Kelly-Gorham Private Wealth
Strategy Update
“If there's a recession, I'd buy stocks. That's when you make money: when markets are spooked.” Ben Stein
I hope that everyone is enjoying their summer.
For those who read our special mid-spring Strategy Update, we noted that we prepared for this shift. Year-to-date, our portfolios are still only off a fraction of what the average balanced growth portfolio has dropped.
Canada and the U.S. are experiencing the highest inflation levels seen in decades. A combination of the war in Ukraine, the shock of high oil/gas prices, labor shortages, and the ongoing pandemic and supply chain woes have all played a factor. Collectively, these issues increase the likelihood of a recession. RBC Economics thinks that we may see a recession in 2023, albeit a relatively short/mild one. Remember, equity markets are usually forward-looking and tend to drop long before a recession begins. By the time the recession hits, we hope to add more equity exposure to take advantage of high-quality companies trading at attractive valuations. Please see the U.S. recession scorecard below.
As of July 18, 2022, year-to-date, the NASDAQ is showing down -28.21%, S&P500 down -20.21%, Dow Jones Industrial Average down -15.08% and Toronto TSX Composite down -12.66%. Bond markets have not done well either, with the iShares Canadian bond index (XBB) down -12.83% and iShares US Aggregate Bond Index (AGG) down -10.76% year-to-date. The U.S. 20-year treasury index (TLT) is down -22.35% year-to-date. Also, for balanced portfolios, iShares (BAL) balanced index is down -15.30 % and the Vanguard Balanced index (VBAL) is down -15.06% year-to-date. Tough sledding, in other words.
As we pre-positioned equity and fixed-income portfolios, we dramatically outperformed our comparable benchmarks. As of July 18, 2022, our unaudited average year-to-date balanced growth portfolio return was down -6.64%, with some portfolios being slightly higher and some being slightly lower (we roughly calculate this by adding the total value of every balanced portfolio and then calculating the weighted average return). I have stressed since 1996 that there are no guarantees and that we focus on risk reduction. We have succeeded in avoiding much of the drops compared to various benchmarks in every downturn – 1998, 2000, 2008/09, 2011, 2015, 2018, and 2020. In 2022, we are also avoiding much of the drops. We now have ample cash on hand to buy both bonds and equities.
You may not notice much change in portfolio holdings quarter to quarter, but over multiple quarters you will. We dramatically lowered technology exposure from late 2020, while rotating to more value, resource, and dividend focused exposure.
In our mid-spring Update, I mentioned that we made 35%–40% on our preferred share index exposure, which helped the fixed income portfolio outperform the bond benchmarks mentioned above. We also had significant exposure to short-term fixed income.
Since our mid-spring Update, we made considerable changes to our fixed-income portfolios. Prior to this quarter we already lowered much of our medium-term bond ETF/mutual fund exposure to short-term or floating rate bond ETFs and increased our cash positions. With this major shift, we sold much of our bond ETF/mutual fund exposure and we sold most of the short- and medium-term bond ETF/mutual fund exposure. Large portions of money market yielding 0.70% were replaced with short-bonds returning 2.36–4.23%. For taxable accounts in the maximum tax bracket, the interest equivalent yield was more than 5%. 
When interest rates were running between 0.25% and 0.70%, we kept our exposure to floating rate bonds, ultra-short-term bonds, and money market. This prevented our fixed income portfolio from experiencing the large drops that many other fixed income portfolios may have experienced. Now, as those bonds mature, we will roll some of that into other direct bond holdings but will begin to enter back into domestic and global bond ETFs/mutual funds. Our preference is to buy exchange traded ETFs, as it provides mid-day liquidity as opposed to end-of-day for mutual funds.
Over the entire quarter, we continued to either take profits on equities, reduce exposure to select sectors, or sell out equity positions entirely. One specific area was in the financials/banks over the past quarter by reducing that from 6% of the Canadian Equity portfolio to 5%.
We have also put a significant safety net around our Canadian Equity portfolio and some of our US$ equity accounts with more than $50,000 in US$ equities. This helps reduce portfolio volatility.
Conclusion:
As I have said many times, doing all of this does not mean you are never down. There may be a time when we are down much more than the markets are down. What this does mean is that we have the flexibility to make measured decisions and not be under pressure to recover.
We have a large amount of flexibility due to the short-term bond positions, portfolio insurance (puts/safety net), cash, and a relative out-performance to our benchmarks. The relative out-performance means we do not have to take more risk to try to increase returns.
We are not done with the recent volatility but we can buy investments that might be oversold and/or represent undervalued prices. We are also now able to buy fixed income that can add significantly to portfolio returns.
Again, we are in a marathon, not a sprint, and a clearly defined strategy and process matters.
As always, we appreciate and value your trust. Please do not hesitate to contact us if you need anything. We are available to meet by phone, via WebEx, or in person.
** Here’s the fine print and there’s a lot of it…
Currency can add return when the Canadian dollar goes down but reduce returns when the Canadian dollar goes up for non-currency hedged US and international investments. Also, please remember that your US accounts report values in US dollars.
Securities or investment strategies mentioned in this newsletter may not be suitable for all investors or portfolios. The information contained in this strategy update is not intended as a recommendation directed to a particular investor or class of investors and is not intended as a recommendation in view of the particular circumstances of a specific investor, class of investors or a specific portfolio. Options, and other strategies mentioned, may not be suitable for all investors. You should not take any action with respect to any securities or investment strategy mentioned in this newsletter without first consulting your own Portfolio Manager or in order to ascertain whether the securities or investment strategy mentioned are suitable in your particular circumstances. This information is not a substitute for obtaining professional advice from your Portfolio Manager. The commentary, opinions and conclusions, if any, included in this newsletter represent the personal and subjective view of Daniel Kelly who is not employed as an analyst and do not purport to represent the views of RBC Dominion Securities Inc. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. Investment Trust Units are sold by RBC Dominion Securities Inc. There may be commissions, trailing commissions, management fees and expenses associated with Investment Trust investments. Please read the prospectus before investing. Investment Trusts are not guaranteed, their values change frequently, and past performance may not be repeated. (Keep reading, there’s only 7 more sentences to go.) This commentary is based on information that is believed to be accurate at the time of writing and is subject to change. All opinions and estimates contained in this report constitute RBC Dominion Securities Inc.’s judgment as of the date of this report, are subject to change without notice and are provided in good faith but without legal responsibility. Interest rates, market conditions and other investment factors are subject to change. Past performance may not be repeated. The information provided is intended only to illustrate certain historical returns and is not intended to reflect future values or returns. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ®Registered trademarks of Royal Bank of Canada. Used under license. ©2022 Royal Bank of Canada. All rights reserved
Investment portfolios are not guaranteed, and past performance is no indication of future returns. In addition to these portfolios not being a guaranteed investment, there can also be significant fluctuations in the value of the portfolio.Did anyone read this far?