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  • Tag: Making Sense of the Economy

    How to protect your investments from a market downturn

    At our investment meeting this week, one of my colleagues shared the news that he had received a call late the night before from a prospective client confirming his decision to hire us to manage his portfolio. While that itself is not news we’re thankful to say, what was interesting was the voice mail message the investor left, saying, “The market seems a bit high so I’m moving my money over to you guys to put to work in your more diversified platform.”

    Although we may be biased, we think there is merit in what he says — and we applaud his foresight. Too many investors (even professional ones!) have a tendency to extrapolate current investment trends well into the future. That is, they buy in after markets have been performing well only to sell out of fear when they turn bearish. In other words, they buy high and sell low. Frequently-cited research by DALBAR shows that over the past decade, investors have cost themselves potentially 4% per year in returns by doing the wrong thing at the wrong time.  In this business, one must be vigilant about not letting emotion drive decision making.

    Let’s face it, the last few years have been good ones for investors.  The media has been full of stories of the Dow Jones Industrial Average making new highs. Stock markets have been strong throughout the world, and that has people feeling good about their investments. The data shows us that volatility is down, which indicates investor complacency. We haven’t seen a meaningful market correction since 2011. It’s nice when you have the wind in your sails. However, to further that analogy, what will happen when a storm blows in? The pundits are warning of the next market correction. Have you heard of the Swoon in June? What’s next, the Slide in July? What rhymes with August?

    As risk managers, we are always concerned about protecting capital. It is interesting that recently we have had more conversations with people, like the above-mentioned investor, who have done well with their investments over the past few years by taking higher risk, and are now looking to protect what they have gained. They are coming to us for a more diversified and conservative approach than is commonly available.

    We welcome the opportunity to put our experience and expertise to work for these people, and we hope we can save them some angst and pain if and/or when the “Scourge in September” comes along. Will you be ready?

    When will natural gas prices turn?

    Record warm temperatures made for a comfortable Canadian winter this year. But they’ve caused a chill in the energy market. Particularly natural gas prices which dropped to a 15 year low.

    What’s the cure?

    “Low gas prices” is the standard response from industry experts. Low prices spur demand and cut off supply. It’s just a lesson in economics.

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    Greece default a positive for markets

    “There is too much debt in the world and if Greece defaults on its debt, this will be good for the markets in the short term, especially if it defaults big.”

    That was the message we heard yesterday morning from Barry Allen of Marret Asset Management, considered by many to be the top manager of high yield bonds in Canada and one of the external managers we use for yield mandates.

    Barry was in to give us an update and his view was uncharacteristically optimistic: “Now that the European Central Bank has put a floor under European banks with its 3-year loans, smaller governments can now default without bringing down the banking system.”

    Barry contends that Greece and Portugal should, and will, default and this will be good for the overall global deleveraging that will continue for several years.

    He also reminded us that Italy runs a structural budgetary surplus and has a strong industrial base that “makes good things people all over the world want to buy”, especially luxury goods desired by the growing affluent classes in emerging markets.

    i f61222dbe164d94d4f97ee11c5d73986 cortina1 25Jan2012 Greece default a positive for markets

    He thinks Italy will be successful in its efforts to crack down on tax evaders, citing the amusing anedote of the recent tax raid on the luxurious winter resort of Cortina D’Ampezzo.  Tax inspectors found 42 top-end cars registered to people with declared annual incomes of 22,000 Euros (about $29,000 CAD). The investigation highlights the problem of tax collection in Italy, which Barry thinks will ultimately be resolved given the strong sense of nationalism and patriotism in that country; the upper middle class “will do their part to put the country back on sound fiscal footing.”

    Barry’s overall message was that Europe is in better shape than the world has given it credit for. Not exactly a screaming ‘buy signal’, but still upbeat news for a grey January morning in Toronto.

    How safe are GICs?

    Yesterday marked what could be a watershed moment for investors in Europe as Germany managed to sell €3.9 billion worth of six months bonds at a negative interest rate. Marginally negative, but it demonstrates that investors are so worried about the economy in Europe that they are willing to pay Germany for the privilege of lending it money. When these bonds mature, investors will receive less money than they invested. They would quite literally be better off sticking their money under a mattress.

    Investor sentiment worldwide is cautious with a tremendous amount of cash sitting on the sidelines. Recently, I’ve had several conversations with prospective investors who have asked whether their capital would be safe in GICs. The answer to this question is not straightforward as we first have to define what “safe” means.

    If the question is whether I believe that investors will get their money back and earn a return on GICs, then the answer is “yes”. The Canadian banking system is strong and well capitalized. There is no reason to believe that investing in the debt of these banks is risky, unlike the view many investors are taking towards European banks.

    The majority of high net worth investors worked very hard to build their net worth and are naturally risk averse. They generally state that at the very least, they want to preserve the value of their portfolio. I generally interpret this to mean that they want the portfolio at a minimum, to grow greater than the rate of inflation. By stating they want to preserve the value of their portfolio they are really trying to say, “preserve my standard of living”.

    So, if the question is whether I believe that investors will preserve the value of their capital by investing in GICs, the answer is “no”. A dollar today, invested in a GIC will be worth less in the future.

    i e435f94d582438842ab0b7cfbfd7ff04 Inflation Calculation 10Jan How safe are GICs?

    Investing in a locked-in one year GIC with a major bank will result in a return of 1.15% on which tax must be paid at the highest marginal rate (for this purpose assume 46.41%). The Bank of Canada puts the rate of inflation at 2.90% on a year over year basis. Since last March, the inflation rate has hovered around 3.0%, at the higher end of the Bank of Canada’s target range. In the graph, I have plotted how a portfolio invested in GICs would grow, after tax, if invested at 1.15%. I have also plotted the effect inflation would have on the cost of goods.

    For the purpose of this exercise, I have assumed that these rates hold steady going forward. In five years, the purchasing power of a dollar invested in a GIC would decline by 10.6%. In other words, a dollar invested in GICs today will be worth 89.4 cents five years from now, if inflation stays the same. With so much cash flooding the system, inflation rates may well be higher in future years, and the return more negative.

    GICs can be a good solution for the short term when uncertainty remains high, but they will do little to protect the value of your portfolio or your standard of living over time. So what do you do?

    We still believe a well diversified portfolio managed with some cash (i.e. T-bills) as a defensive measure and a a client’s tolerance for risk in mind will outperform the markets and preserve your standard of living.

    Is the U.S. job market really improving? Don’t believe everything you read.

    Earlier this week the U.S. Bureau of Labor Statistics (the “Bureau”) announced that the US unemployment rate had dropped to 8.6% and that 278,000 jobs had been created. On the surface, this seems like great news; however, I have a healthy degree of skepticism over an improving U.S. job market.

    Let me explain.  US employment peaked in March 2007 and bottomed in October 2009 losing 7.94 million jobs in the process. Unemployment rose by 8.9 million people over the same period, so it’s reasonable to assume that nearly 1 million people entered the labor force over that time and were unable to find jobs.

    i da7c8136fd83d52d41bafdbbd86a1abc US Economic Data Is the U.S. job market really improving? Dont believe everything you read.

    Since the bottom in October, 2009, unemployment has fallen by 2.3 million but this drop includes 595,000 people who are no longer looking for work but would surely take a job in a New York minute if one was offered.  If one nets out this “marginally attached” group the number of unemployed has now only fallen by 1.7 million people. So there are still 7.2 million people who either lost their jobs or couldn’t find one during the credit crisis and recession.

    The Bureau reported that the labour force has actually fallen by 138,000 people over the same period.  How can the labour force not grow when the population is growing? According to World Bank estimates and the U.S. Census Bureau, US population has grown by 3.6 million people; 2.0 million of which are between the ages of 20 and 65…working age. In other words, on average, the U.S. has added an additional 90,000 working age people per month since October 2009. Where did these people go if the labour force didn’t grow?

    Even if one accepts the Bureau’s 2.2 million jobs having been created since October, 2009, that barely absorbs the growth in the population of working aged citizens let alone makes any dent on those who actually lost their jobs.

    It gets worse. If one adds the number of people who are working part time because they can’t get full time work to the number of unemployed the total is a staggering 15.6% of the U.S. labour force! One out of every 6.5 working people in the U.S. are earning significantly less than they were before the recession.

    Why does this matter? The consumer represents 70% of GDP in the US.  Without a meaningful improvement in jobs, the US economy will continue to languish.  When making decisions about where to invest we need to understand whether the economy is improving and whether corporate profits are likely to grow from improving demand. Our analysis goes much deeper than the reported headlines. We consult economists, analysts, our independent investment managers, our clients who own businesses, and we conduct our own research. Digging deeper enables us to gain more insight into whether an apparently improving statistic actually translates into a growing economy. In the case of reported labour statistics, we don’t believe it does.

    What you can learn from financial history

    i 465c064247774bc82455c712459bdcf9 iStock 000002481097Medium no grey What you can learn from financial historyComing off of a couple of weeks of topsy turvey markets, it’s understandable if investors are feeling a little rattled these days.

    Some comfort may be taken in the perspective of someone who has managed through more than a few bear markets:  Dennis Starritt, one of Canada’s investment luminaries and a key manager of the Newport Canadian Equity Fund.

    Dennis joined us for a chat at one of our recent Inside the Tent events (where we bring together thought leaders from our network to discuss topics of interest). Judging from the engagement of the audience – there were more questions than we could accommodate in an hour and a half – he certainly captivated everyone’s attention with his views.  We offer a short recap that may be useful for these times.

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    Where to find yield now?

    As individual investors return from summer vacation and revisit their portfolios, most are likely frustrated with the lack of performance. The gloomy economic cloud resulting from European and U.S. deficits and debts continues to weigh on the capital markets. Equity markets corrected, again, leaving North American and global indices negative for the year. Corporations and individuals are holding cash patiently waiting for signs of leadership and direction before they risk capital. In the meantime, negative real returns (after adjusting for inflation) on cash (or near cash) at -2.6% haven’t been this low since the 1970s.

    There is no quick fix for the economies of developed countries. Repaying debt takes years, and there will be more casualties along the way. Volatility is likely something investors will have to manage around. So what are investors to do to eke out returns when there is so much uncertainty?

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