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 regarded 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?

 

 

 

Maybe the US president does affect markets after all

Many thought when Donald Trump became US president markets would react badly. How wrong was that?

Tax cuts and de-regulation have provided a boost to markets. However trade policy has also provided uncertainty. Rising interest rates, often not good for equities, have been seemingly offset, so far, by low unemployment and inflation and rising corporate profits.

With the most recent events in Washington, including Trump’s out-of-left-field tweet announcing an immediate troop withdrawal in Syria, followed by resignations by Defence Secretary Mattis and US anti-ISIS Envoy McGurk, Trump asking if he can fire Fed Chairman Powell, Trump associates being indicted and convicted by Mueller and other prosecutors, the Trump foundation closure due to inappropriate use of funds, the government shutdown that Trump said he would be proud of, Treasury Secretary Mnuchin’s calls today to top banks to check on their liquidity (was that even a problem?), to name a few, may mark a tipping point where the unpredictable deeds of Trump and his administration start to affect consumer and business confidence as well as market sentiment.

Investors have to be scratching their heads and wondering where all this is going and how much damage the seeming chaos might bring. 2019 doesn’t look like it will get much better with unresolved trade issues with China and others, the ongoing Mueller investigation and with the Democrats taking a majority role in the House of Representatives, where they will have the power of subpoena to conduct ever more investigations into Trump et. al. No one knows what tweet will next emanate from Trump’s fingers.

Powell is signalling a slowing of interest rate increases for next year. That might help markets settle. But forecasted profit growth is also slowing for 2019, same for global growth. Trump’s erratic behaviour seems to be amplifying uncertainty.

I can’t help thinking 2019 will be more volatile than 2018 as the drama, or do I say crisis, south of the border plays out.

We certainly live in interesting times.

Update: The Washington Post has a piece about how investor expectations may be adjusting to the reality of a Trump presidency.

 

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.

My latest article on secular trends and investing has been published in Canadian MoneySaver

Canadian MoneySaver published my latest article on thematic investing in the July/August 2018 edition.

This time I discuss the investment opportunities in alternative energy. While there are headwinds in the short to medium term, long term this theme offers considerable potential, especially in Asian markets.

See more here (paywall): Canadian MoneySaver

Second quarter secular trends fantasy portfolio results are now posted

With the second quarter completed, I’ve updated my secular trends fantasy portfolio performance report.

It’s been a strong year so far for the overall performance, but some themes are doing much better than others.

The total portfolio has delivered a 5.89% total return so far this year. The leaders are Amplify Online Retail ETF (IBUY), up ~25% and ETFMG Prime Cyber Security ETF (HACK), up ~17%.

The laggards are Vanguard FTSE Emerging Markets ETF (VWO), down ~7% and iShares Global Clean Energy ETF (ICLN), down ~5%.

By contrast, my secular trends benchmark is up only ~1% year to date. Other major indexes have total returns year to date as follows:

  • NASDAQ (QQQ) +10.6%
  • S&P 500 (SPY) +2.52%
  • TSX Composite (XIC) +1.14%
  • Dow Jones Industrial Average (DIA) -0.91

So, secular investing this year so far has done fairly well even though performance varies widely by theme. See the full performance report 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 eCommerce secular trend made news today

WalMart, the once-stodgy bricks and mortar retailer, made news today with its largest acquisition ever – $15B US for 75% of eCommerce retailer Flipkart in India.

It reportedly beat out Amazon for the deal.

WalMart shares dropped 3% on the news.

Amazon’s shares rose 1%.

Softbank appears to have done very well. Other players were involved including Alphabet, Microsoft, Tencent Holdings and Naspers.

The deal hasn’t fully closed yet….

More from Bloomberg here.

 

What US macro risks are investors facing these days?

It’s been over a year since I last wrote about macro risks emanating from the US and how they might affect Canadian investors.

Given how many changes are taking place in the macro environment recently, and how influential the US macro situation is for Canadians, I thought it would be interesting to do an update. The idea is to try to identify major driving factors that might affect US, Canadian and global equity markets in an effort to reduce the “surprise factor,” which may in turn lead to bad investment decisions (out of fear or panic).

So what does the macro risk profile look like south of the border? No one really knows for sure of course, but it is interesting to contemplate, especially if you have any US holdings in your portfolio.

Let’s take a look at some of the frequently-cited risks that may affect investors and try to determine if relative risk levels have increased or decreased since my last effort at this in January 2017.

I have listed them from what I propose are the highest to the lowest risks.

Notation used:

⇑ = risk is increasing

⇔ = risk is not changing

⇓ = risk is decreasing


Tax Risk = ⇑ (increased risk rating since Jan/17)

Definition: the risk that an investment will lose its value or return on capital because of taxation (most investments are subject to this risk)
My take: Recently, Trump decided to impose new taxes, in the form of tariffs, on steel and aluminum, and on various goods manufactured in China. China is already beginning to retaliate, raising the prospect of a trade war. It is unclear if Trump will lay on even more tariffs. It remains to be seen what the economic impact of new tariffs will be but the general consensus appears to be net negative due to rising costs of goods for consumers. Corporate and limited personal income tax cuts were delivered in December 2017 so that matter is settled for now.


Political Risk = ⇑ (same risk rating as Jan/17, but the overall risk is likely higher)

Definition: the risk that an investment will lose value because of political action in a country where one has investments, including one’s own country
My take: While his core support seems to be holding, the US president remains erratic and sensational in policy pronouncements, his cabinet turnover is record-setting, new cabinet and legal advisory appointments are arguably increasingly controversial and recently look like they are veering hard to the right of political spectrum and more confrontational in tone. Relations with Iran may become increasingly strained while relations with North Korea could possibly (but not likely) improve (the new national security advisor, John Bolton, advocates war with both countries). The president continues to accommodate, even congratulate Russia while many observers suggest this is inappropriate given demonstrable evidence of Russian interference in the last US election among several other concerns. The Mueller investigation continues to slowly gain momentum on three fronts: Trump’s possible (likely?) obstruction of justice; Trump/team conspiracy with Russia to tip the last election; and Trump/family financial dealings, including potential money laundering. New revelations about Cambridge Analytica’s role in the 2016 election and potential connections to Russian interference are gaining a bit more traction. The trial for Paul Manafort, Trump’s former campaign chairman, begins in July and further indictments by Mueller in other cases remain likely. The ongoing investigation means a constitutional crisis could easily be triggered if Trump does indeed fire the Special Council as he reportedly intended to do last summer, and may be more inclined than ever to do given his recent appointment of Joseph diGenova, who claims the domestic security establishment (a.k.a. “deep state”) in the US is trying to frame Trump. The possibility of impeachment is likely remote still, but increasing. There are mid-term elections in November which could lead to one or both Houses of Congress flipping to the Democrats, thus hobbling Trump’s agenda and making him accountable. Given all this uncertainty, I believe political risk is elevating in the US and by extension the world.


Market Risk = ⇑ (same risk rating as Jan/17, but the overall risk is likely higher)

Definition: the risk that an investment can lose its value in the market (applies to equities and fixed-income investments)
My take: Given the US market had been climbing steadily since November 8, 2016, the recent pullbacks have been long overdue. Most market gyrations tend to be short-term in nature and are of little consequence to long-term investors. Many commentators still claim the market is over-valued based on historical price/earnings ratios. Overall though the backdrop of corporate earnings, economic growth and planned orderly increases in interest rates contribute to medium term optimism in equity markets. There are no compelling hints of a recession yet on the horizon. Having said that, volatility has been increasing so far in 2018 (the ^VIX is up 125%), in large part due to increasing political, inflation and tax uncertainties. Market risk is being reflected CNN’s Fear and Greed Index (7% out of 100%) and in the recent drops in major indexes. Of the three major US indexes, only the NASDAQ is in the black so far this year. I would suggest market risk is rising due to heightened uncertainty in the political and tax environments discussed in this post and the recent increase in volatility.


Legislative Risk = ⇔ (reduced risk rating since Jan/17)

Definition: the risk that an investment will lose value or benefits because of new legislation (all investments are subject to this risk)
My take: This risk is related to political risk. The most recent spending law (as of writing today still unpassed before a midnight deadline) appears to be ignoring fiscal conservatism. Regulations related to offshore drilling, the environment and banking have been changed and, again, in the short to medium term are being well-received by investors. Longer term, these changes could be damaging to the US economy by contributing significantly to increased US fiscal indebtedness, reckless banking practices, over-stimulation of the economy, environmental degradations and potential knock-on inflationary impacts. NAFTA talks drag on, with some signs the US may be softening its position, especially in the auto sector. If a new deal is not struck soon, there will be little time for Congressional ratification, leaving the future uncertain. We don’t know what else could be forthcoming in the legislative and regulatory environment, but presumably not too much will change before at least the fall mid-term elections. If in fact a Democratic House of Representatives emerges, this would likely provide a damper on Trump’s legislative agenda.


Interest Rate Risk = ⇔ (reduced risk rating since Jan/17)

Definition: the risk that an investment will lose value due to a change in interest rates (applies to fixed-income investments and sometimes to equity investments depending on investor expectations for interest rate changes)
My take: Interest rates are still on track to rise three times this year (once already this week) even with the appointment of a new Fed Chairman. With two more rate increases promised in 2018, on top of this week’s rate increase, the market should be prepared. Wage inflation, in large part due to low unemployment coupled with economic growth, could also be a driver of higher than expected interest rates later this year, which could be bad for equity markets. We saw the market react to some of these expectations earlier in the year. Due to the combined effects of tax cuts and increased deficit spending expected this year, the US federal debt will climb, which is not positive for rates longer term. This is a tough one to forecast at the best of times but on balance it would seem interest rate risk in the short to medium term has decreased since January 2017.


Purchasing Power Risk = ⇔ (reduced risk rating since Jan/17)

Definition: the risk that an investment will lose its purchasing power due to inflation (applies particularly to cash and fixed-income investments)
My take: This risk is somewhat related to interest rate and tax risks in that the main concern would be higher-than-expected inflation, driven by wages, higher health care costs and possibly new tariffs, but counterbalanced to some degree by lower personal and corporate taxes. If Trump’s policies end up being inflationary then purchasing power may erode. This would likely take some time to happen. On balance the risk of higher inflation, from a very low level since the 2008/09 financial crisis, has probably increased, but for the short to medium term does not appear very likely to happen. The recent tax cuts, especially to individuals, will marginally add to purchasing power in the short to medium term and low unemployment could eventually cause wages to go up, improving purchasing strength of individuals.


Liquidity Risk = ⇔ (same risk rating as Jan/17)

Definition: the risk that an investment will not be easy to sell when needed (applies to some equities that don’t trade in large volume, fixed-income investments and real estate and other property that may be hard to sell quickly at an equitable price)
My take: I don’t see any reason to think liquidity risk has changed since January 2017– at least not in the short term. If some of the other risks in this post materialize, this could change, and possibly quickly. I leave this risk at the mercy of “black swans” without changing the risk rating from January 2017.


Reinvestment Risk = ⇓ (same risk rating as Jan/17)

Definition: the risk that an investment will be reinvested at a lower rate of interest when it matures (applies to fixed-income investments)
My take: If we expect interest rates to continue an orderly climb higher in 2018, new money that is being invested in fixed income should attract higher rates. If one deploys fixed income funds to rate reset preferred shares and/or bond funds or bond/GIC ladders of short to medium term duration (e.g. five years or less) then reinvestment risk should be falling.


Are there any actionable ideas here?

I believe that several risks I am tracking are falling, but the three risks that I believe are increasing (political, taxation and market) could have major impacts in the short to medium term. Longer term I remain somewhat optimistic.

But….

With rates rising south and north of the border, and related sector rotation, there has been pressure on utilities, telecoms, consumer staples, materials and energy this year. Bond prices are slightly weaker so far this year as rates rise. I recently added to both utilities and bonds.

If the technology sector continues to outpace this year, I will at some point likely need to re-balance to reduce the percentage this sector represents in our portfolio. It is roughly 20% now and rising.

As stated over a year ago when last reviewing macro risks, I continue to balance short-term risk with longer term secular trends. Since January 2017 I have bought an ETF for robotics. I continue to hold biotechnology and water-themed ETFs and I continue to hold Shopify in the e-Commerce space (although I trimmed it somewhat last year). I am researching both alternative energy and cybersecurity as other possible investment themes for new cash in the future (and likely will be writing articles on them for Canadian MoneySaver).

In conclusion, it remains pretty much stay the course for me. I have an expectation that things will be more volatile in equity markets in 2018 compared to 2017. So I remain prepared for that eventuality. Otherwise, who knows?

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).

Another new ETF to play the robotics and AI secular trend

I wrote an article about robotics/artifical intelligence for Canadian MoneySaver published last November. In that article I mentioned two ETFs: Robo Global Robotics & Automation ETF (ROBO) – which I own – and Global X Robotics & Artificial Intelligence ETF (BOTZ). Both trade on the NASDAQ and each has just under $2.5B US in assets under management. ROBO has a 0.95% management fee and is based on the ROBO Gbl Robotic & Automat TR USD index. BOTZ has a 0.69% management fee and is based on the INDXX Global Robotics & AI Thematic TR USD index.

Since writing the article, a Canadian version of ROBO was introduced on the TSX by Horizons called Horizons Robotics and Automation ETF (ROBO.TO). It is still small with only $51M CDN in assets under management and has a management fee of 0.75%. As it approaches $100M in assets under management, this hedged fund could be of interest to Canadian investors wishing to invest in this theme in Canadian dollars.

But the latest addition was announced on February 22 of this year. It is called First Trust Nasdaq Artificial Intelligence and Robotics ETF (ROBT), has just $3M US in assets under management and a fee of 0.65%.

According to ETF.com:

The fund tracks an index developed by the Nasdaq and the Consumer Technology Association, the Nasdaq CTA Artificial Intelligence and Robotics Index. The benchmark’s methodology selects stocks at the global level that meet [sic] have sufficient liquidity, at least $250 million in market capitalization and free float of at least 20%. 

While it is not yet a week old, ROBT is one to watch for those wishing to invest in this secular trend. Given the growth in assets under management (ROBO and BOTZ in the last three months combined have seen inflows of $1.7B US) and the growth in the number of funds, there seems to be considerable investor interest in this secular trend.

(If you didn’t see it already, Ottawa Share Club member Jan also wrote about disruptive technologies that include AI and robotics. More here.)

Note: these are not endorsements or promotions – conduct your own due diligence and see our disclaimer.

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.

Three things to watch for markets in the near future

At the time of writing, pre-market stock trading in the US is showing minor declines on the three major stock exchanges.

The US government shutdown is but one factor, even if an extension is voted in for the next three weeks.

NAFTA negotiations are about to start their sixth round on January 29th in Montreal. Reports have it that US/Canada relations are acrimonious and may lead to the US serving notice of withdrawal.  In a recent move, Canada has filed a World Trade Organization (WTO) complaint against the US. Donald Trump is signalling his considerable displeasure with Wilbur Ross as Commerce Secretary.

A third factor coming back on the horizon is the US debt ceiling, which is expected to be reached in early March 2018. Some are expressing concerns that it is aligning closely with budget debates.

With an erratic White House at the “helm” and over-stretched stock market valuations in the US and Canada, what could go wrong?

Is Wal-Mart starting to make a dent in Amazon’s juggernaut?

This month, Forbes featured an article about how Wal-Mart is fairing in the e-commerce space. Well worth a read and shows that Wal-Mart is starting to grow its online business.

When I wrote about investing in the e-commerce secular trend for Canadian MoneySaver last January, I mentioned Wal-Mart as a potential value play in the e-commerce space.

“Although Wal-Mart is …not at core an e-commerce company… it remains interesting. It is making a big bet on e-commerce and indications are that its online sales are growing considerably faster than its off-line sales, notwithstanding some hiccups along the way. It sells about one-sixth as much online as Amazon does, at $14B per year, but those sales are starting to grow fairly rapidly. With its purchase of Jet.com, Wal-Mart’s online presence should grow even faster. As a bonus, Wal-Mart pays a 2.86% dividend, has a much lower P/E ratio (about 16) than most “pure plays” and fared better than most businesses during the financial crisis. This could be a good value play.”

Here is Wal-Mart’s chart showing year-to-date total return and stock price performance. Pretty impressive:

My full article from Canadian MoneySaver is available for free here. (Note: below the article link I’ve provided some information about an e-commerce ETF for emerging markets that might be worth a further look.  I also wrote another blog post that discusses a second ETF that lets investors invest in e-commerce called IBUY.)

 

 

 

Jan’s research on ETFs for robotics, artificial intelligence and other disruptive technologies

After the last Share Club meeting featuring the topic of driverless cars, Jan, a Share Club Exec, has kindly provided his research into ETFs following robotics and artificial intelligence and other disruptive technologies.

His material is posted here on his Ottawa Share Club member page.

Don’t forget, much more OSC member and guest content is available here.

 

OSC December 12, 2017 presentations are posted

The presentations from the December 12 OSC meeting are posted.

See John Gosson’s autonomous driving material here. My notes with a few possible ETFs to consider are here.

See June’s OSC fantasy growth portfolio trade material here.

All available OSC member and guest content is posted here.

My article on investing in the water secular trend – now available for free

With permission from Canadian MoneySaver, I am happy to provide a free copy of my article on investing in the water secular trend that was published in June 2017.

The article explores the long-term trend in water-related businesses and some investment opportunities and risks.

Here is my article: Water_Patenaude

Here comes the US debt ceiling again, and the possibility of a government shutdown

I have mentioned a white swan event here before. But it was avoided for the time being.

We may see one or more again.

December 2017 will be a busy month legislatively for the US federal government. Along with tax cut legislation, Congress and the president must deal with the debt ceiling and the possibility of a government shutdown due to lack of funds.

December 8 is an important date to resolve the funding issues. The end of the year is the president’s imposed deadline for tax cut legislation.

Failure on any of these major initiatives will be embarrassing at best and potentially be very damaging to the US economy and market confidence at worst.

US markets are near or at all time highs and volatility is very low.

One could argue market sentiment is a bit too complacent right now.

If stocks go down, what’s your plan?

My thoughts from early 2016, when markets were pretty soft are here. While early 2016’s pullback seems like a long time ago, my perspective hasn’t changed all that much since.

Has yours?

 

The white swan swims upstream – for now

Not long ago I wrote a post about a possible “white swan” event. It was in reference to the risk that the US could have trouble raising its debt ceiling by the end of September.

The surprising deal between Trump, Democrats and presumably some moderate Republicans has pushed the risk out by three months.

For now, that is good news for markets.

There is even a movement afoot to eliminate the debt ceiling as we know it today, thus ending the recurring brinkmanship over raising it.

That too could be good for markets.

So, we’ll see if the white swan returns in December.

My portfolio trade ideas for September 2017

I’m looking ahead to my self-imposed quarterly trading date in September (this time it will be a bit earlier than mid-month as I am travelling).

We’re about 2% above our 47.5% target equity allocation right now.

The market seems a bit fragile and pricey to me. I believe risks that could affect markets have materially heightened during the course of 2017 (mainly due to sabre-rattling and possible political instability down in the US).

But then again, who knows?

I am planning on taking a bit of a risk-off posture when re-balancing this quarter.

Here are my trading thoughts:*

  • Reduce Shopify SHOP (overweight in equities, overweight in a single security & overweight in the tech sector)
  • Sell Cineplex CGX (overweight in equities, small holding/clean up trade, recent change in business model & very high volatility in the last quarter)
  • Sell Enghouse ENGH (overweight in equities, small holding/clean up trade & overweight in the tech sector)
  • Buy investment grade corporate bonds with 2-4 years duration (bond ladder replenishment & putting some idle cash to work)
  • Buy Valener VNR (shift to an income stock in the more defensive utility sector as part of transition into retirement, decent business fundamentals/value, low debt, sustainably growing 5.1% dividend along with a very low beta)
  • Buy North West Co. (NWC) (shift to an income stock in the more defensive consumer staples sector as part of transition into retirement, decent business fundamentals, not too much debt, sustainably growing 4% dividend along with a very low beta)
  • Buy gold (asset rebalancing)

Selling some shares in Shopify requires me to overcome some strong emotions. I have a history in e-commerce dating back to 1989 (as a consultant and as an entrepreneur) and probably appreciate what Shopify is doing better than many.

I still have a lot of long-term confidence in the company.

But we’re now well above the maximum allocation I’d like to have to any one company (it represents 9.4% of our equity holdings, and 4.6% of our total portfolio).

Additionally, over half of our portfolio’s gains this year have come from this stock. In 15 months we’ve made a 239% return. I feel like it is becoming too much of a gamble.

So I think it’s time to take some profits and reduce to a smaller, but still overweight position (~5% of our equity holdings). Like I say, I am still confident in the company long term.

 

*When I first posted about my trades I had thought of selling Fairfax Financial FFH as well. But I was reminded that it is still somewhat non-correlated to markets (5 year beta of only 0.23) due to the nature of some of its private equity holdings. So I am going to stay the course and keep it. I also had not identified my intent to buy North West Company.

Ben Carlson of “A Wealth of Common Sense” thinks Canadian house prices are in a bubble

I was intrigued today when I saw a blog post by Ben Carlson (someone I follow and respect) from yesterday about Canadian real estate prices.

In his post he references an article he wrote for Bloomberg in June called: Canada’s Housing Bubble Will Burst.

His central evidence is that since the sub-prime mortgage fiasco blew up in the US in 2006, Canadian house prices have climbed 56%, while US prices have not yet recovered to their 2006 levels (still down 13% from their peak).

Let’s unpack this a bit:

  • Average Canadian residential real estate prices are disproportionately influenced by the Vancouver and Toronto markets, which have both posted major increases between 2006 and 2016
  • Down payments are generally much higher in Canada than they were in the US pre-2006 – we generally don’t have NINJA (no income, no job or assets) loans like those commonly available in the US at the time
  • The Canadian real estate finance market is much more tightly regulated and supervised than the US’s was in 2006
  • Most (all?) of the housing-related debt has not been collateralized and sold off to unsuspecting investors as toxic, sub-prime loans masquerading as high quality debt
  • The bubble in Canadian real estate, to the extent it exists, is largely confined to greater Toronto and Vancouver, and both markets have shown some signs of cooling in the last year since governments intervened with new taxes on foreign investment
  • An increase of 56% in average Canadian residential real estate prices from 2006 to 2016 represents an annual compounded increase of 4.55% per year (well above inflation, but hardly off the charts)

Due to some of the major differences in the Canadian and US residential real estate markets, I find it to be a somewhat irrelevant comparison to say: On a real basis, Canadian housing prices experienced a much smaller, shorter decrease in prices during the financial crisis and a much larger, longer increase in prices during the recovery.

There is no doubt that some real estate markets in Canada are very, very expensive, especially relative to incomes and consumer debt levels (something Ben Carlson points out too).

Caution is absolutely warranted!

But some commentators have been calling for the Canadian real estate bubble to burst for many years. Some investors and short-sellers have been shorting Canadian banks and alternative lenders like Home Capital Group in anticipation.

Specifically in the case of Home Capital Group, Warren Buffet begged to differ.

I am not saying a crash is not possible, but it seems to me, especially outside of greater Vancouver and Toronto, a milder correction or even just a slowdown is more likely.

With respect to Ben Carlson, I think saying no one knows when insanity like this will come to an end is a bit overstated.

I could be wrong though and prudence is always wise.

 

 

 

 

Markets (and maybe some companies) are amoral

One thing I think is becoming patently clear these days is that markets are amoral (who knew?).

I choose that term carefully: markets are unconcerned with the rightness or wrongness of something.

When Donald Trump was elected president of the USA, major US market indexes moved forward in a highly positive manner (the “Trump Bump”).

Why?

The promise of deregulation, tax cuts and infrastructure spending (not so much ripping up trade agreements) are bullish for profits.

Markets don’t care about what Trump stands for (or if he stands for anything at all for that matter) as long as the perception is he and the Republican Congressional majority will deliver the goods.

Now that Trump appears to be lurching from one political crisis to another (Mueller investigation, failed health care repeal/replace, North Korea, Charlottesville, etc.) markets still don’t care. As long as there is a belief that deregulation, tax cuts and infrastructure spending are on the way, politics don’t appear to matter.

Major business CEOs (including Merck, Under Armour, Intel, 3M, Campbell Soup, United Technologies and Johnson & Johnson) began defecting en masse from two of Trump’s business councils due to his public remarks about events in Charlottesville since last Saturday. Today these councils were disbanded (or, perhaps disbanded themselves).

Some or all of the business leaders may have opted out for moral reasons (the prevailing reason offered). These business leaders do not want themselves and their companies to be associated, in their customers’, shareholders’ and employees’ eyes, with the increasingly widely-derided “equivalence thesis” advanced by the president about violence in Charlottesville.

Maybe many businesses are also somewhat amoral. The CEOs on these councils, and the shareholders they represent in their businesses, generally have a profit motive as their primary (but not exclusive) reason for existence.

Do these defections also suggest some of these business leaders have lost confidence that Donald Trump and his Republican Congressional majority will deliver all the promised deregulation, tax cuts and infrastructure spending?

If some of the biggest US businesses have lost confidence and concluded their profits (and reputations) may suffer under Donald Trump’s presidency at this time, what does that mean for markets?

We’ll see as this drama continues to unfold Stateside.