The Inflationary Heat Wave

In his book “The Ministry for the Future”, author Kim Stanley Robinson imagines a heat wave impacting India, pushing temperatures ever higher for an extended period of time. Eventually temperatures exceed the “wet bulb temperature”[1] for human survival, the point when a human body can not cool itself down by sweating, sitting in the shade, or drinking water. The death toll is unimaginable. Millions die. So begins Robinson’s account of a world in the throes of global warming.

This year contained many headlines that echoed Robinson’s book. There were heat waves in Australia, India, North America, Europe, the Middle East, Africa, and Asia. It comes on the heels of energy and food shortages, exacerbating already stressed pressure points for global security and worsening inflation. To date I’m not aware that there have been any places where the WBT has gone above 35C, but that doesn’t mean people, economies, and nations aren’t being pushed to the breaking point. Forest fires are common after such an extended period of heat. Crops suffer and efforts to stop agricultural failure are expensive. Water patterns are disrupted, with sudden downpours and earth so parched it can’t absorb rapid deluges leading to flooding. Electrical grids are increasingly stressed to their breaking point as demand surges. And of course, people die due to heat exhaustion.

How hot are these heat waves? In January temperatures in Buenos Aires reached 41.1C and 700,000 people lost power. In Australia a town called Onslow reached 50.7C, tied now for the hottest temperature recorded in the Southern Hemisphere. The city of Perth had 11 days of temperatures over 40C. In the same period (early February), Palm Springs in California reached 34C.

In March and April 90 deaths would be recorded across India and Pakistan, a number almost certainly (and deliberately) inaccurate. Cities across the subcontinent saw temperatures more than 42.8C, and one city in Maharashtra state recording over 45C. Pakistan saw temperatures in excess of 49.5C and 47C in various cities. Birds fell from the sky in Gujarat, and a bridge collapsed in Pakistan following glacial flooding. While the official total was only 90, other more recent heat waves across Europe reveal those numbers must be much higher, with some of the most vulnerable in the society simply going uncounted as victims.

In June heat waves hit much of Europe, pushing temperatures up to 40C, or higher across much of the continent. That same heat wave reached the UK, pushing the temperature in London to 40C as well, a first in living memory for the country. While that spike was short lived, it was a reminder of just how dependent populations are on the infrastructure built on certain climatic expectations. Air conditioners, while not totally uncommon, are not used by the majority of Europeans, and often homes or apartments cannot easily accommodate their introduction by design.

Our thinking can also be quite constrained by experiences, but the extreme temperatures we’ve seen affect more than people. Heat waves and their accompanying droughts can also create problems we wouldn’t consider. In France the temperature of rivers (specifically the Rhone and Garonne) rose so much that they were too hot to cool nuclear reactors, forcing shutdowns. In Germany the Rhine was so low in early August that it was in danger of being shut to cargo, potentially hindering delivery of the coal now needed to meet energy needs. And in China, Foxconn, a major industrial supplier for companies like Apple and Toyota, suspended plant operations as the region suffers from hydropower shortages due to low water levels in the Yangtze.  

We’ve just passed the end of summer, but across much of the world heat waves have left significant impacts on economies and peoples.  I started writing this piece while in Spain with my family in July, where everyday temperatures had remained above 40C. Since then I have been returning to this essay only to note that things have gotten worse. The high temperatures being faced by people in countries like India, Pakistan and Bangladesh have been compounded by surging demand for electricity, forcing governments to have structured rolling blackouts. Protests have been erupting in Pakistan as energy prices have continued to soar despite the ongoing blackouts. In Bangladesh production in the garment industry has struggled as a result of the mandatory power cuts, efforts to curb the rising prices faced by the nation in energy and food.

If water levels were low in China at the beginning of August, they were positively dire at the summer’s end. China’s largest freshwater lake, Poyang Lake, nearly dried up forcing extensive trench digging operations to keep water flowing to farmland. In France portions of the Loire River ran dry (the government is quick to point out the river is still open to traffic and is not at its historic lowest point) while in Nevada the artificial lake created by the Hoover Dam, Lake Mead (the primary source of water for Las Vegas) is at its lowest levels since 1937 (Lake Mead has had a small rebound since the end of July, driven in part by reduced demand downstream of the dam). The heat wave affecting California is now thought to be one of the worst and most persistent in history. Meanwhile in Pakistan heat waves have given way to unparalleled flooding. An estimated 33 million people have been displaced, 15% of the country’s population, as its crumbling infrastructure has proven no match for extreme weather.

Global warming has much the same effect on economies like black holes do on physics, warping everything around them until the laws we assume that govern things become unrecognizable. In the period of a week or so, roughly 900 people died in Spain from the heat, including the death of a sanitation worker who dropped dead on the job in Madrid due to heart failure. Reportedly his internal body temperature was above 40C when he was attended to by paramedics. In the face of tragedies like this, what are governments likely to do? What will citizens do?

They will be forced to act, encouraging the use of air conditioners, building more resilience in the electrical grid, directing public funds to deal with vulnerable individuals who are at risk in high heat conditions. If crops start to be affected, you can also bet that governments will be more predatory when it comes to protecting grain supplies and working on minimizing the effects of climate related inflation. If energy rationing becomes more common it will force more top down restrictions, more public money towards expensive infrastructure projects, and contractions in living standards.

For my own part I remain unconvinced that governments will be proactive with regards to these challenges, and instead I expect them to be reactive to a fault with only the richest nations able to potentially solve more than one problem at a time. But short-sighted self interest is not unique to kleptocratic dictatorships. In the United Kingdom, which came under numerous “hosepipe bans” in the summer, selling off reservoirs for new developments while not investing in any new significant water infrastructure for 30 years goes hand in hand with climate change impact. Countries across Europe, Asia and North America have been robbing Peter to pay Paul, and now the bill is coming due.

Winter is coming, and before us lies the potential for further difficult months. Heatwaves have raised food prices and taxed electrical grids. Winter promises to see further pain as energy needs traditionally met by Russian oil will now need alternatives. Coal, a major contributor to the climate crisis, is the current favourite choice both across the developing world, but now also in wealthier western countries facing the pinch of oil and natural gas shortages. The demand is so great that coal use is expected to be at an all time high in 2022. In Germany people are buying electric heaters, but being so inefficient they actually use more electricity and will likely increase energy prices further for Europe’s most beleaguered industrial powerhouse.

Headlines in 2022 have been dominated by central banks raising interest rates to combat inflation. The risk of this strategy is a recession, potentially globally, but the cost of failure is an inflationary environment where food, energy, utilities, and consumer goods become more expensive. And yet that is exactly what has happened; over confidence, short sightedness and a fundamental misunderstanding of resilience planning has made us all “richer” in the short term, but promises to make us pay more in the long term. Heatwaves are baking in our inflation.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)* – ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). Adrian Walker is registered to advise in securities and mutual funds to clients residing in British Columbia and Ontario.

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service.

[1] You may never have heard of the wet bulb temperature before, but it will be something we all come to know. The temperature is determined by having two thermometers side by side, one covered with a “sock” soaking in water. As air moves over the wet bulb of the second thermometer, moisture will evaporate and lower the temperature, giving you a different reading from the unadulterated thermometer. The first tells you the outside air temperature. The second tells you how much cooler you can be if water is evaporating off you. If in a heat wave the WBT reaches or exceeds 35C, the human body can not survive for an extended period outdoors.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Your Pessimism is Welcome

This year has been filled with ups and downs. And then some more downs. After some fairly strong performance through the first two years of the pandemic, markets began a significant retreat, particularly in the areas of technology though all sectors of the market have been affected.

Going hand in hand with these market declines have been a host of real economic problems including (but not limited to) inflation that’s proved to be sticky, a sharp rise in interest rates to curb that inflation, and the looming potential of a significant economic slowdown. On top of all that, geopolitical tensions have continued to rise over the past few months. While the pandemic was one thing that occupied everyone’s thinking while offices were closed and children studied at home, the receding  pandemic has revealed all the persistent issues that were pushed to the back of our minds while the one VERY BIG THING happened.

Russia’s invasion of Ukraine, ongoing and maybe even heightened tensions with China over its claimed disputed territories, the recent brutal and deadly heat waves that swept Europe, the United States and Asia, worries about food and energy shortages; the end, as historian Dan Carlin says, is always near.

So perhaps it shouldn’t be surprising that on the back of all this negative news, Bloomberg reported that Consumer confidence in Ontario was as low as it had been in March of 2020. Unsurprisingly this happened to coincide with a low point on the TSX so far in the year, with oil prices dropping after having kept the TSX afloat through much of the first few months.

Investors are not crazy for being worried. In addition to turbulent markets, our economies are in flux, and the geopolitics of right now are intimidating. But investors should be reminded that it is when pessimism is high that opportunities tend to be better. As Warren Buffett famously said “be fearful when others are greedy, and greedy when others are fearful.” As an investing philosophy it may lack nuance, but offers some sound advice about the madness of crowds.

I suspect few would be willing to throw all their chips into a strategy as bold as Buffett’s maxim, but that’s probably true of Buffett himself who does considerable research on his acquisitions. As is often the case investors must chart a course that works for them, balancing the needs of their investment goals with the risks they can stomach. What Buffett’s words should remind us of is that markets aren’t “bad and good” so much as they represent shifting terrain of opportunities that can only be recognized by a cool head. Turbulent markets and uncertain times that prompt emotional responses from crowds are not good guideposts for our own decisions.

There is much still lying ahead of us, and the global economy has many vulnerabilities, from debt crises in the emerging world, Canada’s own vulnerable housing market, and the absence of a history successful “soft landings” by central banks when trying to curb inflation. It would be wrong to assume that simply because sentiment turned very negative that we’re on the other side of a market correction, and it is interesting to note that even as markets have been bracing for a worsening economic situation, US employment numbers have remained strong, and signs of inflation have been receding. The world is unpredictable, and good decisions are rarely made by a crowd in mass panic.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)* – if applicable ACPI is regulated by the Investment Industry Regulatory Organization of Canada (http://www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (http://www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and

bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service.

1 6

Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Unravelling

In his book Fooled by Randomness, Nassim Taleb says of hindsight bias “A mistake is not something to be determined after the fact, but in the light of the information until that point.”  With this guidance we can forgive some of the covid precautions and restrictions governments imposed on populations in 2020, a period of great uncertainty. 

But in mid-2022 assessing the course of action by governments and central banks as they attempt to tackle a number of non-pandemic related crises (as well as still managing a pandemic that is increasingly endemic) I think its fair to say that mistakes are being made. From political unrest, to cost of living nightmares and finally inflation dangers, the path being plotted for us should be inviting closer scrutiny by citizens before we find ourselves with ever worsening problems. 

Let’s start with the twin risks of inflation and interest rates. Inflation is high, higher than its been in decades, and central banks the world over are attempting to stamp this out with aggressive rate hiking. It is easy to point to Turkey, a country whose inflation rate is 70%, and see that their recent cutting of interest rates is a mistake in the face of such crippling inflation. But what are we to make of North American efforts to slow inflation, even at the risk of a recession? Inflation for much of the West has been tied to economic stimulus (in the form of government action through the pandemic), supply chain disruptions and low oil and gas inventories. The economy is running “hot”, with lots of businesses struggling to find employees. But inflation, measured as the CPI is a rear-view mirror way of understanding the economy, also known as a lagging indicator. But here is one that is not. The price of container freight rates, which have fallen substantially from the 2021 highs.

We can count other numbers here too. The stock market, which is having a bad year, has fallen close to pre-pandemic highs. A $10,000 investment in the TSX Composite Index would have a return of 6.1% over the past 28 months, or an annualized rate of 2.6%. In February of this year that annualized rate was 8.85%, a 70% decline in returns. The numbers are worse for US markets. While US markets have performed better through the pandemic, the decline in the S&P500 is roughly 75% from its pandemic high in annualized returns (these numbers were calculated at the end of June, offering a recent low point in performance).

For many who felt that the stock market was too difficult to navigate but the crypto market offered just the right mix of “can’t fail” and “new thing”, 2022 has wiped out $2 trillion (yes, with a “T”) of value. 

In fact speculative bubbles are themselves inflationary and their elimination will also help reduce inflation. Writes Charles Mackay in his famous book Extraordinary Popular Delusions and the Madness of Crowds (1841) on the Mississippi Bubble in France, “[John] Law was now at the zenith of his prosperity, and the people were rapidly approaching the zenith of their infatuation. The highest and lowest classes were alike filled with a vision of boundless wealth…”

“It was remarkable at this time, that Paris had never before been so full of objects of elegance and luxury. Statues, pictures, and tapestries were imported in great quantities from foreign countries, and found a ready market. All those pretty trifles in the way of furniture and ornament which the French excel in manufacturing were no longer the exclusive play-things of the aristocracy, but were to be found in abundance in the houses of traders and the middle classes in general.”

Evidence today indicates that supply chains are beginning to correct, an important component of taming inflation, while trillions of dollars have been wiped out of a speculative bubble. Even oil, which seems to be facing structural issues that would normally be inflationary has had a significant retreat, along with other commodities like copper, lumber and wheat. Some of these declines may only be temporary as markets react to recession threats, but these declines do not happen in a vacuum. They are disinflationary and should be treated as such.  

But central banks seem ready to trigger a recession in the name of defeating the beast of inflation even as it seems to be bleeding out on the ground. In June the Federal Reserve raised its benchmark interest rate by 0.75%, and the current view is that the Bank of Canada is likely to do the same in July. All this is sparking deep recession fears that seem to be driving markets lower. 

In the background remain genuine issues that seem to be addressed at best haphazardly. Inflation is a real issue making food prices go up, but its been crushing people in housing for years. Even as interest rise and house prices moderate lower, average rents in the GTA were up 18% over the last year. The Canadian government’s response to the mounting costs of living has been to propose a one time payment of $500 to low income renters. That is just a little more than the average increase in rent over the previous 12 months. 

In the face of such mounting housing pressure the city of Toronto has done the following things:

  1. Ban the feeding of birds.
  2. Consider the leashing of cats.
  3. Raised development fees 49%. 

For the record, Toronto is believed to have the second biggest property bubble globally. 

Globally Europe looks to be on the cusp of a serious recession. If North American central banks are looking too aggressive, Europe is struggling to chart a path for its shared currency. Rates have been at record lows but recently the ECB has said it will begin raising rates to tackle inflation. Across the continent the rate of inflation is over 8.1%, but it varies widely country to country, with Germany closer to the average, while Lithuania is at 22%. In the face of mounting inflation the ECB hasn’t raised rates once yet this year, though its expected to this month, even has the European economy and stock markets have been doing worse and worse. 

Coincidentally, Germany, who is now both the linchpin in NATO support for Ukraine while simultaneously its weakest link, has seen its economic health crumble due to decisions made years ago to pin Germany’s energy needs to Russian energy supplies. Will Germany today be able to make political decisions that support NATO and the EU even if it means further economic pain for a country that has grown accustomed to being the beneficiary of these arrangements?

It is not just Western or developed nations that are struggling. China is in the middle of some kind of debt bubble in its real estate market, whose impact is harder to know, but will likely be long lasting given its size. Numerous developing nations are on the cusp of debt defaults, the tip of the iceberg being Sri Lanka.

A small island nation off the southern tip of India, Sri Lanka has been reasonably prosperous over the past few decades with an improving standard of living. Yet government mismanagement, graft and a haphazard experiment in organic farming have left the country destitute. Literally destitute. Out of money, gas and food. In the past few days protests have moved beyond general unrest into a full blown revolution, with the Sri Lankan people storming the government and the political leaders fleeing for their lives.

Behind them is El Salvador which has decided to embark on an experiment in making Bitcoin an official currency, a move designed to liberate the country from the tyranny of the World Bank and the US Government. It has instead likely led to a default, financial instability, and a more regressive and authoritarian government. 

This year stands out for the complex problems that have grown out of the pandemic, but if we’re serious about the kinds of big problems politicians regularly say that must be tackled, then it raises a question as to whether we are handling them properly, or whether we are making mistakes given what we know right now.

For the last few years I have written or touched on many of these topics; on housing, inflation, crypto currencies and the fragile nature of many of our institutions. And while I am cautious about making grand predictions, it remains worth asking whether we are making smart choices given what we know, and if we are not we should be making greater demands of our elected leaders. And if our elected officials continue to make poor decisions, we as investors should plan accordingly.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Control Your Soul’s Thirst for Freedom

Since late February the bulk of global attention has been focused on the Russian invasion of Ukraine. The invasion remains ongoing, and will likely last for months, potentially even years, and represents the most dangerous geopolitical situation we are likely to face until China tries to enforce control over the South China Seas or invades Taiwan.

But while our attention has been narrowly focused, interest is growing about how the world’s second largest economy is choosing to mange the late stages of the pandemic, a series of choices that have ramifications for much of the world.

China has had mixed luck with Covid. By the end of 2020 it looked as though China might be the only winner economically from the pandemic, but 2021 turned out to be a year for the West. First, Western vaccines, particularly the mRNA vaccines were highly effective, while the Chinese vaccine produced domestically had only a 50% success rate. The Chinese government also was hyper critical of the more effective Moderna and Pfizer vaccines, essentially precluding them from Chinese use. This has left the country in a difficult spot. Chinese mandated lockdowns have been brutal but effective, leading to uneven vaccine use. The low infection rates that the “Covid Zero” policy has delivered has also robbed the country of natural immunity. Today China, already struggling economically, is still locking down whole cities in the hopes of containing outbreaks.

Shanghai is the current major city to be shut down, but the lockdowns are spreading. Complaints about food shortages and people trapped in apartment buildings, offices, and closed off from their places of work have led to some fairly strange places, including protests and at least once the use of “speaking drones” urging citizens to comply with rules and reprimanding the citizens singing in protest one night to “Control your soul’s thirst for freedom. Do not open your windows and sing.”

This image came from early April

Chinese lockdowns are also worsening global inflation. The supply chain disruptions caused by the most recent lockdowns in Shanghai are dramatic to say the least. In the above picture each yellow dot represents one cargo ship waiting to be docked and unloaded. Supply chains were already deeply stressed when Shanghai went into lockdown last month, and the global impact of further supply disruptions is something we’re very likely to notice.

This image came from early May

Lastly, some months ago (October 2020) I had detailed how China’s foreign policy, which was heavy handed and often petulant, was angering nations all across the globe. China may not view the world the way its geopolitical rivals do, but its inability to grasp at least what might be considered fair or just by other nations is damaging its own ability to wield soft power, an essential part of being a global hegemon. China’s decision to back Russia in its invasion of Ukraine likely reflected China’s near-term goals of retaking Taiwan and its general contempt for the current world order. However, the global resistance to the Russian invasion, the support shown Ukraine and the barrage of negative publicity (as well as realizing that an untested military in countries with lots of corruption may not be able to score quick military victories) must serve as a wake-up call to China’s ruling class. As of 2022 China seems to have squandered much of its international good will and is unlikely to find many willing allies for its global ambitions.

China seems to be suffering on all fronts. 2021 was a bad year for China’s economy, cumulating in the public meltdown of one of its biggest developers in November. But everything, from its politics to its public health policies are working against it. The world’s second largest economy, one that is the largest trading partner to 130 countries, can’t seem get out of its own way, and as it falters it can’t help but impact us.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

What’s Happening With Markets?

Markets have been falling through the year, and despite some encouraging rallies the trend so far has been decidedly negative. The NASDAQ Composite, one of the three big indexes heavily tilted towards technology companies had a -23.86% YTD return as of Monday, May 16th, a minor recovery after it had reached a low of -27% on Thursday of the previous week. The Dow Jones and the S&P 500 have YTD returns of -10.31% and -14.82% respectively. The question for investors is “what to do?” in such markets, especially after some of the best years despite the pandemic.

A closer inspection of the markets however shows that while there have been some steep sell offs reflected in the broad market, the real market declines have been far more concentrated. And while there are many different market headwinds to choose from when it comes to reasons for the recent selling action; inflation, interest rates, geopolitical strife, COVID-19, maybe even Elon Musk, the sector that has been sending markets lower has been the tech sector.

Over the past couple of years the companies posting the biggest gains in the markets have been tech companies. Apple stock (AAPL) was up 88.97% in 2019, 82.31% in 2020, 34.65% in 2021, and is down -11.6% so far in 2022. Amazon (AMZN) was up 76.26% in 2020, and has fallen -30.18% this year. Facebook, now META Platforms (FB) gained 56.57% in 2019, 33.09% in 2020, 23.13% in 2021 and has lost -38.08% in 2022. Netflix was up 67.11% in 2020, and a further 11.41% in 2021 but is down -68.74% this year. Tesla, which had an astounding 743.4% gain in 2020 and another 49.76% return in 2021 is so far down -17.36% in 2022, how long can it resist gravity? (All prices and YTD performance were collected from ycharts.com on May 6th, 2022).

I predict that we may never fully understand how the pandemic changed thinking and why stock prices climbed so much, but the reality was that many tech companies benefited from people staying home, going online and the changing priorities that coincided with not having to be in offices and commuting. Tech companies that became huge like Shopify (SHOP), which allowed traditional retailers to become online retailers, benefitted immeasurably from the lockdowns. But it too has seen its stock decline this year by -69.59%, pushing the price back to where it was in December 2019.  

Because the tech sector has become so large, particularly in the NASDAQ, the retreat of these companies carries big implications for indexes and by extension the wider market as well. As markets fall, it encourages investors to panic sell, aided and abetted by the army of computers that help multiply the effects of momentum selling. This is especially true as investors have migrated to low-cost passive index ETFs, a trend so noticeable that experts worry it might be warping the market as investors worry less about the value of individual companies and instead pile money into broad indexes with no quality filters.

Markets are facing other risks too. Inflation, which seems to be running at about 8%, can threaten economies as people buy fewer items due to cost increases. Interest rate hikes, which are meant to ultimately curb inflation by restricting monetary supply and reduce lending/economic activity have hit bond markets particularly hard. Higher interest rates mean higher borrowing costs, and its here we might hypothesize about some of the unintended consequences of the incredibly accommodative monetary policy that the pandemic introduced. That might be that investors were able to borrow to invest, and the threat of both rising interest rates and stumbling returns will only hasten the exit of money from the market by some investors. Higher borrowing costs will also have another impact on markets, as a sizeable amount of stock market returns over the past decade have come from share buy backs, funded in part by low-cost borrowing.

Having said all that, economies are still looking very strong in the present. Earnings have remained high, jobless claims continue to fall, and while we’ve seen a spike in costs the ability to address those inflationary pressures may not be something that can be easily done through monetary restricting.

There are many different sources of inflation, but two significant issues are not connected to “cheap money”. Instead we have issues that are primarily structural and represent the failure of political foresight. The first among these has to do with oil. Since the price of oil fell in 2014, infrastructure development has stalled, heavily indebted producers have retreated, and now Russia has been closed off from much of the global market. This confluence of events has unfortunately arrived as economies are reopening, global use nears pre-pandemic levels, and global refined supply is at historic lows. There is no simple solution for this, as the only remedy is time (and development). In theory, Canadian and US oil could make up much of the global need, but for a multitude of reasons neither country is in a position to rapidly increase production.

Similarly, supply chain disruption and the heavy reliance on offshore manufacturing have meant that there is no simple solution to production problems occurring in other nations. China is the key issue here, with an enormous grip on much of global supply on many items and their current insistence on a “Covid Zero Policy” China is effectively shut to global business. This means ships can’t get into port, and with-it products cannot make it to market.

Higher borrowing costs seem unlikely to handle this problem. High gas prices and lack of supply may be inflationary, but high borrowing costs can’t target those issues. Instead, higher interest rates and the threat of more in the future are hitting the parts of the market that have been pushed higher by cheap credit. The stock market and the housing market.

If markets seem to be moving independently of economies, its possible that won’t stay that way for long. As previously mentioned, higher energy prices are not controllable by higher lending rates. But higher energy prices can introduce demand destruction, a fancy way of saying that economies shrink because prices get out of control. Oil is still in high use and its needs go far beyond powering cars. In fact internal combustion engines only account for 26% of global oil need, meaning those higher prices for crude, if they get too high, can have wide inflationary impacts to the entire economy.

Higher lending rates may also lead to a substantial economic reset, especially for Canadians who have much of their net worth tied up in their homes. With almost 50% of new mortgages in Canada variable rate mortgages, home prices having skyrocketed in the past few years and with most Canadian debt connected to homes, the risk to home owners is very real. Can the Bank of Canada tame inflation, orchestrate a soft landing for the housing market and keep the economy chugging along? Such a question invites highwire act comparisons.

So what’s happening with markets? Perhaps we are simply correcting a narrow subset of the market that got too hot through 2020-2021. Perhaps we are seeing the dangers of printing too much money. Perhaps we are seeing the realities of people buying too many index ETFs. Perhaps we are witnessing people being too fearful about the future. Perhaps we are too fearful of inflation or interest rates. Perhaps we are on the brink of a recession.

Perhaps, perhaps, perhaps.

But let me offer a slightly different take. Investing is frequently about connecting your needs as an investor with the realities of the world. As Warren Buffet famously said, in the short term the stock market is a voting machine, in the long term a weighing machine. If you can afford risk, you can be risky, and with that comes the potential for significant market swings. If you can not afford risk, then your portfolio should reflect that need. If you cannot stomach bad days, potentially weeks or even months of bad news, then you need to find a way to keep your investment goals aligned with your risk tolerance.

When I started this essay we had just completed one of the worst weeks of the year, which bled into the second week of May. As I finish this piece markets are in the process of rallying for a third day, posting modest gains against the backdrop of significant losses. It would be nice if I could end this with some confidence that we’ve turned a corner, that markets had bottomed and that the pessimism that has led to so much selling is evaporating as people come to recognize that stocks have been oversold. Yet such prognosticating is the exact wrong tack to take in these markets. Instead, this is a good time to review portfolios, ensuring that you are comfortable with your risk, that your financial goals remain in sight and that the portfolio remains positioned both for bad markets, and for good ones too.

If you have any concerns about how your portfolio is positioned and need to review, please don’t hesitate to contact us today.

Walker Wealth Management is a trade name of Aligned Capital Partners Inc. (ACPI)*

ACPI is regulated by the Investment Industry Regulatory Organization of Canada (www.iiroc.ca) and a Member of the Canadian Investor Protection Fund (www.cipf.ca). (Advisor Name) is registered to advise in (securities and/or mutual funds) to clients residing in (List Provinces).

This publication is for informational purposes only and shall not be construed to constitute any form of investment advice. The views expressed are those of the author and may not necessarily be those of ACPI. Opinions expressed are as of the date of this publication and are subject to change without notice and information has been compiled from sources believed to be reliable. This publication has been prepared for general circulation and without regard to the individual financial circumstances and objectives of persons who receive it. You should not act or rely on the information without seeking the advice of the appropriate professional.

Investment products are provided by ACPI and include, but are not limited to, mutual funds, stocks, and bonds. Non-securities related business includes, without limitation, fee-based financial planning services; estate and tax planning; tax return preparation services; advising in or selling any type of insurance product; any type of mortgage service. Accordingly, ACPI is not providing and does not supervise any of the above noted activities and you should not rely on ACPI for any review of any non-securities services provided by Adrian Walker.

Any investment products and services referred to herein are only available to investors in certain jurisdictions where they may be legally offered and to certain investors who are qualified according to the laws of the applicable jurisdiction. The information contained does not constitute an offer or solicitation to buy or sell any product or service. 16 Past performance is not indicative of future performance, future returns are not guaranteed, and a loss of principal may occur. Content may not be reproduced or copied by any means without the prior consent of the author and ACPI.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Chaos Unleashed

Two weeks ago Russia began its invasion of the Ukraine in earnest. What had begun in 2014 following the ouster of a corrupt pro-Russian government was followed by the annexation of the Crimea and then the fermenting of a civil war in the Donbas region of eastern Ukraine, finally cumulating in his goal of retaking the entire country and bringing it back under Russian purview, most likely in the form of a puppet government.

No one has been more successful at undoing Russian strategic goals than the Russian government. Putin had once hoped to establish a new Warsaw style pact, he hoped to undermine NATO, he’d longed to set up an Eastern European economic zone to compete with the EU. To imagine that any of these goals could today be defined as likely is to dabble in fantasy. His ultimate goal, at least defined by his own comments, was to restore Russia to its previous status as a respected superpower like it was under the Soviet Union. Today it seems as though his army, impressive and large though it is, has already met its match in conventional warfare in the early days of its Ukrainian adventure.

While the military side of his invasion doesn’t seem to be going according to plan, something that must have really taken him by surprise was the resolve he faced globally. Though NATO has said it won’t get involved, weapons are flowing into the country. Nations, like Finland and Sweden whom Russia has treated as extensions of its old empire, are making loud noises that they too would like to join NATO. Germany, long a NATO laggard has promised to increase its military spending above the target 2% of GDP for NATO members. The notoriously neutral Switzerland has said it will freeze Russian assets, and throughout the world condemnation has been swift, especially on the financial front.

In the space of a few days Russia didn’t just find itself diplomatically isolated, but financially as well. The international banking system has been effectively closed to Russia and its central bank, putting a stop on many of its rainy day funds it will need to sustain its campaign. I won’t endeavor to explain the full range of how the global bank sanctions work, as the process is complicated and other better versed people can explain it more succinctly, but the truth is that the Russian state is deeply isolated and in financial chaos.

Markets have responded to this chaos with a fair amount of volatility, with some big swings both up and down since the invasion began. This is understandable, but what comes next will be more unpredictable. Russia does not have many face-saving ways to undo its situation, a fact that has not gone unnoticed by many. Stuck in heavy fighting in Ukraine, a collapsing economy, a restless population at home and a kleptocratic network of military officials and billionaire oligarchs who hide their assets in Western nations, Putin may find himself backed into a corner with few options open to him, some of which were likely previously unthinkable.

Sun Tzu, famed military strategist and author whose book sits unread on the shelves of tedious hedge fund managers.

I’m reminded of a saying from Sun Tzu, the famed military strategist of ancient China, whose book on strategy is often “required reading” for a certain type of hedge fund manager. “When you surround your enemies, leave an opening; do not push too hard on the enemies who are desperate.” Even if Putin is ultimately successful in Ukraine it’s hard to see what kind of victory can be cobbled together on the world stage. Russia will need a way out, an opportunity to exit and with walls closing in our own “Western” victory of aiming to contain Putin may create more chaos than we are expecting or can anticipate.  

I don’t want to be alarmist, but the nature of war is to be unpredictable, and cautious investors should take note that we are still in the early days of what could prove to be a long, protracted, and ultimately surprising conflict that has many unknowable outcomes, some of which may leave the world order changed, for better and worse. Putin has unleashed something, and what that is can not be fully guessed.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

Looking Back on 2021

Its traditional that the end of a year should stimulate some reflection on the past and the future, and so in the spirit of tradition I thought I’d take some time to look over some of the stranger and more surprising aspects of 2021.

China

While 2021 brought the pandemic *closer* to an end through the distribution of vaccines, markets underwent some fairly dramatic reversals over the course of the year. For instance China looked to be the principal economy in January. Following its own strict enforcement of Covid restrictions and solid economic performance, China seemed to be an earlier winner by the beginning of 2021, and set to enjoy robust growth through the year.

By March the tide was shifting however. China’s leader, Xi Jinping, proved to be every bit committed to his past comments about protecting and strengthening the CCP over free market concerns. Several billionaires, notably Jack Ma the founder of Alibaba, disappeared for long periods before reemerging only to publicly announce that they would be stepping down from their roles.

However, even while China was shaking down its billionaires and upsetting foreign nations, a new economic threat appeared in the form of a housing bubble looking ready to burst. Evergrande, one of the country’s largest property developers announced that it could not finance its debt anymore and looked likely to default. This news was unwelcome for markets, but for China hawks it fit their long standing belief that China’s strength has been built on a mountain of unsustainable debt, with property one of the most vulnerable sectors of the economy.

The finer points of China’s housing market are too nuanced to get into here, but it’s enough to know that the property bubble in China is large, built on sizeable debt and could take some time to deflate (if it does) and no one is sure what the fallout might be. Combined with China’s ongoing policy of “Covid Zero” – an attempt to eradicate the virus as opposed to learning to live with and manage it, we head into 2022 with China now a major outlier in the Asian region.

Inflation

Inflation was probably the other most discussed and worrying trend of 2021. Initially inflation sceptics seemed to win the argument, as central banks rebuffed worries over rising prices and described inflation as transitory. That argument seemed to wane as we entered late Q3 and prices were indeed a great deal higher and didn’t seem to be that “transitory” anymore. Inflation hawks took a victory lap while news sites began to fill up with worrying stories about rising prices on household goods.

The inflation story remains probably the worst understood. Inflation in Canada, as in other Western nations has been going on for sometime, and its effects have been under reported due to the unique nature of the CPI. But some of the concern has also been overwrought. Much of the immediate inflation is tied to supply chains, the result of “Just-in-time” infrastructure that has left little fat for manufacturers in exchange for lower production costs. Bottlenecks in the system will not last forever and as those supply chains normalize that pressure will recede.

The other big pressure for inflation is in energy costs, but that too is likely to recede. Oil production isn’t constrained and prices, while higher than they were at the beginning of the pandemic are lower than they were in 2019. In short, many of the worries with inflation will not be indefinite, while the issues most worrying about inflation, specifically what it costs to go to the grocery store, were important but underreported issues before the pandemic. Whether they prove newsworthy into the future is yet to be seen.

*Update – at the time of writing this we were still waiting on more inflation news, and as of this morning the official inflation rate for the US over the past year was 7%. Much of this is still being chalked up to supply chains squeezed by consumer demand. An unanswered question which will have a big impact on the permanence of inflation is whether this spills into wages.

This political advertisement from the Conservatives ruffled many feathers in late November

Housing and Stocks – Two things that only go up!

If loose monetary policy didn’t make your groceries more expensive, does that mean that central bankers were right not to worry about inflation distorting the market? The answer is a categorical “No”. As we have all heard (endlessly and tediously) housing prices have skyrocketed across the country, particularly in big cities like Toronto and Vancouver, but also in other countries. The source of this rapid escalation in prices has undoubtedly been the historically low interest rates which has allowed people to borrow more and bid up prices.

In conjunction with housing, we’ve also seen a massive spike in stock prices, with even notable dips lasting only a few days to a couple of weeks. The explosion of new investors, low-cost trading apps, meme-stocks, crypto-currencies, and now NFTs has shown that when trapped at home for extended periods of time with the occasional stimulus cheque, many people once fearful of the market have become quasi “professional” day traders.

Market have been mercurial this past year. Broadly they’ve seemed to do very well, but indexes did not reveal the wide disparities in returns. Last year five stocks were responsible for half the gains in the S&P 500 since April, and for the total year’s return (24%), Apple, Microsoft, Alphabet Inc, Tesla and Nvidia Corp were responsible for about 1/3 of that total return. This means that returns have been far more varied for investors outside a tightly packed group of stocks, and also suggests markets remain far more fragile than they initially appear, while the index itself is far more concentrated due to the relative size of its largest companies.

Suspicious Investment Practices In addition to a stock market that seems bulletproof, houses so expensive entire generations worry they’ve been permanently priced out of the market, the rapid and explosive growth of more dubious financial vehicles has been a real cause for concern and will likely prompt governments to begin intervening in these still unregulated markets.

Crypto currencies remain the standout in this space. Even as Bitcoin and Etherium continue to edge their way towards being mainstream, new crypto currencies trading at fractions of the price, have gotten attention. Some have turned out to be jokes of jokes that inadvertently blew up. Others have been straight-up scams. But all have found a dedicated group of investors willing to risk substantial sums of money in the hope of striking it rich.

NFTs, or non-fungible tokens have also crept up in this space, making use of the blockchain, but instead of something interchangeable (like a bitcoin for a bitcoin, i.e. fungible) these tokens are unique and have captured tens of thousands, sometimes hundreds of thousands of dollars for unique bits of digital art. Like cryptocurrencies, much of the value is the assumed future value and high demand for a scarce resource. However, history would show that this typically ends poorly, whether its housing, baseball cards or beanie babies.  

Lastly, there has been a number of new investment vehicles, the most unusual of which is “fractional ownership”. The online broker Wealth Simple was the first to offer this in Canada and it has been targeted to younger investors. The opportunity is that if your preferred stock is too expensive, you can own fractions of it. So if you wanted to invest in Amazon or Tesla, two stocks that are trading at (roughly) $3330 and $1156 respectively at the time of writing, those stocks might be out of reach if you’re just getting started.

This is a marketing idea, not a smart idea. The danger of having all your assets tied up in one investment is uncontroversial and well understood. The premise behind mutual funds and exchange traded funds was to give people a well-diversified investment solution without the necessity of large financial position. The introduction of fractional ownership ties back to the market fragility I mentioned above, with younger investors needlessly concentrating their risk in favour of trying to capture historic returns.

The End

For most investors this year was largely a positive one, though markets went through many phases. But while the pandemic has remained the central news story, the low market volatility and decent returns has kept much of us either distracted or comfortable with the state of things. And yet I can’t help but wonder whether the risks are all the greater as a result. Many of these events, the large returns in an ever tightening group of stocks, the growth of investors chasing gains, the sudden appearance of new asset bubbles and the continued strain on the housing market and household goods add up to a worrying mix as we look ahead.

Or maybe not. Market pessimists, housing bears, and bitcoin doubters have garnered a lot of attention but have a bad track record (I should know!) Many of the most pressing issues feel as though they should come to a head soon, but history also teaches us that real problems; big problems that take years to sort out and lead to substantial changes are often much longer in the making than the patience of their critics. The test for investors is whether they can stand by their convictions and miss out on potential windfalls, or will they become converts right as the market gives way?

Next week, we’ll examine some of the potential trends of 2022.   

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Interviews – 2021

Last year we put on a number of interviews with various experts and journalists. Some were very well received and I’m sharing them again here in case you missed any of them.

Alexander Hay is a global consultant on resiliency, and the author of three books. His work is aimed at helping governments and companies design and implement resiliency plans in the face of natural disasters like flooding. His commentary was insightful and particularly relevant in the face of the massive flooding that occurred in British Columbia last month, wiping out highways and isolating the interior.

Edward Luce is the senior US Commentator for the Financial Times, author of several books on the economic and social challenges facing the United States, with his most recent being the Retreat of Western Liberalism. Edward joined me in July to discuss the United States post Trump, the strength global markets, the rise of populism and the failures of the pandemic response from governments.

Sam Cooper is a journalist with Global News and has made a career out of following political corruption, organized crime and financial crime. His book, Wilful Blindness, chronicled the Chinese government and organized crime’s influence on Canada and the blind eye taken by our political leaders. He joined me in August to discuss his book and how corruption has shaped the opioid epidemic and real estate.

Matt Gurney is a prominent Toronto journalist and columnist featured on television, radio and in print. His insightful commentary through the pandemic has highlighted where our infrastructure has failed, and Matt joined me in late August to talk about what lessons we should, but probably won’t, learn from the pandemic.

In total we did eight interviews last year (several are not permitted for unrestricted release) but I hope you’ll take a moment to check out the above videos if you missed any. There will be a few more video interviews this year and if you have any suggestions for either topics or people we are open to hearing about them.

Please enjoy, and Happy 2022!

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The End of the 60/40 Split?

For the past few weeks I’ve been struggling to capture what’s been happening in markets since late January. There has simply been so much that it is hard to succinctly cover it all in a single blog post.

So instead, toady I hope to touch on one thing that should stand out to us, the potential end of an investing strategy that is so standard it is reflected in almost every corner of the financial services world, from mutual fund companies to robo-advisors to banks.

The 60/40 split, or balanced portfolio, is the general go to solution for steady returns. The principle is simple: 60% of a portfolio is weighted towards equities, that is stocks in companies, mutual funds or ETFs, and the remaining 40% goes towards fixed income; a collection of bonds or other “safe” investments that pay some income in the form of mutual funds or ETFs.

This is a wide space to play in. Within the stock or equity portion, a portfolio may have exposure to any number of companies, sectors, or geographies. Similarly, the fixed income component can have government debt, corporate bonds, T-bills, mortgage securities, either domestic or foreign, in short or longer durations. The individual positions may have short term impacts on performance, as some investments will outperform for limited stretches, but the general architecture of the portfolio should see relatively stable and consistent returns over time with an acceptable level of risk for the majority of investors.

This wasn’t just speculation. It had some math behind it, explained in the form of the “Efficient Frontier”, a curve that showed the relation of risk to return and aimed to help identify an optimum portfolio based on these two metrics. The goal was to maximize the amount of return for the risk undertaken. Its easy to get lost in the weeds here, but if you’re ever interested you can read up on Modern Portfolio Theory or Harry Markowitz. Put simply, the lesson the industry took was that a diversified portfolio of investments, with rough weightings of 40% in fixed income and 60% in equities would largely suit most people.

It’s worth asking why this is. And the answer has a lot to do with buying a house in the late 1970s and early 1980s.

As anyone who remembers 8-tracks will tell you, buying a house in the early part of the 80s was expensive. 5-year fixed rates were 20%, or more. According to the website ratehub.ca, the prime lending rate in Canada peaked at around 21.75% in August of 1981. By comparison, my current 5-year mortgage is a whopping 1.8%. In 1981, you could buy a Government of Canada 10-year bond with a coupon rate of 15.3%, and a 5-year GIC with a rate of 15.4%. Today a 10-year government of Canada bond has a yield of 1.51% and the most generous GIC I can sell is 1.96% from Haventree Bank with a minimum deposit of $50,000.

Figure 1 From London Life – Looking Back at Historical Returns

Okay, so what’s the connection?

The issue here is not just that buying a house cost more when it came to lending in the 1980s, but that the cost of lending itself has been falling for the last 40 years. We tend to think of bonds as an investment you buy, when in reality they are a loan you are making that can be traded on an open market. So imagine you were building a bond portfolio in the early 1980s, and the average yield of that portfolio (the interest you will receive based on what you paid) is 15%. It’s very safe, made entirely of Canadian 10-year bonds. Now, three years pass and a new 10-year bond from the GoC has a rate of 12.3%, what’s the effect on your bond portfolio?

It’s good news! It’s worth more, because for the next 7 years your bonds will pay 3% more than any new bond issuance. By 1986 a 10-year bond was paying 6% less per year than your portfolio. For the last 40 years the cost of borrowing has continued to decline, and the result has been to make bonds issued in previous years more valuable. And so, while there may have been fluctuations in returns over short periods of time, by and large a portfolio of bonds returned not just income, but also capital gains as older bonds were worth more with each decline in the cost of lending.

Figure 2 From http://www.Ratehub.ca/prime-mortgage-rate-history

Today the cost of lending is low. Very low. Central bank lending rates for Canada, the United States, and the ECB are 0.25%, 0.25% and 0% respectively. A 30-year government of Canada bond has a current yield of 1.948%. In other words, were you to buy that bond today, the most you would earn is 1.948% on whatever you paid for the next 30 years.

But remember, bonds are traded on an open market. This means that the value of a bond fluctuates with its demand, and with it the return the bond gives. So, if you think that 1.948% is not enough interest to warrant buying the bond and the broad market agrees with you, the price of the bond should fall enough to push up the yield (for reference, the yield is the interest paid by the bond, divided by its price) until it pays enough interest to warrant investing. And that is what has been happening this year. Government bonds in the United States have been dumped as investors expect stock markets to do well and bond yields are considered too low. And as the bond price falls, the yield the bond pays goes up in relation to the decline of the price, and with it sets a borrowing rate investors are more comfortable with.

What this means for portfolios is that the 40% allocated to bonds is now very vulnerable to both investor sentiment and future rate hikes by central banks. With borrowing rates already at rock bottom both of these risks seem likely, and it’s left the traditional “balanced portfolio” exposed when it comes to reducing risk through different asset classes.

You might assume that this is a new problem, but it isn’t. Risk has been growing and portfolios have been evolving in complexity to meet the needs of investors for the last few decades. Much of this has happened on the equity side of portfolios, with investors demanding, and ultimately gaining access to a much wider range of investable products since the 90s. The period where you could have a portfolio made up of just Canadian dividend paying stocks ended long ago, and in its place, portfolios now hold a variety of investment products with access to large cap, small cap, US, North American, global, international, Emerging Markets, Frontier Markets, sector specific investing, thematic investing, commodities, dividends, value, growth, and growth at a reasonable price. Bonds have undergone a similar transformation, with investors moving from government bonds, to corporate bonds, to junk bonds (bonds with lower quality ratings and potentially higher default rates) both domestically and globally.

Today, to achieve a return of about 6.5%, the average investor is taking on risk at a much higher rate than they would 20 years ago. In 2000 a 6.5% return could be achieved with a portfolio of exclusively bonds. 20 years later a 6.5% return would require a much larger range of positions, including US stocks (large and small cap), real estate, private equity and would have a relative level of risk of more than double (almost three times!) the 2000 level. The above changes to the bond market will only mean more risk and more volatility for investors.

I’m reluctant to ever declare something “dead” or “over”. That language betrays too much confidence about tomorrow, but financial history is much longer than most people appreciate and is filled with disruptions and the ending of economic certainties followed by the arrival of new paradigms. Whether it is the bankrupting of the Medicis, or the popping of a tulip bubble, economic realities can change.  The “balanced portfolio” with its 60/40 mix, has been a cornerstone of simplified investing, a “go-to” solution that has made mass investing using discount platforms affordable and easy.

Figure 3 From Wealth Simple’s web page, simply choose your risk comfort and get a portfolio with more or less bonds. No need to think, no need to worry.

In an ideal world we might wish that investing was more “set it and forget it” than not, but long-term data and averages obscure the reality for many people. In the last ten years we’ve seen two serious “once in a lifetime” events that have shaken markets and governments. Investors, no matter what their stripe, whether they prefer robo-advisors, bank products or a personal financial advisor like myself, should be cautious that the rules to successful portfolio building are immutable.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc

The Game Stop Chronicles

Last week may go down as one of the weirdest weeks in investing history.

By now you have been made aware of the company Game Stop (GME:N). You’ve undoubtably been forced to look up what a short position and a “short squeeze” are and have collided head first into the meme fuelled online community of Wall Street Bets, the subreddit that lives for dangerous investments and may go down in history for the first market based populist uprising.

My first twig that something was going on came the week before last. I had investments in Blackberry (BB:TSX), a company that I had felt was undervalued and believed had made a successful transition into cyber security, a market sector I believe poised for long term growth. The ride had had not been fun. And then, all of a sudden the stock began going up. At first it seemed to be in response to a series of positive news stories; a settled IP legal case with Facebook, a new deal with Amazon for cloud services, and the sale of some 90 patents to Huawei. And then the stock took off. Within days a stock that had been languishing around $8 – $9 had suddenly doubled and was now looking to triple.

I was elated, until I read about Wall Street Bets (WSB), Game Stop, a hedge fund and how a number of stocks, including Blackberry, were being driven higher in an attempt to hurt a hedge fund. The story was fascinating but also terrifying. On Tuesday morning I exited Blackberry and began trying to understand what was going on.

The internet is a weird place, and far from creating a new universal society, it has instead hastened the growth of more insular and specialized communities. From the outside these groups can feel pretty alien. They have their own language, jokes and hierarchies and the subreddit Wall Street Bets is no different. But once you had pushed past the memes and lingo, it became clear the WSB, which is filled with amateur traders, had caught on to a risky move by a hedge fund called Melvin Capital. Melvin Capital had taken out large short positions on Game Stop, a legacy business that sold physical game cartridges in malls that was obviously struggling. The price of the stock had recently gone up following a new board member and announced plans for further restructuring. The traders at Melvin Capital believed the price of the stock over valued and had opted to short the stock (a method of betting on a future price decline by “borrowing” stock, selling it and buying it back within a set period of time). What the investors over at WSB understood was that the size of the short was too big, and that if they were to buy up all the available stock and hold it they could create a “short squeeze” in which the price of the stock climbs and the available supply of the stock falls, forcing potentially unlimited losses on those holding the shorts.

From here everything becomes extremely weird. It turned out the Wall Street Bets crowd wasn’t interested in making money as much as they were interested in crippling Melvin Capital. The trading platform that facilitated all of this, Robinhood, which prided itself on “democratizing trading” and offered no fees for doing trades, suddenly seemed to fold under the most minor of pressure to the request of another hedge fund to restrict retail trading on Game Stop, allowing only selling and no buying on Thursday. Suddenly members of Congress from across the political spectrum were tweeting and complaining about the restriction of trading regarding Game Stop and threatening to hold hearings into Robinhood’s practices.

On Friday limited purchases of Game Stop reopened, and much to the surprise of many, the commitment to “hold” did hold. While the price of Game Stop stock had fallen Thursday during the period only selling was allowed, the price decline reflected minimal volumes. On Friday morning the stock opened again above $300, and despite considerable volatility closed the week at $325 a share.

You’d be forgiven if you’re having a hard time following all the facets of this story, but from my vantage I’d like to share the 4 major issues this convoluted chain of events has created.

1.Populism and Democracy – Twitter and Reddit have been alive with excitement over screwing with a hedge fund, and its apparent that those engaging in the initial rally for GME are committed to undermining Melvin Capital, but the sharp response from Wall Street institutions that this represented some kind of illegitimate assault on the markets highlights the lack of interest in a “democratized” market. Like a lot of internet buzz about “making things more accessible” or “democratic”, when put into practice established institutions don’t seem to like the rabble actually having all that much power. Whether it’s a crowd sourced populist group of traders playing the other side of an over leveraged short position, or simply an online vote that wishes to name a scientific vessel “Boaty McBoatface”, efforts to open, engage and democratize previously closed off institutions seem to fail when it turns out the masses don’t share the goals or reverence of those institutions.

2. Hedge funds often describe themselves in terms of significant reverence and are self-styled “Titans of Wall Street”, but as a group hedge fund performance frequently falls flat. What hedge funds have been good at is risking other people’s money. The brashness and over confidence displayed by hedge fund traders is precisely how you end up with a short position worth 130% of the available stock of a company and squandering $5 billion in a week. Some may find “shorting” a controversial practice, but in reality it is a common and well understood strategy. But in the hands of hedge funds it can become predatory as efforts are made to sometimes game the system and force stock prices down unnecessarily.

3. The Robinhood trading app, which has become all the rage with DIY investors seemed to have its brand implode in the week, and it perhaps revealed far more about this business than anyone had wanted. Like Google or Facebook, where the service is “free”, people using the Robinhood trading platform were the product. Robinhood, legally but controversially, makes its money by “payment for order flow”, or by directing the orders to different parties for trade execution. This all gets pretty complex, but at its core those using the Robinhood app may have been paying fractionally too much for their trades, but when in the context of billions of trades it adds up to a substantial amount of money. The benefit of buying overflow is that high frequency trading algorithms can potentially front run those trades, which was the subject of the controversial Flash Boys book by Michael Lewis. Perhaps more nefarious was who was Robinhood’s primary purchaser of order flow; Citadel Execution Services, which is owned by Citadel LLC, which just bailed out Melvin Capital.

4.Much of this will end up bypassing the bulk of the population. The story is too weird, to convoluted and too specialized. It involves a cynical and anarchistic online community whose rallying cry is “WE CAN REMAIN RETARDED LONGER THAN THEY CAN STAY SOLVENT”, something that many will find repellent and will keep people from looking closer. What might make people pay attention is the money.

The apocryphal story of the famous investor receiving investment advice from the shoe shine boy right before the great crash has some modern parallels. Prices for stocks, some at all time highs, keep going up despite worrying fundamentals. Companies like Tesla, which have devout adherents, have bid up that stock so that the total company is worth more than all the other major car companies combined! This reeks of the beginnings of a mania, one that can only be made worse by a prolonged lockdown, low interest rates, and the use of social media to hype up a stock. The allure of easy money, embodied by the events surrounding Game Stop will only attract more investors that believe that they too can beat the market.

At the end of last week the number one app in Canada was the Wealthsimple Trade App, a similar low cost trading platform to Robinhood, while the Robinhood App itself remains highly popular south of the border.

The wind has been let out of the sails somewhat this week. Game Stop closed under $100 on Tuesday, and early hype that silver was going to be the next big WSB play seem to have fizzled also. Markets seem to have responded to this cooling of temperatures by resuming their positive direction, but the spectre of market mania looms over returns. Where we go next, I don’t know. But I do know that sensible investors should be watching this with concern. Whatever the merits of hunting hedge funds through crowd sourced market initiatives, the larger story remains one of deep concern, involving all the worst aspects of investing.

“Information in this commentary is for informational purposes only and not meant to be personalized investment advice. The content has been prepared by Adrian Walker from sources believed to be accurate. The opinions expressed are of the author and do not necessarily represent those of ACPI”.

by The Walker Report of Walker Wealth Management and Aligned Capital Partners Inc