Commentary January 2025 – Preparing for New Directions

Reblogged from Brintab

This fall the economy and the markets were undisputably fixated on the US election more than anything else. As the promises on both sides of the aisle scaled the cliffs of outrageousness, in the end the Republican platform prevailed and they swept the Presidency, Senate, and House of Representatives.

There is no doubt in my mind that many of the election promises by Candidate Trump will be walked back by President Trump either because they are not achievable or not actually desirable. We have already seen, for example, Republican voices acknowledging that solving Ukraine is not going to be achieved “in 24 hours” as was promised. What a surprise.

Now many in the investment industry are trying to figure out the realistic outcome of the more economy-linked positions. As a case in point, the across-the-board 25% tariffs on everybody is now looking more likely to be varying tariff rates limited to specific products from specific countries. The new regime has undoubtedly come to realize (no doubt thanks to American businesses that have their ear) that the proposed tariffs would not only hurt trading partners but have potentially devastating impacts on the US economy.

It would certainly seem that they don’t want the economy in a tailspin exactly when they go into midterm elections. The Republicans only have 2 years until a probable Democrat resurgence in Congress and various proposals could not be implemented without Congress (and in some cases without a supermajority). They will need to proceed carefully to achieve the successes they are hoping for without shooting themselves in the foot.

Because there were so many outlandish campaign positions and it is not clear what will actually happen, markets are likely to be up and down a bit (a.k.a. volatile) in the near term as investors try to read the tea leaves of the unfolding new US policy. For us, this implies needing to consider being nimbler than our typical long-term investing focus, although that is not our preference or bias.

Bonds and Interest Rates

The overnight rate established by the US Federal Reserve hit its peak of 5.33% back in August 2023 and stayed there for a year before the Fed started lowering rates from the plateau in August 2024. The Fed continued dropping overnight rates through this fall but long-term bond rates did not follow suit. Basically, long term bondholders felt inflation has not yet been totally vanquished and they feared the Fed would have egg on its face, having to revert to raising rates again when inflation resurfaces. This was a particular concern once the Republican clean sweep was evident because the Republican ideas related to stripping out red tape are thought to be pro-economy and likely pro-inflation too.
Long term rates rose because investors did the math thinking that short term rates would need to rise back up sooner rather than later. Remember that when rates rise, bond prices fall. See below the behaviour of the purple line in December.

Fig. 1: Bonds-Med. term Cdn-blue, Corp-green, High Yield-orange, Long Term US-purple – 2 years – Yahoo Finance

We acted quickly the morning after the US election having a trade ready before the market even opened to sell a significant bond position we held. Although we lost a bit in the turmoil, we avoided a significant backslide and have just this month bought back some bond position at a lower price. Interestingly, even though Trump is thought to be a pro-business leader, in his past presidency of 2016, just like this time around, bonds briefly sold off from election day to inauguration and then rose up for the year after that. If this inauguration is a repeat there will be money to be made in bonds.

Currencies

This autumn the Canadian Dollar fell against the US Dollar, ending the year at around 69.49 USD/CAD or 1.44 CAD to buy a USD. Canada was not alone. The USD strengthened this quarter against the Pound, Euro, and Yen too. Overall we can say that the US economy has held up stronger than other economies lately, powered by a strong IT industry and discretionary spending. That won’t last forever.

Last quarter I wrote that the CAD could toy with the 0.70 USD range and here it is. Although it could conceivably dip a bit lower I feel it is near the bottom. Just after the yearend we liquidated some US investments to purchase Canadian investments and part of the logic was the modestly priced CAD. There might be more of that shifting from the US to Canadian investments.

There are a few factors that could stall a recovery in the CAD such as:
• The position of the next Canadian government on economic issues, including oil
• Whether the US attitude of pump more oil includes importing more from Canada or just pumping domestically
• Outcome of the US global tariff wars with respect to Canada
• Upcoming NAFTA2 renegotiations for 2026 (which could conceivably be rolled into the tariff driven negotiations of 2025)
• Re-emergence of Russia and Iran as oil exporters, depending on the US approach to each

Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

Currency moves are notoriously difficult to predict and so we try not to delude ourselves in that sphere. Our long-term strategy has always been to leave our US investments unhedged because when stocks go up the US Dollar tends to go down and vice versa. Hence the USD exposure implied by owning US stocks has helped smooth out overall returns. This is the first time in about the past 2 decades where I felt it wise to de-emphasize the USD and it is just a general leaning, not an attempt to pick the exact moment when the USD fades and the CAD rises up.

Stock Markets

Over the past 2 years the stock market laggards (in the chart below of five countries) has been particularly the UK and somewhat Canada. Japan really did well until early 2024 and then roughly flat-lined. The outperformer has been the US, with the performance heavily concentrated in the “magnificent seven” tech stocks.

As I mentioned in the bond discussion above, as soon as the Republican clean sweep was evident on November 6th we quickly liquidated a significant bond position and redeployed capital to equities. Such moves are not typical of our more long-term focus but it seemed the situation warranted it. As a consequence portfolios likely performed a couple percent better last year than they would have with a simple weather the storm mindset.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

Now there are signs that “magnificent seven” dominance and the “Trump trade” are starting to fade and that is one reason that we liquidated some US equity investment in early January 2025 in favour of Canada. The Canadian market is not the only place with opportunity but broadly speaking I would say we are going to see a “changing of the guard” in 2025 in terms of stock market leadership. That is largely a reiteration of my perspective at the end of the last quarter but picking new investment opportunities will be a judicious and patient process.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Asset Allocation, Financial Planning, Investment, Risk Management, Tax, Uncategorized Tagged with: , , , , , ,

Commentary October 2024 – Wobbling Toward a Cooler Economy

Reblogged from Brintab

 

In the July letter I noted that the transition of economic cycles between growth and recession is rarely a smooth path and that was evident that last month.  Note that I am often primarily referring to the US economy because it is so dominant in driving what happens all around the world.  In late summer we saw signs of things slowing down in the US economy, on the other hand we got September signals of slightly higher than expected inflation and a strong “non-farm payroll report.”  This led to the knee-jerk reaction among some that the recession has been averted and the US economy is back in growth mode.  The way I see it, we are definitely not out of the woods yet.

Bonds and Interest Rates

As the US central bankers started signalling the intent to decrease interest rates, long duration bond prices started rising (remember, when interest rates fall, bond prices rise).  I have included a longer-term trend chart here to help get a broad perspective. Bond prices appear to have bottomed in October 2023, after which they have been slowly rising, but with wobbles along the way, such as the pullback into April 2024 and the second pullback just now in October 2024.

Fig. 1: TLT ETF price since 2005 (illustrative of US 20+ year treasury bond prices) –Yahoo Finance

We do see the gradual cooling of the economy in the US and also in Canada.  There are concerns among some people, however, about the possibility of inflation heating up again, and forcing the central bankers to return to higher interest rates to keep things under control.  I don’t think that will be the direction things will take.  I think interest rates will be decreasing (and bond prices rising) from where they are.

One of the sources of inflation worries is the long list of promises being made by both US presidential candidates.  In reality, post-election those strong positions will tend to get watered down, in part because usually the Presidency, Senate, and House of Representatives do not fall to the control of one party through a clean sweep.  As a result, we get divided government and gridlock in Washington and the changes promised during the election are moderated drastically.  The middle-of-the-road ideas have more chance of getting through.

Also, many homeowners could not afford the current mortgage rates if they were to renew or buy a home.  Even though most Americans have mortgages with rates locked-in for the full timeframe until their mortgage gets amortized right down to zero (i.e. 20-30 year rate lock-ins),  as the years pass, people are gradually pushed into the mortgage market due to loss of jobs, divorce, relocation, coming-of-age, and other factors.  The result is that, over time, more and more people bump up against this mortgage cost pressure from higher interest rates and they either cannot buy or renewal rates force them to rein in their spending in other areas just to cope.  Ultimately, the consequence is a cooling of the economy and a need for interest rates to go lower (and bond prices to go higher) than where they are now.

After the past year’s movement in the US 10-year interest rates, those rates still remain at least a couple percent higher than the rates people are currently locked into.  We can see that rates still have room to fall more to come into line with realistic affordability.

Nonetheless, we do keep the opposing thesis in our minds to at least be aware of where things could go if something else panned out.  The opposing thesis largely circles around nationalism/deglobalization.  To the extent that Americans believe their economic woes come from foreigners, they are susceptible to raising barriers to trade with foreigners.  This could raise the cost of many goods that would have to be made in the USA, causing inflation.  If such a scenario unfolds it will be wise to protect against rising inflation, which would likely push US interest rates and the US Dollar higher.  We keep this possibility in the back of our minds for close monitoring.

Currencies

As is typically the case, when US interest rates fall, the US Dollar weakens and when US interest rates rise the Dollar strengthens.  This is generally the case to the extent that large moves do not happen to the other currency to which we are comparing the US Dollar.  Since investors usually compare it to a basket of currencies called DXY (which is a mix of Euro, Yen, Pound, Can Dollar, etc.) then the individual moves of those other currencies are watered down in the index and it basically conveys the US Dollar behaviour.

During the most recent quarter, the Canadian Dollar dipped from 0.7342 US at the beginning of the quarter down to 0.7204 in August, bounced back up to 0.7443 in September, and then receded to about 0.7244 in October, just after the quarter ended.  There is a chance the Canadian Dollar could go lower.  The signs of the economy fading are more evident in Canada than in the US and so the Bank of Canada may drop interest rates at a slightly faster pace in the coming months than the US Federal Reserve does.  If this happens the CAD could be toying with the 70 cents US mark.  Similarly, any geopolitical shock (e.g. Middle East escalation worse than it already is) could temporarily bump the “safe haven” US Dollar higher as I feel the rise of the USD to the current level does not reflect much of a safe haven trade so far.

Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

The implication is that now is likely a better time to convert from USD to CAD rather than the reverse (sorry, Snowbirds) an although the CAD could dip even lower, I don’t see it going very much lower from here, the main caveat being that if Donald Trump wins the presidency and initiates tough NAFTA renegotiations, the CAD could get spooked temporarily. By the way, I just can’t get my tongue around calling NAFTA 2 the USMCA or CUSMA or whatever so for now, for me its still NAFTA 2.

 

Stock Markets

Just like bonds, the US stock market started out the quarter fairly stable before receding into August and then recovering into the end of the quarter, putting it at its frothiest since late 2021 and vulnerable to a pullback.  At this point I would say we have lots of “dry powder” (money ready to deploy) should a pullback happen.  We have moved capital from stocks to bonds and from cyclical stocks into utilities and less cyclical businesses.

With the strong recent markets, we have reduced/exited certain holdings which seemed to face dark clouds in the short term ahead.  Methanex was one of them.  We no longer own any shares.  I still do believe Methanex has strong prospects in the long term.  The growing interest of methanol as a fuel, particularly for ocean shipping is promising and when stacked up against other fuels that can have a green source such as green hydrogen, green LNG, or biodiesel, methanol seems to be one of the best candidates from the perspective of cost of carbon-neutrality production and ease of storage (liquid at room temperature and pressure).  Nonetheless the stock does have some near-term headwinds if a broad economic headwind creates challenges for the plastics end-markets that use methanol as a source.  We wouldn’t hesitate to hold Methanex again in the right circumstances as it likely controls the market for a fuel of a green future.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

When reviewing markets around the world, we can see from the chart that over the past two years Canada (blue line) lost ground to most other markets back in 2023 and hasn’t really regained that yet.  Canada is jointed by the laggard UK stock market in yellow.  I believe this will shift.  While the US markets rose on the backs of high tech (especially artificial intelligence stocks) and Japan started to emerge from decades of struggles, those factors are abating.  I expect to see Canada close the gap on the US market however not the way you think.  With its numerous high-priced high-tech stocks, the US index is more likely to come down to meet Canada’s rather than Canada’s index leap to meet the US index.  Of course, even in our US positions at the moment we are not highly exposed to those tech stocks and therefore not exposed to their potential retrenchment.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Financial Planning, Investment, Risk Management, Tax, Uncategorized Tagged with: , , ,

Commentary July 2024 – Getting through Indigestion

Reblogged from Brintab

As winter gave way to spring we began to hear more and more that the tightening effect of higher interest rates is showing up in various parts of the economy.  There have been reports of weaker markets for consumer durable purchases (appliances, cars, …).  Also, there are reports of consumers downgrading to cheaper alternatives as noticed by basic goods stores like Walmart, fast food restaurants, and credit card companies.  All point to consumers being under strain.  The restaurant feedback is one of the first clues that service spending is following in the path of goods spending.

Meanwhile inflation rates and other economic indicators tend to be bouncing higher and lower from month-to-month so the trend and pace of decline is challenging to pinpoint.  I would say this is not unlike past cycles of economic easing.  It is never a crystal clear smooth, steady path.

Bonds and Interest Rates

In the spring I wrote that “the plateau in interest rates is starting to break.”  Indeed we have now seen a couple rate cuts by the Bank of Canada but thus far the US Federal Reserve has held off on rate cuts, wanting to see a clear path of inflation rates converging on 2%, rather than the “down one month, up the next” gyrations they are seeing.  It makes sense that Canada’s economy would be cooling off quicker than the American economy because in Canada our house mortgages tend to lock in rates for no more than 5 years whereas many mortgages in the US lock in rates for the entire amortization (payoff) period of the mortgage.  Hence when rates rise, the new higher rates roll through the entire Canadian base of homeowners in a matter of 5 years whereas in the US the rate increases have a far more gradual impact.  Also the US has likely been more positively impacted by the Artificial Intelligence craze than Canada.

Fig. 1: Bond ETFs:  Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance

You can see from the chart above that long term bond prices bottomed around October 2023 (bottoming prices imply peaking interest rates), rose into the year-end, and then declined somewhat in the first half of 2024.  We see them bottoming again now (and interest rates peaking) as it becomes increasingly clear that there will be no need to raise interest rates further.

Now the question is more about how far interest rates should fall and how fast.  There is some view amongst market pundits that a Trump presidency would be more inflationary whereas a Harris presidency would not and so interest rates would have less tendency to fall if Donald Trump wins the presidency and more tendency to fall if Kamala Harris wins.

In terms of our bond strategy, I don’t think the political outcome will matter too much because I feel the path of bond prices is clearly flat-to-higher, it is just a matter of degree.  The notion of bond prices falling significantly from here does not seem in the cards with either presidency.

Currencies

With some countries starting to drop interest rates before others (Canada being one of the first major economies to begin the interest rate descent), their rate moves compared to the US will impact their currency moves relative to the US.  Recall from above that the US Federal Reserve has not started its interest rate cuts yet.

Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

You can see in the chart above that from December 2023 the blue line has steadily increased (CAD weakening.  In December it traded at almost 1.32 CAD/USD (76 US cents per CAD) and is now trading in the ballpark of 1.38 CAD/USD (72 US cents per CAD).  It may fade slightly in the next couple months but once the US Federal Reserve starts cutting rates alongside the Bank of Canada, I don’t see much more weakening in the CAD.  By that I mean that if the CAD fell below 70 US cents, I think it would only be brief, perhaps for a matter of months.

We still have significant exposure to the US dollar, through our US stock and bond positions but if there were a brief drop down in the CAD, we would consider the possibility of some rebalancing of that currency exposure.

Stock Markets

As shown in the chart below, Major global stock markets took a breather in April from their winter acceleration and then once May arrived markets parted ways.  The US (purple) and Japanese (red) markets rose into the summer while the UK and German markets did not move much and the Canadian market actually declined slightly.  The unique performance of the US and Japan can be chalked up primarily to two factors: in the US the AI craze pushed tech stocks higher and these have grown to really dominate the stock market (not good from a diversification perspective). In Japan, there has been a sense that after decades of struggling the Japanese economy is once again on more solid ground and in position to do well going forward.  As such there has been some crowding into Japanese stock markets, pushing them higher.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

After the end of the quarter, July experienced (not shown) a pullback in the US index due to a pullback in tech stocks.  Meanwhile, stocks in other sectors tended to do better.  It is not clear if this is the end of the tech frenzy but I would say it is a lot closer to the end than to the beginning.

Just after the quarter’s end we purchased meaningful positions in Emera, a utility company where we owned a small position in the past.  Emera’s profitability in the past few years has been challenged by increased costs as it gradually wound down old coal-fired power plants.  Now they are almost all closed and the remaining few are slated for closure in the next few years as Emera builds the new electrical generation capability to move away from coal.  Emera is building renewable facilities at a blistering pace and also increasing its ability to tap into the Labrador hydro facilities through increased transmission capacity.  Hence, with all this expenditure behind it, Emera should see stronger days ahead.  And to boot, the company is currently paying a dividend yield of over 5%.  Emera seems to have a solid future ahead of it and we continue our search for other businesses with the same.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Asset Allocation, Financial Planning, Investment, Uncategorized Tagged with: , , , , ,

Commentary April 2024 – Getting through Indigestion

Reblogged from Brintab

 

This winter we witnessed coping with foggy economic conditions in various parts of the world, from China to the Middle East, Ukraine, and North America.  Not to say things were dire per se, but we waited for economic clarity on a number of fronts.

 

In the far east, we watched to see if China could cope with the struggles of a floundering property market and re-establish its solid growth track record.  For years China has had weak consumer and made up for that with government projects around the country, building highways, railways, airports, power plants, and everything imaginable.  At the same time, rural Chinese flocked to the jobs in the (primarily coastal) cities, driving real estate prices ever higher.  When real estate started to flounder, regional banks looked exposed to mortgage and loan problems, the Chinese government stepped in once again, attempting to juice the economy with more government capital.  The property market is still on shaky ground and in general economic growth in China is very weak relative to its historical track record.  At this point, it appears that it might take China years to get through overcapacity – too many steel mills, too many condominiums that sit empty, and newly built roads to nowhere.  The industrial growth that once drove Chinese equipment imports from the rest of the world is roughly flatlining so this informs our outlook for industrial companies wherever they may be located.

 

At the same time, hostilities continued in the middle east, involving ship attacks in Yemen, missile swaps between Iran and Israel, and various signs of risk of the Israel-Hamas conflict spreading and escalating.  While the humanitarian impact is a widespread concern, there is also worry about the worldwide risk to the price of oil.  This is happening at the same time as attacks by Ukraine on oil storage and refining facilities in western Russia.  The American government is attempting to dissuade the Israelis and the Ukrainians from attacking oil facilities.  While there are countless reasons to not want wars to escalate, it should be very apparent that rising gasoline prices in the US would throw salt in the wounds of inflation-weary voters right before an election.  Not good for the incumbent Democratic president!  In the Middle East, the flare-up between the Israelis and Iran seems to have somewhat calmed down (although peace between Israel and Hamas still seems out of reach).  In Ukraine, it was likely hard to listen to US urging to back off on attacking refineries when the war chest was bare and it seemed that was one of the only tools left for Ukraine.  Now that the US government (in late April) has agreed to renew support to the Ukraine military, their voice likely carries more weight in Ukraine.  The risk of attacks extending from the initial target of Russian refineries/tanks to also include oil production facilities is likely off the table at least until US election day on 5 November.

 

Closer to home, we are seeing signs in both Canada and the USA that inflation is remaining more stubbornly high than expected by many (myself included).  The stalling of the economic cooling off has bought some individuals and companies time to cope because unemployment has not yet increased and corporate profits have held up too.  A delayed slowdown is good for anyone, personal or corporate, carrying a lot of debt. We will see how long it lasts.

Bonds and Interest Rates

Back in the fall, we experienced a phenomenal increase in bond prices.  Remember that when the expectation for interest rates on newly bonds falls, investors flock to (and bid up the prices of) existing bonds in the market.  If you look at the chart below, you can see that this happened to some degree to most bonds but the purple line (TLT) illustrates that this happened the most to long duration government bonds.  This happened because investors thought the economy was cooling and so the central banks (Bank of Canada and US Federal Reserve) were going to start dropping interest rates.

Alas, it isn’t happening yet.  Although inflation has subsided from its almost 10% peaks of mid-2022, it has stayed firmly above the 2% target.  Although there are cracks showing in the economy (hours worked, part time vs full time jobs, etc.) it has not been enough to convince central bankers were are on our way to a cooler economy and lower interest rates.

Fig. 1: Bond ETFs:  Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance

What is the implication?  The bond markets got a little ahead of themselves at Christmas and this winter they have pulled back somewhat.  We still feel bonds are going to be one of the best investments as things eventually cool off but that day of economic reckoning is still down the road.  We are increasingly well positioned with bonds but those profits are likely a fall 2024 story.  If the US government can finesse it, they would surely prefer for inflation to weaken but the economy to remain strong until at least November 5, just like their oil price bias.  Back in January I voiced the opinion that bonds would eventually rise above their December 2023 levels and I still believe that to be true but as we can see from the chart above the path higher is going to be a little bit bumpy.

Currencies

Due to the stall in dropping US interest rates (and perhaps also due in some part to the winter’s geopolitical risk) the US Dollar gradually rose against most other currencies (or you could say the other currencies weakened against the US Dollar.  The Loonie is trading in the 72s, a long way down from the 83 cents of three years ago.

Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

Where do we go from here?  There are two competing forces at play.  In general, when the economy rolls over, the US Dollar briefly (for at least a few months) strengthens against most, the CAD.  I have also talked frequently about how oil exports are really the foundation that supports the CAD.  This month we have seen the completion of the Transmountain Pipeline which will drive more oil exports via the Pacific.  Although the incremental capacity of Transmountain is small versus Enbridge’s Mainline to the US Midwest, that said it is a force at the CAD’s back.  Hence, compared to the typical economic cycle, it is less clear than usual that the CAD has weakness in the cards for the near-term future.  Our bias towards the USD is not as strong as it was a year ago when economic weakness seemed more imminent and the Transmountain completion seemed a long way off (if ever).

Merging this currency view with our bond outlook, we have been biased towards holding long-duration US government bonds but around the corner we may be adding some long-duration Canadian government bonds to the mix.

Stock Markets

This winter stock markets around the world have risen while bond markets have fallen.  The Japanese market rose the most, thanks to belief that the multi-decade wallowing of Japan’s economy may be coming to an end.  Among major markets, the UK fared the worst, followed by Canada.

Through the winter we have started to see signs of strength across commodities like oil, copper, gold, and silver.  That is often the last stage for an economic growth cycle so we are watching closely.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

This is third time in the past 4 years we have seen stocks zig while bonds zag.  It happened for a few months in spring of 2023 and also back in 2020.  That emphasizes the benefit of diversification but so far it has worked mainly to stocks’ advantage, not to bonds’ advantage.  We expect to continue pruning our stock portfolio in the months ahead but that doesn’t mean we won’t deploy any money into stocks.  We are always on the lookout for good companies, in stormy seas and in calm.

 

Respectfully submitted,

 

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Asset Allocation, Financial Planning, Investment, Risk Management, Tax, Uncategorized Tagged with: , , ,

Commentary January 2024 – A Tale of Two Sectors

Reblogged from Brintab

The Autumn season in the markets was punctuated by concerns over the Israeli-Hamas fighting and its geopolitical impacts, watching with bated breath about how consumers would digest the insidious impact of interest rates, and in China a property market decline that was spilling into the broader economy.

Bonds and Interest Rates

Over the course of the fall months, the Bank of Canada and US Federal Reserve leaders repeatedly expressed that interest rates would remain higher for longer, as they watched and waited for broad inflation statistics to gradually decline below their 2% target. Meanwhile, those bond investors who are macroeconomic-focused were digging into the statistical details and noting that various signals showed cooling was well underway, even if it hadn’t hit the main inflation numbers yet.  They were looking at things like the number of people with second jobs, delinquencies on car loans, how many of the newly created jobs were part time versus full time, and more.  Early in the quarter the central bank chorus on the interest rate outlook of “higher for longer” prevailed and rates rose into October (which is why bond prices fell in Chart 1 below) but later in the quarter the voices of market analysts won out and the Federal Reserve softened its stance, implying there might be space for short term interest rate cuts later this year (2024).  As a result, bond interest rates fell (slightly) and bond prices rose from mid-October toward the end of the year.  In fact, bond prices rose so fast that at the New Year many market technicians felt there was too much euphoria, and bond prices would have to pull back a bit in early 2024, which did happen.

Fig. 1: Bond ETFs:  Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance

The economic slowdown is continuing and I do think, especially since the slight long bond rate rise in January 2024 that interest rates have more to fall (and bond prices more to rise) in the year ahead but the moves will be more gradual than the bond price bounce we saw in November-December.

Currencies

As is typical, when US interest rates rise like they did through September, the appeal of (and price of) the US Dollar rises.  Then when US interest rates fall (like the November-December behaviour) the US Dollar weakens.  Figure 2 shows this clearly.

I have mentioned before that the biggest violator to that generalization is that if there is a major geopolitical scare, there is a rush into “safe haven currencies” which usually pushes up the value of the US Dollar, Swiss Franc, and Japanese Yen regardless of interest rates.  Interestingly, we can see below that the October 7 attack by Hamas on Israel and the ensuing hostilities there and that spread to various countries on the Middle East did not lead to any major move in safe haven currencies, signalling that global investors see it as a temporary localized issue.

Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

When we consider buying long-term Canadian and US bonds, with the exception of the “fear trade” currency impact (which would favour the US), there will come a point (exchange rate) where we would consider diversifying our US long bonds with some Canadian long bonds.  We haven’t reached that yet but we are aware of it.  To be clear, we are not talking about a precise exchange rate; we are talking more about what investor sentiment we consider embedded in the exchange rate.  We watch, for example, whether bonds are moving with or against the stock market.  We watch if the best parts of the stock market are non-cyclical businesses or speculative ones, we watch how much fear-mongering we see in investment news media.

Stock Markets

Although the Canadian stock market bounced around for the first part of the year without much trend, in September and early October it pulled back along with most major global markets, before staging a rally in the back half of the quarter (and into early 2024, too).

By the end of the year, after the October trough most global markets recovered to have slight moves (slightly higher or lower) from their mid-summer peaks but the US stock market was the exception.  It moved meaningfully higher, largely on the backs of the “Magnificent Seven” tech businesses (Facebook, Tesla, Microsoft, Google, Apple, Amazon, Nvidia).  I have talked in the past about how unhealthy it is for the S&P500 stock average to be driven higher by just a small cluster of (in this case of 7) stocks while the rest of the companies muddle along to varying degrees.  The speculative fervor creates the risk of a Nortel-style crash of those stocks that brings down the average.  Of course, there is no doubting that they are good businesses but gambling on high-flyers is not typically our style and right now we are trying to insulate our investors from the change in focus of fad investing.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

During the quarter we sold Suncor.  While we do think the soon-to-be inaugurated Transmountain Pipeline should improve Albertan oil prices and if Albertan nuclear power talk leads to anything it eventually could make Suncor one of the lowest carbon sources of oil in the world, in the meantime there is risk of a recession which typically leads to a decline in oil stocks.  This is part of our efforts to gradually reduce exposure to equities overall and at the end of the quarter equity exposures were in most cases down to about 50% of portfolios overall.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Uncategorized

Commentary October 2023 – Ready for a Turn

Reblogged from Brintab

This summer into fall, markets have been fixated on the economic “soft landing” narrative and the notion of rates being higher for longer. It is true that circumstances have made it tougher than in past cycles to slow down the economic freight train, but that likely just means harsher interest rate increases, and more likelihood of something breaking along the way. Fortunately, we feel comfortable with our preparedness for that, while we feel some investors are really throwing caution to the wind.

Bonds and Interest Rates

In the bond market we can see the impact of the economy needing stronger medicine to bring down inflation. As central bankers in Canada and the USA continue to monitor the economy (especially the inflation it is experiencing), they see that “goods inflation” has largely come under control but “services inflation” is still high and the labour market is still very tight (pushing wage inflation). This after a record increase of short-term interest rates (with long term rates gradually following them up, too). Longer-dated bond prices are much more sensitive to a particular change in interest rates than short term bonds experiencing the same interest rate change. That is why we can see that longer dated bonds (purple line in Figure 1 below) have declined more than shorter term bonds. We generally have some mix of shorter and longer dated bonds in portfolios. In the past year we have been shifting our holdings more towards the longer-term bonds. After the long-term bonds bottomed in October 2022, they rose into the end of the year before declining once again in the summer of 2023, even though a recession had not yet happened. We expect these long-term bonds to find a floor and then rise again as stock markets decline and investors seek out safer investments. It looks like what we thought would be a 2023 phenomenon will more likely be witnessed in 2024. In any case we feel ready. We expect to be buying more long-term bonds at current low prices.

Fig. 1: Bond ETFs: Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance

In looking for signs of impact from the interest rate increase, the primary result worth noting is that particularly in the US, where homeowners can lock in 25-30 year mortgage rates, the number of home sales transactions has declined dramatically to an annualized rate of just over 4 million units (see Figure 2, below). First of all, owners with a mortgage are not eager to move and trigger a refinancing at the new, higher rates. Secondly, would-be home buyers who are not yet in the market are being squeezed out by the higher required mortgage payments.

Fig. 2: Annualized number of existing home sales transactions, by month – from NAR

In the housing market price declines are usually preceded by sales volume declines so it wouldn’t be surprising to see prices drop around the corner. In 2023 prices teetered (Figure 3 below), but haven’t yet shown the impact. When home prices fall, some people feel their wealth is in jeopardy so leisure spending falls too.

Fig. 3: US existing home sales price index, from St. Louis Fed.

As an illustration of the leisure space starting to cool off, we are starting to see telltale signs of slowdown, such as in airline ticket prices. After Covid, when airlines struggled to manage the travel demand, prices skyrocketed (Figure 4, below). Now, not so much. This is just an example for illustration; we can see similar signs of cooling off in various parts of the service economy.

Fig. 4: airfare pricing trends, St. Louis Fed.

When markets freeze up (fewer transactions happening) they don’t work as smoothly. That means there is more chance that the transition to recession will be a bumpy ride. While that outcome is not guaranteed, it is an increasing probability. Holding long maturity US bonds is a typical safe-haven strategy when other things struggle.

Currencies

As US interest rates have risen, that has made US Dollar-denominated bonds more appealing so, as we would expect, the US Dollar has strengthened with it (Figure 5, below). Before summer there was widespread belief that interest rate increases were done. Then this summer the US economy continued to show resilience so there is a growing belief in the market that the US Federal Reserve will need to raise US interest rates even further to cool down the economy. Now the Canadian Dollar is trading at about 1.36 CAD per USD or on the reciprocal 0.735 USD per CAD.

Fig. 5: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

As discussed in the past, it is not only rising US interest rates that strengthen the US Dollar but also geopolitical fear/panic. At the moment, I believe the US Dollar is near its top as far as the interest rate impact is concerned, however the US Dollar could still bounce stronger if an extreme event happens. Notably, at the time of writing the Hamas attack on Israel just happened and the US Dollar did not strengthen in response. This conveys that the market expects the fallout of the Hamas attack will be contained.

Stock Markets

As illustrated in Figure 6 below, there was not a uniform global stock market trend this summer. The markets in the US and German clearly declined through the summer, while those in Canada and Japan were roughly flat and the UK market rose. This contrasts with October 2022, when we saw most major worldwide markets dip in unison.

Fig. 6: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

The fact that stocks and bonds have both been soft together has made this summer a challenging investment market in the short term. However, as we progress towards a cooling economy there should be less of a tendency of stocks and bonds to move together, thus improving our diversification. With respect to different types of stocks, gradually we are approaching a time when utilities and similarly steady businesses tend to outperform the market, which is the basis of our forward-looking asset rebalancing bias within the stock category right now.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Asset Allocation, Financial Planning, Investment, Risk Management, Tax, Uncategorized Tagged with: , , , ,

Commentary July 2023 – Déjà vu from 2000

Reblogged from Brintab Corp.

The first quarter of 2023 had markets driven most dramatically by US interest rates, their repercussions, and whether the US Federal Reserve would pivot from an interest rate increasing phase to an interest rate decreasing phase.

Bonds and Interest Rates

Bonds continued to be “range-bound” this spring. Basically, central bankers, after their dramatic increase of interest rates of 2022, which pushed bond prices lower, continued this spring their stance from the winter: wait and see. They are waiting and watching to see if the interest rate increases of 2022 were enough to bring inflation back down under control. Since there is a substantial lag of many months from the increase in rates until we see the economy slowing down and until we see inflation coming back to target levels (about 2%/year targets in Canada and the USA), it is a slow process that is far from precise. Think of it like turning the steering wheel on a huge ship and then waiting to eventually see the ship turning.


Fig. 1: Bond ETFs: Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance

In June the US Federal Reserve decided to wait another month without any more rate increases to see the extent to which interest rates were having an effect. Meanwhile north of the border the Bank of Canada elected to raise rates in June, seeing an economy that was still clearly withstanding the pressure of the rising rates. This is not the first time the Bank of Canada increased ahead of the Federal Reserve. Back in 2022 the BoC was also faster at accelerating their rates.

Overall, we are starting to see the early results of the interest rate increases. We now see new unemployment claims starting to edge up in the US and we also see fading purchasing manager expectations and fading Chinese factory utilization rates. It turns out the Chinese “post-Covid re-opening” did not amount to much in terms of global economic impact. Hence, while there may be 1-2 more Fed rate increases, central bankers north and south of the border are roughly in the peak restraint mode.

Currencies

This spring the US Dollar continued the winter’s trends highlighted in the April commentary. Although exchange rates bounced around a little, they have been roughly flat since late fall as the dramatic interest rate increases mellowed out. We are now likely at a point where, once the economy slows down, the US dollar will begin to weaken, but before that happens we need to be cautious.


Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

The interest rate increases have put strain on various parts of the economy. We never quite know where or when something will break (and usually something does break before the economy cools and central bankers can start lowering rates again.) That breakage typically results to a flight to safe haven currencies, those being the US Dollar, the Japanese Yen, and the Swiss Franc. Hence, I wouldn’t be surprised to see a very brief brief surge up of the safe haven currencies before a gradual decent and (as the other side of the trade) an eventual gradual strengthening of the Canadian Dollar. Not quite yet.

Stock Markets

This spring we have seen a couple of phenomena in the stock markets worth noting. The first phenomenon is that Japan (red line in chart below) and Germany (in green) had the most impressive recoveries recently, with Germany’s market starting from a deep low in October and Japan’s just building steam this year. There are a few macroeconomic factors at play here. In Japan, it is believed that the “Abe-nomics” economic policies of Japan under the former leadership of Shinzo Abe have finally started taking effect, putting Japan back on a growth track. Meanwhile Germany, after having to cope with the struggles of last year’s skyrocketing European natural gas prices, faced an outcome less than the feared worst-case scenario as European gas importers and foreign gas suppliers stepped up to address the extreme gas shortage (or at least the fear of it).


Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

Note that both Japan and Germany are major capital goods producers. They have strong industries making factory robots, mining equipment, construction equipment, and other industrial equipment with price tags typically north of $1 million. It is surprising to see these two economies do so well at this late stage in the economic cycle. Normally by now capital goods purchases by major corporations would be declining, however a couple of factors are likely keeping capital goods purchases strong. 1) The political hostilities between the USA and China are leading to more “re-shoring” which entails setting up new factories (with the resultant capital goods spending) in more politically-aligned countries. 2) The US government is rolling out the inflation reduction act and infrastructure projects which will help keep capital goods spending strong. To make a long story short, a few atypical factors have contributed to capital goods-dominant economies like Japan and Germany doing better than usual at this point in the business cycle.

The second phenomenon that is quite striking this year is the narrow breadth of the rising stock market. By that I mean a few stocks are rising a lot and most stocks are not. There has been an almost feverish crowding into stocks related to artificial intelligence and related themes by investors. As a result, the S&P500 index, which has roughly 500 major US stocks driving its returns, has been dominated by a small handful of tech stocks. While I don’t doubt there is merit in the belief of the potential that artificial intelligence brings to the table, on the other hand this feels oh so similar to 2000-2001 when the likes of Nortel and JDS Uniphase stock prices were blasting off into space until they totally dominated the stock market index before eventually crashing back to earth. At its peak Nortel represented 45% of the Canadian stock index. Right now a small handful of tech companies are collectively just as dominant of the much larger US index! Right now Nvidia (centre stage of the AI movement) is trading at a price/earnings ratio of about 215. That implies it would take 215 years of current earnings to break even on the purchase price. Of course, Nvidia can grow but can it grow that much? That sounds like a stretch.
Just as a few super star stocks have recently pushed the S&P500 higher, likewise, they will probably pull the average lower at some point too.

As I foreshadowed in the April letter, we responded in the quarter to this market situation by continuing our gradual shift out of equities and towards bonds. In particular we did a fair bit of equity position trimming in May. As a result, I see us now in a much stronger risk-managing stance now. Although “risk managing” usually implies missing some of the upside in the market’s frothy days, it should also help avoid some of the downside, leading to a smoother ride overall. As I have said before we can never precisely predict the market tops and we can’t predict the bottoms either but through focused strategic risk management we can help ensure we have the staying power for the long run.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

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Commentary April 2023 – Will the Fed Pivot

Reblogged from Brintab Corp.

The first quarter of 2023 had markets driven most dramatically by the US interest rates, their repercussions, and whether the US Federal Reserve would pivot from an interest rate increasing phase to an interest rate decreasing phase.

Bonds and Interest Rates

We can see that last year until about October bonds declined as the US Federal Reserve (and the Bank of Canada, too) engaged in the steepest interest rate increase in history. Once that steep increase was plateauing, bonds found their footing and basically since the start of 2023 have been roughly flat while bouncing up and down in a more typical range.

Fig. 1: Bond ETFs: Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance
Central bankers (and market participants too) are now attempting to judge whether the interest rate increases to-date are enough to cool off inflation or not. Inflation is certainly easing from the high single digits we witnessed a year ago, however are the increased interest rates the cause of this inflation slowing down? Maybe not. The reality is that last year the craving for post-Covid spending was still rampant and the supply chain issues had not yet been fully resolved. High demand with constrained supply mean prices escalate. While I think interest rate increases have played some role in cooling off inflation, in truth I believe the heavy lifting came from getting the core economy back to normal operations (supply stabilizing and feverish demand easing off).

Traditionally it takes many months for higher interest rates to trickle through to fully impact the economy. As borrowers renew their mortgages, take out new car loans, and refinance corporate debt, the higher interest rates are gradually going to squeeze more and more people. The full impact of interest rate increases is still coming down the pipe. Recently central bankers are talking about pausing the interest rate hikes to see how much impact the increases carried out so far will have on inflation before hiking further. I believe we may see an additional 0.25% increase but not much more. As we wait and watch the impact of these interest rate increase, inflation and the economy will cool more and more.

One complicating factor is that in China, where there was a very heavy Covid-induced lockdown, there has just been a reopening starting in December 2022. I do not believe it will outweigh the impact of interest rate increases in other countries. The two dominant parts of the Chinese economy have been manufacturing for export and construction. With respect to the construction, there is an astounding inventory of empty condos in Chinese cities now, with builders building and speculators buying purely on the basis that prices kept going higher. Now that prices have stabilized and/or declined in various areas, it feels like the feverish level of Chinese construction has eased. Meanwhile, looking at export-driven production in China, that basically hinges on developed world consumer demand. Now we see major corporations in the US taking preventive steps to anticipate a recession with moves like hesitation on supplier orders and either laying off employees or at least instituting hiring freezes. Hence, consumer demand in the USA and Europe, which drives the Chinese economy, is likely weakening. In conclusion, I do not believe the impact of Chinese reopening will significantly counter the cooling developed world economies.

I would be remiss if I didn’t mention the fall of a relatively significant US regional bank this winter. Silicon Valley Bank failed last month and various other regional banks were known to be in a very tight financial situation. This is illustrative of how the central bank interest rate hikes are starting cause pain in various parts of the economy. The impact here is twofold. Firstly, banks are tightening their willingness to lend as a precaution and secondly, bank stocks have declined as investors themselves exercise caution. Issues like this are to be expected as the economy progresses toward what I consider an inevitable recession.

Currencies

Although the US Dollar strengthened until October 2022 against both the Canadian Dollar (blue line in the chart below) and against a basket of major currencies (green line), we can see that since October the USD/CAD exchange rate has roughly stabilized and in late last year the USD actually declined against the currency basket. In Europe there was a feeling that the worst of the war-driven impacts have been absorbed and in Japan there has been for the first time in years, discussion of raising interest rates.


Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

Once it is clear that the Federal Reserve has raised interest rates enough, a recession is unfolding, and interest rates should decline, then the US Dollar will decline too (likely in 2024). However, in the meantime, if the tightening of interest rates causes a major market breakage anywhere in worldwide capital markets, the US Dollar typically rises as a “safe haven” play. I do expect breakage somewhere and so I do expect the US Dollar safe haven role to unfold, before once again the fear subsides and it is time for other currencies like Canada’s to have their day in the sun.

Stock Markets

After a difficult 2022, in the first quarter of 2023 stock markets around the world rose up in January and February before retrenching in March. Since then, they have started inching higher again but we are not out of the woods yet!


Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

I believe market participants are hoping that the interest rate increases are done and their impact on the economy is done so they believe the 2022 pullback the stock market experienced was the purge that was needed to let off steam. That is likely wrong. Generally speaking, it is not possible to get inflation under control without some increase in the unemployment rate and that has not happened yet. To the extent that central bankers stick to their inflation reduction goals (i.e. they don’t cave in to political pressure) then unemployment will come.

We have seen some “rotation” in the stock market where less cyclical sectors like healthcare, consumer staples (groceries, etc.) and utilities have done well while more cyclical sectors have struggled. This has somewhat played to our strength as we have had a strong weighting in those sectors that are more in favour.

Given where we are in the economic cycle, this winter we have been gradually trimming exposure to various equities and increasing exposure to long-duration bonds, primarily through purchases of EDV. We have continued this general trend after the end of the quarter too, and expect further opportunistic trimming and rebalancing as the situations present through the spring and summer.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

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Commentary January 2023 – Applying the Brakes Worked

Reblogged from Brintab Corp.

As summer led to fall wild rebounding growth began to yield to taming. Markets were somewhat pulled back into line to begin to reflect a more conventional reality. Since investment markets tend to anticipate and “front run” what happens in the real economy, they responded accordingly.

Bonds and Interest Rates
Central bankers in Canada and the US continued their drive to push interest rates higher to take the froth off the economy and get inflation back in check. Note in the chart below summarizing bond investments that the long-dated government bonds shown here (TLT in purple) dropped the most through the summer until finally finding their footing around early October. This quarter you can see that these long-dated bonds slowly began a stabilization/recovery. We continue to see inflation come down and although interest rates may stay this high for a number of months until the Bank of Canada and Federal Reserve are absolutely certain they have broken the back of the self-reinforcing inflation cycle, by the end of 2023 we expect to see inflation lower, unemployment rates rising, and thus Chairman Jerome Powell and Governor Tiff Macklin softening their talk and shifting towards the notion of easing interest rates.


Fig. 1: Bond ETFs: Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance
Note that the longer-dated bonds fall more than short-dated bonds in an interest rate raising phase and then on the flipside they generally rise more in an interest rate dropping phase. Therefore, it is my expectation that we will gradually be shifting to longer dated bonds through the year ahead. In industry lingo we would call this “increasing duration exposure.” To some extent you can already observe the beginning of our move. In December we began dipping our toe in with the purchase of some units of EDV, a very long-dated (high duration) bond pool. Moves like that will probably continue.

Currencies
Back in October I talked about the difference between the USD/CAD behaviour and the USD behaviour against other major world currencies. Our expectations tended to be how things ultimately panned out this fall. Specifically, the Bank of Canada has been raising rates more or less in tandem with the US Federal Reserve. While the USD did strengthen somewhat vs the CAD through the summer (rising blue line in Figure 2), it was not as dramatic as the extent of the USD rise against other currencies (green line).


Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

Now the Bank of Canada and the Federal Reserve are both slowing reaching their interest rate peaks while others are just in the early innings of their interest rate hiking trends. The outlook for interest rate hikes overseas explains why the USD has recently started falling back against a basket of foreign currencies (green line declining) this fall. With out graphing all the various details for you, I will note that of the CAD, the British Pound, the Euro and the Yen, it was the Yen that had the most astounding decline in the first 9 months of 2022 and then the most impressive rebound against the USD this fall.

Back in October I had indeed signalled expectations of the USD fading by the end of 2023 however to be clear I think its weakening against overseas currencies may be more pronounced than its moves against the CAD. The caveat to that is if oil goes higher the CAD will go higher.

Stock Markets
The gyrations of stock markets around the world were wilder than usual recently. This makes discerning comparative performance a little challenging but note that the Japanese market (Figure 3 red line) has been steadily declining for the past two years. Meanwhile the UK market (beige line) has gradually continued rising. The Brits are gradually getting past the Brexit heartburn that plagued their stock market. Also, the “Footsie” index has more mining representation than US indexes and recently those mining stocks have pushed the FTSE index higher.


Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

While the US market has declined substantially from its peak at the end of 2021, part of this has been driven by its larger tech industry representation in the index. The tech industry has been significantly impacted by the post-Covid fade in tech spending and also by rising interest rates. That is not over yet. Cell phone makers, computer chip makers, and others in the tech space are still reporting tougher business conditions and we have recently seen layoffs at many tech companies.

While the economic cycle is largely unfolding as typical, there are a couple wrinkles we are watching. First of all, this fall China substantially opened up its economy from widespread Covid lockdowns. It could be they increase global demand, prolong inflation, and make central bankers around the world keep interest rates higher for longer. Despite the possibility, I do not think it will have a major impact. The Chinese economy is still heavily impacted by exports to USA, Europe, etc. and so with recession clouds in the West, it is hard to envision Chinese domestic consumer demand overpowering that.

The other consideration, particularly for Canadians, is how much oil demand will fade and recover through the coming recession. Rising oil will certainly complicate the job of Tiff Macklin at the Bank of Canada. I expect the oil story would be a tailwind for Canadian – more consumers doing well, railways, industrial equipment, and so many sectors feeling the boost. Nonetheless if it forces interest rates to stay higher for longer, staying away from interest rate exposed businesses will be a consideration.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in Asset Allocation, Investment, Risk Management, Uncategorized Tagged with: , , ,

Commentary October 2022 – Interest Rate Increases Start Cooling the Economy

reblogged from Brintab.com

During the summer we saw the first shoots starting to appear of interest rate increases reducing the extreme intensity of inflation and thus beginning to cool off the economy. More fading of high single digit inflation is likely around the corner so we can sigh about interest rates slowing and gradually stopping their recent relentless march higher.

Bonds and Interest Rates

Central bankers are routinely watching inflation rates and trying to boost interest rates when they need to slow down the economy to stop inflation getting out of control. This is a very tricky task since inflation, once in place, has a lot of momentum and can be hard to slow down. For example, if the price of oil rises then, plastics makers will at first absorb their input cost increase before gradually passing it on to plastics users. These plastic products makers, in turn will absorb some input cost increases at first before gradually passing that on to wholesale buyers, who will gradually pass the cost increases to retailers, who gradually pass it on to consumers. Then of course with consumer prices increasing, workers start to demand higher wages and a second wave of inflation rolls through the various participant companies in the economy. You can imagine that once the inflation ball starts rolling, it takes quite some time and quite some interest rate increases to tame inflation back down!

Fig. 1: Bond ETFs: Gov’t:XGB, Corp:XCB, High Yield:XHY, US 20-yr:TLT–2 yr –Yahoo Finance

As I alluded in the spring, central bankers in the US and Canada have certainly raised interest rates and even beyond that they have also telegraphed to the investment world that more interest rate increases are on the way. Nonetheless I do believe that this fall could see the end of the most acute interest rate increases, with possibly some small (0.25%) increases to follow next year. Other regions (e.g. the European Union and Japan) are further behind on their interest rate increases and may follow in time.

As interest rates have increased, bond prices have fallen. Figure 1 shows the impact on various types of bonds. Medium term government bonds (XGB) and Investment Grade Corporate Bonds (XCB), of which we often own some, have fared better than long term government bonds (TLT). We have been adding to TLT lately, thinking the majority of interest rate increases are likely complete. Our bias is toward still buying more long bonds although in taxable accounts there may be some tax-loss selling opportunities. High yield corporate bonds have also fared ok although we expect that the rising interest rates and pending recession will be hard on those high yield bonds as some of those companies face financial distress from having too much debt.

Generally, each month the government marches out the latest statistics on inflation. The statistics the media usually quote are the year-on-year inflation for the month. That statistic compares the most recent month’s prices to the prices in place for the same month a year ago. We recently looked deeper into the inflation statistics because this year-on-year number unfortunately masks exactly WHEN during the past year the inflation occurred. The month-on-month (rather than year-on-year) numbers give a hint to this although they are a bit messy. Messy because for example, there is much more Christmas shopping in November than in October and much less leisure travel in September than in August. You can imagine that looking at month-on-month numbers is a little like comparing apples to oranges. Still, we can see that as the economy recovered from Covid19 there was significant inflation back around October 2021. This leads me to believe that once we get this year’s October numbers (to be released in November) and this year’s November numbers, we will start to see the most extreme inflation fading. Furthermore, we have seen some commodity prices (oil, copper, natural gas) roll over this fall from the high values they experienced in the summer and oil first had its major rise around the time of the Russian invasion so by next spring we will be comparing oil prices to previous high numbers. To me, all this points to the gradual stabilization of prices and takes pressure off the need to raise interest rates much further.

Currencies

The biggest drivers of the moves of one currency against another tend to be a) the difference in interest rates in one country versus the other, b) flows to and from countries considered “safe havens” and c) in the case of Canada the price and volume of our top export – crude oil.

We can see from Figure 2’s blue line that it now takes more CAD to buy a USD (i.e. CAD weakening) than it did a year ago. The slow steady march higher for the USD accelerated in August/September this year to the point where at the end of September it took 1.37 CAD to buy a USD (reciprocal conversion rates is $0.73 USD per CAD).

Of course, if you look at the acceleration of the USD versus a basket of major global currencies (Green line) you can see that the USD really shot higher dramatically. In that sense the CAD held its own better than other currencies did. This is because the Bank of Canadian and the US Federal Reserve more or less raised rates in parallel.

As I mentioned in the bond discussion above I think the rate increases in the US and Canada are fairly complete, while other central bankers may still have work to do (UK, Japan, Europe). Thus, the substantial rise of the USD is likely to plateau in the next few months. There is still risk of geopolitical concerns (Russia-Ukraine, China-Taiwan) triggering a flight to a safe haven currency and surge in the USD but those are low-probability events in my eyes. In all likelihood I see the USD fading by late 2023.


Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

The strength of the USD has held at bay many commodities priced in USD. It could well be that a fading of the USD leads to an aggressive rise in the prices of various commodities from oil to copper, gold, etc. These have all struggled lately.

Stock Markets

When we look at the performance of stock markets around the world, the one with the notably toughest past couple of years is Germany (Figure 3, green line). It was already struggling to keep pace with other world stock markets into the beginning of 2022 but then the Russian invasion of Ukraine and the corresponding skyrocketing of energy prices in Europe put the brakes on the German (and broader European) economy hard.

Also worth noting is that Japan’s quicker stock market recovery (in red) from Covid19 plateaued earlier and has somewhat struggled since. The US stock market has had the best recovery since March 2020 but then faced the largest pullback. I attribute this to the strong acceleration of US interest rates (which hurt stocks in general) and to the US stock market containing more high technology stocks than other parts of the world. Tech stocks tend to be harder hit by rising interest rates than other parts of the stock market.

Around the world, after most markets fell back in June, they rose again through the summer into August and then fell back at the end of September. We can never precisely predict where the bottom of the stock market will be and a long-term investor should avoid get distracted by spending too much time on it but suffice to say stock prices have now absorbed higher interest rates and a strong likelihood of a recession so they are much more modestly priced than they were a year ago.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

Note that when I talk of a pending recession, the typical investor may suspect that means it is time to think about taking investment money off the table. Actually, the opposite is likely true. Statistics show that the stock market typically anticipates a recession by 6-18 months and so the stock market usually hits its lows (and starts rising up again) before a recession is even declared! This means that exactly when recession-watchers are tempted to reduce their bets, astute investors are often putting more investment money to work. Roughly speaking, we are somewhere in that space now.

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

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Commentary July 2022 – Central Bankers Start Taking Inflation Seriously

reblogged from Brintab Corp.

This quarter, as inflation continued to thrust forward, the US Federal Reserve aggressively raised interest rates to try to get their inflation-busting measures back on track after being caught off-guard earlier in the year.  The only major sign of relief in “goods” inflation is coming from the fact that economic reopening has allowed US consumers to redirect some of their spending on leisure (travelling, dining out, etc.) rather than solely on goods purchases (new furniture, backyard renovations, etc.)  The Russian invasion of Ukraine has not only impacted commodity prices (near term effect) but also triggered a reassessment of military spending by NATO countries.  This second factor is milder to be sure, but could be a slight inflationary spending factor with a very enduring effect if it lasts a decade or more.  Similarly, it seems globalization is now firmly in reverse.

Bonds and Interest Rates

As consumer spending shifts from goods to services we are witnessing inflation shifting to that sector too.  The inability to properly staff airline operations has led airlines north and south of the border to reduce their flight schedule, particularly near the end of the quarter.  For sure this leaves consumers scrambling for the fewer available seats, no doubt at top fare prices.

In response to the persistent high inflation the US Federal Reserve recently raised interest rates by the once inconceivable 0.75% and announced the likelihood they will do it again this summer.  A combined 1.5% interest rate impact in such short order would amount to the steepest increases in over 40 years.  We are already starting to see signs of impact in dwindling US mortgage refinancing and a slight cooling of the US housing market overall. Upping the ante, the Bank of Canada just raised rates after the quarter’s end by 1%.  Wow!

Historically bonds have over the long term moved somewhat opposite the stock market.  When stocks went up bonds often went down and vice versa.  As I telegraphed over the past couple commentaries, the bond market has been challenged to fulfill that counterbalancing role, instead moving alongside the stock market.  During this quarter we have seen some signs of that abating, with bonds occasionally moving opposite to stocks (hurray) and thus starting to show signs of reverting to their traditional offsetting role.  I expect to see more of that ahead.

Often the long bond market moves in anticipation of where the central banks are going with benchmark interest rates.  The market predicts inflation and adapts before the Federal Reserve has a chance to make any formal announcements.  Now it appears that long maturity bonds have already priced-in rate increases that are expected in the Federal Reserve short term rates and so it appears the tough time for long term bonds is coming closer to an end.

In addition to the customary depiction of medium-term government bonds, investment grade corporate bonds, and high yield bonds, I have included in the chart below the movement of long-term government bonds.  TLT is a pool of roughly 20-year US government bonds.  We can see that these long bonds have had the toughest time but once interest rate increases slow down they may have the best prospects ahead.

Fig. 1: Bond ETFs:  Govt-XGB, Corp-XCB, High Yield-XHY, US 20-yr-TLT – 2 years – Yahoo Finance

Currencies

As the US has raised interest rates more aggressively than any major economy around the world (except Canada just recently), the US Dollar has been strengthening in response.  We have observed a slight USD strengthening trend vis-à-vis the Canadian Dollar for over a year since May 2021.  If you were to look at the USD against the Euro, British Pound, or Japanese Yen the impact is astounding.  Our Canadian currency has somewhat held up against the USD more than others because 1) the price of our top export, crude oil, has strengthened and 2) the strength of the Canadian economy (especially housing market) has let the Bank of Canada raise interest rates (and hence strengthen the CAD) more than in Europe, the UK, or Japan.

Among the various impacts of swaying currencies, the two biggest ones a Canadian investor is likely concerned about come from a) the value of our US securities when converted back to CAD and b) the impact of the strengthening/weakening of the US Dollar on the overseas profits of multinationals.

While I think the interest rate spread between the US and other economies may be nearing its peak (and hence the currency pressure pushing the USD higher may also be nearing its peak), the other factor (the safe haven effect) has not come into play much.  Thus, it is conceivable that if there is a safe haven panic, we see one more push higher of the USD before it plateaus and gradually weakens.

Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance

Stock Markets

In general, growth stocks (of which we own few) feel more pain from rising interest rates than value stocks (of which we own many).  During this quarter we saw the stock market continue the retrenchment it has pursued since the new year.  This has been substantially because the growth stocks have declined precipitously in response to rising interest rates.

Usually as a market pullback lengthens the more skittish investors panic and throw in the towel in something we call “capitulation.”  At this point we haven’t seen substantial investor capitulation however we have seen a few days when there is a broad-based decline across many stocks.  I am anticipating this could happen at any point, creating buying opportunities.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

Respectfully submitted,

Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.

Posted in All Archives, Asset Allocation, Financial Planning, Investment, Risk Management, Uncategorized Tagged with: , , , , , , , , ,

Commentary April 2022 – Inflation Goes Into Overdrive

Reblogged from Brintab

As the developed world navigated past the Omicron virus wave, various factors lengthened and/or accelerated the inflation we once hoped would be transitory.  On the economic demand-growth side, various economies saw increased consumer activity, especially in leisure spending.  On the economic supply-constraint side:

  • Covid-induced supply chain issues only abated slightly,
  • Since wage inflation has not kept up with price inflation, various strikes among unionized workers broke out.  Also hiring employers found it tougher to find new recruits
  • Russia’s invasion of Ukraine led to the escalation of various commodity inputs like grains, oil, natural gas, uranium, potash, and nickel.

At the end of the quarter there was a very slight counter-effect abating the inflation concern.  In China the breakout of yet another Covid wave led to lockdown of varying degrees in several cities in March and into April which, for example, pushed back slightly on the rising price of oil.

Bonds and Interest Rates

Jerome Powell, head of the US Federal Reserve has been dogged by criticism that the timid Fed has not risen to the fight against inflation.  In my opinion the original source of inflation was indeed transitory but since it did not get fixed expediently, various knock-on effects (like increased labour demands) have started to snowball, making it self-perpetuating.  The Fed definitely changed gears this winter, and has come out strong in its determination to boost interest rates to finally throw cold water on an economy where inflation is getting uncomfortably high.

Back in January I talked about the likely challenging environment ahead for bond investors.  If you look at how much bond prices have fallen this winter you can see just how much impact the change in Fed stance (with other central bankers like the Bank of Canada) has had.  Although bonds had faded a bit in 2021, the decline in government bonds (blue line) and investment grade corporate bonds (green line) since January 2022 has been in the 8-10% ballpark.  It is typical that a rise in interest rates (and fall in bond prices) of this magnitude foreshadows an economic recession typically 6-18 months down the road.  It is often the time to consider more bond purchases since they have become relatively cheap.

Fig. 1: Bond ETFs:  Gov’t (XGB), Corp (XCB), High Yield (XHY) – 2 years – Yahoo Finance

Currencies

This winter we can see that the US Dollar trended higher against a basket of currencies (green line) but it did not move much against the Canadian Dollar (blue line); it just bounced around.  Why the two different experiences?  Mainly Russia.  Specifically, the Russian invasion of Ukraine boosted oil prices (good for the Canadian Dollar) and caused worry in other global economies that are more hurt than helped by rising commodity prices.  And, of course when there is war the USD typically acts as a safe haven, pushing it higher.  Layer onto that the fact that Canada’s strong housing market allowed the Bank of Canada to keep up with interest rate increases planned by the US Federal reserve and the result is a Canadian currency that more or less held up against the US Dollar.

Going forward the USD is likely to remain strong.  As we edge into an economic recession down the road, likely by 2023, a leaning toward safe havens will tend to persist notwithstanding the likely recovery of the Euro as the impact of the Ukrainian war inevitably fades through military exhaustion.  This means a USD likely maintaining its strength.

Fig. 2: US Dollar Index and Cdn Dollar vs USD – 2 years – Yahoo Finance

Stock Markets

This winter, after 2021’s long run higher in stocks, the market experienced the jitters typical of a later stage boom phase.  The Russian invasion had the most impact on the German market (green line) while the Canadian market (blue line) was the most stable, largely due to the Russian invasion pushing Canadian commodity stocks higher.

Although Russia significantly impacted commodity stocks, with the Canadian market really feeling the impact, in the US stock market Russia was not the main driver.  High tech stocks are a much more meaningful part of the US market than in Canada. The rising interest rate regime has had severe impact on tech stocks (as well as housing related stocks such as Home Depot).  The newfound eagerness of the Fed to quash inflation has really doused the flames in high tech and in housing stocks.

Meanwhile, although Russia has accelerated the climb in commodity stocks, even without Russia it is common for commodity stock to rise up late in an economic cycle.  We also see stabler (i.e. sometimes called defensive) sectors perform.  Utility stocks such as Hydro One have held up well for us through the turbulence.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

You might wonder, “With all this talk about ‘late-stage economy’, ‘recession’, etc. why don’t we just shift our stocks to cash and wait out the recession?”  History shows that trying to time the market like this is a fundamentally bad idea.  First of all, a substantial part of the stock market’s long-term performance tends to happen just before a recession.  People who move to cash tend to miss those pre-recession returns.  Then when a recession causes a pullback, even if there is a 15-20% decline from the new pre-recession high that they missed, these cash-sitters tend to re-enter the market after the recession at higher prices than their original exit! A truly bad outcome.  Then what, you ask, is a wise strategy?  When we buy stocks and bonds over time, our portfolio typically consists of a mix of great businesses bought at modest prices and moderate business bought at cheap prices.  We are routinely reviewing the portfolio to see if those business are holding up to our expectations and/or getting too expensive given their long-term prospects.  The result is the constant weeding of our investment garden, trying as best possible to maintain a crop of strong productive holdings, regardless of their short-term fluctuations.  Now might be, as mentioned in the “Bonds” discussion above, the time when we see opportunity to channel more money into bond and income-oriented investments through the summer.  Although this outcome seems likely, only through monitoring will we see which opportunities actually arise.  Simply, that is what we do.

Respectfully submitted,
Paul Fettes, CFA, CFP
Chief Executive Officer,
Brintab Corp./Efficertain Corp.

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Commentary January 2022 – Digesting Omicron and Persistent Inflation Impact

Reblogged from Brintab

Commentary January 2022 – Digesting Omicron and Persistent Inflation Impact

There were many winds washing through the markets in the months leading up to the New Year.  Hence it was a tumultuous time.  To name a few:

  • The Delta variant succumbed to the milder yet faster-spreading Omicron
  • US hostilities continued with respect to China, Russia, and Iran
  • Covid fatigue and resistance to lockdowns led many people in various developed countries to either stage protests or simply ignore Covid and go about their business
  • Omicron spread like a prairie grass fire and the widespread sicknesses and self isolations led to staffing shortages that crimped many businesses – notably airlines had to reduce operations to cope, although planes were reportedly half empty anyway.
  • Kazakhstan faced widespread revolt against fuel price increases – oil and uranium prices rise and Russia landed troops into Kazakhstan to support the government and put down the protest.
  • Various economists (most notably at the US Federal Reserve) who had been declaring inflation to be temporary acknowledged that either it was not as temporary as they thought or that “temporary” meant more than just a few months.
  • West Virginian Senator Joe Manchin singlehandedly killed the Biden’s government’s hope to roll out a $3 trillion stimulus package (that had already been dialed back to $1.75 trillion through compromise).  This would have been on top of the $1.5 trillion infrastructure bill already passed.
  • Europe declared natural gas to be “green energy” (happened just into the new year).

Wow.  That’s a lot to digest!

Bonds and Interest Rates

Roughly speaking, bond returns move inversely with the likelihood of central bankers raising interest rates, which markets anticipate as economic fear factors dissipate (or rise) and a recovering/inflationary economy increases chances of central bank rate increases.

Fig. 1: Bond ETFs:  Gov’t (XGB), Corp (XCB), High Yield (XHY) – 2 years – Yahoo Finance

We can see from the bond chart above that safe haven government and high-grade corporate bonds (green and blue lines) rose in the summer as the Delta variant dominated, fell in the early fall as the spread of Delta slowed (and economic recovery was anticipated) and then rose again into November as the Omicron variant surged around the world.  Now in the New Year (not shown on the graph) we are seeing bonds fade again as Omicron gets under control, inflation is proving to be more persistent than central bankers had expected, and there is increasing commitment among central bankers to raise interest rates to keep inflation in check.

Looking ahead, fixed income investing is likely to be challenging.  On the one hand an increasing interest rate regime is bad for bond holders and on the other hand holding bonds is a very important way to protect against a geopolitical or economic shock.  Our job will be to mitigate these two opposing factors.

Currencies

Since roughly May 2021 the US Dollar has been strengthening against the Canadian Dollar and against a basket of world currencies.  This is essentially because the US economy is recovering faster than other economies and US interest rates are likely to rise faster than in other countries.  Such is the case somewhat because the US population was more insistent than other countries on reopening the economy despite collateral damage in terms of Covid sicknesses/deaths.  Although this cycle’s explanation relates to post-Covid reopening, the truth is that in most cycles the US economy and markets recover faster than elsewhere.  This is largely driven by the US preference to have a more “laissez-faire” market stance that results in more aggressive restructurings, layoffs, etc. in downturns but positions the economy with a faster, stronger rebound when things recover.  This is typical in most cycles even when Covid is not a factor.

Fig. 2: US Dollar Index and Cdn Dollar vs USD – 2 years – Yahoo Finance

That said, we often see that later in a recovery the US Dollar’s strength subsides as economic recovery spreads to other countries.  Of particular interest north of the 49th, the Canadian Dollar often recovers strength when the oil industry recovers, which is typically part of a global rebound after the US economy has led the way.

Stock Markets

Although stock markets experienced some October recovery from their Delta variant-induced September pullback, we now see that from the beginning of November they finished out the year either flat (US and UK) or down from October (Canada, Japan, Germany) as the Omicron variant and other global concerns I mentioned at the outset took a toll.  Importantly, central bankers (especially US Federal Reserve Chairman Jerome Powell) telegraphed intentions to take inflation more seriously and raise interest rates several times during 2022.  This threw cold water on equity markets and especially tech stocks.  It drove the beginning of a sectoral rotation out of tech stocks and into more conservative stocks as investors sought safety.

I would note that through 2021, although we had not completely written off strong technology businesses, we were leaning towards and net acquirers of conservative investment alternatives so this market shift played somewhat to our strengths.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

Looking ahead, while we continue to scour for good individual businesses, I expect our view will be influenced by 1) how completely the stock markets absorb the interest rate increase news/expectations, and 2) the degree to which inflation fades or remains strong.  One of the biggest sectors where rising interest rates have the potential to cool things off is the housing sector.  That is one place to look for telltale signs that inflation-driving demand is easing as interest rates rise.

Respectfully submitted,
Paul Fettes, CFA, CFP
Chief Executive Officer,
Brintab Corp.

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Commentary October 2021 – Beyond Delta

reblogged from Brintab

This summer’s markets were initially driven primarily by concern regarding the potential impact of the Covid Delta variant worldwide. As summer turned to fall the Delta variant’s fade gradually became clear and the dominant factor shifted to supply chain bottlenecks around the world and whether current high inflation was transitory or long-lasting. Part and parcel of that is the level of US government spending. The Whitehouse had proposed a one-trillion dollar first spending authorization followed by a further 3.5 trillion dollar spending authorization. That would be a lot of money dumped into the economy!

Bonds and Interest Rates

As I mentioned in early July the bond markets this summer continued working hard to parse out the details of inflation, the recovering economy, and the likely government response (i.e. the potential for rising interest rates). Although employment is improving, there is still a possibility for stagflation where inflation is running high but the economy is wallowing and the government can’t raise rates without killing the main-street economy. I do believe that is the reality we face, to a certain extent. We will see the Federal Reserve try to ease off with their bond buying, which has depressed interest rates for a while, but the Fed won’t go as far as some pundits think, for fear of quashing the economy. As a result, they will not be able to fully address the inflation and it will continue at rates above the 2% target for at least the year to come.


Fig. 1: Bond ETFs: Gov’t (XGB), Corp (XCB), High Yield (XHY) – 2 years – Yahoo Finance

As a side note, when completing my MBA over 20 years ago we had a supply chain simulation where we looked at disruptions to the chain and how many purchasing cycles it took for the chain to restabilize. It took a long time! Now, to me it is shocking to see how shocked experts are on the length of time to restabilize supply chains. This was a basic lesson two decades ago! It will take time and meanwhile the prices of various items that are in short supply will lean higher.
This summer the Fed became more hawkish (leaning toward raising interest rates) and so bonds fell slightly but in my mind they can’t go far. There is now so much debt across government, the housing sector, and other industries that the economy simply can’t tolerate much higher rates. That is why I believe the Fed (and to some degree central bankers here in Canada too) is painted into a corner – they can’t raise rates much. With that in mind, we remain comfortable holding some bonds as a diversifier for when the stock market takes a deep breath.
By the quarter’s end there were concerns that the government spending would exacerbate inflation and force rates higher (and stock markets lower). After the quarter-end it has become evident that 1) the US government needs to pare back the $3.5 trillion spend to get it through Congress and 2) the US labour market is getting on board with the recovery. As such, the market expects inflationary pressures and stagflation risk (stagnant economy alongside high inflation) to be less extreme than the scenario envisioned 4 months ago.

Currencies

Economies around the world are healing from the pandemic at different rates. As a result central banks around the world are able to raise interest rates at different paces and therefore their currencies don’t all strengthen equally. Canada has recently been one of the strongest recovering economies. If you add to that the fact that our top export (crude oil) has experienced a dramatic price escalation, you can understand why the CAD is strengthening in USD terms and indeed against currencies around the world. Even though the USD has done well versus major global currencies (green line in Figure 2 has been rising since May) the CAD has been doing even better, with the USD weakening against the CAD since its peak in August. Just in time for the border reopening and the snowbirds heading south!


Fig. 2: US Dollar Index and Cdn Dollar vs USD – 2 years – Yahoo Finance

Looking ahead we can expect the CAD to remain strong until a stock market panic occurs. These panics (stock market pullbacks) are an inevitable part of equity investing and although we cannot predict the timing of shifting emotions, we need to recognize that reality. Recently in our fixed income allocations many accounts have added a US bond pool to their holdings. This implicitly increases the US currency exposure versus holding Canadian bonds. This is an intentional move to provide more stability when stock markets pull back and safe-haven currencies (US Dollar, Japanese Yen, Swiss Franc) typically rise versus other currencies.

Stock Markets

This summer equity markets continued to rise but by the beginning of September the bloom was off the rose (actually Japan has been fading since February.) Various equity market fell through September to hit a short term low (which we can only know with the benefit of hindsight) at the end of September/beginning of October. As such we did some trading just after the end of September in response to this opportunity created.

While it is easy to find a chart of the overall equity market behaviour, that does not convey the trends happening “under the covers.” The major trend is driven by how equity markets are interpreting the broad economic situation and the bond market response. Think of that as (at least) three blocks:
1) most high-growth tech stocks won’t generate meaningful profits until many years into the future. Therefore, they like a low discount rate (low bond yields) so that those future profits are just slightly discounted to the present and are still big numbers in the end. When bond rates are looking to rise, tech stocks tend to be falling and vice versa.
2) consumer packaged goods are feeling the brunt of cost inflation. As their raw material input costs rise they can only maintain their margins if they can pass on cost increases through higher prices to consumers. This is not easy. Too much price escalation and consumers reduce their purchases. Hence consumer packaged goods companies (like our Unilever holding) are facing stock price pressures because they are facing challenges passing their cost increases along to consumers. They can only raise consumer prices so much. That said, once they have successfully navigated this tough profit-squeeze phase and cost inflation abates they should look great in the long run.
3) the natural resource companies and various others (e.g. container shippers) are the bottleneck in the whole supply chain situation. Therefore, we are seeing price escalations for oil, coal, many metals, crops, and other commodity areas. To some extent these stocks have the wind to their back right now but we need to be cautious – these businesses are highly cyclical.


Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

We are looking for opportunities to take advantage of these trends but we do not want to be dragged into the hot-trader mindset. We are looking at what is panning out through the eyes of a long-term investor.

You will recall that in the springtime we sold the position many accounts held in Shaw Communications following Rogers’ takeover bid for Shaw, which made the stock price leap higher. Following that sale we were looking for an opportunity to increase exposure to the telecoms space and specifically looking at Rogers Communications. Awaiting a better entry price for Rogers we have not yet purchased any shares and thankfully so – current boardroom drama at Rogers has pushed the stock price meaningfully lower, from above $67 in July to a recent low just above $56.

Respectfully submitted,

Paul Fettes, CFA, CFP
Chief Executive Officer,
Brintab Corp.

Posted in All Archives, Asset Allocation, Financial Planning, Investment, Risk Management, Uncategorized Tagged with: , , , ,

Commentary July 2021 – Assessing Economic Progress

Reblogged from Brintab.com

With the gradual reopening of businesses post-Covid, we are seeing glimmers of hope regarding the economic recovery.  Still, the pandemic created chaos that continues to settle out bit by bit.  There were changed buying habits, pent up demand, supply chain chaos, bankrupt businesses and unemployed workers that, beyond the first level of the recovery, where the rising tide floated all boats, has now left us having to get a refined assessment of what is back to “normal” and what parts still have a long way to go.

Bonds and Interest Rates

There has been so much stimulus by central banks and so much central bank support for governments (especially the US) spending and going deeper into debt that stock and bond market participants have been walking on eggshells wondering when and how intensely central bankers will start to jack up rates as the economy recovers.  In terms of cooling off overheated markets will it just be a cool mist or an ice bath?

There was not much deviation by central bankers from prior guidance until mid-June.  Investors were becoming increasingly concerned that the US Federal Reserve was going to let inflation get too wildly out of control without reining it in by boosting rates.  Then in June Fed Chairman Jerome Powell, followed by others, made comments about recognizing that inflation had grown more than expected, that some of it was not transient, and that interest rates may increase sooner than previously thought.

Fig. 1: Bond ETFs:  Gov’t (XGB), Corp (XCB), High Yield (XHY) – 2 years – Yahoo Finance

This triggered a mid-June market pullback as can be seen in the response of the bond market, the US currency, and the stock market.  Even though this interest rate rally grabbed a lot of headlines in June’s financial papers, you can see from the tiny dip in government and corporate bond ETFs in June that it was trivial compared to the ups and downs we have seen in bonds over the past two years.  Now we do expect that bond yields will face some upward pressure on the horizon but the reality is that there are certain areas of the debt markets (mortgages, corporate debts) that would feel major strain from even the slightest rate increase and so the Fed (and other central bankers in many countries) likely has its hands tied – it can’t let rates rise much.

That implies the central banks may have little choice but to keep rate increases modest even though some segments of the economy are experiencing ongoing inflation.  This results in a difficult scenario for bonds.  To be precise, corporate bond yields may barely keep ahead of inflation.  With stock markets somewhat bubblish, it will pay to have some money in bonds when the stock market pulls back but upon witnessing a regular business cycle pullback, it will likely be high time to keep government bond exposure low.

Currencies

To a certain extent, you can consider interest rates and currency exchange rates as joined at the hip.  They are strongly linked to how one country economy is doing relative to another. For example, if the US economy is floundering (forcing the US fed to keep interest rates low) while the Chinese economy is recovering strongly (causing Chinese central bankers to raise interest rates) then all things being equal we would expect the US Dollar to weaken while the Chinese Yuan strengthens.  A huge flow of bond investors would be converting their cash from USD to Yuan to buy higher yielding Chinese bonds, putting downward pressure on the USD and upward pressure on the Yuan.  This happens with currencies around the world as they jostle to establish exchange rates reflective of each economy’s strength relative to each other[1].

Fig. 2: US Dollar Index and Cdn Dollar vs USD – 2 years – Yahoo Finance

With that in mind we can see (Figure 2) that since the Covid-induced US Dollar spike in Mar 2020 the US Dollar has faded not only against the CAD (blue line) but also against a basket of currencies (green line).  It is clear that the US government is going to need to spend extensively (and the central bank to keep rates low) for a significant period of time while other economies (especially global economy number 2: China) are poised to recover much better.

In June 2021 we can see that the USD recovered somewhat against the CAD and also against a basket of currencies but this June bounce still leaves the USD meaningfully down since its pre-Covid levels of 2019.  The new range is likely where the USD will settle out for a while until we eventually see more clarity on how different economies are recovering from the Covid-induced economic shock and also how various geopolitical tensions play out under the Biden regime, especially with respect to US-China relations.  As such, the relative economic strength may be fading in importance and the safe haven effect may be rising in importance as it relates to the USD exposure decision.  That spells a continued role for US stocks (as opposed to Canadian stocks) in portfolios, since it has been some time since we have experienced any geopolitical shock.

Stock Markets

Through the late spring we saw Canada continue to gradually build strength while we saw a continued decline in Japan and roughly flat-lining in the UK, Germany and the US (until the US market once again bounced higher in June).  The continued Canadian strength spanned various industries but of particular note (because the industries are so big) are banking and oil.

The banking sector is being driven by modest non-performing loans, strong loan growth and rising net interest margin.  People are getting back to work and mortgage delinquencies are less than feared.  As housing prices skyrocket, so does mortgage loan growth.  Furthermore, if you consider that banks borrow short term (daily chequing accounts etc.) and lend longer term (e.g. 5 year mortgages) then they will do well when 5-year rates rise up while short term rates stay pinned low.  That is exactly what we are seeing now.

In the oil sector, despite long term pressures to move away from fossil fuels, the industry is still driven primarily by the near-term price of oil.  That has been on the rise and has helped the oil industry.  There are constant debates about when Iranian oil will return to the market in volume, and about the pace of demand recovery around the world (i.e. people driving once again in a post-pandemic environment.)  The balance of oil supply and demand is something hard for OPEC to finesse and equally hard for investors to predict.  Nonetheless oil has been on the rise, taking Canadian energy stocks with it.

Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance

With all this froth in equity markets, one might wonder where we go from here.  It is worth remembering that timing market tops (and bottoms too) is supremely tricky business.  That said, our current efforts to put money to work is focusing primarily on low volatility investments.  For example, just at the close of the quarter we made a purchase in numerous client accounts of some preferred shares of Enbridge.  Without getting into the details of the security, you could generally consider that preferred shares are lower volatility than common shares and are usually bought primarily for their dividend yield, which for the Enbridge pref was high single digits.  Furthermore, for any taxable accounts they are taxed more gently than bond interest.  We continue to look for opportunities to put money to work earning returns that are more reliable and expect to find some over the summer.  Stay tuned.  In today’s market it is not likely the time to layer on a lot of additional risk.

In the April letter I wrote “In the time since the 2008 financial meltdown just over a decade ago, we saw many corporations use the presence of low interest rates to load up on debt and pay out profits to shareholders.  They mostly did this by buying back shares in the open market and cancelling them.  If the same company has fewer shares outstanding, then implicitly the value per share rises.”

The caveat to this is that the company should be paying to retrieve the shares from the market a price that is less than the company’s value per share.  Some companies carry out buybacks willy-nilly regardless of whether their own shares are undervalued or overvalued.  Other companies like Berkshire Hathaway and Fairfax Financial take a much more calculating approach to this.  They buy back specifically when they think their own shares are undervalued.  When management that we believe in buys back shares, we see it as a strong vote of confidence for the business.  This spring Fairfax India (run by the Prem Watsa team at Fairfax Financial) undertook a buyback.  Normally a company would buy back shares in the open market and you would not directly hear about it but Fairfax India did it by way of a Dutch Auction.  You may have received materials in the mail giving you the opportunity to tender your shares to the buyback.  The company is run by someone often called the Warren Buffett of Canada.  Prem Watsa’s leadership is one of the reasons for the Fairfax India investment in the first place.  Furthermore, once the toll of Covid has abated in India, the country has strong long run growth prospects.  As such I have not tendered any shares to the offer.  I think it’s better to stick with this management team for the long term and I certainly appreciate seeing their strong vote of confidence in their own long-term prospects.

Respectfully submitted,

Paul Fettes, CFA, CFP

Chief Executive Officer,

Brintab Corp.

Posted in Financial Planning, Investment, Risk Management, Tax, Uncategorized Tagged with: , , , , , , , ,

Commentary April 2021 – A World Refocusing

Reblogged from Brintab.com

As the winter progressed, markets were driven more than anything by increasing signs of successful vaccine rollout and hence risk reduction in the global economy.  Early in the quarter markets bounced around a bit but the month of March saw full-speed ahead.  The acknowledgement of the Covid 3rd wave did not yet appear evident.

Bonds and Interest Rates

As signs of increased certainty emerged (first a successful transition of presidency in the US and then increasing roll-out of Covid19 vaccines) the investment world gradually began to conclude that the central banks may not need to keep interest rates pinned down to the floor as long as originally thought.  Rising longer term rates offered on new bonds means falling prices for existing bonds and so in February we saw government bonds (represented below in blue) and low risk corporate bonds (below in green) decline, before stabilizing in March.

This means that the “safe haven” part of portfolios struggled through the winter, but was offset by strong equity markets. Still, having some very low-risk, counter-cyclical investments is key to a long-term prudent portfolio and so we still see a role for these investments.  It’s just that this quarter wasn’t their time to shine.

Fig. 1: Bond ETFs:  Governments (XGB), Corporates (XCB), High Yield (XHY) – 2 years

Late in March we saw bonds bounce back a little bit.  This may have been related to the surprising surge in the Covid19 third wave impacting Canada, various parts of Europe, India, Japan, Brazil, and others.  While there has been substantial vaccine roll-out in the US and the UK, and also China has kept Covid19 spread under control, they can’t do it alone.  Through the spring we will see how markets absorb the news of the third Covid wave.

Currencies

This winter was a tale of two worlds.  If we ignore the brief spike down (USD weakness versus CAD) in the blue line of Figure 2, the general trend below over the past quarter was US dollar rebounding strength versus a basket of currencies but continued weakness against the Canadian Dollar.  The Loonie has strengthened on the backs of rising prices for commodities (of which we export a lot) as well as the fact that the Bank of Canada seems more tolerant of rising interest rates here in Canada than central bankers in other countries.  Indeed, the red hot Canadian housing market has put pressure on the Bank of Canada to raise rates a bit to cool things off.  Meanwhile, the US has done better than other countries in rolling out vaccines so their interest rates might rise sooner than rates in other countries abroad.  This has led to a bit of a recovery in the US Dollar versus some other currencies.

Fig. 2: US Dollar Index and Canadian Dollar versus the US Dollar – 2 years

A second factor is the probability of the US government approving a stimulus program worth over $1 trillion!  To the extent that happens, the US Federal Reserve will certainly be likely to increase interest rates to keep the economy from overheating. All else being equal, such an increase in US rates would strengthen the USD versus other currencies.

Stock Markets

In January I commented on the major outperformance of tech stocks versus the rest of the market and how that, combined with US tech stock concentration, made the US market look so much better than others.  Later this winter we saw a bit of a retrenchment of that differential.  Although Figure 3 below still shows that the US market (in purple) as done the best over the two-year snapshot, looking at the month of March 2021 will show that Germany (in green), a major industrial goods producer and exporter, had the steepest rise, even steeper than the US market.

Fig. 3: Equities USA-purple, Canada-blue, Japan-red, UK-yellow, Germany-green – 2 years

In the time since the 2008 financial meltdown just over a decade ago, we saw many corporations use the presence of low interest rates to load up on debt and pay out profits to shareholders.  They mostly did this by buying back shares in the open market and cancelling them.  If the same company has fewer shares outstanding, then implicitly the value per share rises.  There was a much weaker tendency by many corporations to reinvest in growing their businesses.

That may be about to change.  There may be a significant refocus in the use of corporate funds.  Just consider the following few examples:

  • a transition to electric vehicles on the horizon
  • a shift in electricity generation from coal to other sources
  • a need to reinforce sea sides from rising ocean levels
  • a need to refresh electrical distribution networks long left to perennial decline
  • a reshoring of businesses due to geopolitical hostilities
  • automation and artificial intelligence that triggers fresh innovation

We could dispute this, arguing that at any point in time there is always a long list of societal shifts that drive the need to invest in the future.  Nonetheless, I view these shifts more as a series of long waves rather than a steady assent and after a decade with a dearth of reinvestment, I feel strongly that a decade of capital spending may be in the cards now. This logic is in sync with the recent rise in markets in Germany, a capital goods powerhouse of the world. This narrative will certainly impact our perception/ interpretation of the potential opportunities we scan.

During the quarter we had a couple securities held in various client accounts worth noting.  For some time we have considered Shaw Communications as an undervalued stock.  This winter Rogers and Bell decided they shared our opinion.  A takeover contest happened for Shaw, with Rogers the likely winning bid.  The price of Shaw stock leaped and we sold it shortly thereafter.  Also during the winter, there was a takeover bid for Atlantic Power, a company whose preferred shares we own in various accounts.  As a result, the preferred shares jumped.  The bid was approved at a vote shortly after the end of the quarter and in time we expect the preferred shares to be sold.

Respectfully submitted,

Paul Fettes, CFA, CFP Chief Executive Officer, Brintab Corp.

Posted in All Archives, Asset Allocation, Financial Planning, Investment Tagged with: , , , ,

Commentary January 2021 – Coping with the Froth

Reblogged from www.brintab.com

This fall we saw mostly continuation of trends from the summer best described as splitting of the investment world.  The prospects of a Covid19 vaccine and US government spending triggered major shifts in currency and certain stocks continued to part ways with the herd.

Bonds and Interest Rates

You can see from XGB charted below that government bonds peaked at the beginning of August and have gradually declined since then.  This is in line with an investment world getting more comfortable with the state of the Covid19 world and drawing money away from safe haven investments toward more risky investments.  Meanwhile, investment grade corporate bonds (XCB) dipped into the beginning of November and recovered after that while high yield bonds continued to rise through the quarter.  This decline in government bonds and rise in high yield (i.e. higher risk) corporate bonds illustrates the shift from safer to more aggressive investing.

I would note that a lot of the survival of certain at-risk corporations has come from government subsidies, government buying corporate debt, bank loan deferrals, and various other tactics to prop them up.  This means you shouldn’t exactly interpret the shift toward corporate investing as a sign these companies are once again in good stead.  The reality is that many lower grade corporations are on life support.


Fig. 1: Bond ETFs:  Governments (XGB), Corporates (XCB), High Yield (XHY) – 2 years

The transition from a Republican-led to Democratic-led US Senate (only fully clear after the two Georgia senate races concluded after the year-end) means there is increased US government appetite for spending to prop up the economy and so investors largely feel the government has got their back.

Late in the year we saw long-maturity government bonds fall dramatically, illustrated by TLT.  This signals investor belief (due to government spending and also the vaccine roll-out) that the government will successfully navigate the economy to a recovery and with the huge inflationary effect of all that government spending, interest rates will rise in the long run.

Traditionally, when government bond prices fall (implying interest rates rise) it has presented a good opportunity to buy bonds and the like.  Ultimately they change course and rise back up.  Note however that since the peak of interest rates in 1981 we have experienced a 40-year decline in interest rates (which means bond prices rising).  For bond investors, the wind has been at our back, so-to-speak.  Now, with interest rates for long maturity government bonds barely above 1%, is that still a realistic expectation?  It’s not so certain. As a result, when the stock market heats up, these days we are more likely to look for lower cyclical stocks, rather than shift to government bonds.  That said, there is still a place (but smaller) for the stabilizing effect of government bonds in many portfolios.

Currencies

In general, government spending is inflationary and devalues a currency (at the rate of inflation).  Typically, we associate this phenomenon with small emerging countries with poor fiscal discipline but in 2020 it became clear that the immense government spending to keep the US economy from totally falling apart, combined with the US Federal Reserve commitment to keep interest rates low even in the face of inflation above 2%, meant there was a partial exodus from US dollar holdings.  From its high on 23 March, 2020, the US dollar fell 12.6% versus a basket of other currencies.


Fig. 2: US Dollar Index and Canadian Dollar versus the US Dollar – 2 years

A decline in the USD is usually associated with a “risk-on” investing stance.  That unfolds because when investors are more at ease they sell US dollars and buy foreign currency to invest further abroad.  On the other hand, when US investors get panicky, they sell their foreign investments and bring their money back to the US, pushing the US Dollar up.  For us, as investors with part of our portfolio in US stocks, I have noted before that this currency impact means that when stock markets falter our decline is muted because the rising USD partially offsets the falling market.  On the other hand, when the stock market is soaring, the typically sliding USD dampens our upside.  Overall the impact smooths our portfolio but this fall has been one of those “dampening our upside” phases.  It would sound nice to jump into and out of US investments according to the stage of this cycle but of course being able to execute on that time after time after time is in my mind naively optimistic. It’s better to think about long term strategic portfolio construction and put together US and Canadian exposure that helps us in the long run.

That being said, we do always think about where to put to work our incremental cash whenever we have cash sitting on the sidelines and a weak US Dollar does at times tilt the investing table in favour of buying US stocks.  Now is likely such a currency-induced tilt.

Stock Markets

Usually when reviewing stock markets I use indices from around the world to convey how different parts of the global economy are doing.  Broadly speaking the US stock market has outperformed other markets around the world but the question is why.  It is not precisely the better US economy, it is more driven by the fact that the US stock market contains more high technology stocks than any other stock market in the world.  Therefore, digging a bit below the surface we can see that the difference is really driven by techs stocks versus non-tech stocks.  The top 52-week performers in the S&P500 index are dominated by the likes of Tesla, Etsy, Nvidia, Paypal (all high technology stocks).  Meanwhile other parts of the market just inch along to varying degrees.

As was the case with the dot-com implosion of 2001, some of these high-flyers are trading at nose-bleed prices.  For example, Tesla is trading at 204 times next year’s earnings.  That means if Tesla were to start paying out investors all the company’s annual profits as dividends and were able to maintain that profit level it would take investors two centuries to break even!  Maybe Tesla will do well and double its profitability.  Then it would only take one century, not two to break even!  For anybody who has been investing a while, this is reminiscent of Nortel.  Take a look at the charts below.  On the left is the market during the three-year period from 1999 to 2002.  On the right is the three-year period starting in 2019.  The red line is the QQQ, indicative of tech stocks. The blue line is the SPY, indicative of the broader market.  The intense escalation of tech stocks is astounding, once again.  The difference this time around is that tech stocks have infiltrated the SPY more, so this time tech stocks are driving the broader index up too, while the rest of the stock market just trudges along.

When looking at other fad investments, the likes of bitcoin illustrate that there is extreme bullishness (i.e. buyer beware) in various corners of the market.  Government stimulus may push the market higher but things are looking pretty frothy right now.

With that in mind here is what we have been doing.  We have found various businesses trading at modest prices and also some reasonably priced preferred shares.  For the most part the businesses we have found are not part of the ra-ra trend.  We have been buying positions in the likes of Unilever, Loblaws, and Hydro One, all what I would consider very stable businesses.  We have also found preferred shares in utilities, grocers, and the like, yielding dividends in the 4-6% range.

Furthermore, with the economy so frothy and also with the chance of inflation triggering possible further US Dollar depreciation around the corner we have taken a step that I have not taken during my investment career: we have taken a position in Barrick, a gold stock.  To a large extent the price of Barrick moves with the price of gold and the price of gold moves with inflation fears.  Essentially this position is a hedge against runaway inflation, given all the government spending.  I am hopeful that it is not needed – that inflation is deftly managed by central bankers and our gold stocks do little while our other stocks do well.  That said, it does provide protection.  Barrick peaked this summer around $40/share before falling back.  Depending on the account we bought some Barrick shares just below $34/share and more shares in the $29s.  Lately it has been trading between $28½ and $31½. We will see how necessary the protective hedge was in the year ahead.


Fig. 3: Tech stocks in red, broader market in blue – 1999-2002 on the left, 2019-2022 on the right

In terms of selling, we have been reducing long-held positions in some of our high-flyers such as Maxar (the latest incarnation of the old McDonald Dettwiler/Spar Aerospace/ Loral Systems).  Another example of a good company trimmed back is CME Group (the Chicago Mercantile Exchange), which runs financial exchanges.  We still like the company but have to be prudent.  At the same time there has been a bit of portfolio housecleaning.  Western Union was sold.  While the company is impressively well-entrenched around the world, in reality there are many different technologies such as cell phone money transfers, cross border bank cards, etc. that are all nipping at its heels.  In the end WU might come out a winner in the international money transfer business but the way I see it, it won’t be easy.  Parting with solid businesses is a hard thing to do but portfolio pruning is our job.

Respectfully submitted,

Paul Fettes, CFA, CFP
Chief Executive Officer,
Brintab Corp./Efficertain Corp.

Posted in Asset Allocation, Financial Planning, Investment, Risk Management, Uncategorized

Commentary October 2020 – a touch of rationality

Reblogged from Brintab.com

After markets recovered this spring from the worst of the pandemic impact, the summer was a season of optimism, perhaps misplaced optimism, while a little bit of realism arrived with the coming of fall. There will likely be more ups and downs over the next few months in financial markets as an understanding of the long-term impact of Covid-19 gradually becomes clearer.

Bonds and Interest Rates

While the fixed income markets experienced a continuation of the springtime recovery in July, for the remainder of the quarter bond prices slightly faded as interest rates drifted higher. Late in the summer there were various signs that the economy was not recovering as quickly as hoped and the US Federal Reserve emphasized they would keep overnight rates low even while they allowed inflation to gradually rise and stay above the 2% target of the past. If there is longer term inflation on the horizon, long bond interest needed to rise (and thus bond prices needed to fall) to reflect that.

With the US and Canadian economies (as well as those in many other parts of the world) in dire need of government spending to prop the economies up, there is going to be a flood of government bond issuance to pay for it. It will take all the central bankers can muster to keep interest rates from rising. Central banks will be big buyers of government bonds to keep prices bid up (i.e. keep interest rates down).

Where do we go from here? Government bonds were a good safe haven during the spring and early summer. Now, it seems they face a stacked deck. Bonds might rise a bit, but on the other hand, there is a strong likelihood they will either stay flat (dead money with almost no yield) or fall off. In the income oriented space they may not be the place to be! Future-oriented income investors better be looking for more rewarding and potentially inflation responsive investments in the months ahead.

Currencies

All through the summer the US dollar slid against the Canadian dollar and against a basket of other currencies, too. This amounted to not just the usual “risk on” trade but was strengthened by an exodus of currency traders from the US Dollar upon realization that the US government was going to be issuing a mammoth amount of debt (an inflationary pressure) and also the Federal Reserve was going to keep short term interest rates low (adding fuel to the inflationary fire) while the government issued the debt. High inflation is a good recipe for a declining currency, especially when the Federal Reserve declared that they fully intend not to pay enough interest to keep up with inflation. Unless you own stocks or something that is going to rise with inflation, the USD is a poor place to park your money. Of course, when risk briefly arose in September, investors flocked back to the “safety” of the US Dollar, however is that short-lived? Over the next 6-12 months I expect we will see the US Dollar flip-flopping before it trends lower, but lower against what? We know that the UK, Canada, Europe, and Japan all need to spend like drunken sailors to keep their economies afloat. Which countries are in a stronger position? China, among others. Generally speaking, developed country governments all went into this pandemic with a full serving of debt. Beyond China, the governments in the strongest debt position were primarily those forced onto a “debt diet” before the pandemic came along.

Are those glad tidings for the Canadian Dollar? Along with Australia, ours is one of the few major developed economies with a heavy natural resource exposure – in our case to oil. Even though oil is on the back foot right now with floundering demand and green investors steering investment money towards renewables, oil demand is global, encompassing many growing emerging economies. Oil prices will strengthen, and with oil prices the Canadian Dollar will eventually strengthen too. I’m not suggesting anything like trading at par to the USD, something it briefly flirted with a few years ago, but the leaning will be more towards a stronger Canadian Dollar than a weaker one.

Stock Markets

In equity markets a handful of tech stocks that were surrounded by euphoria dominated the US market. Other markets around the world recovered but did not do nearly as well. The driving force behind the economic recovery was the sense that the pandemic was being contained and everything would be okay. Spread of Covid19 in Canada and many other countries was subsiding and promises were being made that a vaccine was right around the corner. Late in the summer investors lost confidence in the lofty valuations of tech stocks. Adding to this, emerging statistics showed that fuel consumption during the US summer driving season undershot expectations and it became clear a vaccine was not close at hand and Covid cases were rising. The exuberance began to fade.

By the end of September, market participants became more focused on the “when” and the “how much” of the government stimulus, particularly from the US government. Also, markets began to slightly pivot towards industries that would benefit and away from industries that would be hurt by a Joe Biden presidency. This means some of our long-term business holdings have been hurt and some helped in the short term. We can see from the recent stock market dip (especially in the US) that investors are still coming to grips with the impact of the Covid19. Many businesses have clung on for dear life but (particularly retailers and restauranteurs) are bleeding red ink badly. I fully expect to see another market pullback in the year ahead as many storefronts close and at this point in time I am primarily choosing new securities with that outlook in mind.

Respectfully submitted,

Paul Fettes, CFA, CFP
Chief Executive Officer,
Brintab Corp./First Sovereign Investment Management Inc./Efficertain Corp.

Posted in Asset Allocation, Investment, Risk Management

We’ve just witnessed the stock market’s echo, echo, echo!

Reblogged from brintab.com

The echo has arrived. Over the course of the spring and summer I have often talked about how most major stock market pullbacks are followed by a rise up and then a second pullback. That second pullback (the echo) is upon us. Over the summer stock prices recovered from the March lows to reflect very optimistic (let’s say extreme) investor expectations. Since about the beginning of September we have witnessed a decline in the S&P500 index and various markets around the world.

Near the end of the summer, statistics showed that US fuel consumption during the summer driving months came in below the optimistic mid-summer expectations. That was followed by a decline in the tech stocks that had risen far out of step with the rest of the market and the economy. Then we began to see a resurgence in Covid19 infections in Canada and many parts of the world. The oil consumption undershoot, the spooking of momentum traders about tech stocks, and the increase in Covid19 were enough to knock the froth off the markets. From its summer peak of almost 3600, the S&P500 index has fallen just over 10%, and fallen back to early July values.

While it is not realistic for investors to think they can time the market bottom, the pullback has brought some rationality to the market that was missing this summer. Over the course of the summer I had parked some of my money in government bonds and the like. Even though the interest they pay is a frustrating pittance, it now looks like that was a decent place to be to sit out the summer’s rollercoaster. Now there are likely much more reasonable opportunities to be had this fall.

Posted in Asset Allocation, Financial Planning, Investment, Risk Management, Uncategorized

Time to rethink RRSPs?

Is the writing on the wall for cliché RRSP-driven tax strategies? In the past, for many families it was almost a standard response that if you were in the 32% marginal tax bracket in your working years then you should definitely defer the tax by buying RRSPs. In all likelihood you would be in a similar bracket or drop to the 20% bracket in retirement. That may be about to change.

We all know that the federal government is running up massive Covid-induced debts to keep the economy on life support. Governments around the world have all reached for their cheque books in the same way. In 2019 the federal debt was about 685 billion. Some forecasters peg it approaching 900 billion by 2021. If interest rates stay on the floor then the interest expense of servicing the debt is a manageable cost but at some point, without central banks buying a lot of government bonds and “kicking the proverbial can down the road.”

Ultimately, some politicians will bow to pressure to get the debt under control. With the economy on life-support, and likely to continue so for some time, cutting government spending is not going to be the source of much improvement. At some point, the government will undoubtedly turn to taxation as a way to get the debt under control. They cannot tax the working class much without cutting the legs out from under the economy so there is a decent chance they will tax the rich. The thing is that top bracket tax rates are still pretty high and the wealthiest have ways to move their money outside Canada if things get too egregious. Thus, the taxman will likely go down-market to the upper middle class, whose money is less likely to flee Canada. That could happen in a variety of ways such as:

  • Lowering the threshold for each tax bracket so you run into a higher bracket sooner
  • Deindexing the annual reset of each tax bracket that currently lets the bracket rise with inflation
  • Eliminate exemptions like recently done with cash profits retained inside small businesses

The first two – deindexing and bracket shifting have the potential to put various taxpayers in a higher tax bracket in retirement than they are in now. This steals away the main benefit of the RRSP – putting money away for a 32% credit now and eventually taking it out for 20% taxation down the road.

While the details of the government’s tax strategy will only become apparent over time it is worth questioning the standard assumption of always putting away money in your RRSP whenever you can. In the months ahead we will be watching for signs of direction in taxation – direction that may make us rethink our response.

Posted in Uncategorized

Rainmaker or Storm-maker? Is this roller coaster coming from Trump?

Reblogged from First Sovereign Investment Management

Recently we in the investment world have been coping with the uncertainty related to the combative trade negotiations between the USA and China. When faced with the Trump regime’s caustic approach to trade negotiations, other nations (e.g. Canada and Mexico) have taken more of a placating approach. Conversely, China’s leader Xi Jinping has fought back aggressively and very publicly against the US stance. For example, state-run news agency Xinhua recently ran an article entitled “Forcing ‘America First’ on others will lead to ‘America Alone’” as a counterattack.

Through the winter the US government routinely released comments on how well the trade negotiations with China were going. Notably all through that period China was NOT releasing similar upbeat comments. Once talks fell apart this spring, there was a broadening of the issues tabled from trade alone to a long laundry list including issues such as Taiwan’s independence, Muslim minorities in China, Belt-and-Road Project’s alleged predatory lending, and control of the South China Sea. This morphed the narrowly scoped trade negotiations into an overall battle about America’s global dominance. The scope expansion and the entrenched positions of the two parties tell me we will wait a long time before seeing headway.

Adding yet another layer of geopolitical turmoil, the US government’s approach toward Latin American refugees has been all stick and no carrot but has not made progress on the issue at hand. The latest response was to target Mexico by threatening a stairstep series of tariffs on all imports starting June 10th.

What has been the result for investors? It seems like the negotiation rainmaker has become more of a storm-maker (let’s hope it’s a tempest in a teapot). If you look at the chart below of the S&P500 Index (US stock market indicator) you will see that in early 2019 the market rose up from the Dec 2018 lows but after the May 2019 selloff the US market is now roughly where it was almost a year and a half ago at the beginning of 2018!

Meanwhile let’s take a look at the VIX index (below). This index shows the implied monthly volatility levels expected in the S&P500 stock index. You can see that through 2017 the expected volatility was generally confined to the 10-12 range but starting in 2018 it really rose up. Now the expected volatility tends to be in the 12-24 range with occasional spikes up into the 30s.

Some pundits claim we should not be too overly concerned by these sensational political headlines and just focus on what is happening in the real economy. I disagree. Solely monitoring the real economy is like looking in the rear-view mirror instead of looking toward the future. The real economy is driven by spending (mainly consumer spending and business investment spending). The ebbs and flows of spending depend on consumer and business confidence. The link to the real economy is that headlines can sow the seeds of worry, then worry can spook confidence, and weakening confidence can soften spending, both at the consumer and the business level.

But let’s not be chicken little; the sky’s not falling. In the world of finance here are a few tidbits I have learned over more than two decades in the industry:

  1. At the core of the investment process, prioritized above regular stock selection, first come strategic asset allocation and diversification. While we constantly search for specific investment opportunities, we start with setting the right strategy and ensuring diversification as the top two priorities. This implies staying strategically focused on the long term.
  2. Bear cases are seductive arguments. Because the media tend to grab sensational, often worrying stories, it is always easier to put together a so-called ‘air-tight’ hypothesis based on downside than on upside. Despite these fearmongers, over many decades markets have risen as companies continuously invent and create. Thus, we need to beware of falling prey too easily to bear case hypotheses.
  3. If you can tolerate volatility, then volatility can be your friend. We aim to buy stocks where the stock price undervalues the business and sell stocks where the price overvalues the business. To do this we rely on the twin emotions of fear and greed in the market pushing around stock prices until they reach unreasonable levels (too low or too high). If the market did not have this emotion and volatility it would be harder to find mispriced stock opportunities.
  4. If you watch the news media, the primary advice is to get out of this industry/sector; get into that one; get out of equities; get into bonds; get into equities; time to buy gold. This approach to investing is referred to as market timing. Market timing is one of the most difficult tactics in investment management. While this may make good news fodder, most people trying to implement it will not get the timing perfect and analysis shows that if your timing is off by even a little bit, you don’t make the profits and potentially lose money. That’s why many experts call overall market timing ‘a mug’s game.’
  5. Indirectly a value investing approach will often automatically adjust asset allocations to reflect the ever-changing economic cycle by looking at company valuations. This can lead us to buy industrials when the time is right, and likewise utilities, etc. When we sell a business and raise cash, we are looking for places to reinvest that cash. Often the stocks most out of favour will have the lowest prices and look the most appealing. This value-focused process often leads to buying out-of-favour stocks and naturally preparing for what will do well in the future rather than what has done well in the recent past.

Do today’s circumstances represent a rare occurrence? While some commentators like to blame the entire situation on President Trump, the reality is that if we look back through past economic cycles we see that this has happened before. Often, early in an economic recovery the market rises up relatively smoothly. Then later in the cycle when the recovery becomes more “mature” we tend to see more volatility and periodic pullbacks. Later stages of an economic recovery are never as smooth as the early stages. For example, if I look at my own personal portfolio I see that after the winter’s rise up, the portfolio was down 4.5% in the month of May. Then from May 31 to June 11th it was back up from the 1.3% in the next 7 trading days! I expect these bigger routine moves will generate opportunities on both the stock buying and the stock selling process.

Paul Fettes, CFA, CFP
CEO, First Sovereign Investment Management Inc. and Efficertain Corp.

Posted in All Archives, Investment, Risk Management Tagged with: , , , , , ,

Market pullbacks

Reblogged from: First Sovereign Investment Management

In the past couple month, the increased volatility of investment markets has led two clients to write to get my sense of the market situation and how/if we should react to that. With the sense that the voices of a couple might represent the thoughts of others, I wanted to share with all clients some reflection on recent markets.

If we zoom into the relatively short-term perspective of the last 12 months the chart below shows what things have looked like for the US stock market index (in blue) and for the Canadian index (in purple). In 2018 we have seen the first big ups and downs in the beginning of the year and then the second time again in the last couple months, predominantly in October with follow-on tremors in November and December.

We can point the finger at several different factors but they largely fall into two groups. First there is the geopolitics. This group includes issues such as the US-China tension, American sanctions against Iran, rumours of a military coup-d’état in Venezuela, concern about a rough Brexit, OPEC oil negotiations, Russian meddling investigations, and more.

Secondly there is the maturing economic cycle. The USA and China are the largest two economies in the world. In the USA, strong economic growth, low unemployment, and the risk of rising inflation has led to a series of interest rate increases to cool the hot economy. Thus, prognosticators are predicting slower growth ahead. In China, a tightening of lending, among other factors, is slowing the multi-decade growth that had become the norm in China.

Ultimately the concern is that the global economy will cool too much and tip into recession. Combining the first and second group of factors I would draw your attention to the following:

  1. In general, the factors of the first group (geopolitics) do not trigger recessions. Geopolitical issues do garner major headlines and make the stock markets more of a wild ride but typically cooler heads prevail and some resolution is achieved even if it is no more than a tense temporary truce. Even with President Trump’s supposed willingness to cancel NAFTA during negotiations, compromises were made and it eventually got signed. Nonetheless those geopolitical issues trigger continuous regular cycles of market fear and euphoria.
  2. There is a well-researched body of research regarding investors’ mental processing that shows the average person’s analysis of anything distorts facts by putting much more emphasis on the recent past than the distant past. It may seem that there are a lot of geopolitical issues on the table right now and that they are all significant but if I asked most people how many issues and which issues were of concern back in say 2005, few people could list more than 1-2. Does that mean 2005 was much more stable than now or does it mean that memories fade?
  3. The second group of factors (which I will call bank credit tightening) is the group that more typically drives a recession because it is tricky to precisely cool off the economy enough but not too much (a Goldilocks economy). It is like trying to thread a needle. In that sense we have seen various central bankers soften their message in the last couple weeks on credit tightening so things are looking better on that front.
  4. During an economic expansion like we have witnessed over the past few years there are a series of scares and market pullbacks that happen during the economic rise.

Take a look at the chart below. I showed only the US index for the past 20 years, excluding the Canadian index for simplicity. You can see the dot-com triggered recession of 2001 (1) and the sub-prime lending recession of 2008 (2). You can also see the pullbacks in 2004, 2006, and later in 2010, 2011, 2015, and most recently in the autumn of 2018. The major recessions drove two big declines where the S&P 500 US market index retrenched 49% from the dot-com bubble and 57% from the sub-prime crisis before recovering. Furthermore, the sample pullbacks that happened in between recessions showed retracements in the range of 8%-19% (see table). In the fall of 2018 we have experienced a pullback of around 10%.

Of course, every recession starts with what basically looks like a small mid-cycle pullback so given what we’ve seen this fall some people will wonder whether we should be running for cover.

S&P 500 Index peak trough percent decline
1: 2001 dot-com recession 1527 777 49
a: 2004 pullback 1156 1063 8
b: 2006 pullback 1326 1224 8
2: 2008 sub-prime recession 1565 677 57
a: 2010 pullback 1217 1023 16
b: 2011 pullback 1364 1099 19
c: 2015 pullback 2131 1829 14
2018 autumn to 13 Dec 2931 2633 10

Does that work? Imagine investors exiting the market in 2016 just after a 14% decline in the market. Those investors would have missed out on the recovery of 2016 which basically offset the losses of 2015. At what point would they have reinvested? Likely after the market had shown substantial recovery such as in late 2017. How would their performance compare to the markets? Not too well, to say the least! A lot of research has shown that trying to time the tops and bottoms of the market is almost impossible for even the best experts.

That said, should we be doing anything differently late in the economic cycle than early in the cycle? We need to differentiate between strategy and tactics. First and foremost, we should always make sure we are in the right place with respect to long term strategic asset allocation. Crudely speaking, this relates to two factors we need to balance: our return expectations versus all kinds of constraints we face such as our investing time horizon, our financial ability to tolerate various outcomes, and how much volatility we can stomach along the way.

Once we have the strategic asset allocation right based on the long term, then the investment approach doesn’t change but as we progress through the cycle some things become self-adapting and result in natural tactical changes.

Fundamental investing is about finding stocks worth more than the price they are trading at right now. Together we have purchased many stocks that analysis has indicated could be worth a lot more than the purchase price. As the economic cycle progresses some company shares rise in price and we have to sell them. Sometimes the economic cycle heavily influences which companies or industries are in favour (expensive) and which are out-of-favour (cheap). That is how the selection of out-of-favour stocks is to some extent self-adapting to the economic cycle so it shifts somewhat naturally without us having to try to predict the cycle.

We still have our ups and downs but we are generally confident in the businesses we own, something that helps when Mr. Market seems to bounce stocks around more than usual. Here is an internal test I perform: When a stock goes down am I inclined to buy more or to sell? During the recent pullback we bought a variety of stocks, highlighting confidence in the underlying business fundamentals, despite the daily gyrations of Mr. Market.

Paul Fettes, CFA, CFP
CEO, First Sovereign Investment Management Inc. and Efficertain Corp.
Registered Agent, Verico Reliance Mortgages, FSCO #10357

Posted in Financial Planning, Investment, Risk Management Tagged with: , , , , ,

Real Estate Capital Gains Tax: Budget 2017

What’s your game plan for winding down your Capital Gains tax liability?

Yesterday Canada’s Finance Minister presented the government’s latest budget. there had been many fears about the potential increase of capital gains taxation. To do so would not only disproportionately affect the wealthy but also those who have chosen real estate instead of traditional stock and bond investment portfolios as their core investments.

Almost a decade ago the feds introduced the TFSA. Between that and the RRSP, many Canadians of modest means will recognize no capital gains to the extent they channel all their savings into one of those two accounts. Of course those restrict investing directly in investment properties so that really only helps traditional stock and bond investors.

Furthermore, once you have a little more wealth you are likely saving/investing far more than your TFSA and/or RRSP will allow so likely you have direct tax exposure (capital gains and otherwise). Adding to that the recent strong rise in Canadian real estate and many high net worth Canadians are sitting on a dramatic unrealized taxable capital gains.

This means increasing the capital gains taxation would fulfill the current government’s aim to have the wealthy pay a bigger share. Don’t forget this may also apply to your cottage, condo, or hobby farm.

Delayed but not Allayed

In large part to wait for the outcome of US tax reform, the government has stalled any significant changes to Canada’s Income Tax Act but that doesn’t mean it isn’t still coming down the pipeline.

Foresight is leading prudent Canadians to have a financial plan for winding down the tax exposure from their recent investing success, whether in non-sheltered stock and bond investments or in directly owned real estate.

Eliminate-no, mitigate-yes!

Posted in Estate Planning, Financial Planning, Investment, Risk Management, Tax, Uncategorized Tagged with: , , , , , , , ,

TFSA limit boosted – does it change your estate planning game plan?

In the just-released federal budget, the TFSA limit was increased from $5,500 to $10,000/person/year. The new $10,000 amount is not indexed so don’t expect it to rise annually. Does this impact your financial plans?

Consider this: Historically spouses often held non-registered investments in joint accounts but the size of the TFSA reduces the need for that. Upon death a TFSA can bypass estate and hence bypass probate fees but only a spouse can receive the account whereas a joint account could be joint between any two (or more) adult people (eg parent and child), not just between spouses.

Also, use of the TFSA for seniors rather than a joint non-registered account reduces the recognition of current income (interest, dividends, capital gains, etc.) and therefore reduces the tax plus reduces the risk of claw-back of benefits such as Old Age Security.

As you get older, and especially if you have no spouse, the benefit of bypassing probate with a joint account may outweigh the reduced tax benefit of the TFSA. This must be considered on a case-by-case basis. If this is an issue you are dealing with, we would be glad to provide assistance.

Posted in Estate Planning, Financial Planning, Tax

4 Ways High Earners Should Adjust for New Spousal Tax Laws

In recent months the Canadian government has mused about the potential for changes in the tax code so that Canadian couples can start filing their income tax returns jointly once the budget is balanced. Most people outside the financial planning profession probably don’t even realize we can’t already do this in Canada. Our neighbours south of the border have been able to do this for years.

Well, in fact there are a few minor ways spouses can share in Canada such as the spousal amount, spousal RSPs, medical expenses and pension splitting but in reality these help very few people in a meaningful way.

The big impact will be for high income professionals and business owners. The issue is this, using Ontario as an example: the combined federal and provincial taxes are about 20% on the first $43,000 of income, then 32% on the next $43,000, then 43% on the next $47,000, then 46% tax when you hit about $133,000 of income. That’s a lot of tax. For high earning professionals, you are giving almost half of every marginal dollar you earn to the CRA. So for example, if you earned total gross income of $200,000 then of the last $67,000 only $36,000 went into your pocket and $31,000 went to the feds.

The idea of getting some of that income reclassified into a lower earning spouse’s name really boils down to getting some income taxed at as low as 20% rather than at 46%, hence putting the difference, 26% back into your pocket. You can see that the biggest bang for your buck is when one spouse is earning substantially more than the other.

A big part of our financial planning service is to properly manage your taxes to maximize your long term wealth in situations like this.

Of course, many people have already come up with financial planning strategies to get around the old problems but those strategies take effort on the part of professionals and hence come with their own costs.

While we don’t know the exact text of the tax code changes yet because they are at least three years away (2016 at least), here are four things to think about to revise your plans now:

  1. On the surface this looks like a major opportunity to reduce taxes so it doesn’t seem likely that the government would do this without some other alterations to prevent the tax savings becoming too extreme.
  2. If you believe this is coming in the next three years you may want to use some income stall tactics between now and then to hold off until you can get your income taxed at a lower rate.
  3. There are a variety of structures that can reallocate income. If you are thinking about setting up something like this right now, you may conclude it is not worth the effort.
  4. Depending on the details of how the income is transferred in the new rules, there could be an increase in Canada Pension Plan contributions and hence an increase in the CPP you would collect in retirement. This may be another factor that alters your financial planning.

Many people will wait until the tax code changes are in place before they begin changing their strategy. What a shame. What a planning opportunity lost. If you want your plans to be on top of this opportunity now, contact us to see how we can help.

Posted in All Archives, Financial Planning, Tax

Buffett and Gates on Success

Posted in All Archives

Cars and Corporations

Many small business owners ask the perennial question of whether they should own their car within the corporation or personally. There are several factors that go into answering that question, such as:
-how many kms will you drive in the year for personal use and for business use.
-how much will the car cost
-how long will you keep the car
-what is the cost of liability insurance for a car owned by the corporation versus a car owned personally
-what is the cost of collision insurance for a car owned by the corporation versus a car owned personally
-how much collision insurance will you maintain and what will your deductible be
-what is the address of the corporation versus your personal address
-what are the fuel and maintenance costs for the car
-how roughly do you expect to treat it and will there likely be a loss on sale or a gain on sale compared to how much you’ve written it down?
-does the corporation have more than one owner
-what assets does the corporation have versus you, personally?

The question essentially boils down to a tax management element, insurance cost element, and a risk management element to the extent that you choose to self-insure.

Posted in Financial Planning, Risk Management, Tax

Is 4% an Unsustainable Withdrawal Rate

Historically, 4% was thought to be the withdrawal rate the average portfolio could withstand on a long term basis without eating into capital. Recent research indicates that in today’s lower investment return environment, maybe that’s no longer sustainable. We all think of our average long term portfolio returns as the determinant of the sustainable withdrawal rate but another big factor is the portfolio’s volatility because if you happen to take money out when the portfolio is facing a dip, it may never recover. Hence the need for more stable portfolios when withdrawing.

Posted in Financial Planning, Investment, Tax