Recapping Last Week’s Market

A quick video looking at the sudden rise in markets last week and what conclusions we can draw from it.

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.

Why Can’t Markets Be Calmed?

A series of bad days, a moment of respite, and then more selling. This was the story of 2008, and it lasted for months. The rout lasted until finally investors felt that enough was going to be done to save the economy that people stopped selling. Massive quantitative easing, an interest rate at 0%, aggressive fund transfers, bailouts to whole industries, and the election of a president who seemed to embody the idea of “hyper competence”. That’s what it took to save the economy in 2008. Big money, an unconditional promise to save businesses and people, and the rejection of a political party that oversaw the bungled early handling of a crisis and had lost the public confidence.

I don’t think Donald Trump has never had been viewed as hyper competent. I doubt even his most ardent supporters see him as incredibly clever, but instead a thumb in the eye of “elites” who have never cared to take their concerns seriously, and to an establishment that seemed incapable of making politics work. Trump was a rejection of the status quo and a “disruptor in chief”. A TV game show host who played the role of America’s most sacrosanct character, the self made man, asked now to play the same role in politics.

There’s nothing I need to cover here you don’t already know. A history of bad business dealings, likely foreign collusion to win an election, surrounded by sycophants and yes men with little interest or understanding of the machines they have been put in charge of, and an endless supply of criminal charges. Like a dictator his closest advisors are members of his own family, and perhaps more shockingly he fawns over and publicly admires the dedications of respect other dictators get from their oppressed populations. Never has a person been so naked in their desires and shortfalls as Donald Trump.

Markets have played along with this charade because Trump seemed, if anything, largely harmless to them. Indifference to the larger operation of the government and the laser like focus on reduced regulations and tax cuts made Trump agreeable to the Wall Street set. If he could simply avoid a war and keep the economy humming, Trump was a liveable consequence of “good times”. Until the coronavirus issue, Trump had not done terribly. The economy wasn’t exactly humming. It had a bad limp due to a trade war with China. It had a chest cold because wealth inequality was continuing to worsen despite decreasing unemployment. And its general faculties were diminished as issues around health care, deficit spending, and other aspects of the society began to languish. But as far as unhealthy bodies go, the American economy still had its ever strong beating heart, the American consumer.

Whatever name you prefer; COVID-19, the coronavirus, SARS-CoV-2, or the #Chinesevirus (as Trump is now busy trying to get it renamed) has exposed the fault lines in the administration and the danger of such blinkered thinking by Wall Street. Having spent the last few weeks downplaying the severity of the outbreak and hoping China would be able to contain it, until finally, grudgingly, acknowledging its seriousness. Markets have suddenly come face to face with a problem that bluster and bravado can’t fix. Trump is a political liability for markets, and his leadership style, which is heavy on cashing in on good times with little management for rainy days, means that markets may not really have any faith that he can properly address these problems.

Other efforts to calm markets, largely through the federal reserve, have not reassured anyone. Two emergency rate cuts are not going to fix the economy but did spook investors globally (it did signal to banks that they should take loans to cover potential shortfalls). The promise of a massive set of repo loans to provide liquidity will keep markets open and lubricated, but again won’t save jobs and won’t prop up the physical economy. What will fix markets is an end to the pandemic, a problem with the very blunt solutions of “social distancing”, “self isolation” and the distant hope of a vaccine.

What investors are facing are three big problems. First, that we don’t know when the virus will be contained. Optimistically it could be a month. Realistically it could be three. Pessimistically people are talking about the rest of the year. Even under the best conditions we are also likely facing a recession in most parts of the globe, and even then stimulus spending and financial help won’t be as effective until people can leave their homes and partake in the wider market (postponing tax filings and allowing deferrals on mortgages are good policies for right now, but at some point we need to spend money on things). But the last problem is one of politics. The Trump administration is uniquely incompetent, has shown little interest in the mechanisms of government, and in a particularly vicious form of having something come back to bite you, dismantled the CDC’s pandemic response team.

The best news came last week, when it seemed a switch had been flicked and the general population suddenly grasped the urgency of the situation and people began self isolating and limiting social engagements (I am now discounting Florida from this statement). Those measures have only been strengthened by government action over the last few days. Similarly, while I write this, Trudeau has announced a comprehensive financial package to come to the aid of small businesses and Canadian families. All this is welcome news, and I expect to see more like this over the coming weeks as Western governments take a more robust and wide ranging response to the crisis. So there is just one issue still unaddressed. The political mess in Washington.

I can’t say that markets will improve if Trump is voted out of office, but its hard to imagine that they could be made worse by his exit. Markets, and the investors that drive them, are emotional and it is confidence, the belief that things will be better tomorrow, that allow people to invest. Trump promised a return to “good times”, to Make America Great Again, and it is his unique failings that have left it, if anything, poorer.

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.

When Only One Thing Matters

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In my head is the vague memory of some political talking head who predicted economic ruin under Obama. He had once worked for the US Government in the 80s and had predicted a recession using only three economic indicators. His call that a recession was imminent led to much derision and he was ultimately let go from his job, left presumably to wander the earth seeking out a second life as political commentator making outlandish claims. I forget his name and, so far, Google hasn’t been much help.

I bring this half-formed memory up because we live in a world that seems focused on ONE BIG THING. The ONE BIG THING is so big that it clouds out the wider picture, limiting conversation and making it hard to plan for the future. That ONE BIG THING is Trump’s trade war.

I get all kinds of financial reports sent to me, some better than others, and lately they’ve all started to share a common thread. In short, while they highlight the relative strength of the US markets, the softening of some global markets, and changes in monetary policy from various central banks they all conclude with the same caveat. That the trade war seems to matter more and things could get better or worse based on what actions Trump and Xi Jinping take in the immediate future.

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Now, I have a history of criticizing economists for making predictions that are rosier than they should be, that predictions tend towards being little more than guesses and that smart investors should be mindful of risks that they can’t afford. I think this situation is no different, and it is concerning how much one issue has become the “x-factor” in reading the markets, at the expense of literally everything else.

What this should mean for investors is two-fold. That analysts are increasingly making more useless predictions since “the x-factor” leaves analysts shrugging their shoulders, admitting that they can’t properly predict what’s coming because a tweet from the president could derail their models. The second is that as ONE BIG THING dominates the discussion investors increasingly feel threatened by it and myopic about it.

This may seem obvious, but being a smart investor is about distance and strategy. The more focused we become about a problem the more we can’t see anything but that problem. In the case of the trade war the conversation is increasingly one that dominates all conversation. And while the trade war represents a serious issue on the global stage, so too does Brexit, as does India’s occupation of Kashmir (more on that another day) , the imminent crackdown by the Chinese on Hong Kong (more on that another day), the declining number of liberal democracies and the fraying of the Liberal International order.

This may not feel like I’m painting a better picture here, but my point is that things are always going wrong. They are never not going wrong and that had we waited until there were only proverbial sunny days for our investing picnic, we’d never get out the door. What this means is not that you should ignore or be blasé about the various crises afflicting the world, but that they should be put into a better historical context: things are going wrong because things are always going wrong. If investing is a picnic, you shouldn’t ignore the rain, but bring an umbrella.

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The trade war represents an issue that people can easily grasp and is close to home. Trump’s own brand of semi-authoritarian populism controls news cycles and demands attention. Its hard to “look away”. It demands our attention, and demands we respond in a dynamic way. But its dominance makes people feel that we are on the cusp of another great crash. The potential for things to be wiped out, for savings to be obliterated, for Trump to be the worst possible version of what he is. And so I caution readers and investors that as much as we find Trump’s antics unsettling and worrying, we should not let his brash twitter feuds panic us nor guide us. He is but one of many issues swirling around and its incumbent on us to look at the big picture and act accordingly. That we live in a complex world, that things are frequently going wrong and the most successful strategy is one that resists letting ONE BIG THING decide our actions. Don’t be like my half-remembered man, myopic and predicting gloom.

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.

Beware the Rally

*At the time that I wrote this markets had just finished several positive sessions, however by the time it was ready markets had once again changed directions!

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I’m going to potentially embarrass myself and go on the record as saying we shouldn’t place too much trust in the current market rally, though the upturn is welcomed.

Rallies present opportunities for potential short-term gain, and with markets having shed roughly 10% over the month of October, there is certainly money to be made if you’re feeling sufficiently opportunistic and have a plan. For the rest of us, the rally is a welcome break the punishment the market has been delivering, and an opportunity to see portfolios stabilize and regain some ground.

S&P 500 Rally

The long-term viability of a rally, its ability to transition from opportunistic buying to sustained growth, very much depends on the fundamentals of that rally. Are markets sound, but oversold? Or are fundamentals deteriorating and represents more hopefulness than anything else?

Readers of this blog will not be surprised to find out I have no set answer to this question. As always, “it depends”. But as I look over the news that has supposedly rekindled the fire in the markets much of it seems at best temporary, perhaps even fanciful. Up against the wall of risk that investors are currently starring down, the best news currently available is that Trump had a phone call with Xi Jinping and has asked for a draft to be prepared to settle the trade disputes between the two countries.

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I’m of the opinion that a recession isn’t imminent, but it should be obvious that recessions happen and the longer we go without one, the more likely one becomes. That seems especially true in a world that is undergoing a seminal shift when it comes to international trade and multilateral deals. To take one example, in the last year U.S. soybean exports to China have dropped by 97%, with no exports for the last quarter. This is a trade war still in its infancy. Other market data is mixed. Even as job growth exceeds expectations it will also keep the Fed raising rates. Housing starts have dropped significantly below expectations, driven in part by rising costs.

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All this is to say that market rallies like the one we’ve just seen should be treated with trepidation. Investors should be cautious that a bottom has been reached and that this is a good time to rush into the market looking for deals, and we should keep an eye on the fundamentals. Rallies falter precisely because they can be based more on hope than on reality.

So what should investors do if they want to invest but are unsure about when to get into the markets? Come talk to us! Give us a call and help get a plan together that makes sense for your needs! Check out our new website: www.walkerwealthmgmt.com or give us a call at 416-960-5995!

The Deceptive Nature of Indices

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An essential part of the business of investing involves figuring out how well you are doing. In some respects, the best benchmark for how well you are doing should be personalized to you. How conservative are you? What kind of income needs do you have? How old are you? While the case remains strong for everyone to have a personal benchmark to compare against their investment portfolios, in practice many people simply default to market indexes.

I’ve talked a little about market indexes before. They are poorly understood products, designed to give an impression about the overall health and direction of the economy and can serve as a guide to investment decisions. Large benchmarks, like the S&P 500, the TSX, or the FTSE 100, can tell us a great deal about the sentiment of investors (large and small) and what the expected direction of an economy may be.

But because these tools are usually poorly understood, they can contribute to as much confusion as they do clarity. For instance, the Dow Jones uses a highly confusing set of maths to determine performance. Last year General Electric lost about 50% of its market capitalization, while at the same time Boeing increased its market capitalization by 50%, but their impact on the Dow Jones was dramatically different. Boeing had an outsized positive contribution while General Electric had a much smaller negative impact.

The S&P 500 currently is one of the best preforming markets in 2018. Compared to most global indexes, the S&P 500 is ahead of Germany’s DAX, Britain’s FTSE 100 and FTSE 250, Japan’s Nikkei and Canada’s TSX. Yet if you are looking at your US focused investments, you might be surprised to see your own mutual funds lagging the index this year. If you were to ask an ETF provider or discount financial advisor why that is they would likely default to the answer “fees”, but they’d be wrong.

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While the S&P 500 isn’t exactly “running away” it is doing considerably better than the TSX and the UK’s FTSE 100

This year is an excellent example of the old joke about Bill Gates walking into a bar and making each patron, on average, a millionaire. While the overall index has been performing quite well, the deeper story is about how a handful of companies are actually driving those returns, while the broader market has begun to languish. Of the 11 sectors in the S&P 500, only two are up, technology and consumer discretionary, while a further 6 were down for the year. In fact the companies driving most of the gains are: Facebook, Amazon, Apple, Alphabet (Google), Netflix and Microsoft. The 80 stocks in the consumer discretionary space not in that list have done almost nothing at all.

What does this portend for the future? There is a lot to be concerned about. The narrowing of market returns is not a good sign (although there have been some good results in terms of earnings), and it tends to warp investment goals. Investors demand that mutual fund returns keep up with their index, often forcing portfolio managers to buy more of a stock that they may not wish to have. In the world of Exchange Traded Funds (or ETFs), they participate in a positive feedback loop, pulling in money and buying more of the same stocks that are already driving the performance.

In all, indexes remain a useful tool to gage relative performance, but like with all things a little knowledge can be deceptive. The S&P 500 remains a strong performing index this year, but its health isn’t good. Healthy markets need broad based growth, and investors would be wise to know the details behind the stories of market growth before they excitedly commit money to superficially good performance.  

Did that make you worried? Don’t be scared, call us to set up a review of your portfolio to better understand the risks!

The Sentry Scandal & Unethical Sales Practices

For the past week I’ve been tinkering with a piece around the allegations that TD’s high pressure sales tactics had driven some staff to disregard the needs of their clients and encourage financial advisers in their employ to push for unsuitable products, and in some instances drove employees to break the law.

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The drop in the value of TD shares following the allegations reported by CBC (from Google Finance)

My general point was that the financial advising industry depends on trust to function, and runs into problems when those that we employ for those jobs serve more than one master. The sales goals of the big banks are only in line with the individual investor needs so long as investor needs serve the banks. In other words, clients of the banks frequently find that their interests run second to the profit and management goals of Canada’s big five.

Yet I was having a hard time getting the article together. Something about the message was too easy; too obvious. No one who read the reports from the CBC was in any doubt about the ethical dubiousness of TD’s position, and forgetting the accusations of illegality, I doubt most people were surprised to find out that banks put their corporate needs ahead of their average Canadian clients.

But then yesterday something truly shocking happened. One of Canada’s larger independent mutual fund companies had to pay a $1.5 million settlement to the OSC for “non-compliant sales practices” (you can read the actual ruling by the OSC HERE). Effectively the OSC was reprimanding a company for giving excessively large non-monetary gifts to financial advisers, rewarding them for being “top producers”.

For the uninitiated, Canada’s mutual fund industry can seem a little confusing, so let me see if I can both explain why a mutual fund company would do what it did, and how you can avoid it.

First, there are several different kinds of mutual fund companies:

  1. There are companies like those of the banks, that provide both the service of financial advice and the mutual funds to invest in. This includes the five big banks and advice received within a branch.
  2. There are also independent mutual fund companies that also own a separate investing arm that operate independently. Companies like CI Investments own the financial firm Assante, IA Clarington owns FundEx, and the banks all have an independent brokerage (for example TD has Waterhouse, RBC owns Dominion Securities and BMO owns Nesbitt Burns).
  3. Lastly, there are a series of completely independent mutual fund companies with no investment wing. Companies like Franklin Templeton, Fidelity Investments, AGF Investments and Sentry Investments all fall into that category.

The real landscape is more complicated than this. There are lots of companies, and many are owned by yet other companies, so it can get muddy quickly. But for practical purposes, this is a fair picture for the Canadian market.

In theory, any independent financial adviser (either with a bank-owned brokerage, or an independent brokerage, like Aligned Capital) can buy any and all of these investments for our clients. And so, the pressure is on for mutual fund companies to get financial advisers to pay attention to them. If you are CI Investments, in addition to trying to win over other advisers, you also have your own financial adviser team that you can develop. But if you are a company like Sentry, you have no guarantee that anyone will pay attention to you. So how do you get business?

Sentry is a relatively new company. Firms like Fidelity and Franklin Templeton have been around for more than half a century. Banks have deep reserves to tap into if they want to create (out of nothing) a new mutual fund company. By comparison, Sentry has been around for just 20 years, and has had to survive through two serious financial downturns, first in 2000 and then 2008, as an independent firm. By all accounts, they’ve actually been quite successful, especially post 2009. You may have even seen some of their advertisements around.

 

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Over the past few years independent mutual fund companies have increasingly turned to public advertising to try and encourage individual investors to bug their advisers about their funds.

 

But while Sentry has had some fairly good performance in some important sectors (from a business standpoint, it is more important to have a strong core of conservative equity products than high flying emerging market or commodity investments) it has also had some practices that have made me uncomfortable.

For a long time, Sentry Investments paid financial advisers more than most other mutual fund companies. For every dollar paid to an adviser normally, Sentry would pay an additional $0.25. That may not sound like much, but across enough assets thats a noticeable chunk of money. And while there is nothing illegal about this, it is precisely the kind of activity that makes regulators suspicious about the motives of financial advisers and the relationships they have with investment providers. Its no surprise that about a year ago Sentry scaled back their trailer to advisers to be more like the rest of the industry.

The fact is, though, that Sentry is in trouble because of their success. No matter how much Sentry was willing to pay advisers, no-one has a business without solid performance, and Sentry had that. The company grew quickly following 2008 and has been one of the few Canadian mutual fund companies that attracted new assets consistently following the financial meltdown. When times are good, it’s easy for companies to look past their own bottom line and share their wealth. That Sentry chose to have a Due Diligence conference in Beverly Hills and shower gifts on their attending advisers was a reflection of their success more than anything else.

And yet, from an ethical standpoint, it is deeply troubling. I have always been wary of companies that offer to pay more than the going market rate for fear that the motives of my decision could be questioned or maligned. Being seen to be ethical is frequently about not simply following the law, but doing everything in your power to avoid conflicts of interest (Donald Trump: take notice). The financial advisers attending the due diligence (who would have paid for their own air travel and hotel accommodation) probably had no reason to believe that the gifts they were receiving exceeded the annual contribution limit. But now those gifts cast them too in the shadow of dubious behaviour.

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This is a man who has a hard time creating the impression that he is above ethical conflicts.

So how can you protect yourself from worries that your adviser is acting unethically, or being swayed to make decisions not in your interest? First, insist that your adviser at least offers the option of a fee for service arrangement. While the difference between an embedded trail and a transparent fee may be nominal, a fee-for-service agreement means that you have complete transparency in costs and full disclosure about where your advisers interests lie.

Second, if an embedded trail is still the best option, ask your adviser what the rationale was behind the selection of each of the funds in your portfolio, and what the trail commission was for each of those investments. This is information that you are entitled to, and you shouldn’t be shy about asking for.

Lastly, ask what mutual funds have given your adviser, but be open to the answer. Gifts to advisers are meant to fall into the category of “trinkets and trash”, mostly disposable items that are visibly branded by the company providing them, though gifts can be moderately more expensive. The difference between receiving cufflinks from Tiffany’s and cufflinks that bare the logo of a mutual fund firm is the difference between ethically dubious and openly transparent.

Regulators in Canada are pushing the industry towards a Fiduciary Responsibility for financial advisers. While that may clarify some of the grey areas, it will certainly create its own series of problems. Until then though, investors should not hesitate to question the investments they have, and why they have them. It may be unfair to expect the average Canadian to remember all the details about the types of investments that they have, but you should absolutely expect your financial adviser to be able to transparently and comprehensively explain the rationale and selection method behind the investments that you own.

If you would like an independent review of your current portfolio, please don’t hesitate to give us a call. 416-960-5995.