution appears to be a classic trait.
As well, larger amounts of student debt incurred and lower employment income will continue to hold back their ability to spend.
Millennial's priorities will be be different.
The Goldman Sachs research confirms this.
I am more interested in how much taller Christine Lagarde (Managing Director of The International Monetary Fund) is than Vladimir Putin.
In all likelihood, the drama that is Greece and Europe will likely find a way to "kick the can down the road" because the Euro needs the weakness that Greece brings with it so that the currency can stay depressed and thus stimulative for the Euro Area economy.
For our purposes this is just a lot of "noise" that distracts financial markets from more important issues.
So, as we head to the end of Q2 and the end of the first half of 2015, lets review some of our themes for 2015 and how they are playing out:
1) Expect The Unexpected
2) Oil Price Shock Repercussions:
3) Central Bankers Don't Like Volatility
4) The US economy will pull the global economy in the 2nd half of 2015:
5) The US Federal Reserve will begin to raise interest rates in September by 1/4%:
6) Deflation or Inflation?
US (with this mornings data release):
7) Bond Markets lead other financial markets:
8) Equity Markets are expensive:
And a new theme to add to the list:
9) The consumer is evolving: Baby Boomers are saving more and spending less as they enter retirement. The soon to be largest cohort, The Millenials, have different consumption habits.
And of course, we are still focused on the long-term!
I certainly understand the argument for a national agenda for better financial literacy, especially when, on an ongoing basis, I see examples of how the financial industry and it's participants continue to try to take advantage of those who are less well-informed (see yesterdays blog).
As a participant in the financial industry (for over 30 years now), I have to say that it is no wonder that regular, hard working people choose to ignore their financial futures when they are faced with a barrage of very confident and polished salespeople who appear to have all the answers, but prove, over time to be acting only in there own best interests (getting paid!)
A few years back, when the small sized investment company where we (a former business partner and I) operated our wealth management practice, was taken over by a large financial institution, I asked the "blunt" question:
Who is more important, the client or the (name of the large financial institution goes here) shareholder?
The senior executive did not even hesitate: "The Shareholder" he told me.
Interestingly, as one serious conflict of interest, part of our "retention bonus" (to encourage us to stay on at the large financial institution) was to be given shares of the company.
Ironically, I became a shareholder, so in essence, I was now more important (to the large financial institution) than were my clients. That was not going to work well for me.
So we decided to move our wealth management practice.
Interestingly, the large financial institution was under the incorrect assumption that our clients were in fact their clients (and that they could somehow do a better job than we had, even though they really didn't care about the client, just the revenue stream). So they incentivized their sales force to try and "retain" our clients. Without success.
My point (finally, you might be thinking) is that if the large financial institution is not looking out for the best interests of the clients, what is the "culture" within the company?
The culture is to reward the top "producers" (revenue generators) with a place in the President's or Chairman's "club" (as well as higher % of the gross revenue that they produce).
Success (for many, but not all) in the financial services business is focused on revenue generation. This is an enormous conflict of interest.
I do believe that I should be paid for the work that I do. However, philosophically, I believe that what I should be paid for is looking after those people who have taken it upon themselves to put their trust in me. It should be clear to my clients what those costs will be, at all times.
It should be even more clear to my clients that I have no other agenda than to seeing them succeed financially. Their success is in fact, my success.
Personal financial success does require using a professional who can guide you through the planning, strategizing, investing, monitoring, adjusting and educating aspects of it.
The key to selecting the correct financial professional is to understand their motivation. That may take some digging, but don't be overwhelmed by their confidence and polished sales pitch.
Be overwhelmed by their devotion to their fiduciary duty to you.
A report from the Ontario Securities Commission released last week states that:
"Evidence from academic research is sufficient to form several clear conclusions about investor impacts of compensation":
1) Funds that pay commission underperform: Returns are lower than funds that don't pay commission, whether looking at raw, risk-adjusted or after-fee returns.
2) Mutual fund distribution costs raise expenses and lower investment returns.
3) Advisors push investors into riskier funds.
4) Investors cannot easily assess what form of compensation is best for them and readily make sub-optimal choices.
Academic research also shows several important facets of advisor behaviour related to compensation:
1) Compensation influences the flow of money into mutual funds. Higher embedded commissions stimulate sales.
2) Advisor recommendations are sometimes based in favour of alternatives that generate more commission for the advisor.
Need I go on?
In essence, most advisors are looking out for one thing: their compensation.
That is a grave conflict of interest.
Investors should be able to trust that the priority (of any investment and wealth management advice) should be to find the best possible risk-adjusted returns in keeping with their goals and level of risk tolerance.
Fees and costs should be completely transparent.
Fiduciary duty should be upheld to offer absolutely no conflict of interest.
Equity Markets (except China) shrugged off the Greek situation and reversed course yesterday as investors and traders "rejoiced" at the continuation of the"lower for longer" interest rate scenario indicated by the FOMC's "dot plot" chart (see yesterdays blog).
The S&P 500 broke up through its recent short-term down-trend as buying re-entered the market with some heavier volume. Momentum could now potentially drive prices to re-test at highs at 2135.
Technically, the long-term up-trend remains intact:
Fundamentally, we are approaching the end of the 2nd Quarter and with that July will bring Q2 earnings reports.
Q2 Earnings Expectations:
Clearly, the fundamentals and the technicals are diverging (again) as market participant's take their direction from the Fed's (and other central banks) continued stimulative monetary policy.
While the Fed continues to see better ("improving") 2nd half 2015 economic conditions (as does the Bank of Canada), current conditions are at best, mixed:
Are central bankers and their "rosy" outlooks actually "cheerleading" the economy?
Slow wage growth and low inflation and only "moderate" economic growth buy the Fed more time.
An interest rate increase remains (by 1/4%) on the agenda for "later" in 2015. Possibly September, perhaps December depending on how the economic data look over the next couple of months.
"The committee continues to judge that the first increase in the federal funds rate will be appropriate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term" Yellen said.
While the Fed has made "considerable progress" toward its goal of maximum employment, " the committee wants to see evidence of further progress."
The above chart shows where individual FOMC members forecast that the Federal Funds Rate will be over the next few years.
Extrapolating that out to 2016:
We can anticipate a Fed funds Rate below 2% by the end of 2016.
When we compare that move to the move 2004-2006, it looks rather tame.
Of course there are a great many variables that (on a global scale) may impact the course of events between now and then.
What happened to US bond markets during 2004-2006?
Short-term maturities felt a greater negative impact from the increase in the Fed Funds Rate, so it makes sense to have longer-term maturities in a bond portfolio (longer duration).
As long as inflation remains at or near the prescribed target of 2% and bond investors remain comfortable with Federal Reserve monetary policy (for containing inflation), the recent volatility will likely be reduced as the inevitable rate increases for "normalization" become "built in" to expectations.
However, there is still plenty of water to flow under this particular bridge!
In the meantime, it appears that US equity market participants are "breathing easier" as there appears to be some buying support that has entered the market. However volume has been lighter and it will take some significant buying to erase the most recent downturn and return the S&P 500 to its highs.
Yesterday the Bank Of Canada released its semi-annual financial system review, which highlights the BOC's "ongoing work in monitoring vulnerabilities in the system with a view to identifying risks to its overall soundness".
1) The elevated level of household indebtedness: Canadian household leverage remains high. debt levels have increased.
2) Imbalances in the housing market: overvaluation remains a concern
3) Illiquidity and Investor Risk-taking in financial markets: a buildup of higher risk positions, especially if accompanied by leverage (borrowing to invest) could lead to systemic stress if there were a sharp drop in asset prices.
In other words, investors are increasing their exposure to risk in order to get higher returns. ( I have often discussed this in my blog).
"Asset price changes resulting from a sudden adjustment of investor positions could be exacerbated by a lack of market liquidity, leading to increased volatility and price distortion across several Canadian Financial Markets."
We have seen an increase in bond market volatility in the Euro area and this has impacted North American Markets.
Bond Markets lead all other markets and we have seen an increase in equity market volatility recently.
Investors need to take heed of the elevated risk factors: We have had 6 years of above average returns and markets will revert back to the average (at some point).
For this reason we continue to be cautious with our client portfolios at the moment. We believe that to prudent.
I was browsing the on-line media yesterday (as I will from time to time) and came across an interesting chart in the Globe and Mail that was published last Wednesday, so it is not "breaking news", however, it may be quite telling and certainly may have significant implications going forward:
Condo vacancies in Toronto have reached record highs.
I leave the discussion about the direction of the real estate market to those who are more seasoned and have a greater degree of expertise.
However, I am afraid of heights and this chart is scary:
As an economist we are trained to understand that everything is cyclical, some cycles can last extended periods of time before an adjustment takes place and predicting the exact timing is never easy.
As a bond trader in the 1980's and 90's it was important to be on top of trading cycles that were in large part determined by interest rate cycles.
As a wealth manager, it has been equally important to monitor the cyclical broad economy and developing trends that follow.
The housing market (in Canada) has had a long cycle of upward price trajectory since the last down-turn (and of course different regions have had their own trends driven by various economic circumstances).
Many have tried (and failed) to predict its collapse (especially in Toronto and Vancouver).
The cycle will end when it ends and for a simple and good reason: there will be more sellers than buyers.
Simple supply and demand economics.
The chart above seems to indicate increasing supply and decreasing demand in the Toronto condo market, just as was the case at the last cyclical peak in 1991-92.
I would not want to have too much of my net worth tied up in that particular asset class, especially if I would need to sell to create personal cash flow (because it is not liquid).
I rent (because I don't like being emotionally tied to any asset).
How much of your net worth is tied up in home (residential, vacation, "investment") ownership?
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist