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Monthly Partner Memo – May 2021

Thankfully, in Canada we are finally making some progress on vaccinations. I hope that most of you have received or at least booked had the chance to book your initial shot. A massive thank you to New Brunswick and Newfoundland/Labrador for sending health care workers to Ontario to help.

 

Friends & Partners,

Thankfully, in Canada we are finally making some progress on vaccinations. I hope that most of you have received or at least booked had the chance to book your initial shot. A massive thank you to New Brunswick and Newfoundland/Labrador for sending health care workers to Ontario to help. 

Let’s get right into it this month – the market seems to defy many people’s expectations, but many are  finally starting to accept the fact that there remains continuous liquidity being pumped into the system, and the economy isn’t about to fall off a cliff. The Fed remains historically dovish and supportive of asset markets (despite the rebound in economic activity), and a steady decline in COVID-19 cases in the U.S. continues. Record-level easy financial conditions have led to indiscriminate asset inflation, floating all boats. There remain risks as always, but the main pillars supporting markets remain intact – massive government stimulus, historic Fed accommodation, vaccine progress and a continuing economic rebound. So, despite concerns around inflation, taxes, sentiment and timing around when the Fed starts letting off the gas, the outlook still appears relatively supportive for assets. But we need to be cautious, because timing pullbacks is impossible, and it won't take much to get a pullback as the hype surrounding the re-opening economy eventually starts to fade.

So let’s assess some of the risks:

US Corporate and Capital Gains Tax Increases – A Significant Market Risk?


In short – not really.

President Biden unveiled his Made in America Tax Plan recently, which proposes an increase in the US corporate tax rate to 28% from 21%. Though this is unlikely to pass through Congress in its current form, the prospect of higher corporate taxes has caused some heartburn for the markets. But historical market performance data indicates that changes to the corporate tax code should not be feared – calendar years in which tax hikes went into effect have historically coincided with double-digit S&P 500 price returns and stronger US GDP growth, on average. And tax regimes don’t have any meaningful long-term impact on broader market performance historically.

Biden also proposed an increase to the capital gains tax for high income earners (unsurprisingly). Looking at similar situations in the past, a hike could cause some investors to sell some equity positions sitting on sizable gains, but the potential downward pressure on equity markets from these selling flows would likely be short-lived as these sellers eventually buy back positions to restore their allocation back to previous levels.

The exhibits from RBC GAM below show the historical maximum capital gains tax rate in the U.S. and the performance of the S&P 500 before and after increases in the tax rate. At a high level, and without considering prevailing economic fundamentals at the time of previous tax increases, equities tended to experience some choppiness in the lead-up to the implementation of the capital gains tax hike, but weakness was by and large transitory. 

The Hot Topic of Inflation – It’s Definitely Here, But Will It Persist?


I’ve been noting for months that inflation expectations and yields were likely going to pick up, and that this puts some bond holdings at risk. So far this is playing out, and most bonds are down ~5% year to date. Ouch. These are ‘safe’ instruments that most people didn’t expect to ever lose capital on.

Inflationary signals are popping up everywhere we look. Composite PMIs are at or near all-time highs. Business spending is higher than pre-pandemic levels. Inflation indicators are rising everywhere and confidence surveys are surging to multi-year highs. I’m sure you’re feeling it first hand. Pent-up household demand has spilled into the real estate market (we just went firm on selling our house yesterday!). This has all led to a supply shortage, soaring home prices and depleted inventories of building materials.

Economic growth is surging, and GDP prints are big. Altogether, unemployed, underemployed, looking for better jobs and discouraged workers is 22 million. There's never been so much slack in the economy. As they come back into the workforce, they will drive spending, pay taxes and grow the GDP.

The US 5 year break-even inflation rate (a market-derived proxy for inflation expectations) has gone from an all-out collapse last March to breaking out of its historical range and hitting the highest level in nearly 13 years. Yet the Fed is still buying $120 billion/month of bonds, which is nearly 50% more than the $85 billion/month that occurred during QE3 (or “Quantitative Easing” from January 2013 through December 2013).

So is this inflation ‘transitory’? Are all of these pressures noted above heavily “front-loaded” in nature as the Fed believes? 

A number of the deflationary headwinds experienced since the global financial crisis remain – mainly, aging demographics and high levels of indebtedness. Many think that 9 to 12 months from now, much of the supply/demand mismatch should be back in balance—at least in the US. And that when the virus is under control, the economy could simply be back to where it was in 2019, with low growth, low inflation, low interest rates, and already-excessive debt that is now worse. 

There is no way to know for sure, and you may want to respectfully avoid anyone who claims that they have the answer. But we can monitor and position for some of these risks – this is what prudent portfolio management is all about. Going into a high growth and high inflation environment, we want exposure to companies with strong pricing power and operating leverage.

Investor Sentiment & Positioning Also Creates Some Risk


A near record-high percentage of global fund managers stated in a recent survey that they were overweight equities. Institutional investors are mirroring the same enthusiasm for exposure to common stocks as their retail counterparts. One year ago, expectations were dismally low. Today, more optimistic outlooks have radically re-priced risk upward. This transition will continue to be bumpy.

Investor complacency is illustrated by a host of sentiment measures. The concern is that that market volatility will be greatly amplified by the current record levels of margin debt and call-option buying. Investors have never been so levered. The result is a riskier market environment.

I’m a Broken Record Here, But Your Portfolio May Be Broken


I hosted an interesting event this past week with 3 of Canada’s leading alternative managers – Jason Mann from EHP Funds, Sal Malik from Anson North Star and Chris Rowan from NewGen Assets Mgmt. They did a great job of explaining how uncorrelated and well-hedged funds fit into your portfolio, especially in this environment where bonds are likely going to be precarious investments for the foreseeable future as rate and inflation rise.

So moving forward, your traditional stock/bond balanced portfolio (known as the 60/40 portfolio), is unlikely to offer a smooth and solid risk adjusted profile moving forward. This is not unlike the environment we saw in the mid part of the century when we were essentially in the same boat as we are today.

Chris Cole of Artemis is sharp, and he puts it very succinctly: "Unfortunately, with history as a guide, investors expecting the gains of the last 40 years with a traditional portfolio will be massively disappointed. The global economy is entering a period of change whereby deflation or manufactured inflation will destroy wealth to eliminate debt… collective Recency Bias is leaving most blind to the problem. Suppose history rhymes, and at some point in the next twenty years, we face a global crisis in servicing the historic levels of leverage. In that case, global deflation or stagflation will wreak havoc on traditional retirement portfolios. Wealth and savings will be destroyed, and many pension systems will become insolvent or require multi-trillion-dollar bail-outs by the government. None of this will be free. YOU will pay for it, either through higher taxes or loss of purchasing power due to higher inflation. 2020 was not the climax but merely the first act of this epic Greek Tragedy.”

But We’re Going to be OK, I Think…


 

This is a momentum driven market we’re in. The plumbing of this market means that pullbacks or corrections (even 10%-15%) can appear out of virtual thin air, simply because of the pile-on effect of algos, HFTs, etc. – it’s the way it is when the world is awash with liquidity chasing returns. But active portfolio management (i.e. smart stock pickers) will continue to outperform. In Q1 2021, almost 33% of the S&P 500 constituents beat the market by more than 10%, suggesting it is not just a few names that can make or break a portfolio. Moreover, in Q4 2020, 37% did the same. In this context, it is less about the index and more about the stocks within it. Index/ETF investing has had its day.

Vaccine production is surprising to the upside, stimulus is full throttle, the Fed remains as dovish has as ever, ‘excess savings’ are set to be spent as the economy opens up, stimulus cheques are flowing into the stock market, very easy year-over-year comparisons are making for some eye-popping growth numbers, and volatility remains subdued. However, the taper tantrum of 2018 could pale in comparison to a real rate tightening cycle. We need to be positioned for these risks – you will never time a pullback perfectly. Minimizing drawdowns is vital to long-term capital accumulation since large drawdowns at any point in an investor’s life have long-lasting consequences – it takes a much bigger gain to make back a loss. This is an environment we’re built for.

Wealth Management Alpha


I often finish up my monthly letter by noting a wealth management or tax minimization strategy that you may not have considered or want to learn more about (see a short collection of tax minimization strategies here). Social responsibility is a very important topic and something that many want to incorporate into their lives and their portfolio.

Socially responsible investing is any investment strategy which seeks to consider both financial return and social & environmental good to bring about positive social change. Many advisors aren't discussing responsible investing with their clients – the 2020 Responsible Investment Association (RIA) Investor survey found that 75% of respondents wanted their investment adviser to inform them about Responsible Investments but, only 28% have been asked about these options. We make it a cornerstone of our practice to offer our clients specific portfolios geared to those who wish to invest with impact. Our solutions are designed to generate competitive risk-adjusted returns with a view toward integrating environmental, social, and governance (ESG) factors into each investment.

Multiple studies have shown that investing with this purpose in mind does not have to detract from your risk-adjusted return profile. See how we offer socially responsible investing solutions for our clients here.

 

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Monthly Partner Memo – April 2021

Spring seems to have come quickly, and with it some hope that vaccines will be administered for you and your family in the coming weeks and months. If you haven’t seen this yet, you can register on Shoppers website and you’ll get an email/text when you qualify for the vaccine: "Register now and when eligible we will contact you to book your COVID-19 vaccination appointment." https://covid-19.shoppersdrugmart.ca.

 

Friends & Partners,

We All Seem to Love Bad News…


The media does a great job scaring us. I have a number of clients, both seasoned and new, who are very fearful of the market outlook. There are certainly risks to the outlook, there always are. If there weren’t, you’re likely buying at the top!

The problem is that we demand bad news, it’s not the media conspiring against us. In 2014, a Russian news site conducted a bold experiment. Instead of posting its usual largely negative news stories, it reported only good news. The result? No one cared. The site lost two-thirds of its normal readership that day. In that business they say “if it bleeds, it leads.” Humans are wired to crave bad news and the media delivers.

The financial media is no different. How many market doomsayers have you seen in the media espousing negative forecasts whose comments often spread like wild fire? They’re endless. One of my close friends who is a chief economist at another institution had a positive outlook at the bottom of the market last March when the world was ending with COVID – we know now that his outlook was correct – but the leading financial networks wouldn’t let him on the air for weeks because he had a positive outlook at the time, and that wasn’t “selling” viewership.

Below is a collection of notable predictions from RBC GAM, along with the market’s response in the time since:

COVID-19 market volatility chart in page

This doesn’t mean markets don’t go down or that there aren’t risks. But we need to consider all the data points when we invest, and prepare and position accordingly to minimize risk using process. That’s what I’m here to help you with.

Rising Yields and Inflation – The Talk of the Town


As most of you know by now, a cornerstone of my message for some time has been to expect yields to rise, bonds to get hurt, inflation expectations to increase, and bond correlations to become positive with stocks (remember, this is bad – we want bonds to move opposite to our stock holdings to offset the noise, a role they’ve traditionally played for many years). These predictions have all come to fruition, and are likely to continue.

Yields rising aren’t necessarily a negative if they’re associated with a positive economic outlook, but equities remain at risk of a sell-off if yields rise at a faster-than-expected pace. What level of Treasury yields will trigger a significant selloff in stocks? Fund managers largely think ~2%.

Expect inflation to also continue to dominate the narrative in concert with yields moving upward, and most of us are feeling it by now. The Fed will clearly let yields and inflation ‘overshoot’ to the upside as they’ve always done, so the risk of a ‘taper tantrum 2.0’ remains significant for later this spring. This could also hit equities as it has done in the past.

But, both Morgan Stanley and CSFB found that rising inflation doesn’t tend to pressure P/E valuation ratios until inflation breaches 3%:

So:

  • The recovery of the economy --> reflationary
  • Sizable deficit spending by US --> weaker USD, higher rates --> inflationary
  • Supply chain disruptions --> higher input costs --> inflationary

Financial markets have not faced these dual factors of rising yields and inflation in 20-30 years, so we can expect markets to over-react and remain very sensitive to rising interest rates.

And Valuations Remain a Concern


Goldman Sachs notes that in absolute terms, most of the US equity market carries above-average valuations relative to history. This is unsurprising with the S&P 500 trading at 22x next-twelve-months P/E (96th percentile). Valuations today are arguably more elevated than they were in 2000 at the height of the dot com bubble. 20 years ago, the aggregate S&P 500 P/E was a similar 24x, but the median stock traded at 14x. Today, the median firm trades at 21x.

But There Are Also Many Positives for the Outlook

In Australia seated dining is not only back to normal, it is double pre-COVID levels:

Many people are wealthier than ever, and have money to burn – wealth is higher than ever, bank deposits are through the roof, and government handouts are likely to be spent:

As well, research estimates across the Street still may be too low, so companies may be performing much better than expected. Currently, 2021 revenues for the S&P 500 are forecasted to grow ~10%. However, economic forecasts imply 14% revenue upside (see chart below). If these predictions are even directionally correct, S&P 500 revenue and earnings estimates are far too low:

So What Are We To Do?

Given that central banks have been pumping the gas for some time and continue to do so, we are in a semi-permanent state of a perpetual boom, punctuated by the occasional sharp crisis where we all have a near-death experience and breathtaking drawdowns. This has implications for the underlying distribution of asset prices and for volatility – there is increasing ‘tail risk’. This means that you very likely have much more risk exposure in your portfolio than you think. It has become nearly impossible for the average investor to manage their risk, and most investors are not equipped to hedge properly.

Leverage in the system is much to blame for this. But it isn’t going away, and you can’t ‘fight’ it - this is the battlefield moving forward. Every event seems like a one-off exogenous event, but they keep happening with more frequency, and we get end-of-the-world reactions like people wanting to shut down the markets. And leverage in the system keeps increasing.

 

Expect inflation to also continue to dominate the narrative in concert with yields moving upward. On this theme, commodities may continue to have a bright outlook – Goldman Sachs commodity analysts are bullish in part because of what they see as “structural underinvestment” in commodities, particularly in energy, following a decade of poor returns. While the energy-heavy S&P GSCI commodity index has rallied 66% from its April 2020 low, its total return has been negative 60% over the past 10years against a 263% total return for the S&P 500 index.

We’ve noted in prior months that the case for being cyclically-tilted is strengthening, which has been playing out recently and should continue to do so. These points support the continued positive outlook on this front:

Like many finance professionals, I believe that we will eventually have a correction, it’s as certain as death and taxes. It’s a necessary and healthy reality of the stock market. But you can’t time it and real professionals don’t. But we can be prepared with a defensive asset mix and some cash to deploy at the right time.

It’s also important to remember the U.S stock market has always recovered from corrections. All 28 corrections over the past 50 years have been more than completely erased by a subsequent bull market rally.

I noted in last month’s note that timing the market is a mug’s game, and there are still a number of supportive factors to the overall outlook. But we need to be positioned accordingly, risks remain, and bonds aren’t going to play the capital preservation role they’ve traditionally played. Alternative assets with uncorrelated returns to the market are one of the few solutions to utilize moving forward, something I’m lucky to have almost 20 years’ experience in.

So Be Prepared and Positioned in Solid and Active Portfolio

It’s important to realize not every single stock recovers from corrections and bear markets. Active management should continue to outperform passive strategies (i.e. buying a bunch of ETFs to track various indexes will continue to underperform for the foreseeable future I believe). Dispersions within and across asset classes have widened (meaning that strong portfolio managers can outperform by picking winners and avoiding losers).

“This is a time to be focused on stock picking and conviction investing,” says Tony DeSpirito, CIO of U.S. fundamental equities at BlackRock. “This business cycle will be faster and there is a lot of pent-up demand. The dynamics of the cycle will play to the strengths of stock pickers.” In February, 70% of large-cap actively managed funds outperformed their benchmarks, the best performance since 2007 according to Bank of America.

This will all result in continued high volatility and less market efficiency – contributing to a ripe environment for strong and active portfolio management. I partner with the leading global portfolio managers to bring my clients the best-in-class risk-adjusted portfolios developed to grow and preserve your capital – if this sounds of interest to you, let’s have a discussion.

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Monthly Partner Memo – March 2021

With a semblance of normalcy returning to daily life just on the horizon, and the blessing of a few warmer and sunnier days of late, there is a glimmer of hope for many of us to be able to put groundhog day behind us. We’re almost there… But let’s get right into it this month as there are a number of interesting things to address. 

 

Friends & Partners,

The main subject on everyone’s mind is yields screaming higher and talk of inflation, and how this impacts the outlook here. With bonds and many equities going down together, the scenario we’ve feared and expected is starting to play out. On cue, Warren Buffett wrote in his letter this weekend that “fixed-income investors worldwide – whether pension funds, insurance companies or retirees – face a bleak future”. This has been a core pillar of our key messaging, and focus of my recent event with Andrew McCreath: your traditional 60/40 portfolio that has worked well for the last 40 years is now looking perilous. I have stated in recent monthly notes, the following:

“A continued upward drift in yields remain the biggest risk to equities in my view, because as yields rise, multiples should fall because investors aren’t as willing to pay as much for expensively valued stocks… yields have the potential to up-end a positive outlook for stocks. And we want to make sure we are not blindsided by a spike in yields or inflation, because in that environment both stocks and bonds will decline, which is essentially the worst-case scenario for investors. So we position our portfolios and utilize investments that can work through these potential scenarios.”

We positioned for this in our portfolios, they are performing extremely well through this noise, and we expect them to continue to do so.

What’s Driving Yields Higher? And Some Stocks Lower?

The rise in the 10 year Treasury yield that has occurred over the past two weeks is coinciding with inflation expectations that are hitting multi-year highs. It has been compared to the “Taper Tantrum” of 2013, but there’s a key difference: surging yields are being driven by rising economic growth expectations this time around, and the Fed promises to remain very accommodative unlike in 2013. Bond yields are not spiking because the Fed is getting less dovish, they are spiking because the markets are anticipating a looming explosion in economic growth (Q1 2021 GDP growth is estimated at 9%!) and inflation (both of which are negative for bonds). And, that’s before we get an additional ~$2 trillion in additional stimulus.

Positive economic growth is good for corporate earnings and for stocks – if bond yields are moving higher in response to improving economic conditions, equities should fare well as this should coincide with stronger GDP and earnings growth. This is as long as yields don’t rise too quickly – which is the problem currently. Goldman Sachs noted that a two standard deviation move in Treasury yields in a month has historically caused equity market volatility, and we got that volatility on cue, hitting high-valuation tech stocks the hardest as we would expect.

The Current Outlook – Are We Really in a Bubble?

Let’s assess if we are in a bubble – or if there is simply a bubble in those calling this a bubble… The definition of a bubble may be when people are making money all out of proportion to their intelligence or work ethic. We have seen some pockets of this, but I’m not sure it’s rampant quite yet.

Higher bond yields on their own are not necessarily negative for equities, unless they rise too quickly. Looking at previous periods of rising Treasury yields, RBC and BMO found that equity markets have fared reasonably well, on average. When the U.S. 10-year Treasury yield increased by at least 100 basis points since 1960, the average price return of the S&P 500 during these past periods of rising bond yields is ~12%, while the average price return for the TSX Composite is even better at ~20%.

Expect the Fed to begin to address the rise in yields in the next few weeks, and if they do (as the ECB is starting to do), then we should see the rise in yields begin to moderate. However, if the Fed continues to ignore yields and merely continues its dovish reiterations and we see expectations for growth and inflation continue to build, expect the 10 year yield to keep rising, and for equities (especially tech) to continue to be weak near-term.

Both CSFB and JPMorgan made the call this week that we are NOT in a general equity market bubble at this point (yet) – I would tend to agree with this assessment. As I noted last month, there are certainly pockets of speculation, but I don’t expect that we are setting up for a protracted bear market. JPM notes that “we do not see a broad equity market bubble but rather certain pockets of the market that are experiencing hyper growth such as electric vehicles and renewables. While there is a lot of talk about bubbles, it is hard to see one in the broad equity market, where a dominant group (FANGs) practically hasn’t moved for 6 months despite massive amount of stimulus and an expected economic recovery, Financials that have barely recovered 2020 losses, and Energy that is still down 25% from last year despite a commodity bull market."

A Potential Replay of the Roaring 20’s??

There is certainly an argument that this is one of the most equity-friendly setups many of us has seen. The bullish argument for equities here would be as follows:

  1. Washington is moving forward with passing a large fiscal relief package.
  2. Fed has been vocal in policy stance and has indicated it will remain patient with inflation and rates moving higher.
  3. US economy is re-opening and economic momentum is strong. JPMorgan's Chief Economist ever goes so far to call that the US V-shape recovery will soon surpass China. 
  4. Fake news? Or just selective reporting? There remains a substantial perception gap between policymakers/media and COVID-19 realized data, and a closing of this gap is positive for risk assets.
  5. Millennials are at a spending inflection, and are steadily allocating assets toward equities as we know. Believe it or not, equities are seeing positive inflows in 2021 for the first time in 12 years.  Remember my data point in last month’s note: since 2008, 96% of the $3T in household savings went into bonds!
  6. Bonds are becoming less attractive total return vehicles as inflationary expectation are increasing, boosting the attractiveness of equities.
  7. Volatility (VIX) is steadily declining, and periods of declining volatility historically led to big equity gains, particularly for cyclicals.
  8. High yield and investment grade spreads are still stable, which is constructive for market structure.
  9. High household liquidity with record cash reserves (savings of ~$11.3 trillion).
  10. Potential wealth effect (~$124 trillion net worth) from rising asset values across home equity, stock market holdings and lower consumption (declined by ~$300bn in 2020).
  11. Healthy consumer balance sheet with debt service ratio at 40yr low, consumer leverage relative to disposable income at only ~9%, and historically low delinquency rates for consumer loans.
  12. Healing labor market with declining unemployment rate, rising average workweek, and potentially higher minimum wage.

Expect inflation to also continue to dominate the narrative in concert with yields moving upward. On this theme, commodities may continue to have a bright outlook – Goldman Sachs commodity analysts are bullish in part because of what they see as “structural underinvestment” in commodities, particularly in energy, following a decade of poor returns. While the energy-heavy S&P GSCI commodity index has rallied 66% from its April 2020 low, its total return has been negative 60% over the past 10years against a 263% total return for the S&P 500 index.

We’ve noted in prior months that the case for being cyclically-tilted is strengthening, which has been playing out recently and should continue to do so. These points support the continued positive outlook on this front:

 

  1. Vaccine rollout set to accelerate.
  2. US cases dropping quickly.
  3. US economy set to re-open
  4. US corporates reset cost structures = strong operating leverage.
  5. US credit markets strong = cost of capital falling.

 

Thoughts on Trying to Time the Market

I’ve taken a number of calls from those who are hesitant about deploying funds and investing in this market. I certainly understand that tentativeness, and keeping dry powder is never a bad idea (and particularly attractive today). However, to remain allocated largely to cash longer term is never a good idea.

Following is an excellent chart on this from my colleagues at RBC GAM – it shows a theoretical client who deployed funds over the last 30 years in 10 deployments into the S&P/TSX equity index, each at the absolute worst time - on the brink of the largest market pullbacks. This client STILL ended up with double the amount had they kept it in cash.

Also note that all-time highs are fairly common occurrences. Since 1950, the S&P 500 has reached an all-time high over 1,190 times, which is an average of just under 17 times per annum.

On the other hand, should we try to pick bottoms? Trying to pick a bottom is a mug’s game – on any given day, there’s a 4.5% chance that the market is at an all-time low that won’t be seen again. Using those numbers, we can conclude that investors have less than a one in 22 chance of perfectly timing a market bottom even once. The odds of timing the market on a consistent basis are astronomically low.

Still think you can time the market consistently? Try this fun online game and see how it goes for you!

But Shouldn’t I Simply Buy the Index (or a Basket of ETFs)?

This is another question I get fairly consistently. Over time, this strategy will result in capital growth. And it has worked fantastically well in the last decade – we’ve all seen the studies showing how difficult it’s been for active managers to outperform. But, I’m a proponent that this will change moving forward. To boot, it’s been happening recently, and I expect selected active management outperformance to continue. As stocks climbed in recent months, US stock participation in the market rally has broadened, expanding the universe of opportunities for active investors. As well, performance breadth has increased, and the dispersion of individual stock returns has increased. So, rising performance dispersion and decreasing correlations means a good manager can create ‘alpha’ (i.e. outperform). You want exposure to the best-in-class portfolio managers moving forward.

Bottom Line: The Risks, Our Positioning and Preparedness

So, what could go wrong? There are the two possible events of 1) a COVID variant resisting the vaccine or 2) some sort of surprise geopolitical drama. Both are unlikely at this point, but we need to be conscious of their potential.

Valuations are arguably high (cool charts on this subject are here), but are still attractive versus alternatives like bonds. The famous Buffett indicator shows that US equities total market cap is becoming big compared to nation's GDP. Currently it stands at 244%.

At this point, the imminent threat is simply that we get too much of a good thing. As we have said in the past, there is a reason that governments of major developed economies haven’t pegged rates to 0% for years, openly welcomed an increase in inflation and exploded debt and deficits to open a fire hose of money on the economy. Because that type of policy could breed: 1) speculation, 2) substantial inflation and 3) a disorderly rise in bond yields. AKA ‘overheating’.

So, the bottom line is that we want our partners to be aware that while the outlook is positive, it’s not an outlook without risks, and we will be watching and positioning for indicators of risk (Treasury yields, inflation expectations, signs of froth) very closely in the coming months if too much of a good thing becomes a material negative.

We continue to position for a continued rotation into cyclical and value names from the highly valued growth sectors, which we expect to continue. This rotation could restrain the absolute gains in the S&P 500 (due to the tech overweight in that index). This plays into the inflationary theme as well, and bodes well for Canadian stocks overall.

Wealth Management Alpha

In the most recent instalment of my "you don't know what you don't know" series, I discuss the matter of Wills, which is something that many of us kick the can down the road on. In many instances, a secondary Will should be put in place as well, which isn't as bad as it sounds...

A multiple Will strategy can save you significant taxes upon our passing, and is a simple strategy that many of us need to consider. Read more about this in my article here .

RANKED 1 trophy illustration

Monthly Partner Memo – February 2021

As we continue to live through lockdown with hope on the horizon, we are seeing a good number of respected market pundits make a ‘market top’ call, and claims that we’re deep into bubble territory. Though it’s debatable whether markets overall are in a ‘bubble, there are certainly pockets that are demonstrating investor behaviour consistent with bubble-like sentiment. 

 

Friends & Partners,

The internet and social media (and my email!) are lighting up this week with stories like GameStop, AMC, etc and retail investor behaviour in selected speculative names – this is a sideshow and a distraction from process-driven investing that we are focused on. We’ve seen similar stories before – remember when Hertz was bankrupt but the stock was screaming higher, Volkswagen in 2008, and the dotcom bubble. Every Tom, Dick and Harry was buying stocks. Different mechanics at work, but similar undertones. The market is becoming ‘democratized’ now, but fundamental forces will always remain the same longer-term. Now the retail players are also playing the options market in size (industry reports suggest that >41mm call options have traded over the past week and a half. To put this into context, this number is twice the 2019 average). In options trading, when a small retail account enters an order to buy an out-of-the-money call option, the market maker must hedge that position by buying the stock. As shares continue to rise, the market maker must buy even more shares to hedge as the correct hedge ratio increases with price, which causes even more noise in short term pricing as we have recently seen. You don’t want to short these speculative stocks either, the downside can be infinite as some poorly positioned hedge funds are currently experiencing.

For now, investors have justified general market valuations on higher growth companies with low or negative interest rates, making the prospect of future profits more appealing than they would be if interest rates were higher. Investor sentiment is bullish on many measures, and valuations are certainly rich compared to historical absolute levels (though not versus bond yields). It is interesting to note, however, that many past equity bubbles hit higher valuations than we are currently experiencing, but these were in a bond yield environment of ~5+% not ~1%, so bonds were a real alternative when bubbles burst. And remember that ‘bubbles’ can inflate for a very long time, and history suggests that bubbles can inflate even as rates start to rise. My friend Bob Decker, who is one of the more astute ‘macro’ and market pundits in my view, puts it well in noting that “the current backdrop, courtesy of our friends at the Fed, is that there is too much money chasing too few things. This is the hardest part for people to get their collective heads around in bull markets. The 'narratives' that drive markets have fertile ground on which to grow.”

Some Risks to Monitor – Yields, Sentiment and Valuations

A continued upward drift in yields remain the biggest risk to equities in my view, because as yields rise, multiples should fall because investors aren’t as willing to pay for expensively valued stocks once they can generate more of a yield. As the US government cranks spending/stimulus on COVID relief (it doesn’t matter which to markets), this may lead to 1) higher inflation, 2) higher debt, and 3) larger deficits, which should continue to put upward pressure on Treasury yields (and downward pressure on bond prices).

Valuations may not be the be all and end all for where the markets are heading near-term, but over time they certainly matter, and we need to keep a close eye on them. While the path of least resistance has remained higher for equities, we need to be aware of where we stand versus history. While the S&P500 and TSX indices are by no means cheap compared to their own history, valuations remains attractive when placed next to bonds. reflecting a return to normalcy in due course. Following is a good chart showing this:

 

Unsurprisingly, given the craziness we are seeing around the perceived high-growth names, valuation dispersion continues to sharply widen, so we need to be positioned to both take advantage of this trend while being cognizant of the fact that it will likely normalize in due course. Following is the P/E multiple of top and bottom S&P 500 sector-neutral valuation quintiles:

Sentiment is clearly an issue, but is that the canary in the coal mine? Morgan Stanley’s Cross-Asset Strategist makes an interesting observation in noting that "sentiment measures are better at identifying buying opportunities than market tops. One reason may be that the nature of the events that cause investors to panic means they panic together, creating a strong impulse that leads to an investable low. Optimism, in contrast, is more diffuse and has a harder time producing such a singular moment." That said, we’re at levels not seen since the tech boom:

Is Canada Finally Compelling?

Interestingly, relative to the U.S. market, the TSX currently trades at an extraordinarily deep discount of ~25% on a forward P/E basis. At current valuations, the Canadian market has rarely been this cheap. If we ignore the global financial crisis, we have to go back to the early 2000s to find the last time Canada looked this cheap relative to the U.S.:

An Interesting Counter-Argument to the Bear Market Calls

If we look at retail investor inflows since 2008, $3.1 trillion has flowed into financial assets, and 94% of this went into bonds, while less than $200bn (or 6%) went into equities. Can stocks be in a "bubble" if 94% of investor inflows are into bonds? Rather, wouldn't that make bonds more of a bubble (most of you know by now that I’m no bond bull?) One might be tempted to think the past 12 months shows a more favorable equity flow environment given the run in stocks, but that doesn’t appear to be the case. As the time series chart below shows, investors liquidated stocks at an accelerating pace since 2017. In fact, the past 3 years saw massive outflows from equities, so it doesn’t feel like an absolute ‘top’ quite yet:

Our Conclusion – Where From Here?

Market tops are usually processes, not a defined event. We think that one of the most important services we can provide to our clients in 2021 and beyond is to ensure we are looking at everything (economic events, political events, geopolitical events, earnings, investor sentiment and position) through the lens of “what does it mean for stocks and yields”, because yields have the potential to up-end a positive outlook for stocks. And we want to make sure we are not blindsided by a spike in yields or inflation, because in that environment both stocks and bonds will decline, which is essentially the worst-case scenario for investors. So we position our portfolios and utilize investments that can work through these potential scenarios.

As we look ahead to 2021, we consider 1) the economy and its outlook; 2) market positioning and consensus; and 3) potential negative scenarios. We conclude that the global economy is undergoing a cyclical rebound, and public companies are generally faring well as we peer across the precipice. Household finances are in good shape and the consumer is ready to spend, while companies have pared back supply. Equity markets have continue to surge in response until this past week, and in the near-term, sentiment is stretched and speculative behaviour abounds, and there continues to be risk of an equity correction of 5–15%. But the longer-term outlook remains strong, and we look to pullbacks to tactically deploy cash. I believe that the next 10 years will be where active managers will outperform, so the ETF/indexing portfolio may finally underperform best-in-class managers. John Mauldin summarizes this well in saying “I think the 2020s will once again be the decade of active management. The 2020s are going to be about rifle shots, not the shotgun approach of index funds. This will be a decade to focus on absolute returns as opposed to relative returns. Passive index investing is a relative return strategy and I think it will be a very poor choice in the coming years. As my dad used to say, every dog has its day. Passive investing had the last decade. Active investing is getting ready to take the lead.” We are active investors with defined process, which will we will continue to follow.

Wealth Management Alpha

The following is from my “You Don’t Know What You Don’t Know” series about tax minimization and planning strategies. This month, I assess strategies around charitable giving.

Do you give to charity most years? You may be doing yourself and your charities of choice a disservice by not utilizing a charitable giving program, which can provide substantially more capital to your charity over the long-run (on the same amount of your money contributed), and can create significantly more wealth overall. In another installment of my "You Don't Know What You Don't Know" series, I illustrate why you should consider implementing strategies like a Charitable Gift Program. Read about this in more detail here.

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Monthly Partner Memo – New Year’s 2021 Edition

As we move into 2021, things remain difficult, but there is much hope on the horizon. I’m releasing this month’s note early in the month as we embark on a new year and there remains much to consider and address – I wish you only health and success in 2021.

 

Friends & Partners,

I hope you had a relaxing holiday, most of us certainly were due to unplug for at least a few days. The one thing that WFH has seemingly brought some of us is the inability to separate work time from our personal and family time, so a conscious effort on this front is important to consider. As we move into 2021, things remain difficult, but there is much hope on the horizon. I’m releasing this month’s note early in the month as we embark on a new year and there remains much to consider and address – I wish you only health and success in 2021.

There still remains significant confusion over how the markets remain so robust while the virus ravages the economy, so I will touch upon that in this month’s note. Most strategists and pundits expect a strong 2021 overall, and I wouldn’t disagree with that general call. As usual, we will get bumps and pullbacks along the way, and there are always risks lurking – we are positioned for these, and will continue to remain so. In last month's note, I touched upon inflation being a risk that could upend markets, and it also remains possible that a third wave of infections emerges in the spring as happened during the 1918 flu pandemic which could also delay a return to normalcy. Sentiment remains very bullish overall (a contrarian indicator and often a warning sign), as does sentiment around vaccines, but there could of course be bumps in the road with vaccine rollouts, distribution/execution, unexpected side-effects, as well as efficacy with new strains and mutations of the virus. However, the virus could also start to retreat on its own as the weather shifts. Bottom line is that the commitment to keep interest rates low and Quantitative Easing into 2022 at a minimum remains the main tailwind for risk assets (stocks, bonds, real estate, commodities). But further upward pressure on inflation and/or a disorderly rise in yields remains the main risk to this positive medium and longer-term outlook for markets at this point in my view. Upcoming pullbacks are unlikely to prove to be bearish game changers longer term however, so we will be positioned to capitalize accordingly.

The Stock Market Isn’t the Economy (Well, Not Exactly)

In the US and Canada, small businesses drive almost half of economic activity and private sector employment, and 2/3rds of net new jobs. Public companies on the other hand only represent 1/3rd of US employment. So, the stock market arguably fails to reflect this hugely important part of the economy, and the part that we personally ‘feel’ day to day, so it affects our ‘biases’ as well.

Also consider that the S&P500 is a market cap-weighted index, where the big 5 tech names represent almost a quarter of this index (Microsoft, Apple, Google, Amazon and Facebook). 44% of its weight is concentrated in Big Tech (technology and communication services), and the top five sectors comprise almost 70% of its weight. So, the tech/growth names are moving this index in large part, and these names are benefiting from the stay at home measures as we know, while small businesses are getting crushed by it as a rule. So, the S&P500 companies often fail to capture the economic realities of many private companies in large parts of Canada and the US.

The stock market is also forward looking – things may feel bad today, but in the long-run for an established company, the current slowdown may well be a ‘blip’ (assuming it can withstand the short-term pain). The stock market usually leads the economic cycles, so is currently reflecting a return to normalcy in due course. Following is a good chart showing this:

Of course, there are always risks to markets as I’ve discussed. However, central banks are also almost certainly going to maintain their exceptionally accommodative stance as the renewed wave of COVID plays out, mitigating some of the near-term risks.

Growth Stocks Have Crushed Value Stocks for Years, Is that About to Change?

In short, there are a number of reasons to believe that value stocks may finally play a bit of catch-up with the growth names that have outperformed for years now. At a minimum, I believe it is prudent to have some exposure to value stocks as we move into 2021. Note the following points on this:

  • Monetary easing is off the charts = value stocks lead
  • Cyclicals have proven resilient, and retooled business models, costs, and processes = operating leverage and lower risk premia = higher valuations for value stocks
  • Continued shift to de-urbanization is asset heavy (people buy houses, cars, etc) = value stocks benefit
  • Real interest rates will remain negative for quite some time (most negative in over 60 years) = cost of borrowing remains extremely low = real asset boom = value stock tailwinds (since 1960, Value stocks outperform Growth stocks when real rates are in the lowest decile, which they certainly are now)
  • Growth stocks are arguably expensive, especially compared to value stocks. On a relative basis, the valuation gap between the two styles has reached extremes not seen since the late 1990s (see chart below)

A durable shift to value leadership will likely require more evidence of a self-sustaining economic recovery, rising inflation and pricing power, and a steepening yield curve. These are all looking more likely, and investors can potentially outperform over the next few years with some exposure to a combination of cyclical, value, small caps and non-U.S. stocks.

And things can shift quickly on this front, so we need to be and are positioned for this potential scenario…

We Can’t Possibly Invest at These Highs, Can We?

The million dollar question – we all want to buy low and sell high, though few pull that off consistently. If you’re hesitant, it’s prudent to average-in: but we don’t want to be completely in cash and out of the market 100% for long if that’s a position you’re in. Timing is a fool’s errand as a general rule, and I can send along lots of research to back that up. For an extreme example, let’s take a look at how you would have done in the past had you only invested at all-time highs in the S&P 500 Index from 1950-2020 – the returns are not too far off those had you averaged in every day:

Wealth Management Alpha

This month, I’ve attached a concise piece that summarizes some strategies to minimize taxes, as well as build and protect wealth – it touches on risk management, vacation home planning, incorporating various trust structures, family income splitting strategies, and succession planning. These concepts are high level and get much more in-depth, but it speaks to the value of working with an advisor and institution that can help you and your situation. If you’d like to discuss anything in further detail, I’m here to help.

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Monthly Partner Memo - December 2020

In this month’s note, I’ll touch on, and hopefully add some context to, the market’s recent strength, outlook and risks as we head into 2021.

 

Friends & Partners,

It’s been a hell of a year – as the virus continues to rear its head, we all look forward to spending the holidays with our immediate families, and there’s much to be grateful for with hope on the horizon – we send our best to our clients, partners and friends.

In this month’s note, I’ll touch on, and hopefully add some context to, the market’s recent strength, outlook and risks as we head into 2021. I’ve also attached a brief article I wrote regarding a very valuable tax-minimization strategy that you may not have considered or been aware of. And for fun, here’s a link to a video  that our favourite NHL goaltending coach Steve McKichan recently posted from his YouTube series where he profiled my son Stanley and me. We discuss the similarities in the preparation, journey and focus required for professional athletes, business professionals, and beer league hockey players (I tick the box on all three of these for better or worse!). The takeaway is to simplify things when possible...

Remember a few short months ago when most assumed it would be years before the vaccine would be proven and distributed? I had no better idea of timing than the next guy, but I knew this was a ‘bet’ against human ingenuity – when countries or the world pour their brainpower and money into solving a problem, never bet against that. When JFK said they would put a man on the moon and set a hard deadline, you knew they would stop at nothing until that was achieved. This is a global episode of that type of challenge. There will inevitably be hiccups and challenges as we roll out the vaccine, but the market is looking past this for the most part as it’s a temporary issue in the long-term outlook.

Goldman Sachs economists expected half of the population of the U.S. and Canada likely to be vaccinated in April. They then forecasted the U.K. would vaccinate half of its population in March. They expected children under the age of 12 to start being inoculated in October 2021. One of the leading thought leaders on this subject in the US expects that between herd immunity and vaccination schedules, the US will largely be back to normal June/July 2021. Hopefully this plays out on that timeline, but we’re getting closer. But the near-term fear is that the second wave could cause economic shutdowns again, but it can be argued that this is unlikely to have a major effect on economic output like it did in the spring. Businesses are operating better now, the virus and its effects are better understood and not as fear-inducing, and social distancing rules are more targeted and not as widespread as they were in the spring. And remember, only a small subset of sectors is restricted currently – manufacturing, construction, education, etc are all running fairly normally now. And though the affected sectors are getting hit hard as we know, RBC Economics astutely points out that the combination of travel agencies, arts, entertainment & recreation, and accommodation & food services (hotels, restaurants and bars) only represented ~3% of the Canadian economy before the pandemic, where the combined output fell by more than half during the first wave. They have since recovered almost half of what they first lost, and even if they were to retreat all the way to their April low, it would only represent the subtraction of 0.7% from Canada’s GDP. Whereas the Canadian economy shrank by 18% in the spring, RBC Economics team believes it could well shrink by only 1% or so this fall, and the analysis is similar for the U.S. So, they anticipate a few months of stagnation/decline in U.S. and Canada, but not across even a full quarter. So, if correct, this analysis doesn’t support the view that economic shutdowns could cause a major pullback in markets.

There is ample evidence that the global economy is reflating. The copper/gold ratio and the more broadly based base metals/gold ratio are both surging, indicating cyclical strength. Earnings sentiment is improving in every region of the world. Other cyclical indicators, such as heavy truck sales, are turning up in a way that is consistent with an early cycle rebound. The consensus is that equites will be strong through much of next year, and is often reason to be cautious – but this is one of those few times that I would agree with current consensus on this point.

But There is Reason to be Near-Term Cautious

All that said, at current levels, the S&P 500 is essentially pricing in positive resolution of virtually all the major market influences (and ignoring some notable deteriorations) in my view. U.S. economic data is decent but the high-frequency readings (jobless claims, PMIs) are showing signs of a loss in momentum. Stimulus chatter is occurring, but nothing is actually happening as far as real money going into the economy. But, the market is forward looking, and the market has aggressively priced in positive incremental improvement across virtually every major market influence, and while that easily could occur, even if it does the short-term upside from here could be limited.

Some technicals are also starting to appear near term toppy. Investor positioning and sentiment does now appear short term stretched, with mutual fund equity exposures (i.e. “betas”) at highs, short interest at lows, and sentiment readings at highs. This could be a near-term headwind for performance:

 

All major markets trade at 10-year valuation highs on a 12-month forward price to earnings multiple:

 

And finally, this is always a good chart to check in on, and is one that Warren Buffett sometimes highlights. It shows the US market’s total valuation versus GDP - markets are trading at 1.8x GDP, which is about 30% above of the Dotcom peak:

 

One thing is sure, it "feels" nothing can move lower from here – and that in itself is reason to be cautious. So we prepare and position our portfolios for these risks as always, keeping some dry powder to deploy when the opportunity arises.

The Biggest Risk I See As We Move Into 2021 – In One Word: Inflation

Last week, market inflation expectations quietly surged to 18-month highs. And yesterday, for the first time since records were kept, real yields on corporate debt turned negative. We take both signals as early warnings that we need to watch 1) Inflation and 2) The rise in bond yields in 2021 closely, as both are risks to markets. A recent pop in inflation expectations, combined with relentless downward pressure on corporate yields, has created an environment where expected inflation (1.89%) is higher than the Bloomberg Barclays Average Investment Grade Yield (1.85%). That is a situation that frankly shouldn’t be, and I think it reflects the fact that the “bond bubble” just continues to spread across fixed-income securities and grow in size.

There’s not much talk about this, as bullish outlooks abound. And while I don’t disagree with the general consensus on this front, few are noting the risks to this outlook. The biggest risk to this bullish dream is a surprise spike in inflation, and as such we should be paying attention to what’s happening in the bond markets recently. Here’s why inflation could, almost single-handedly, destroy the bullish 2021 outlook:

 

  1. Rising inflation would push bond yields higher, and as bond yields rose the market multiple would start to fall from the historically high 20x-22x to something more traditional like 17x-19x (depending on how quickly yields were rising). That would immediately take ~10%-20% off the S&P 500.
  2. The real estate market, which is arguably the strongest part of the economy, would take a big hit as mortgage rates rose from the current historical lows.
  3. Consumer spending would likely slow (possibly materially) as rates on virtually everything would rise: Car loans, personal loans, and credit cards. 

 

I understand anticipating the return of consumer price inflation and higher yields has tripped up many pundits for more than a decade. But I’ll also point out that we have never had a potential environment this conducive to sparking higher inflation (at least over my career and as far back as anything I can find). This is an environment that includes: massive ongoing quantitative easing (with no end in sight), promised 0% interest rates for years and years into the future, and historically massive looming fiscal stimulus (that dwarfs the package for the financial crisis). Additionally, due in part to years and years of historically low rates and global central banks pushing funds out the risk curve to find yields, we now have most highly rated government bonds providing solidly negative real yields, and now investment grade corporates providing a negative real yield. Of course, this can continue for quite some time, but at this point there is so much invested in fixed income funds that I actually shudder to think about what would happen if there was a stampede out of fixed income if inflation actually started to move even a bit (think 2013’s taper tantrum times 100).

I’m not advocating for massive portfolio shifts at this point, but we do need to be prepared and positioned. ‘Times are a-changin’, and your typical portfolio construction will not respond well to these events if unprepared. We are prepared.

 

RBC Wealth Management has launched their Global Insight 2021 Outlook, which showcases unique perspectives on issues and opportunities that could define the year ahead. You can enjoy the complete report in PDF format here:Outlook 2021

Happy Holidays, and Happy New Year! Enjoy some time with the (immediate!) family, and good riddance to 2020 – onward and upward.

 

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Monthly Partner Memo - November 2020

This is my inaugural Monthly Partner Note – the goal is to keep it informative, impactful, and concise.

 

There’s no shortage of market information and pundits to give you their views, but I’m here to try and help distill it all down for you, cut through the noise, and give you the overall market impact of recent events and longer-term outlook. Near-term calls are usually a gamble, and not what we want to speculate on, but we need to position for all market conditions. In most notes, I will also include a Wealth Strategy section at the end of the note to highlight selected planning and tax-saving strategies that may be new and informative to you. As usual, I’m always accessible and happy to help if and when you have any questions or concerns.

Market Update & Outlook

We are through the US election (I expect), and are now looking towards the holidays. Cutting thru the noise, low interest rates, an improving economy and vaccine news continue to be the main drivers and tailwind behind this current market’s strength. Low interest rates are stimulative since financing is more attractive – for your house payments, cars, corporate interest rates, etc. This leads to more spending and a fast growing economy. It also pulls forward spending, as many won’t want to miss out on current low rates and consume more today because of it. Lower rates also increase the discounted present value of future cash flows (a dollar today is worth more than a dollar received in ten years).

Practically speaking, that the market is focused on new catalysts that will decide the next near-term direction of stocks (whether we see a 5%-10% pullback or a rally into year-end) and those catalysts are:

  •  COVID cases (how bad it gets in the next few weeks), and
  • Stimulus (when, and how much).

 

Put clearly, we know the outlook six months from now has turned generally positive for stocks because of the vaccines, historic central bank stimulus, likely fiscal stimulus, and resilient corporate performance. But what we do not know yet is how much exploding COVID cases and increasing lockdowns will weigh on economic growth over the next few months. That matters because if it’s a lot, then that just leaves a bigger figurative “hole” for the economy to climb out of once the vaccine is distributed and life returns to quasi-normal (the market is expecting this to happen by next spring/summer). And the market is currently not priced for a very negative outcome on this front. If we see COVID cases continue to surge through the holidays, breaching 200k-300k cases per day in the U.S. and resulting in moderate economic restrictions such as many of the states instituting some sort of economic lockdown, with stimulus coming after early February, expect to see a 5-10% equity pullback from here. If it gets worse than that, things could get uglier.

However, longer-term we are sowing the seeds of a continued bull market however. Stocks should gain ground as COVID-19 infection levels eventually subside, progress continues on the vaccine front, and the global economy eventually normalizes, thanks to further fiscal and monetary stimulus. Valuations in most countries are not unreasonable given the ultralow interest rate environment. By the middle of 2021, we could be looking at the following macro environment: COVID is essentially over due to the vaccines, global central banks keep rates pegged to 0% for years to come and are still engaged in historically massive QE, more historically large fiscal stimulus has come from Congress, and a divided government exists in the U.S. that essentially maintains the status quo (no tax increases, etc.). That’s a potentially very positive macro environment for equities, and one of the most positive environments we’ve seen in some time. But as with all things in the markets, there are legitimate risks to that outlook that need to be monitored, especially in the near-term. So we are positioned for many potential scenarios, and are ready to take advantage of any weakness in markets along the way.

Traditional Asset Allocation Concerns

One of my main fears that you’ll hear me speak a lot about is that bond prices may be at risk longer-term, and positive correlations between asset classes like stocks and bonds is going to become a problem over time. We’re starting to see signs of this bubble up already. In short, this simply means that if stocks correct, bonds may not offset that move with strength as they’ve traditionally behaved through much of our lifetimes. We could be slowly moving into an environment much like the 1950’s, when stocks and bonds became positively correlated (meaning they moved together instead acting as natural hedges to each other and offsetting the other’s losses). This is why I advise that you work with an Advisor who understands assets that are uncorrelated to stocks and bonds, and of those there are few…

Case in point, the graph below from Forge First highlights that bond prices (red line) have been falling along with stock prices (white line) recently. The first week of November marked only the 24th time since 1962 that prices of both major asset classes have tumbled together, according to Bespoke Research.

 

Howard Marks, one of the most respected minds in finance, added to this notion astutely in pointing out that pricing for every asset becomes connected in a low interest rate environment. If you’re considering buying something, you will usually assess the risk and return proposition of that compared with another potential purchase or investment. Money will move between assets in search of the best deal, until everything reaches equilibrium. So when Treasury notes yield well under 1%, investors will chase returns elsewhere, like in stocks. Thus bidding up the prices and leading to lower future returns. So, low interest rates drive lower returns, and encourage riskier behaviour by folks searching for higher returns (to match their past returns) farther out the risk curve.

It’s difficult to find an asset class offering compelling long-term returns, so diversification is key along with the implementation of multiple assets outside of simply stocks and bonds and some real estate exposure. The combination of a cooperative Fed, fiscal stimulus, and the high probability of gridlock in D.C. combined with rich asset prices should keep long-term returns in check, but on a positive trajectory. But there will certainly be noise along the way, and combining all of these dynamics leads us to conclude that the strongest portfolios will be those that integrate proven strategies featuring high Sharpe ratios and limited or negative downside capture (i.e. better risk-adjusted return profiles). Because I anticipate that your bonds aren’t necessarily going to do that job for you for long moving forward.

We have the experience and knowledge to implement strategies and investments that are outside of typical stock and bond exposure, and we implement them where appropriate for our clients.

Wealth Management Strategy

For most of my monthly notes, I’m going to touch upon a value-added wealth management strategy. Everyone’s situation is different and calls for customized planning measures, and that’s what I’m here to help with. In the meantime, I’ll shed some light into individual strategies you may or may not be familiar with.

This note, I want to highlight insurance. Before your eyes glaze over, insurance strategies are the single most overlooked wealth building strategy I’ve come across. The following is a sneak peek from one of the articles I will be posting on my website and LinkedIn that I call the “You Don’t Know What You Don’t Know” series:


As part of this series, I try to shed light on some of the often complex financial planning solutions to make it as simple and consumable as possible. Financial planning, wealth management, insurance, and investments can be very complex in their applications, but are always simple in terms of the human needs which they address. And it is always the simplicity of the need, rather than the complexities of the applications, to which I vow to communicate with you.

There is one financial planning tool that faces a significant knowledge gap that is costing many adults a lot of money – but I get it. Becoming fluent in estate planning and tax minimization strategies is a full time job, and best left to a professional. But the professional you work with should be able to simplify these strategies for you. Most of us need to recognize that we don’t know what we don’t know, and to take some time with a good advisor to be aware of the basics, because it’s a short meeting very well spent, believe me. Many wealthy individuals believe they know best when it comes to household finances, so they need to take a step back and ensure they are actually armed with all the information – this won’t be the case if they’re not working with an advisor who is versed in advanced wealth planning strategies.

This is especially true when it comes to life insurance strategies. To many, life insurance is seen as a cost and not as an investment – and, in many cases, this is simply the wrong way to look at it. There’s a plethora of insurance strategies that can be employed to minimize taxes and add significant value to your estate than traditional fixed income strategies, with significantly lower risk (and we’re talking hundreds of thousands or millions of dollars of additional value in most cases…). It’s worth sitting down for 30 mins to see the illustrations first hand, you’ll likely be shocked at the figures.

To illustrate this point, the Life Insurance Marketing and Research Association highlights that one-third of wealthy Canadians don’t own any personal life insurance. Among this group, over half say they have enough money to cover their family’s financial needs without the benefit of life insurance in the event of their death. As well, many of these folks don’t consider it a ‘good investment’, while some simply ‘don’t believe in life insurance’, and mistrust the life insurance industry. I suspect these people either don’t work with an advisor at all, or have an advisor that is perhaps not up to the task of understanding and explaining these vehicles… because these people are simply mistaken.

Life insurance should be an integral part of most financial plans. Apart from the income-protection benefits of regular term insurance, I would argue that life insurance is an important and integral alternative asset class. Unlike term insurance, permanent life insurance policies (that is, whole life and universal life policies that are in effect for your lifetime) have the potential to deliver better returns relative to traditional lower-risk vehicles like GICs and government bonds, especially in today’s interest rate environment. Traditional investments are taxed annually on earned interest, dividends and realized capital gains. Not only do permanent life insurance policies provide the basic death benefit (and tax-free to boot!), the policy has an investment income component in the form of a ‘cash accumulation fund’ that is also tax sheltered in both its growth and final payout. Half of wealthy Canadians don’t even realize that a permanent life policy includes an investment component. The policies offer access to liquidity as you can borrow against the policy’s collateral for a loan. Finally, these policies also avoid estate settlement costs like probate (which is typically about 1.5% of your entire estate, not an insignificant charge if you have some assets and dough).

Life insurance is just one example of an asset that is misunderstood by so many – it has significant potential and demonstrable benefits for your estate and net worth, and is even more powerful if you own a business and/or corporation. Clients and their accountants often choose to ‘self-insure’, or face a common misconception to take the seemingly ‘cheapest’ term life insurance plan if they assess insurance at all, so you need to ensure you’re integrating the right investment advisor into the process. This is where I and my team can help. If done right, then ultimately this all means that you’ll create significantly more value and wealth for yourself and your family, leaving them a lot more down the road.

Only about 60% of those who own life insurance purchased it through their own advisor. That means that the necessary conversations aren’t being had, likely because of false assumptions and a general misunderstanding around the products. You’re not alone here – there are a lot of moving parts around insurance, but the general benefits can be simplified and are certainly worth assessing since the right structure and solutions can be very beneficial and powerful.

I have found financial literacy and education a personal passion point, and will do everything I can to simplify and spark curiosity around the subject to educate so that as many can benefit as possible. In the current environment, multi-dimensional wealth management solutions are paramount. If I can help at all on this front to spark a conversation and curiosity, I’m here to help – just reach out.


Finally, I encourage you to read the handful of blogs I have recently posted on my website, where I talk about the new market environment we’re in and how your portfolio may have to adjust to the new realities, the meaning of money, and what makes a good investor and Investment Advisor. You can find those here