As managers of risk, we are a little concerned with an article in The Globe And Mail, where (with a new explanation) Fin Min Morneau outlined a reason for his new tax policy:
"Speaking to The Globe And Mail's editorial board Wednesday, the minister presented an entirely new argument in defence of the controversial tax package."
"Mr. Morneau said the ultimate goal of the changes is to correct an unintended aspect of the tax system that fails to encourage small-business owners to reinvest their corporate savings back into their companies."
Mr Morneau said that "We're actually giving the people incentive to sit the dead money on their balance sheet and invest it in something else", he said. "We've created a big gaping hole for tax planning and at the same time a decreased likelihood that people are going to invest in their business. That's what we are getting at here."
I would suggest, first and foremost, that small business owners know exactly how much they need to invest in their businesses for the growth that they wish to achieve and need not be coerced to invest (risk) more by the government.
Secondly, as a business owner builds her / his business, their security for the future depends on not having all of their "eggs in one basket" (i.e. "investing in something else"). In other words, financial success (and the ability to survive economic slowdowns) depends on the ability to have asset diversity (to be able to ride out the economic storm) without having to add leverage or reduce their workforce. That is lesson one in the management of risk.
This would be especially true as small-business owners approach their ultimate retirement, when it is even more essential to have a broad diversity of investments to carry them through the balance of their lives. They should not have to wait until they have sold their businesses to be able to build a comprehensive investment strategy.
Small-business owners take on enough risk throughout their careers, they have made their contribution to the economic growth of this country. They deserve some respect for this, not derision for being somewhat and rightfully safety conscious.
Each week, like the proverbial broken record, we tell our clients (and any one else who cares to listen) on our weekly client webinar that the changing dynamics brought on by extraordinary monetary policy and liquidity by central banks since the financial crisis have made the old balanced portfolio correlations between equity and fixed income significantly less stable.
In other words, if you are using that "old-school" buy and hold methodology you have way more risk than you likely should have and are vulnerable to permanent portfolio damage if you (or your advisor) do not take the time to assess it.
At High Rock we manage risk first and foremost, so we have a full understanding of exactly what risk our clients (and we ourselves) have.
We often rail against the complacency factor: Canadian investors with global equity exposure have watched (if they pay attention) their portfolio values erode as the Canadian $ strengthened by over 10% (that is where the volatility has been). Did your advisor point out that risk to you?
There are greater risks out there: Asset prices have decoupled from their underlying fundamentals because central bank liquidity has put a temporary floor under them.
Corrections in market prices have not been significant as a result.
However, this liquidity is going to disappear as central banks unwind their extraordinary monetary policies (the US Federal Reserve will start in October) and asset prices and the gap between them and the fundamentals will revert.
The big question is will the lagging fundamentals (like economic growth and inflation) catch up to extended asset prices or will prices fall to more realistic levels?
The big risk is the latter (obviously) and we all need to be prepared for that. If you are not, you could be in for a nasty surprise.
At High Rock, we are prepared. We are underweight expensive equity assets and over-weight cash. We are positioned to protect our clients. We do not use bond ETF's. They are expensive and don't allow us the flexibility necessary to adjust the average duration of our bond maturities. We are tactical: looking for real opportunity as opposed to owning over-priced assets.
Our (Paul and my) voices (blogs) do not get enormous exposure, likely a couple of hundred views per blog or thereabouts. And our profession is not journalism. So our message is not necessarily as far-reaching as some.
But when great voices on this topic echo our sentiment, it is always reassuring: so I would recommend having a peak at this conversation between a great market economist, Dr. Mohamed El-Erian and WealthManagement.com.
In words way more eloquent than mine, Dr. El-Erian suggests that "there is a difference between the investment journey and the destination".
The investment journey being the day to day, week to week, month to month, year to year swings in portfolio value. The destination, of course, is your long term goal. Sometimes it may seem that the journey may not be taking a direct route to the destination, but you have to keep your eye on the target and let the capable managers worry about the day to day, etc. journey.
That is what we do: protect ourselves and our clients from risk that may impact the ultimate destination. Do you know for certain that your advisor is doing the same (especially if you are loaded up, like the rest of the mostly unsuspecting investing public on ETF's)?
Be aware of your risk. We can help.
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!
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist