There is no doubt that the Bank of Canada has some really smart folks putting together all the data and making their best efforts to get a sense of what may be coming at us in regards to the Canadian economy (i.e. is that light at the end of the tunnel sunshine or a train heading our way!).
In their Monetary Policy Report released yesterday, here is the snapshot:
Numbers in parentheses are from the previous report, which means that for Q1, 2018 they have revised expected growth lower by 1/2% to 2.2% from a previously estimated 2.7%.
Likely a good enough reason for not raising interest rates yesterday. Q2 doesn't look so good either. That being said, they must be expecting some pretty good growth in the second half of 2018 (although they are not giving us more detail) because the total 2018 growth is revised up to 2.1% (from 1.8%), which as a matter of fact, matches the IMF's forecast for Canada (see our High Rock Weekly Video for more on that).
For fun (I know, you are all thinking, Scott, get a life, how is this fun!), have a look at the previous 2 year's April forecasts to get a sense of how these folks have done with their work:
Two years ago, the thoughts on 2018 GDP growth were the same as they are now.
But last year, they revised them lower. Likely because of better than expected 2017 growth and the interest rate increases that followed.
Second to the BOC's forecasting abilities, we can also glean that past interest rate increases have definitely put the brakes on Canada's economy (perhaps among other things as well).
As always, we are more interested in looking behind the headline data to see what risks the BOC is concerned with:
1) Weaker Canadian investment and exports: in other words, does increasing competitiveness from US tax reform lure Canadian firms across the border and weaken the prospects for growth?
2) Sharp tightening of global financial conditions: rising interest rates, especially in the US would impact Canadian bond yields and increase debt servicing factors on a highly leveraged household.
3) A pronounced decline in house prices in over-heated markets: which would dampen residential investment and consumption.
What are the bond markets telling us?
2 year bond yields are close to their highest levels in many years (a function of the BOC's actual and expected interest rate increases).
Longer-term bond yields have moved higher, but at a slower pace than the 2 year.
And the spread between 2 year yields and 30 year yields has narrowed to about a 1/2 % differential. When this relationship narrows to 0 (we call it a flat yield curve), it usually signals a recession will follow shortly thereafter.
Another couple of 1/4% increases by the BOC will hasten a recession. Another reason why the BOC is reluctant at the moment.
Confidence in the economy is paramount to economic growth. In all likelihood, the BOC wants to forecast enough growth to keep businesses and consumers participating, but the risks are out there (high and rising) and the bond markets are telling us that.
We (at High Rock) continue to position our collective portfolios with all that is necessary to protect them from the inherent risks that we see building behind the scenes, so that we can all sleep a little better.
Stock markets receive most of the media attention when it comes to retail investing. The retail investing public has been long conditioned to believing that owning shares in a company is the best way to invest.
What many don't necessarily realize is that owning those shares has a lot more risk involved than what they may be lead to believe.
In the chart above, the S&P 500 (SPX) returned almost 14% annually over the last 5 years (compound, absolute return). However, if you consider the potential for a downside move in that index (by 1 standard deviation from the mean), it is in fact the riskiest of the asset classes in the above chart (over that 5 year time period) by a factor of about 10. In essence, that is telling us that in a one year time frame, most of the potential for return could possibly be wiped out by a significant market correction like what occurred in February and March of this year. Therefore the return per unit of risk taken is 1.38 (return/risk). The SP/TSX had a 5 year return per unit of risk taken of 0.90.
This is what we mean when we discuss "risk-adjusted" returns, which looks not only at the absolute return, but also the relative return to the amount of risk that you take.
By comparison, the Canadian High Yield bond index (C$HY), with a compound annual average return (over 5 years) of 5.36%, has a much safer risk profile and as a result a return per unit of risk taken of 1.43. A better risk-adjusted return than the S&P 500.
In the capital structure of a corporation, bondholders get preference to stock (common shares) holders in the event of a liquidation:
You can add that to the list of positive attributes for high yield bonds.
One more reason to own them : Canadian High Yield bonds have 0 correlation to interest rates (none, nada, zilch!).
When government bond prices are falling because interest rates are rising, that is not going to impact Canadian High Yield bonds. That is what we mean by non-correlated assets. Stocks and bonds may go up and down, but that has little impact on how Canadian High Yield bonds perform. That means they are company specific and as long as we are doing our research on the companies that we own, we should be able to manage that risk.
This is some of the added value that our High Rock expertise in Canadian High Yield bonds allows us to bring to the table for our Private Clients.
Our balanced portfolios have much broader diversification.
And that is how we are able to achieve our strong risk-adjusted returns.
As you know, past performance is not a guarantee of future returns (anybody who tells you otherwise will be seriously offside with the regulators). However, at High Rock we work darn hard to get our clients the best possible risk-adjusted returns.
We started this journey because Paul could not get reasonable prices on bonds that he wanted in his personal portfolio from his investment advisor. They were the same bonds that he owned in the fund that he (High Rock) managed for Scotiabank, so he knew their value. But as is the case with banks and investment dealers, everyone who touches securities on their way to your personal portfolio takes their commission and the price keeps going up. That is just the way it is in the retail investment industry. As I have suggested in the past, through my own experience, at the banks, the client takes a backseat to the shareholder.
At the same time, I found myself in a position where I was in disagreement with the direction we were heading with the client service factor at my then wealth management practice. There was a strong influence from the world of Robo-advice: focus on building assets under management and minimizing attention to client service.
So Paul and I put our heads together and came up with a solution for creating a platform for clients that was different and better.
So few investors have a really good understanding of what goes on behind the scenes at the financial institutions that they have come to trust, but if they did take a closer look, they might think again. The Small Investor Protection Association has and what they have found is disturbing.
Read more: An open letter to Canada’s leaders
Nonetheless, we have created a wealth and portfolio management solution that is like no other:
- Fiduciary Duty above and beyond
- Interests truly aligned – we manage our own money exactly the same as client money
- Groundbreaking formation of Independent Review Committee (IRC)
- Manage fund for Scotiabank
- Core competency in the complex, opaque bond market
- Complete Fee Transparency
- Truly Independent – 100% employee-owned
- Experienced Large-scale Risk Managers - $13 billion
- Highest Education in the business – CFA, CIM, and CFP
- Communication – Blogs, Weekly Webinar, Quarterly reports and Semi-Annual reviews
- Registered with the Ontario Securities Commission, not IIROC which is a self-regulatory body owned by the Banks
We must be doing something right because we have been able to more than triple the size of our business over the course of the last three years. Many clients have followed me from my previous practice and many have joined from referral's from existing clients.
We write blogs, we have weekly videos, we send out detailed quarterly reports and portfolio summaries, we try to have at least semi-annual meetings with our clients, so our communication level remains high.
Most importantly, we actually care about each and every one of our clients, individually. You don't get that with big bank or big advisory practices. At the same time, you have all the protection that you would have with a big bank.
So thank you to our clients for putting your trust in us, we do not take it lightly.
Investing is about the future.
The simple rationale for investing is that, over-time, you absolutely need to grow the value of your money at or better a rate of return than the increases that will occur in your cost of living.
Ultimately, when you no longer have employment income, you will have to then depend upon your savings and /or pension plans to provide you with the means with which to enjoy a comfortable lifestyle.
We invest in companies (buying their stocks and bonds) in an effort to give us a future cash flow, dividend income, interest income and also the potential for capital appreciation. This requires a leap of faith, to a degree, that the financial system will continue to provide these (as it has for the most part through history) positive returns.
Through a good portion of 2008 and early 2009, investors (especially investors in the the stock market) lost confidence in the global financial system to provide the growth they were looking and hoping for.
The very extraordinary actions of the world's major central banks helped, over time, to restore some level of confidence that the global financial system would not collapse.
Needless to say, for some, confidence was gradually restored and from 2009 until the end January of this year (with a few minor relapses), confidence had been growing steadily.
The Trump era brought on further confidence (for many) in so far as that what he intended would be economically beneficial: deregulation, tax cuts and infrastructure spending. There were some, however, who were somewhat concerned about his foreign policy initiatives.
Nonetheless, the expected increase in corporate earnings was taken very positively. So much so that stock prices reached levels on a price to earnings basis (in January) that were close to all time highs. Some might suggest that we moved into an area of "over" confidence.
Confidence took a hit in February and March as political rhetoric flared over trade tariffs and protectionism (among other things) and subsequently, stock prices have returned to levels that are more in line with the last 5 year averages (green dotted line in chart below). Still expensive relative to 10 year averages (blue dotted line in chart below):
The investment community is mixed on its outlook from here:
A poll released by Wells Fargo / Gallup in late March claimed that investor confidence was at 17 year high. However, Eurozone investor confidence, according to a report this morning has fallen in April, which was apparently unexpected.
By and large, most participants in the stock market want stock prices to rise, because the majority of participants are owners of stocks. The likelihood of getting any truly honest feedback on this front may be limited to the bias that participants carry with them.
Of course there are also the contrarians, who see high levels of investor confidence as a reason to be bearish. Most likely they are positioned according to their respective views / bias as well.
Earnings expectations for the S&P 500 companies are expected to grow at a rate of 18.4% through 2018. This of course is largely based on the tax cuts and deregulation being put into place by the Trump administration.
This is a fairly lofty expectation that, if not met, may also take a tole on confidence. So we will have to look for possible revisions as the year progresses.
At High Rock we remain cautious (which is our bias). We know that stock markets always over-shoot both to the upside and the downside because of the emotional element that plays into trading / investing. That is why we are currently carrying more cash in client accounts which we can put to work when markets offer the opportunity to make purchases with better value.
When markets are making lower highs, it suggests that there is less buying strength (and better sellers) when prices rise. If markets start making lower lows (and break through buying support), it will show us that confidence is slipping and will likely encourage more selling.
When everyone else is selling, that, historically, has turned out to be the best time to be buying (especially over the longer term). So we will be patient and let the market and confidence levels determine appropriate buying points upon which we will wisely invest our and our clients excess cash.
The benchmark by which we measure our and our client's portfolio performance, a fully invested, balanced and globally diversified mix of the All Country World Index (ACWI), the S&P/TSX and the Canadian Bond Index, finished the first quarter of 2018 with a negative return of about -3/4% (data provide by Bloomberg monthly TRA, Total Return Analysis).
The severe increase in stock market volatility (chart above) and the inability of bond holdings to provide adequate coverage for the losses on stocks and equity ETF's were the main proponents of this negative return for "balanced" portfolios.
As Canadian investors our portfolios are consolidated and reported in Canadian dollars ($C), some of the sting of owning assets denominated in $US would have been reduced by the strength of the $US vs. the $C over the quarter by close to 3%.
This improved the global portion of the portfolio (ACWI) from a negative return of about -0.5% ($US terms) to a positive return of close to 2.5% ($C terms). Mitigating the loss on the benchmark portfolio by close to 1%.
At High Rock, we have advocated for sometime that equity markets were expensive, so we have had underweight (relative to being fully invested) exposure to equity markets, especially the US. However, we continue to hold $US denominated money market assets, so our portfolios were able to not only avoid a good deal of the stock market meltdown, but still benefit from the stronger $US / weaker $C.
We have also advocated that, from a defensive stance, owning non-correlated assets (High Yield bonds and / or certain types of Preferred Shares) can help mitigate some of the volatility in times when the old-style stock / bond correlations are not providing the protection that they have historically (when interest rates were higher).
Needless to say, our style of portfolio management with its more tactical approach was fully tested over the first quarter of 2018 and considerably beat the benchmark (after fees and costs). Depending on your asset allocation structure, most portfolios finished in positive territory.
While we will always be more focused on longer-term returns and the ultimate attainment of our client's future goals, it is nevertheless heartwarming to see that our focus on our first priority of risk mitigation and protecting client capital passed another major test, the second since we began our High Rock Private Client Division a little over three years ago.
And as you all should know, historical performance is no guarantee of future returns, but as you also know, at High Rock we work darn hard to get the best possible risk-adjusted returns as we possibly can.
From the CFA Institute's 2018 Report:
The Next Generation Of Trust
"CFA Institute is the global association of investment professionals that sets the standard for professional excellence and credentials. The organization is a champion for ethical behavior in investment markets and a respected source of knowledge in the global financial community. The end goal: to create an environment where investors' interests come first, markets function and economies grow."
As a portfolio management firm High Rock's Voluntary Code of Conduct specifically refers to our being "governed by the CFA Institutes Code of Ethics and Standards of Professional Conduct" (Paul has been a CFA charter holder since 1991).
As we all know, Trust takes a leap of faith. We are required to show credibility to begin to establish that trust:
"Credibility, which is dependent on track record and experience, provides investors with confidence that the investment professional or organization is professionally accredited to provide the required service successfully."
At High Rock, we have a team of professionals with the highest levels of professional accreditation as well as decades of experience through many tumultuous market conditions (all the way back to and including including 1987's crash). Something to consider in all the crazy volatility we are experiencing now and likely for some time to come into the future:
"Professionalism is more subjective and much harder to assess. Professionalism factors include competency and subject matter knowledge, and values such as putting clients' interests first, empathy, and demonstrating a fiduciary mindset."
"Brand is also becoming a more important method of establishing credibility, and is increasingly a proxy for trust."
I would argue that currently we are seeing an increase in examples where brand trust is being breached.
Without a national brand (although we have clients all across Canada), High Rock has to work significantly harder than the big, branded organizations to earn and build trust. So that is what we do.
"Conclusion: The investment industry is competitive and changing quickly, but investor trust remains a foundational element for success. The good news is that actions and tools exist to increase trust. By knowing investors' goals and fears, investment professionals can serve them better and provide more customized products and solutions."
Friends, the days of the "one size fits all" type of investing portfolios are drawing to a close. It is time to explore the alternatives. Customized solutions to your Wealth and Portfolio Management needs are here. Low cost, full-service and fiduciarily responsible.
Bond markets lead financial markets. The yield spread (difference) between 2 year government bonds and 30 year government bonds and the direction it is moving in are key to the flow of money in the bond market:
The gold line is the spread differential. As 2 year yields rise (because the central bank is raising rates) and 30 year yields rise less, the gold line moves from upper left to lower right on the chart. That is because bond investors are less worried about long-term inflation and move money into longer dated bond investments. Quite simply, they are less concerned about inflation because the higher short-term yields are expected to slow economic growth and lower the potential for inflation.
Recessions (the blue shaded areas) occur, historically, after the yield spread hits zero or goes negative. We call this a flat yield curve (at zero) or inverted (when spreads are negative).
The US yield curve has flattened from a 4.00% spread in 2011 to close to its lowest level since at about 0.80% now.
The US Federal Reserve is expected to raise rates by another 1/2 to 3/4% this year. That should just about flatten the yield curve to zero.
Stock markets don't like recessions. It has taken a bit of time, but it appears that, given all the volatility happening now, some of the smarter stock market participants are starting to get the hint.
S&P 500 In gold, recessions in blue. Yikes! I am afraid of heights!
In Canada, after Statistics Canada announced inflation for the year Mar. 2017 to Feb. 2018 had jumped to 2.2% (mostly as a result of increased gas prices, again), the bond yield curve moved to its lowest point since 2010, a little less than 1/2% from a flat yield curve. Probably one more quarter point increase from the Bank of Canada.
I read a blog the other day where the advice giver was urging her clients to remain calm.
If stocks retreat just 20%, a fully invested portfolio of 60% equity and 40% fixed income is going to give up 12% in the equity portion.
I'd rather be more tactical about it myself (being less exposed to equities with some buying power when markets hit their lows), a little less painful and a lot more calming, to say nothing of getting more invested with better value.
That is the way we like to invest our personal portfolio's and we sleep well at night. We started High Rock's Private Client Division to offer the same to those who wished a better alternative (than just waiting it out).
Meanwhile, keep an eye on the bond spreads.
There it is friends: the institutions that you have come to believe in and put your trust in are relentlessly trying to take advantage of you.
"Retail banking culture is predominantly focused on selling products and services, increasing the risk that consumers' interests are not always given the appropriate priority".
The culture of growing the bottom line with fees and commissions on the backs of their clients wealth is very simply, a conflict of interest.
When the independent financial advice firm where I worked (as a branch manager and advisor) from 2005 to 2011 was taken over by a bank, we (myself and my colleagues) went from a client-first culture to a shareholder-first culture: were told in no uncertain terms that the shareholder out-ranked the client. Of course: client fees went directly to the bottom line and eventually to the dividends paid out to shareholders and the CEO was rewarded when the share price of the bank went up.
If the conflict of interest here is not obvious, I am not sure what is.
Fiduciary responsibility to clients cannot be present when the clients interests are not put first and foremost.
At High Rock we have a Voluntary Code of Conduct that very specifically outlines our dedication to our clients interests. You will not find this in the culture that is outlined in the Financial Consumer Agency of Canada's report.
Every week we see the "aha!" moment when a new client signs on and experiences the vast difference in culture that we offer. We are not commissioned salespeople, we are a portfolio management company with expertise in financial planning, wealth and portfolio management.
Of course we charge a fee, but we would challenge that our fees are at the low end of the spectrum and they are absolutely transparent.
We have exactly the same safety features (Canadian Investor Protection Fund, CIPF, through our Raymond James Correspondent Services custodian) that you would have with a bank.
As I say over and over again, there is an alternative to the traditional bank investment advice offering and we (my business partners Paul and Bianca) think that what we offer is head and shoulders above the rest: low cost, fiduciarily responsible, personal and family wealth and portfolio management with high levels of service and communication.
Nothing to lose, all to gain.
"The economy is raging, at an all time high, and is set to get even better" according to President Trump.
This morning, US retail sales, as reported by the Commerce Department, notched their third consecutive month to month decline:
In the US, interest rates are rising and it is widely expected that they will be increased by another 1/4% next Wednesday following the US Federal Reserve's Federal Open Market Committee (FOMC) meeting to determine the course of monetary policy (and possibly another 2 or 3 times in 2018).
It is required of these folks to do this "in accordance with its mandate from congress to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy".
As we mentioned on our weekly video, the US economy is pretty close to full employment at 4.1% (latest data from last Friday).
Historically, just before a recession (blue shaded area), unemployment reaches its lowest point (top of the economic cycle). When it starts to move higher, intersects with the 3 year average and passes through it, a recession usually begins.
A client, obviously with way too much time on her/his hands (humour) actually watched our weekly video and asked for the "narrative" behind the statistical correlation, so here goes:
This situation tends to happen as a response to the US Fed raising interest rates, which is intended to slow the economy (and the prospect for future inflation) and which historically has lifted the unemployment rate.
In the current debt-laden (record household debt) economy, rising interest rates will increase the amount of money required to service that debt and give the consumer less purchasing power. The consumer is 2/3 of the US economy. Three months of declining retail sales may just be telling us about the state of 2/3 of the US economy (especially in light of the purported benefit of the US tax cut). When the consumer stops spending, inventories rise and businesses have to slow production. This increases the potential for layoffs and the possibility that unemployment rates will start to rise. Add in what also might be an unwanted impact (more unemployment) of protectionist trade policy. So we circle back to the history of unemployment rates and recessions.
As portfolio managers, we have to make some determinations as to how best allocate assets to our clients (and our) respective portfolios. We try to use a number these indicators of the state of the economy to get a handle on where we are in the economic cycle and by virtue of that, which assets might be vulnerable.
Historically, stock markets don't like recessions. As stocks have become relatively expensive over the last couple of years, they are likely to be more vulnerable, especially at this late stage of the cycle. That would indicate to us, as portfolio managers, that despite the emotionally charged equity market environment, being fully invested in equity assets may not be especially prudent.
As for the latest on the US economy in the 1st quarter of 2018 (following today's retail sales data): Growth is expected to be only +1.9%
Raging? I don't think so.
Despite the fact that stocks (especially US stocks) have been in a bull market since 2009, we were reminded in the first week of February that, as an asset class, there is vulnerability to the potential of severe price swings.
If they can go up dramatically, they can also go down dramatically. Some folks are willing to take on that kind of risk, but others are not so comfortable when they look at their portfolio give up 5 or 6% over the course of a week.
And there may be more of it to come:
A 40% correction according to the co-President of JP Morgan:
As human beings we are conditioned to be very happy as long as things are going positively. When it turns and goes in the other direction, we tend to not be so thrilled. Some folks look at their portfolios daily, which is akin to driving with your nose pressed against the windshield, but they just can't help themselves.
Certainly it is good to have equity assets for growth purposes, but a balanced portfolio (with other asset classes) that are not correlated with equities will help alleviate the potential for the sleepless nights that accompany stock market volatility and the inevitable down-turn (markets just don't always go in one direction, they cycle, it is just natural).
So being a little less dependent on equities may be a necessity if you are going to want to continue to get growth when the downturn comes. It may have already begun.
The historically natural offset to high risk equity assets has been to balance them with a collection of high quality government and corporate (investment grade bonds). However, low interest rates have made those correlations less and less realistic (especially as inflation concerns, which erode the value of bonds, are climbing).
We at High Rock have found some alternatives over the last couple of years (because, surprise! we think that stocks are expensive) in other non-correlated assets for our clients: a collection of Canadian High Yield bonds that have had a better than 14% annual average return over the last couple of years, with less than half of the risk associated with stocks and an opportunity in preferred shares that brought a one year return of better than 20%. All of our clients have participated in these in some manner, depending on the structure of their asset allocation strategy (based on their goals as set out in their Wealth Forecasts).
And, no surprise, our client portfolios did not experience the heart-wrenching swings of traditionally balanced portfolios in that crazy first week of February.
Always remember that past performance does not guarantee future results, but at High Rock we work darn hard to provide our clients with the best possible risk-adjusted returns.
When stocks are sliding, you are going to want to have some other opportunities to rely on. When traditional bond assets don't provide it, what are you going to do to continue get growth?
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist