What’s Next? (And When Will It Happen)

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Talk of recession is in the air and amongst my clients and readers of this blog the chief question is “when”?

Ever since Trump was elected, questions about when “it’s going to happen” have been floating about. Trump, an 800-pound gorilla with a twitter addiction, has left a predictable path of destruction and the promise of more chaos always seems on the horizon. It should not be surprising then that investors have been waiting with bated breath for an inevitable correction.

Those predicting imminent doom got a little taste of it last week when markets convulsed and delivered the worst day of the year so far, shedding a dramatic 800 points off the Dow Jones. Globally the news hasn’t exactly been stellar. Germany, Italy and France are all showing a weakening economic outlook, which is to say nothing of Great Britain. Despite three Prime Ministers and two deadline extensions, the nation has yet to escape its Brexit chaos and is no closer to figuring out what to do about Northern Ireland. China too is facing a myriad of problems. Trump’s tariffs may be making American’s pay more for things, but it does seem to be hurting the Chinese economy. Coupled with the persistent Hong Kong protests and its already softening market, last week the Chinese central bank opted to weaken the Yuan below the 7 to 1 threshold, a previously unthinkable option aimed at bolstering economic growth.

In all of this it is the American economy that looks to be in the best shape. Proponents of the “U.S. is strong” story point to the historic low unemployment and other economic indicators like consumer spending and year over year GDP growth. But this news comes accompanied with its own baggage, including huge subsidies for farmers hit by Chinese import bans and other trade related self-inflicted wounds. This issue is best summarized by Trump, who himself has declared that everything is great, but also now needs a huge rate cut.

Trump TweetThe temptation to assume that everything is about to go wrong is therefore not the most far-fetched possibility. Investors should be cautious because there are indeed warning signs that the economy is softening and after ten years of bull market returns, corrections and recessions are inevitable.

But if there is an idea I’ve tried to get across, it is that prognostication inevitably fails. The real question that investors should be asking is, “How much can I risk?” If markets do go south, it won’t be forever. But for retirees and those approaching retirement, now ten years older since the last major recession, the potential of a serious downturn could radically alter planned retirements. That question, more than “how much can I make?”, or “When will the next recession hit?”, should be central to your conversations with your financial advisor.

As of writing this, more chaotic news has led Trump to acknowledge that his tariff war may indeed cause a recession, but he’s undeterred. The world is unpredictable, economic cycles happen, and economists are historically bad at predicting recessions. These facts should be at the center of financial planning and they will better serve you as an investor than the constant desire to see ever more growth.

So whether Donald Trump has markets panicked, or a trade war, or really bad manufacturing numbers out of Germany, remember that you aren’t investing to do as well as the markets, or even better. You’re investing to secure a future, and ask your financial advisor (assuming it isn’t me) how much risk do you need, not how much you’ve got.

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.

The Difference Between Mostly Dead, and Dead

8463430_origThe first (and so far only) good day in the markets for 2016 shouldn’t go by without instilling some hope in us investors. The latter half of 2015 and the first weeks of 2016 have many convinced that the market bull is thoroughly dead, having exited stage left pursued by a bear (appropriate for January). The toll taken by worsening news out of China, falling oil, and the rising US dollar have left markets totally exhausted and despondent. But is the bull dead, or just mostly dead? Because there’s a big difference between all dead and mostly dead. In other words, is there a case to be made for a resurgence?

I am, by nature, a contrarian. I have an aversion to large groups of people sharing the same opinion. It strikes me as lazy, and inevitably many of the adherents don’t ultimately know why they hold the views that they do. They’ve just gotten swept up in the zeitgeist and now swear their intellectual loyalty to some idea because everyone else has. And when I look at the market today, I do think there is a contrarian case for a market recovery. Not yet, it’s too early, but there are reasons to be hopeful.

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This book had a big impact on me growing up.

First, let’s consider the reasons we have for driving down the value of most shares. Oil prices. The price of oil has come to seemingly dictate much of the mood. Oil’s continued weakness speaks to deflation concerns, and stands in for China. It’s price is undermining the economies of many countries, not least of which is Canada. It’s eating into the profits of some of the biggest companies around. It’s precipitous fall has lent credence to otherwise outlandish predictions about the future value. Yet this laser like focus on oil has eclipsed anything else that could turn the tide in the market. Other news no longer matters, as the oil price comes to speak for wider concerns about China and growth prospects for the rest of the world. In the price of oil people now see the fate of the world.

That’s foolish, and precisely the kind of narrow mindset that leads to indiscriminate overselling. The very definition of babies and bathwater. And negativity begets more negativity. The more investors fear the worse the sentiment gets, leading to ever greater sell-offs. Better than expected news out of China, continued employment growth from the US, and the fundamental global benefit of cheap energy are being discounted by markets today, but still represent fundamental truths about economies that will bring life to our mostly dead bull tomorrow.

Don’t mistake me, I’m not trying to downplay the fundamental challenges that markets and economies are facing. Canada has real financial issues. They are not driven by sentiment, they are tangible and measurable. But they are also fixable, and they do not and will not affect every company equally. The same is true for China, just as it is true for the various oil producers the world over. What we should be wary of is letting the negative sentiment in the markets harden into an accepted wisdom that we hold too dear.

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Put another way, are the issues we are facing today as bad or worse than 2011, or even 2008? I’d argue not, and becoming too transfixed by the current market sentiment, the panicked selling and the ridiculous declarations by some market analysts only plays into bad financial management and will blind you to the opportunities the markets will present when a bottom is hit and numbers improve.

So is the bull dead? No. He is only mostly dead and there is a big difference between mostly dead and all dead. We will navigate this downturn, being mindful of both the bad news and the good news. Investors should seek appropriate financial advice from their financial advisors and remember that being too negative is just another form of complacency, a casual acceptance of the world as it currently appears, but may not actually be.

Remember, the bull is slightly alive and there’s still lots to live for.

For over 20 years we have been helping Canadians navigate difficult markets like this, by meeting in their homes and discussing their personal situations around the kitchen table. If you are looking for help, would like a complimentary review of your portfolio, or simply want to chat about your finances, please contact us today.

Swiming With Rocks in Your Pockets

drowningSince 2008 governments the world over have tried to fight the biggest banking collapse since the great depression with modest success. Eight years on and you would be loath to say that the world has turned a corner, ushering in a return of unrestrained economic growth.

Why this is the case is a question not just unanswered by the average layman, but by experts as well. Huge amounts of money have been printed, financial institutions have been patched and repaired, interest rates are at all time lows, what more can be done to fix the underlying problems?

It turns out that nobody is really sure, but as we begin 2016 global markets are reeling on the news that the Chinese economy has even greater problems than previously thought. Only a few days into the week and most markets are down in excess of 2-3%, giving rise to concerns that a Chinese led global recession could be on it’s way.

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The S&P/TSX over the past week.

The difference between now and 2008 is that much of the resources used to try and stem the problems from nearly a decade ago have already been deployed, and there is little left in the tank for another round. Central bakers have been trying to get enough inflation into the system to raise interest rates up from “emergency” levels to something more “normal” but outside of the US this seems to have largely failed.

One of the saving graces after 2008 was that the Emerging Markets were seemingly unaffected. In fact, since 2008 the developing world has become more than 50% of global GDP but in that time the rot that often accompanies success has also set in. EM debt is now considerable, putting many countries that had once extremely healthy balance sheets heavily into the red. Borrowing by these nations has increasingly moved away from constructive economic development and more into topping up civil servants and passing on treats to voters.

World GDP

For some, myself included, it has been encouraging that the Chinese have not proven to be the economic übermensch that some had feared. The rise of the state directed economy with boundless growth had many people concerned that China might represent an economic nadir for the planet. To see it every bit as bloated, foolish and corrupt may not be good for markets, but at least takes the bloom off the rose about Chinese economic supremacy.

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Still, this all of this leads to a couple of frightening conclusions. One is that we have yet to come across any rapid comprehensive solution to a global financial crisis like 2008 that can undo the damage and return us to an expected economic prosperity. The second is that we may have been going down the wrong path to resolve the economic problems we face.

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If debt was the driving force behind 2008, you couldn’t argue we’ve done much to alleviate the problem. At best we have merely shifted who holds it. In the United States, the US government took on billions of dollars of debt to stabilize the system. In Europe, despite attempts to reduce balance sheets across the continent, every country has taken on more debt as a result, regardless of whether they are having a strong market recovery, or a weak one. In Canada, arguably one of the worst offenders, private debt and public debt have ballooned at a frightening pace with little to show for it. Rate cuts and government spending are no match it seems for a plummeting oil price and a lack lustre manufacturing sector.

Interest Rates Globally

Having faced the problem of restrictive debt, putting much of the world’s financial markets in grave danger, our response has been to simply acquire more. Greece owes more, Canada owes more, and now the Emerging markets owe more. It was as though while trying to right the economic ship we forgot that we should keep bailing out the water.

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These charts come from an excellent report by McKinsey & Company called Debt and (not much) Deleveraging. You can download it HERE.

 

None of this is to say that every decision since 2008 has been wrong. Following Keynesian policy saved countless jobs and businesses. But at some point we should have also expected to tighten our belts and dispose of some of the debt weighing us down. Instead central banks attempted to stimulate inflation by juicing the consumer economy with incredibly low interest rates. But as we have seen there is only so much that can be done. A combination of persistent deflation, an aging population and extensive debt have largely upended the best efforts to restart the economy on all cylinders.

Economist cover

This shouldn’t be a surprise. Debt makes us financially fragile. It is an obligation and burden on our future selves. But if we found ourselves drowning in debt eight years ago, it is curious we thought the solution would be to add rocks to our pockets and expect to make the swimming easier.

 

The Media is Turning Market Panic up to 11 – Learn to Tune Them Out

The current market correction is about as fun as a toothache. Made up of a perfect storm of negative sentiment, a slowing global economy and concerns about the end of Quantitative Easing in the US have led to a broad sell-off of global markets, pretty much wiping out most of their gains year-to-date.

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This is what my screen looked like yesterday (October 15th, 2014). The little 52L that you see to the left of many stock symbols means that the price had hit a 52 week low. The broad nature of the sell off, and indiscriminate selling of every company, regardless of how sound their fundamentals tells us more about market panic than it does about the companies sold.

One of the focal points of this correction has been the price of oil, which is off nearly 25% from its high in June. Oil is central to the S&P/TSX, making up nearly 30% of the index. Along with commodities, energy prices are dependent on the expectation of future demand and assumed levels of supply. As investor sentiment have come to expect that the global demand will drop off in the coming year the price of oil has taken a tumble in the last few weeks. Combined with the rise of US energy output, also known as the Shale Energy Revolution, or fracking, the world is now awash in cheap (and getting cheaper oil).

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The price of Brent Crude oil – From NASDAQ

But as investors look to make sense out of what is going on in the markets they would be forgiven if all they learned from the papers, news and internet sites was a barrage of fear and negativity masquerading as insight and knowledge. The presumed benefit of having so much access to news would be useful and clear insight that could help direct investors on how to best manage the current correction. Instead the media has only thrown fuel on the fire, fanning the flames with panic and fear.

WTI & BrentContrast two similar articles about the winners and losers of a dropping price of oil. The lead article for the October 15th Globe and Mail’s Business section was “Forty Day Freefall”, which went to great lengths to highlight one big issue and then cloak it in doom. The article’s primary focus is the price war that is developing between OPEC nations and North American producers. Even as global demand is reportedly slowing Saudi Arabia is increasing production, with no other OPEC nations seemingly interested in slowing the price drop or unilaterally cutting production. The reason for this action is presumably to stem the growth of oil sand and shale projects, forcing them into an unprofitable position.

 

This naturally raises concerns for energy production in Canada, but it is not nearly the whole story. The Financial Times had a similar focus on what a changing oil price might mean to nations, and its take is decidedly different. For instance, while oil producing nations may not like the new modest price for oil, cheap oil translates into an enormous boon for the global economy, working out to over $600 billion a year in stimulus. In the United States an average household will spend $2900 on gas. Brent oil priced at $80 turns into a $600 a year tax rebate for households. Cheaper oil is also hugely beneficial to the manufacturing sector, helping redirect money that would have been part of the running costs and turning them into potential economic expansion. It’s useful as well to Emerging Economies, many of which will be find themselves more competitive as costs of production drop on the back of reduced energy prices.

A current map of shale projects, and expected shale opportunities within the United States and Canada.
A current map of shale projects, and expected shale opportunities within the United States and Canada.

Business Reporting isn’t about business, it’s about advertising revenues.

While Canada may have to take it on the chin for a while because of our market’s heavy reliance on the energy sector, weakening oil prices also tends to mean a weakening dollar, both of which are welcomed by Canadian manufacturers. Corrections and changing markets may expose weaknesses in economies, but it should also uncover new opportunities. How we report these events does much to help investors either take advantage of market corrections, or become victims of it. As we wrote back in 2013, business reporting isn’t about business, it’s about advertising revenues. Pushing bad news sells papers and grabs attention, but denies investors guidance they need.

Throwing Cold Water On Investor Optimism (Not That We Needed Too)

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From The Geneva Report

Yesterday the 16th Geneva Report was released bearing bad news for everybody that was hoping for good news. The report, which highlighted that debt across the planet had continued to increase  and speed up despite the market crash of 2008, is sobering and seemed to cast in stone that which we already knew; that the global recovery is slow going and still looks very anemic.

The report is detailed and well over a hundred pages and only came out yesterday, so don’t be surprised if all the news reports you read about it really only cover the first two chapters and the executive summary. What is interesting about the report is how little of it we didn’t know. Much of what the report covers (and in great detail at that) is that the Eurozone is still weak, that the Federal Reserve has lots of debt on its balance sheets, but that it has helped turn the US

A look at the Fed's Balance Sheet from the Geneva Report
A look at the Fed’s Balance Sheet from the Geneva Report

economy around, that governments have been borrowing more while companies and individuals borrow less, and that economic growth in the Emerging Markets has been accompanied by considerable borrowing. All of this we knew.

What stands out to me in this report are two things that I believe should matter to Canadian investors. First is the trouble with low interest rates. Governments are being forced to keep interest rates low, and they are doing that because raising rates usually means less economic growth. But as growth rates have been weak, nobody wants to raise rates. This leads to a Catch-22 where governments are having to take direct measures to curb borrowing because rates are low, because they can’t raise rates to curb borrowing.

This has already happened in Canada, where the Bank of Canada’s low lending rate has helped keep housing prices high, mortgage rates down and debt levels soaring. To combat this the government has attempted to change the minimal borrowing requirements for homes, but it hasn’t done much to curb the growing concern that there is a housing bubble.

The second is the idea of “Economic Miracles” which tend to be wildly overblown and inevitably lead to the same economic mess of overly enthusiastic investors dumping increasingly dangerous amounts of money into economies that don’t deserve it just to watch the whole thing come crashing down. Economic miracles include everything from Tulip Bulbs and South Sea Bubbles to the “Spanish Miracle” and “Asian Tigers”, all of which ended badly.

The rise of the BRIC nations and the recent focus on the Frontier Markets should invite some of the same scrutiny, as overly-eager investors begin trying to fuel growth in Emerging Markets through lending and direct investment, even in the face of some concerning realities. It’s telling that the Financial Times reported both the Geneva Report on the same day that the London Stock Exchange was looking to pursue more African company listings, even as corruption and corporate governance come into serious question.

All of this should not dissuade investors from the markets, but it should be seen as a reminder about the benefits of diversification and it’s importance in a portfolio. It is often tempting to let bad news ruin an investment plan, but as is so often the case emotional investing is bad investing.

I’ve added an investment piece from CI Investments which has been floating around for years. It pairs the level of the Dow Jones Industrial Average  with whatever bad news was dominating the market that year. It’s a good way to look at how doom and gloom rarely had much to do with how the market ultimately performed. Have a look by kicking the link! I don’t want to Invest Flyer

 

***I’ve just seen that the Globe and Mail has reported on the Geneva Report with the tweet “Are we on the verge of another financial crisis” which is not really what the report outlines. 

Canada’s Economy Still Ticking Along, But Don’t be Fooled

Money CanThis year the Canadian markets have been doing exceptionally well. Where as last year the S&P/TSX had been struggling to get above 2% at this time, this year the markets have soared ahead of most of their global counterparts. In fact the Canadian market triumph is only half of this story, matched equally by the disappointing performance of almost every significant global market. Concerns over China have hurt Emerging Markets. The Ukrainian crisis has hindered Europe, and a difficult winter combined with weaker economic data has put the brakes on the US as well.

YTD TSX Performance

But this sudden return to form should not fool Canadians. It is a common trope of investing that people over estimate the value of their local economies, and a home bias can prove to be dangerous to a portfolio. Taking a peak under the hood of Canada’s market performance and we see it is largely from the volatile sectors of the economy. In the current year the costs of Oil, Natural Gas and Gold are all up. Utilities have also driven some of the returns, but with the Materials and Energy sector being a full third of the TSX its easy to see what’s really driving market performance. Combined with a declining dollar and improving global economy and Canada looks like an ideal place to invest.

TSX Market Sectors

But the underlying truth of the Canadian market is that it remains unhealthy. Manufacturing is down, although recovering slowly. Jobs growth exists, but its highly anemic. The core dangers to the vast number of Canadians continue to be high debt, expensive real-estate and cheap credit. In short, Canada is beginning to look more like pre-2008 United States rather than the picture of financial health we continue to project. Cheap borrowing rates are keeping the economy afloat, and it isn’t at all clear what the government can do to slow it down without upsetting the apple cart.

For Canadian investors the pull will be to increase exposure to the Canadian market, but they should be wary that even when news reports seem favourable about how well the Canadian economy might do, they are not making a comment about how healthy the economy really is. Instead they are making a prediction about what might happen if trends continue in a certain direction. There are many threats to Canada, both global and domestic, and it should weigh heavily on the minds of investors when they choose where to invest.