Global Growth Is Accelerating

After eight years of monetary stimulus, and based on a broad swath of indicators, it appears that a synchronized global recovery has finally begun. This is very bullish for investment markets.

From a technical perspective, there are three legs to a bull market:

  • The first leg is driven by easy/accommodative monetary policy. According to Leon Tuey, former head of market research at RBC DS, the first leg for this cycle started in October 2008 and ended in May 2015.
  • Current bullish action of the various world stock markets suggests that markets are now in the second leg of the bull market which is always the longest and strongest as it is driven by improving economic conditions and rising corporate profits.
  • The third, and final, leg is the speculative phase when the public becomes euphoric and is finally convinced that a bull market is in place.

Easy/accommodative monetary policy can only do so much. For a few years following the world economic crisis of 2008, we did witness a recovery in investment markets. But corporate earnings across the globe have struggled the last two years as we waited for the next phase of the global recovery to take hold. This partly explains why so many markets – including the TSX – have been volatile, but essentially flat. Improved economic conditions and accelerating earnings momentum, however, should help drive markets higher for the next few years. US markets have already been strong for several years, but Europe, Emerging Markets and Canada are among the major markets expected to lead earnings growth in 2017.

Yes, negative headlines (overbought conditions, excessive optimism, real estate bubbles, Trump, Brexit, Frexit, Grexit, China, Russia, etc.) will continue to appear, creating uncertainty and anxiety. They may even cause short term corrections, but that won’t matter in the long run if the overall trend towards stronger global growth remains intact. Short-term corrections are normal and healthy and should not to be feared. They should be viewed instead as a buying opportunity.

While we invest towards trends, we are constantly on the lookout for major trend reversals. Having the ability to protect capital quickly when major trends change is one of the main reasons we moved to a discretionary management platform. There is certainly geopolitical noise, but the long term trend looks quite bullish.

We have continued to fine-tune our process of identifying stronger, smarter investment opportunities in the last few years.  Now we are looking forward to a period of time with the wind at our backs as the global economy strengthens and the overall markets move higher.

Lessons from 2016

As 2016 draws to a close, we look forward to an exciting 2017

As this eventful year draws to a close, I thought I would write a few words about what we have seen the last couple of years and what we see going forward… We believe optimism will be a theme in 2017 as economic data, earnings and sentiment have all inflected positively and are poised to improve through at least the first half of next year. We will concede that certain areas of the market, particularly financials, may have run a little ahead of the fundamentals and areas like interest-sensitives and golds may have over-corrected. Equities look to be the asset class of choice for next year and should be well-supported by earnings, multiple expansion and inflows for the first time in a while.

This is also a good time to reflect on our portfolios and how they have performed the last couple of years.

In 2015, all our portfolios were positive when the TSX was down 11%.

In 2016, so far we have had mostly positive returns, but have lagged overall investment markets. Early in the year, the markets plunged and our indicators suggested moving a portion of the portfolio to cash to protect capital, which we did. Central banks stepped in shortly afterward to prop up the markets and we missed the sharp short-term rebound. Our portfolios have done well in the second half of the year, but not enough to make up for what we missed early-year.

If all we wanted to do was match the index, we could just use index funds. But matching the index means mirroring both the gains and losses. The challenge lies in finding a repeatable process that we believe will outperform the index when markets are going up, while protecting the portfolio as much as possible in years that act more like 1929, 1987 or 2008.

Though we didn’t get the returns we were looking for this year, much was learned. Some important pieces fell into place for our investment philosophy and the rules that we added to our process will help enormously in the years to come.

Related to this, I read a very interesting article on the Mawer Investment Management website. The whole article echoed very much what I have been feeling the last year.

Here is a small portion of the article:

“Mistakes happen. They happen every day, all the time, in investing and in life. They are a normal function of learning and a natural part of being human. And yet, for all the discussion these days of embracing failure, there still seems to be a stigma around errors. This is particularly true in investing, where there is an astonishing need to always appear “right” despite the fact that investing is a very complicated domain involving a great deal of uncertainty and in which perspectives must constantly shift.

“Investing is simply not an arena in which perfect decision-making is possible. And that’s fine, because it doesn’t need to be. So long as your investment philosophy is a resilient one — meaning that it puts the odds in your favour over time — perfection isn’t required.

“Mistakes are not something to disregard — they are meant to educate: we’ve been able to make the most out of them because we have a culture of trust, allowing us to feel comfortable reflecting on and sharing our insights. Mistakes, if learned from, can have a cumulative value over time — and save you thousands (or, in the case of our collective clients, millions).”

