Why I am not changing my portfolio even though the yield curve has inverted

On Friday it was reported that the yield curve in the US inverted for the first time since the last (great) recession. This is supposed to be a reliable harbinger for a future recession in 12-18 months.

What does it mean when the yield curve inverts?

It means the US short-term interest rate (as measured by the 3 month Treasury Bill rate) is now higher than the long-term interest rate (as measured by the 10 year Treasury Bill rate). An inversion like this is generally regard as a negative market/economic sentiment that can affect economic and market behaviour.

The yield curve inversion has sent some scurrying to make changes to their portfolios by raising cash, selling riskier stocks and becoming more defensive (buying utilities, telcos, REITS and consumer staples equities).

Why I am not scurrying to do anything on the news:

  1. I already have some cash (about 10% of my portfolio, including high-interest savings and short-duration bonds maturing later this year)
  2. I already have good exposure to defensive equities: ~18% utilities + ~11% consumer defensive + ~6.5% communications services + ~3.5% real estate = ~39.0% defensive
  3. I have less than 50% of our total portfolio in equities so a market downturn should be offset somewhat by non-correlated holdings in fixed income, cash and bullion (this was true in 2018, when my portfolio returned ~+1% in spite of equity drawdowns in Canada and the US)
  4. If I sell something to raise cash there could be tax consequences in our non-registered accounts, due to potential capital gains being taxed
  5. I don’t know which non-defensive equities to sell to raise cash – I like all my holdings for the long haul or I wouldn’t own them
  6. Recessions tend to be short and I believe my long-term portfolio is structured well for riding out short-term events
  7. An inverted yield curve has reportedly accurately predicted upcoming recessions eight times (by some sources) since 1968 but, if on January 1, 1968, I bought and held the S&P 500 (^SPX) I would have made a return of 2.81K% in spite of the eight recessions (including the Great Recession of 2008-09)
  8. According to Forbes, the chance of a recession in the next year is always about 27% (based on their data pointing to 16 recessions since 1960) and today the chance is 30%, hardly more than average
  9. If the chance of recession is 30% next year there is also a 70% chance there won’t be a recession next year which means, based on probabilities alone, I should be buying risk-on stocks
  10. If the US Fed surprises by lowering interest rates, that could change the situation immediately
  11. I don’t know how to time when to start re-buying the risk-on equities I am supposed to sell now – presumably when the yield curve corrects to non-inversion

I am not saying a recession won’t happen in 2019-20. It may well.

What I am saying, as a long-term investor who buys, holds and monitors a portfolio of retirement assets designed for all markets, who relies primarily on asset allocation rules when making security weighting decisions, and who makes limited and selective trades intended to improve overall portfolio quality, I don’t react to news like this.

Do you?




Annual performance for my secular trends fantasy portfolio is now posted

I’ve posted the annual performance review for my secular trends fantasy portfolio which consists of nine ETFs representing thematic investment opportunities.

2018 was not kind to the portfolio (down around 10%) but cyber-security was a particular bright spot, up about 7%. More here.

More on sequence of returns risk

Sequence (of returns) risk is something I mentioned in my recent piece about my upcoming third quarter portfolio review. Sequence risk is a major factor in my planning as our household heads into retirement in the near future.

Looking at the current valuation of the S&P 500 vs. underlying gross national product is a bit sobering.

More on this here.

Brad’s updates to Steven Brown’s retirement forecaster tool are now available

Brad updated Steven Brown’s Retirement Forecaster Excel spreadsheet tool (version  2.7.2). The changes are as follows:

Version 2.7.2 provides support for defined benefit (DB) pension plans with a Bridge Benefit (such as the Fed Government or Ontario Teachers) and the accompanying DB Survivor pension. Detailed input instructions are provided on the Instructions sheet, under the Instructions section.

You may access the material on Brad’s page here.

Secular trends fantasy portfolio launch

I’ve launched a new fantasy portfolio on the money4retirement.ca website to track secular, or thematic trends for investors.

A secular trend is:

An investment trend associated with some characteristic or phenomenon that is not cyclical or seasonal but exists over a relatively long period.

The rationale for doing this and the initial portfolio structure is presented here.

The first secular trends fantasy portfolio tracking report (and its benchmark) is presented here.

I’ve also added a new menu option called “Secular trends and investing” on the site for quick access.

The decks from the April 2018 OSC meeting are posted

The decks from Mark Seed on DRIPping and from myself (Michael Patenaude) on the Q1 2018 OSC fantasy portfolios and sector allocations presented at the April 17, 2018 Ottawa Share Club meeting are posted here.

Be greedy when others are fearful?

Just a quick post to point out that for the third time so far this year, CNN’s fear and greed index is down below 10 (on a scale of 0 to 100). This suggests, by its seven measures, investors are “extremely fearful” of the US equity markets right now.

Hmmm. What’s on sale in the markets? (Hint: telecoms, consumer staples, energy, utilities and materials).

February 2018 content from the OSC meeting on retirement forecasting is posted

An extensive array of content is now available for planning your retirement courtesy of Fred May and Brad Forden who presented the material at the OSC session on February 13, 2018.

It includes Fred and Brad’s presentation, a link to Steven Brown’s Excel retirement forecasting tool, a link to Brad’s updates to Steven Brown’s tool, and four example forecasting scenarios that Fred and Brad presented at the meeting.

Please see the Ottawa Share Club members and guest page for the material (near top of the page) here.

Note: Brad is looking for feedback on the enhancements he’s made to Steven Brown’s forecasting tool. If you’d like him to work with you to do your retirement forecast and test the changes he’s made, please use the comments feature at the bottom of Brad’s page here and offer a paragraph description of what assistance you need. He is prepared to work with a couple of people only so please submit your request promptly.

Well, what really did happen to markets?

Further to my earlier post about some possible reasons for the recent correction in stock markets globally, I found a thoughtful explanation.

Ben Carlson of A Wealth of Common Sense, who I follow pretty regularly, posted his thoughts yesterday on his site.

Basically he thinks there isn’t a simple and satisfying explanation of causes for the pullback now.  He cautions investors that headlines tend to get blown out of proportion by financial news organizations.

He also makes the important point that anyone in the accumulation phase is now presented with an opportunity to buy good companies on sale.

Further, he predicts that this is not the beginning of a 2008-type crash. It is more likely a correction like we saw in the summer of 2015 (-12%) or the early part of 2016 (-13%).

Ben admits no one can predict what’s next:

The biggest thing to remember is that no one has a clue what’s going to happen next. Short-term market moves are controlled by human emotions, which are impossible to predict.

I couldn’t agree more.

That’s why I have done nothing during the correction and will monitor asset allocations until March 2018, when I reach my next self-imposed trading date. If stocks are still off their highs I may need to add to positions to remain at target weighting.

What just happened to markets?

Headline stories about the stock market pullback this week were largely focussed on the drop in the Dow Jones Industrial Average (less so on other indexes, but they were not immune). The year-to-date total return marked by the DJIA on January 26 was +7.77%. By the close on Friday, the DJIA had settled to +3.34% YTD, a drop of around 4%.

This is a relatively large drop given the low volatility and upward trending we’ve seen in markets in the last couple of years. By historical standards this is a mere blip, and 3.34% YTD total return still represents, annualized, over 35% growth!

I was in my car last night and caught a story on the news radio about the stock market pullback. The commentator didn’t really have a very clear rationale for drop – something about markets and the broad economy not being correlated….. The broad US economy is doing well, creating jobs and growing, but markets took a big pause.  Hmmm. I didn’t find that very satisfying.

A few minutes earlier I had read in WaPo the main reason that markets pulled back, and especially on Friday, was to do with the 10 year benchmark interest rate surpassing 2.8%, on its way perhaps to 3%. The case was made that a 3% benchmark rate will send a signal to some investors that bonds might be more attractive than stocks on a risk-adjusted basis.

I read another article this morning in the NY Times that makes a similar point and goes on to say there may actually be a connection between the pullback and the broad economy: expectations are that the broad US economy is going to grow at, say, 1.5% not the 3% promised by Donald Trump.

So maybe there is a decent connection between stock market indexes and the broader economy after all. Given how expectations affect spending and investment decisions so heavily – both in markets and in the economy at large – this really shouldn’t be a surprise. And the 10-year interest rate moves in large part due to expectations about inflation rates and the cost of money in the future. Inflation expectations may be climbing.

This tells me, perhaps, that expectations could well be shifting to lower future growth rates in the economy and to lower investment returns from markets. Nothing says these expectations will be proven correct, but it is worth noting.

It is also worth reminding that last year’s market performance is no guarantee of future performance. But even at a 3.34% total return YTD, the DOW isn’t exactly off to a bad start.