A look ahead

Sep 05, 2018 | Nick Foglietta


Other than being technically “overbought,” there is no immediate reason to expect financial markets to change direction at present, but this should not be taken as a reason to be complacent.

September to December 2018

Executive Summary:

Stock markets enter the final trimester of the year on a high note.  Interest rate yields continue to flatten across the yield curve at slightly higher levels. 

Other than being technically “overbought,” there is no immediate reason to expect financial markets to change direction at present, but this should not be taken as a reason to be complacent.

My investment thesis remains the same as it has been all year: 

  1. Financial markets will continue to ride a wave of liquidity higher until the liquidity dries up.
  2. The central banks around the world are in the process of switching from Quantitative Easing (QE) to Quantitative Tightening (QT).  This change in the liquidity tide, coupled with SLOWLY rising interest rates, will stop the longest BULL market in history and asset prices (real estate and stocks) will fall.
  3. The central banks will panic when assets fall (maybe 15% - 20%) and return to a QE bias in the global monetary policy.  The change from QT back to QE will create another leg higher in asset prices.
  4. Our goal is to be fully invested in the stock market AFTER a 15% - 20% decline in asset prices takes place AND the US Federal Reserve panics back to QE.  This narrative gives our model a clearly defined technical picture to enter and exit investment positions assuming the scenario above.

Please remember, the timing of all of this remains unclear.  My goal is to stay patient and let the central banks act, even though it is a painfully slow process; they realize they are taking the patient off 10 years of life support.

One final note I would like to make before I begin. 

For most of 2018, I have focused too much on US politics and the leadership of Donald Trump. It has not been “what” he has been trying to do that has captured my attention to such a point that it became distracting…I actually believe many of the things he is doing are necessary…but it is “HOW Trump does things” that has been so troubling to me. 

This “distraction” left me too BEARISH on financial markets during the correction of 2018.  I just kept thinking something crazy might happen out of the blue and cause a sudden drop in already over-valued financial markets.

That was “my bad” and I should have stuck to my long term narrative above which would have led me to be more BULLISH since the beginning of June. 

It is interesting how easy it is to let your emotions creep into your discipline when you invest.  Over the years I have worked very hard to eliminate emotional distractions.  Yet, once again, they resurfaced. 

At the beginning of August I hit the “reset button” on my emotions. 

Goes to show…one never stops learning.

 “The Big Picture” – 2018 rates of return:

Year to date (YTD) data show, again, how American stock markets led the way.  Canadian stocks and bonds were basically mixed in results on either side of a flat rate of return.

Relative valuation of stocks all around the world is negatively impacted by higher interest rates because the rate of return on fixed income is considered safer than dividends on stocks.  It follows that higher interest rates should slow, and ultimately stop, expensive stock prices from going higher when compared in terms of relative value.  We will see if this historical relationship holds true in the present cycle.

One other item I see in the financial news is this idea of “stocks climbing a wall of worry.”  The wall of worry refers to the fears investors have that keeps cash on the sidelines even though stock prices continue to rise.  These investors get frustrated, give up holding cash, and pour their money at ever higher prices.  Therefore, a worried stock market can keep climbing on this fresh cash supply.

What I have noticed from my conversations is that investors “talk” about their worries, but their actions show no fear at all.  They go out and buy stocks, houses, cars, boats, vacations and whatever else you might want to add to the list no matter how negative they talk about things. 

That is very different from the past cycles I have experienced.  For that reason, I’m not sure how large of a “wall of worry” really exists. 

With the US midterm elections taking place during the final trimester of 2018, we remember, once more, the political bias of the US voter. 

The bi-modal distribution of the electorate opens the door to more unpredictable outcomes in the election. 

Investors (myself included) have spent a lot of time weighing different market outcomes predicated upon political outcomes.  Fair enough, but since these are difficult results to handicap…and even if I knew the results I could not say for sure what the financial market response would be…so let’s stick to watching the financial markets closely and taking my cues from the markets, not politics.

The “flattening” yield curve mentioned in the lead section of this report can be seen in the graphic below.

The creator of the chart intimates in the title that investor concerns are not justified when viewing the near-inverted yield curve. In a slide-deck presentation, this chart was used to justify the reason for the lack of concern because it takes a long time for a recession to take hold AFTER the yield curve inverts. Or, on our chart, the grey line goes below zero.

I believe the yield curve shape matters MORE this cycle than in past cycles. This is because interest rates are starting from such a low base.  IF inflation jumps quicker than anticipated, the central banks may move rates up further and faster than presently priced in expectations. 

That would quickly and seriously invert the yield curve.

FWIW - David Rosenberg, Chief economist and strategist at Gluskin Sheff tweeted the following comment after I had written the paragraph above:

“…a rising number of firms are raising their prices and they (prices) are sticking for the first time this cycle.  Risk isn’t the Fed goes to the sidelines but that inflation forces it to do more rate hikes.  This is NOT on the radar screen.”


Canada begins the final trimester of 2018, in pretty good shape. 

Our nations Achilles Heel continues to be high levels of debt at the government, corporate, and personal level, but as long as asset prices can be maintained debt levels are not a problem.

Real estate is where the main speculative fervor resides in Canada. It is well known that the market is softening, as sales volumes are down, speculative sales volumes are way down and, in the Vancouver market, at recorded record lows.

Ontario price data is showing that weak sales is transitioning into prices too.  Check out the sale below as an example. 

This home was bought Nov 24th, 2016, at $1.47M and sold Aug 23rd, 2018, at $1.292M with five price reductions and 106 days on market.

To keep this simple, let me say that Canada is fine as long as interest rates stay low and asset prices stay high. 

So now look at my next graphic. 

Canadian Inflation (CPI)

Higher inflation is a problem for the low interest rate, high asset price crowd. How inflation vs. interest rates vs. debt levels sorts itself out is the key macro idea to keep in mind when considering Canadian investment options. 

The slow pace in interest rate increases is dragging the conclusion out longer than expected, but the ripping higher Canadian inflation rate might speed the process up in coming months.

We will watch this carefully in the next trimester.


The US financial markets have been, head and shoulders, the strongest in the world.  There are signs of slowdown emerging in earnings, consumer confidence, and economic data, but these signs are coming off of record high levels. All in all, not too much worrisome about the US expansion for the coming trimester. 

Of course there is the Donald Trump saga. 

The media cannot get enough of Donald Trump and it loves to keep people in a state of rapt attention. These media focuses on the US are not my largest concerns for investors over the foreseeable future. 

“Trade wars” and “political polarization” dominate social media, the news media and the minds of people around the world.  As stated in the executive summary at the beginning, I am trying to “un-focus” on these issues. 

That said, before I move on, let’s include a chart from RBC GAM that summarized the scenarios considering US Trade Policy. I have no idea how anyone handicaps the ongoing Trade rhetoric, so I present the chart without comment.

For the US, I believe the next set of charts is where things get interesting in the medium term future.

First, let’s view US inflation.

The chart shows Personal Consumption Expenditures (PCE). This is the US Federal Reserve’s “go to” inflation rate when deciding interest rate policy. No question…it is moving higher!

The next chart is the “feature chart” in this presentation. 

It graphically states the case for the market narrative summarized in the Executive Summary and needs to be considered relative to the inflation rate shown above.

The chart shows that, ironically, financial conditions have not tightened at all even though the PCE inflation rate has risen and the US has raised interest rates 7 times in three years (black line below).

It really is quite amazing.

Due to all of the global liquidity and central bank intervention, the Chicago Fed National Financial Conditions index is still negative and at the lowest reading in the past 14 years!  A negative Fed reading equates to “looser-than-average” financial conditions. 

Much like in Canada, it will be interesting to see how far the US Fed will be willing to push higher on interest rates AND if the long end of the bond market will begin to respond with higher interest rates by setting higher yields too.

One last chart on what interest rate increases might mean for US consumers.

Notice how small the rise in the “effective Federal Funds rate” is relative to its historical averages, yet the personal interest payments of Americans is already surging.  Obviously, there is a lot more debt held by people in the present cycle to cause this chart correlation.

The point of the graphic is the US consumer is far more exposed to higher interest rates in the present cycle than in past cycles.

Stock buybacks, pictured below, are absolutely ripping and show no sign of slowing in the face of higher valuations or higher interest rates.  Higher interest rates will impact buybacks at some point. I have no idea what level of interest rates makes a significant difference to company buyback programs.

It is no surprise that companies with the largest stock buyback initiatives have been some of the best performing stocks in the US. 

Miscellaneous Topics:

Global Markets – Balanced portfolios still typically carry a 5% - 18% weighting in global (non-US) stocks and fixed income.  I have been much closer to the low end of that range than the high in most portfolios. 

I won’t get into specific investment themes here, but I do want to make it clear that if you have questions about these markets, or if you just want to explore some ideas around investing in these types of markets, please touch base with me and we can meet to discuss your goals.

There is a reasonable case to be made for non-American, global equities at this point in time.

Commodities – The idea of a late cycle exposure to commodity investments has been popular in the financial media as of late.  The US dollar rise has been tough on these types of investment themes.

I agree with this idea and the chart below will likely turn up sharply at the same time the stock market peaks. 

It is an excellent time to sort through the rubbish bin of commodity stocks and get to know some of those companies again. I am not a buyer yet. Wait until the upturn takes hold and buy the new trend when it begins. 

Gold and Oil – The rising US dollar has also beat up these companies for the most part. The larger companies that are in the broad indexes have held in better than the smaller names. There are some excellent values in these sectors but we have to do our homework. Again, call if you are interested. 

Bitcoin and Altcoins – l belong to a social media platform called “Steemit.” It is a blockchain based network that uses the underlying coin called Steem as its basis of commerce. 

I mention this because I hear the laments of lots of “crypto-disciples” and how significant their losses have been in the cryptocurrency investments they made. 

Nothing I see has changed my view that I am 95% sure Bitcoin is a bubble.  Likely there will be a brave new world in the future that uses blockchain (or something similar) as the secure channel to make and record transactions. 

The total valuation of cryptocurrencies at its peak in early 2018, was getting near $1 trillion US.

At that time there were about 700 different cryptocurrencies in existence. At present the total value of the cryptocurrencies in existence is around $200 billion US…and now there are 2,465 different coins!

I continue to watch this area with great interest as a spectator and have no interest to invest the coins at present. 

Wealth Management – I have made a concerted effort over the course of the past two years to make sure a financial projection is done for every client that wants one. There are a few more to go, but I’m feeling like I’m getting close to everyone completed. Please let me know if I have missed you and we will schedule a time to meet and start the two meeting process.


The Executive Summary at the beginning of this report states my position clearly. 

Never in the history of money could debt be compounded upon itself without some kind of reset being triggered. 

Technology and the global central bank community have been able to “control” so much of the present debt super-cycle that many now believe that “debt doesn’t matter anymore.”

Maybe this is true, maybe it isn’t. Who knows? We will see.

But here is the naked truth: 

The entire planet is leveraged to one side of this bet.  If debt does matter again…if interest rates have to be paid with money that can’t be borrowed from somewhere else or printed out of thin air…then the world will change drastically at that point. 

My plan allows for me to adapt to either outcome. 

That is an important value proposition our team brings to investors. Not everyone cares about have a contingency plan if the global central banking experiment fails. For those who do, I promise to do my best to preserve your capital.