Today is the end of the month and the 3rd Quarter and there is lots of volatility in financial markets.
However, we all need to take a deep breath because, for those of us who care (and I must admit that I jumped on the band wagon in early August), we are about to enter one of those very exciting times that don't come around too often.
From 1993 (October 23 to be exact), I have the greatest memory of sitting in the basement of my home in Port Washington, NY (north shore of Long Island and commuting distance to Manhattan) and watching Joe Carter leap around the bases after hitting the home run that gave the Blue Jays the second of back to back World Series titles. I yelled so loud that the new little puppy retriever watching with me yelped and left a wet spot on the carpet (my 3 daughters, 4, 6 and 8 were asleep, as it was a "school night").
The following day Jean Chretien and the Liberals took over the reigns of Canadian government from the long-ruling PC party with an elected majority.
Paul Martin took the helm of Canada's finances, which at the time had the highest debt to GDP ratio of the G7.
The Canadian economy collapsed as he set about to balance the budget.
The housing market in Canada was already well into a significant correction and this continued.
At the time things looked pretty grim.
But the budget got balanced, the economy recovered and markets continued to cycle up and cycle down (especially through the 2008-2009 period).
Cycles happen and we do the best in the short-run to take advantage of the opportunities that they present. In the long-run, however, what remains are the memories and the cycles continue.
So make a plan, stick to the plan, tweak it as necessary along the way (happy to help you out in this department, by the way) and build up your good memories and don't get hung-up on what is happening yesterday, today and tomorrow in financial markets, because in the long run you are not likely to remember it.
But if the Blue Jays are successful (and that is important to you), that you will remember!
From time to time, things happening in financial markets just don't make much sense.
There is a reasonably large seller in the market of a Canadian preferred share ETF, likely because the ETF is now holding a greater amount of the Fixed-Rate Reset Preferred Shares and with the current level of low interest rates, when the rate on these types of preferred shares are reset, they are reset at lower levels paying a lower dividend as a result and making the issue less attractive.
Preferred share markets are not as actively traded as common share (equity) markets and therefore there is somewhat less liquidity. As a result, a large seller can move the market price lower without much trading volume.
However, when the ETF basket is sold, all of the preferred shares in the basket are sold, including the Perpetual Preferred Shares with fixed dividends. Naturally this pushes the prices of these perpetual preferred shares lower and as a result of the fixed dividend, pushes the dividend yield higher (and this is what does not make sense): higher returns (dividend yield) in a low return environment.
What are the risks of owning Perpetual Preferred Shares ?
At the moment, some of the good quality issuers' Perpetual Preferred Shares look very reasonably priced, relative to the bond market and this may be a good opportunity to add these income producing assets to a portfolio if you have room to do so in your diversified, balanced portfolio.
Determining whether you have room is a more complex decision and should be done in conjunction with professional assistance.
It is Webinar Day at High Rock, so feel free to tune in to our latest thoughts on the global economy, financial markets and wealth management strategy (recorded version) after 5pm at
When I began writing this blog in January, I set out a number of "key" themes that I suggested would be significant for 2015.
The overiding theme was to "Expect The Unexpected".
Well there has been lots of surprises for 2015 thus far, as we look back over the last 3 quarters, but the forward looking prognosis remains elusive:
The US Federal Reserve wants to begin the process of normalizing interest rates (and so does the Bank of England).
The "wild card" at the moment is the direction for inflation.
Central banks (generally) want to see a 2% rate of "core" inflation (which extracts the more volatile components like food and energy).
Global economic conditions have been putting downward pressure on commodity prices and at the moment this does not look like it is about to change anytime soon.
The US Federal Reserve remains optimistic about the improvement in the US economy, however admits that there are global factors that have given them cause for concern.
A stronger $US, reduces global demand for US goods and services (exports) and simultaneously allows lower foreign import prices which in turn puts downward pressure on core US prices (in essence the US is importing deflationary pressures).
Certainly there is a corelation between commodity prices and core PCE inflation.
The real question, then, becomes whether or not the US Fed is being too optimistic about its views for the US economy.
It's track record suggests that, in the past, it has erred to the side of being overly optimistic, so there is a credibility issue at stake.
The worry amongst the economic "thinkers" is that if a recession should occur in the US over the next year or two, the Fed will have little room to act in order to lower interest rates to further stimulate economic activity (because interest rates are at 0%).
On the demand side of the equation, consumer activity in the US has picked up, a little. Todays data for August showed a little better than expected uptick in activity:
However, the trend looks to have peaked and most of the consumer spending recently has been on automobiles, rent and restaurants, financed at low interest rates.
The Fed is counting on employment growth to drive consumer spending and in turn, drive the economy. Hence, their optimism.
Next up: 3rd Quarter earnings: expectations are for further declines in S&P 500 company earnings of approximately 4%. If this is the case, it will be the first back to back, quarterly decline in earnings since 2009.
This has been driving another of our 2015 themes, that stocks were / are still, expensive. The 12 month forward price to earnings ratio at 15.2 compares to the 10 year average of 14.1. However, it is down from a level of 17 in May (when equity prices peaked).
It would not surprise us to see the S&P 500 back at the 1750 level , down from the current level of 1900 and the highs at 2135.
This, among other factors, have us calling for a "low return environment" for investment asset growth for the next while.
There will be opportunities to put money to work at better levels / prices down the road, but it will benefit those who are patient.
There may not be much inflation in the broader economy at the moment, however post-secondary education is an exception.
According to Statistics Canada, Canadian full-time students in undergraduate programs paid 3.2% more on average in tuition fees for the 2015/16 academic year this fall than they did the previous year.
The increase in tuition costs in 2014/15 was 3.3% higher than tuition costs for 2013/14.
On average, undergraduate students paid $6,191 in tuition fees in 2015/16 vs. $5,998 a year earlier.
Undergraduate students in Ontario paid the most: $7,868.
(click on the table to enlarge it)
And that is just tuition.
There will be food and shelter, books, computers, activities and possibly travel costs to add on.
So parents (and grandparents) who might want to think about this in advance, if your "youngin'" is going to want a post-secondary education (and hopefully we all wish for this to be the case), then it is going to get significantly more expensive in the future.
The RESP is an excellent vehicle for building education saving for the long-term, but do not fall into the trap of getting caught in an expensive managed plan (and there are lots of salespeople out there who will be trying to take advantage of you, even your local bank branch). Anything managed is going to have a cost to it, so be extremely careful to check the fees, commissions and other costs associated with setting it up.
New parents, the best time to start is right away. You will need a social insurance number for your newborn to open an RESP account.
Best part of it, the Canadian government (and in some cases, your provincial government) will top-up your contribution.
The Canadian Education Savings Grant will give you an additional 20% to a maximum of $500 of what you put in.
So to maximize the grant, put in $2,500 each year (per child) and it will turn into $3,000. You cannot beat this "risk-free" return.
If you miss a year of contribution, you can make it up.
If your child is 5 and you are just staring now, you can "catch-up" 1 missed year, each year: so for the next 4 years you can "double up": $5000 each year and the grant will give you $1,000.
When the government is going to give you money, you should take it. It also beats inflation handily.
There are plenty of strategies for growing this money and the tax on the growth will be deferred until it is withdrawn. When it comes time to utilize it, it is taxed in the hands of the beneficiary (your child). In most cases they will have little if any taxable income, so they will likely not be paying any (or significantly less than you would) tax on the withdrawals.
There are also lots of strategies for withdrawing the money as well, but I would have to defer to my star wealth forecaster and CFP (Bianca) for those!!
Our normal process when we sign up new clients involves a pretty in-depth analysis of their goals and objectives, their current financial situation and their current investment holdings.
When we look at the statements that they put in front of us (from their previous advisor), it is often jaw-dropping.
Why would anyone put a client into a large bank (no load) balance fund (approx. 60% equity) with a 5 year return of 5.65% (10 year return of 3.75%) and an MER (management expense ratio) of 2.36%?
Do the math on this: the manager gets paid, the advisor gets paid (trailer fee) and what about the client? There is not much left over for them.
And yet this balance fund has over $6B in assets under management!
That is just the tip of the iceberg.
I can't name names (oh I wish that I could) because I would so like to out some of the "bad" advisors out there.
They are not bad because they are breaking the rules, they are bad because they do not have the client's needs in mind (that is "skirting" the rules). The only thing that they want is to get paid (their fee/commission/trailer)!
We see these "orphan's" all the time when we look at new clients old statements: be they stock IPO's, closed-end funds, structured funds.
Why were they put into the client portfolio in the first place?
Selling fees paid to the the advisor (so that the issuing institution can also make their fees). Often when these purchases turn into "dogs", there is no liquidity available to move them out of the portfolio. When there is liquidity, the advisor will often use it to "flip" it out to make room for the next new issue and get paid once again (a commission on the sale and on the next new issue).
Certainly some advisors do not have their client's best interests in mind, but the client needs to pay attention too.
Here is some good reading on that:
Wake up, Canadians - you need to start asking more about investment fees - ROB CARRICK
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A recorded version will be available after 5pm.
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In March of 2008, Goldman Sacks called for $200 Oil prices.
A week and a half ago, they called for $20 Oil prices.
In 2008 it was all about demand. In 2015 it is all about supply.
That is economics at its finest: supply and demand will determine price.
As it is in any cycle, eventually supply and demand will find equilibrium and settle in a narrower price range. Until that time "price discovery" and the various participants involved in the process (analysts, economists, traders, speculators, end-buyers, end-sellers, etc.) will "place their bets" as to what the next move might be.
As prices have fallen, higher cost producers have reduced production, but the impact takes time to develop.
The International Energy Agency (IEA) predicts that US production will significantly decrease in 2016.
But, of course this all takes time to filter through the global economy and in the interim, there will be lots of "noise" about all the different inputs into the equation.
And of course, there is the "politics" of oil.
For those "developing" economies (and other producing nations) that are dependant on oil, there is plenty to worry about, especially the debt burden that is tied to growing their economic development.
Economic uncertainty can and may create political instability.
So the caution being exhibited by the US Federal Open Market Committee in their latest analysis of the global economic environment is warranted. As will always be the case there are opinions on whether they should have started the interest rate "normalization" process sooner, rather than later, however (as this blog has been suggesting since the beginning of the year):
Central banks do not like volatility, because it creates uncertainty and undermines economic confidence. Without confidence, consumers will not consume and businesses will not invest in increased production.
An overly optimistic central bank risks credibility. So it might be a good thing that the FOMC proceeded with caution.
Oil supply and demand will give us a good reading on the state of the global economy and its current status is indeed a cause for concern. The cycle will unfold as it always does, but the timing of the adjustments will be what we need to prepare ourselves for.
"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."
Despite an outwardly (perhaps overly) optimistic belief that there are better economic conditions to come:
"with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate."
As we discussed in this blog on Wednesday, global (and US) inflation is low and looks to be heading lower.
As we discussed in this blog on Monday, there is a great deal more global debt outstanding than there was in 2007 and the impact of higher interest rates will therefore have a greater "destabilizing" impact.
Much of the growth of this debt comes from China and emerging economies and the stalling of economic growth there is becoming problematic.
It is problematic because the levels of debt are not being justified by current growth rates.
Lenders want more protection and therefore credit conditions are naturally tightening.
The stronger $US (weaker foreign currencies) is also a drag on the US and global economy.
Fortunately, the Fed has recognized this and have decided to take a cautious approach.
What happens next?
As with any cycle, we must remain patient for it to run its course.
It is not often that I find myself on the side of the majority (as a card-carrying contrarian), but in this case I feel kinship to the 67% of my fellow Canadians who, according to the latest Angus Read Poll asking Canadians to rate the party’s fiscal promises (in the 2015 election), are opposed to a lowering of the annual TFSA contribution limit from the newly instituted $10,000 level, back to $5,500.
Again: 67% of Canadians oppose a change in the TFSA contribution maximum.
Hopefully Mr. Mulcair and Mr. Trudeau will take note.
It really is a fantastic saving’s vehicle, in many cases more useful to savers in the long-run than an RRSP.
An RRSP only “defers” taxes. You still have to pay tax (you will get a T4) when you take money from your RRSP or RRIF at your current income tax rate. It is helpful if you put the money in when you are in a higher tax bracket and have the ability to take it out in a year when you are in lower tax bracket (ie you are earning less income).
With a TFSA you will never pay any tax when you take money out.
When we do 30 and 40 year wealth forecast's, the biggest asset growth is in the TFSA, if you maximize your annual contribution limit.
If you have maxed it out from its inception in 2009, you should have $41,000 (plus growth) currently.
$41,000 now, earning an annual average 6% and maxing out a $10,000 contribution each year will give you almost $1,000,000 in 30 years.
If 67% of Canadians are aware of and care about the TFSA, then that is a huge step in the campaign for financial literacy.
It is a great step forward that Canadians understand the need for diversity.
On average, approximately 60% of Canadian household assets are tied up in real estate. If this asset class should suffer a set-back in value, the impact on the Canadian household balance sheet might be staggering.
Encouraging Canadians to continue to diversify their assets away from highly illiquid real estate assets should be a top priority in strengthening the Canadian household net worth.
The TFSA is a great vehicle with which to promote this.
The TFSA is good for Canada's future financial stability.
Take note Mr. Mulcair and Mr. Trudeau, this is not a small issue.
Most central bank mandates (as I have mentioned before) are based on the premise of achieving "price stability". The US Federal Reserve has a dual mandate of not only achieving price stability, but also "promoting" maximum employment.
Falling commodity prices, especially energy prices this year have brought inflationary pressures to levels not seen since 2009 (and 1955 prior to that).
Central bankers try to factor out the more volatile food and energy data in an effort to gage the inflation of "core" consumer prices.
Why the focus on inflation?
Economic theory tells us that as economies grow, greater demand for goods and services puts upward pressure on the prices for them. In order to afford higher prices, workers then demand higher wages.
In the 1970's and early 1980's this became a particular problem as inflation spiked into double digits in many developed countries. In order to slow economic growth and bring inflation lower, central banks were forced to raise interest rates into double digit territory.
Since 2009, the opposite has occurred. In order to promote higher levels of growth (to offset the recessionary pressures from the financial crisis) central banks dropped interest rates to near zero. There are some places where interest rates have slipped into negative territory because deflation (lower value of assets in the future) is a fear.
If (as the more optimistic central bankers are trying to get us to believe) economic growth is returning, where is this inflation?
With August's data
Not in the US:
Not in Europe:
Not in the UK:
Canada's report is due Friday.
Japan will report on Sept. 24th.
Inflationary expectations are a behavioural trait of consumers based on their experience from their participation in the economy. Currently, prices for consumers are low and increasing at levels below most central bankers targets.
Yet any significant economic growth remains elusive (for the moment).
On the verge of the Federal Reserve's decision on interest rates there is lots of discussion around what the implications will be of a relatively (seemingly) benign 1/4% increase.
The debate, on the global consequences, surrounds the amounts of debt outstanding mostly in (but by no means limited to) emerging market countries.
Simply put, as long as the interest cost on borrowing is less than the growth of the assets that you have purchased with the borrowed money, borrowing is good.
If the growth of those assets slows or even worse, begins to decline, then you have to ask yourself if you had better sell assets and pay down the debt (or the lenders may decide for you, if they become concerned about the situation).
If interest rates begin to rise (and so does the cost of servicing the debt) and there is no growth in those assets, it becomes even more of a problem.
In essence, this is what we are looking at on a global scale.
There has been significant borrowing because interest rates have been at such low levels for so long.
This is has been happening at the household level, the corporate level and the government level.
In Canada, at the household level, low interest rates have continued to hold the Debt Service Ratio (share of income needed to pay interest and amortization) to record lows, however this has enabled borrowers to borrow record amounts relative to their income levels.
As long as the value of the assets is growing and the debt to total assets (pale blue line) is declining, this is not a concern because the debt is productive.
If assets stop growing or interest rates start rising (or a combination of the 2) then assets must be sold and the debt load reduced.
The big problem is liquidity.
If a great deal of debtors need to sell assets to reduce debt, prices of the assets that are being sold may decline in a hurry (significantly more sellers than buyers).
We have seen a glimpse of this effect in the recent global bond, stock and commodity market volatility.
Unfortunately, this is just the "tip of the iceberg".
This is the big issue that central banks are grappling with:
Is global growth at current (and future) levels enough to sustain the enormous amounts of borrowing that exist if interest rates move higher?
Further, the continuing strength of the US$ has increased the debt burden for those (especially emerging/developing nations) that borrowed in US$.
If global growth is slowing and we are in a period of low returns for assets, the time for reducing debt may be at hand.
It may be wise to do so, before you are forced to do so.
Tuesday is weekly webinar day at High Rock, feel free to tune in to our recorded version which will be posted at or about 5pm EDT:
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist