As I have been suggesting (ad nauseum), there are structural adjustments taking place at the consumer level in the US economy that have yet to become part of the conversation.
Traditionally, the US Federal Reserve's mandate tends to be the main focus: "maximum employment and price stability" and the current conversation surrounding the next move in interest rates (to the upside) is focused on these 2 key issues.
However, there are many moving parts to the US economy outside of those 2 issues that also need to be respected.
The consumer is 2/3 of the US economy and while they are getting more and more employed, they are earning less and their spending habits are shifting:
I have talked a great deal about the aging Baby Boom cohort focusing more on surviving retirement without running out of money and the (now largest) Millennial cohort with less money to spend and considerably different consumption priorities.
Next Monday (August 3) we shall see key Q3 data on July Personal Income and Consumption that will give some further insight into the US economy's progress and the consumer that drives 2/3 of it.
However, initial Q3 data are not impressive:
Consumer confidence appears to have peaked and retail sales are slowing.
Automobile sales lead consumer spending higher in Q2 (+2.9%), spurred by cheap financing (low interest rates), but Q2 GDP still fell short of expectations:
If the US Fed were to raise rates it might choke off an economy that is growing, but at a significantly slower pace (at the moment) than is expected.
A slower growing US economy may hamper economic growth on a global scale as most other economies, outside of the UK, are still struggling.
In other words, the Fed's decision will have a global impact and they are certainly aware of this:
"When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run."
(Author and Granddaughter)
I had the great pleasure to have spent the week with my 18 month old granddaughter this past week (hence limited blog writing capability) but a ton of fun trying to keep up with that bundle of energy.
And how (you might ask) did the financial education (see last Monday's blog) part of that experience work out?
I failed miserably.
We visited (at an appropriate distance) with all the various wildlife in their natural habitat (bears, snakes, eagles, osprey, loons, fishes), played ball, participated in water activities, watched "Bubble Guppies"and brushed teeth routinely, but perhaps it was a bit "too early" to discuss compounding and the rule of 72 every night before bed.
Nothing like a little dose of reality to bring me back into line, but I won't give up so easily, it is as important as good dental hygiene.
So what happened in the financial world this week (oh yes I am paying attention)?
and more importantly why?
Furthermore, the S&P 500 is struggling:
So we remain cautious and underweight equities waiting for better value (better reason to buy).
It really is never to early to start educating your children about money. Like anything, however, it does require effort.
From the piggy bank to the savings account and beyond, applying the experience of saving and growing money is best taught from the outset.
It is a wonderful thrill for a child to feel the weight of the gathering nickels, dimes, quarters, "loonies" and "toonies" in a container of some sort and to understand that if you spend that money it is no longer there (especially if the item purchased is consumed and no longer provides utility). But, if you save it, there are some really powerful feelings that come with the continuing growth (accomplishment for one).
Like anything taught, repetition and structure will help make it stick. Unfortunately, cultural influences (the consumer society in which we live) will provide on-going challenges, so it is even more important to build it in to your child's (or grandchild's) regular routine (like brushing their teeth).
It is as important as that.
Understanding value (in financial terms) will be one of the most essential aspects of their lives as they grow (and may be helpful in future years when you, as a parent, have to start giving reasons for saying "no"). Knowing what happens to that saved money when it is spent frivolously and is "gone" (and you have to start all over from the beginning), is a pretty daunting experience and a compelling lesson. Learned early enough, it might just stick.
Like anything, the more enjoyable the routine, the more likely that it will continue.
So play the "what if" game for a few minutes each day:
"What if" we get to $100 and start to earn a return (not much in a bank account at the moment, but it is a place to start) that helps to add to her/his savings. That can also be powerful, if you can forecast how much they might have in 1, 2, 3 or more years with a combination of saving and compounding. Then you have the ability to set goals and there is nothing better than the life lessons learned from setting and achieving goals, regardless of your age.
So set some goals and track them.
Pretty soon, you have a plan.
Everyday, check the plan.
One day they may just thank you!
Canadian inflation (core CPI) is running at an annualized rate of 2.3%, according to this mornings data release for June. That reading is up from last month's 2.2%.
Meanwhile many economists and perhaps even the Bank Of Canada see a chance that Canada's economy has entered into a recession (BOC cut the bank rate by 1/4% earlier this week).
5 year Government of Canada bond yields are below .75%, inflation is running at higher than 2%, that means that buyers of those safe 5 year bonds are giving up at least 1.25% each year after inflation (a negative "real" return). How long will bond investors be prepared to put up with negative returns?
While the Bank Of Canada has cut the bank rate by 1/2% (and there is speculation that they may cut again by another 1/4 %) thus far this year, Canadian banks have only cut their prime rates by 1/4%.
Clearly there is a disconnect from what has been the usual economic progression. We are indeed in uncharted territory, post oil price shock developments.
Meanwhile, inflation data from the Euro area and the US this week show a slight uptick in inflation in those economies as well.
Low interest rates and low "real" (after inflation) returns are forcing investors into riskier assets (like equities), driving prices for equities higher.
Meanwhile corporations are buying back their own shares at levels not seen since 2007 (according to Bloomberg) further pushing equity prices up.
This is in fact distorting earnings per share data. While earnings are stagnant or declining, fewer shares make the EPS data look better. But even EPS data is well above it's historical averages.
Folks, there is a whole set of situations developing that just do not make reasonable sense from my perspective at the moment and that warrants caution.
The BOC July Monetary Policy Report released today expresses hope that future US economic growth will rescue the Canadian economy.
"Overall, as U.S. demand growth becomes more durable and non-energy exports regain momentum, business confidence will likely strengthen and the natural sequence will reassert itself. A pickup in business investment growth should follow as firms look to increase capacity to meet stronger domestic and foreign demand. In this sequence, investment in machinery and equipment is expected to be the main source of growth in business spending, supported by robust demand in the manufacturing sector and favourable financing conditions."
I think that it is fairly telling that the dependence on the US to contribute to Canada's economic growth is not living up to expectations thus far (and as a result the bank rate has been cut).
Meanwhile, south of the border, in her testimony to Congress , Chairwoman of the US Federal Reserve, Janet Yellen, does continue to believe that "eventually" the pick-up in employment will transition to more consumer activity and stronger economic growth.
However, while we hope that all the smart minds that are putting forward these positive/upbeat forecasts are correct, we are a little skeptical (see yesterdays blog and/or the High Rock webinar for more detail, following yesterdays report on US June and May retail sales).
We believe that, at the moment, there is a structural shift happening in the nature of the consumer who is reluctant to spend: the Baby Boom cohort is saving as they head toward retirement. The Millennial cohort (now the largest) does not have the money to spend.
This may impact the outlook for US economic growth because the consumer represents approximately 2/3 of the economy.
At the moment, we do not believe that this scenario (of downside economic risk attributable to the consumer) is being considered enough (or talked about) as part of the forecast.
On a global scale, the Euro area is recovering (but slowly and the focus on Greece has not been a helpful stimulant). China is not consuming exports as they once had been (as growth slows there while they transition through structural economic changes), impacting the Australian and Canadian resource sectors.
As BOC Governor Poloz implied at his press conference this morning, the economic cross-winds are complex. He was significantly more positive in January, that the downturn would be short-lived.
For both central bankers (Poloz and Yellen), they continue to focus on a more robust economic future, but their track record is a little suspect at the moment. As governor Poloz intimated this morning when asked about his previous forecast, hindsight is 20/20.
I would suggest that behind the scenes there are greater concerns than are being discussed in the public forum, despite the image being portrayed of "greater transparency".
That's why the BOC cut the Bank Rate by 1/4%.
So our investment strategy currently incorporates a less than robust economic outlook, for the US, Canada and the global economy in general.
And this has been one of our new and on-going themes (apologies for the repetition) regarding the current state of the US economy:
Baby Boomers are saving for retirement, Millennial's just don't (yet) have money to spend.
When the consumer doesn't spend, inventories sit on the shelves (cars sit on the dealer lots) and producers have to cut back on production.
In the meantime, sellers offer incentive discounts to move their excess inventories and this eventually falls to the "bottom line".
The bottom line is earnings and we have also been hitting on another recurring theme that without earnings growth, regardless of how low interest rates may be, stock prices can not go up.
Earnings have not been growing and expectations for future earnings will likely get revised down.
The basic fundamentals can only be ignored for so long.
The S&P 500 is tired (because there are no new catalysts to take it higher) and buyers are not willing to buy at these (relatively expensive) levels, other than short-term traders covering short positions after the Greek solution.
As the wise market analyst Dennis Gartman often states:
"It takes buying to make a market go up and just a lack of buying to make it go down".
The US Federal Reserve will give pause to think about this number and it could certainly delay the expected September increase in interest rates.
Tomorrow, the Bank Of Canada will announce its decision on monetary policy and interest rates.
And don't forget to check out our weekly webinar, broadcast live at 4:15 every Tuesday and recorded and posted on our website:
Where we discuss wealth management, the global economy, financial markets and the strategic positioning of our portfolio models.
Today, live from Pointe Au Baril on the north eastern shore of the beautiful Georgian Bay.
They sure made it seem like a "nail-biter", but as we had suggested (June 24 blog) the Euro needs the weakness that Greece gives it for the purposes of euro area exporting countries' economic recovery (cheap Euro makes export prices more attractive).
Assuming all the necessary parliamentary ratification takes place, hopefully we can put this to bed for a while and move on with more important matters and our 2015 themes:
Expect The Unexpected.
On Tap for this week:
BOC bank rate announcement on Wednesday: it's 50-50 among the experts for a 1/4% rate cut.
Yes, I have a bias when I write this blog, because I own part of an asset management company that specializes in Canadian High Yield bonds.
However, long before I became involved as a partner at High Rock, I was helping families build balanced and diversified portfolios and came to the realization that in a low return environment, this particular asset class could add an excellent stream of income and also (if the portfolio of high yield securities is well managed) be an important source of strong risk-adjusted returns.
Clearly, the chart shows that, in general, Canadian High Yield bonds represent a better investment than many other asset classes for the relatively low risk and reasonable return (but, as with any asset class, should be only part of a balanced strategy).
Why does it need to be well managed?
High Yield, by definition means that the debt rating agencies have rated these issues as lower than "investment grade", BB or lower (in the cast of most rating agencies), likely because there is increased risk associated with the particular company who has issued the bonds. In turn, the increased risk means that investors want higher yields as protection.
As a result, there is plenty of expertise and due diligence that is required:
Also, most of these issues are not available to individual (non-accredited) investors and are only available in a fund format.
The above table lays out the fact that Canadian High Yield is an asset class unto itself and can be utilized to broaden portfolio diversification.
Also important, this is an asset class that is not necessarily interest rate sensitive and when interest rates start to rise, it is because the economy is strong and that is favourable for the High Yield sector.
A strong economy will mean growth opportunities and the greater potential for a rating upgrade that can offer potential capital appreciation.
All in all, sound arguments for further diversifying a portfolio with Canadian High Yield bonds.
A recently released Angus Reid study on Retirement in Canada found that "financial worries loom large" for retired Canadians (48%) but especially for those still working (74%).
If you are worried, then you need to do a Wealth Forecast.
A Wealth Forecast will help you determine whether you will have enough money in retirement (and, if you wish, what money you may have left to pass on to family, charity, etc.).
A Wealth Forecast will assist you in planning your financial future. It will project, for you, how your financial lives will unfold and determine, long in advance, what your retirement will look like.
If you don't like how it appears, you can make adjustments (now) in order to be able to enhance your life in retirement.
This is truly a worthy exercise to give you peace of mind when it comes to planning how you want your future to unfold and allows you to develop a strategy now to ensure that you meet your goals.
Of course the world we all live in is dynamic and there are always many moving and changing parts. So a Wealth Forecast has to have flexibility and needs to be monitored and updated regularly.
It is also important to have an expert providing you with the guidance needed to put this all together.
Importantly, a Wealth Forecast should not be a tool for the sale of a product (mutual funds or insurance) it should incorporated into your long-term wealth management process.
Being anxious about having enough money in retirement does not have to be an ongoing part of your life . I have never seen anyone walk away from a Wealth Forecast not feeling better, having been given a glimpse of their future with a tool that puts them in the proverbial drivers seat.
It is, in fact, a great sense of relief.
This is not pretty.
Also, as investors face margin calls (to pay back borrowed money used to purchase stocks) they are being forced to sell other assets.
Commodity markets in China traded to their daily down limits in metals and agriculture.
Is Real Estate the next asset to be sold?
And on a global scale, investors are moving away from risk:
We have been cautious for some time now (underweight equity assets) and continue to be inclined to remain that way until we get a better sense of how the dust will settle.
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist