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.