We do have a strong investment philosophy. We are open and honest about what we are trying to do and why. We believe our strategy will provide a superior outcome for all our clients in the years to come. We learn from what is working – and what isn’t – and we adapt. We know we will face bumps along the way, but each year our process gets stronger. The next few years look like they will be very exciting!

For the full article please see: The million dollar lesson

My Takeaways From Tucson

A few weeks ago I attended the Dynamic Leaders Conference in Tucson. It was an excellent way to meet with several of the key managers and find out what they are thinking.

I have included the presentation summary, but here are several takeaways from the conference that I thought were worth sharing.

Protect capital – There are years when it makes sense for a portion of a portfolio to be focused on taking risk and making money, and there are years when one needs to focus on protecting capital. We strongly believe this is a year to be more cautious.

Large currency movements are causing greater volatility – Noah Blackstein said the current volatility in the global markets is being driven primarily by currency movements. It bothers him, but he has no control over it. So he focuses instead on finding the best investments he can. We would agree with that approach. Besides, Canada’s equity markets are less than 3% of overall markets and it makes sense for Canadian investors to diversify their portfolios outside of Canada. Some years a falling loonie will give the portfolio a bit of a boost, some years a rising loonie will hinder growth a bit. This year a surging loonie has hurt any foreign investments. As of June 17, 2016, the S&P 500 is up 1.3% YTD, but when priced in Canadian dollars it is down 5.6% YTD.

Oil & Gold – After being pummelled last year, these sectors have been some of the strongest in 2016. The jury is out on both of these sectors, however. Is this just an overdue bounce off extreme lows or are the fundamentals finally starting to change?

The outlook for global growth is lukewarm at best – Corporate earnings continue to stagnate. Despite all the stimulus and money that has been printed in recent years, this continues to be a weak recovery.

Asset class valuations are stretched – given today’s starting point, a passive buy and hold strategy which focuses on broad stock and bond indices will likely struggle over the next decade. Valuation metrics point to low single digits for the equity markets. However, that may be better than what bonds do

TINA – There Is No Alternative – I hadn’t heard this term before. Central banks are taking us into uncharted territory by forcing interest rates lower in an attempt to boost growth. This in turn forces large numbers of investors who traditionally would invest in fixed income to move into riskier assets such as equities and real estate. If Canadians could get a 5 year GIC with a 5% yield then stocks wouldn’t look as attractive, but investors are faced with record low interest rates, even negative yields, in a significant portion of the world’s bond markets.

NIRP – Negative Interest Rate Policy – Now, some central banks are trying a new tool to spur investment: negative interest rates. Imagine instead of earning interest on your savings or GICs, you pay a bank interest to hold your money. Or you pay $10,500 for a 10 year government bond that will pay you $10,000 when it matures 10 years from now. How does that make sense? Once again, anyone who needs to grow their assets is being forced into riskier assets.

We are in uncharted territory. Despite numerous crises, panics, economic recessions and depressions throughout the course of history, we have never seen negative interest rates in the last 5,000 years. This is not a small isolated anomaly. Myles Zyblock, Dynamic’s Chief Investment Strategist, said that $7.8 Trillion, or 34% of global government bonds, are priced for a negative yield to maturity.

We still believe equities offer better upside potential, but we made significant changes to the portfolios in the last month to try to reduce the potential volatility. This is a time to be cautious.

Is the Correction Over?

Equity markets got off to a rough start in 2016: broad selling pressure dragged most indices into double-digit losses by early February. Global growth concerns, energy price volatility and radical monetary policies dampened investor sentiment. Then, in mid-February, despite no substantial positive macro or fundamental news, a sharp rally began. Has the rally been driven by the return of long term bulls or is it a result of bears taking a profit? Data suggests the latter.

Our relative strength indicators are telling us to be cautious at this time.

What are some of the fundamental analysts saying?

One key theme is a large reversal in style leadership: cyclical, high volatility, low quality stocks have surged past their defensive, low volatility, high quality counterparts. As one manager suggested,

“The best performing 10% of stocks in the S&P 500 gained an average of 56.2% during this rally – these are a litany of energy and mining stocks that had been bludgeoned relentlessly and left for dead. While there is nothing to buy in these groups from a fundamental perspective, these types of rallies are usually one of the first signs that the market is bottoming. Given the lack of quality stock leadership and extreme volatility in all assets including currencies, we have remained defensive.” – Noah Blackstein, Dynamic Funds

So what is the outlook for markets? Are they bottoming? Maybe, but a sustained share price rally is hard to imagine without better support from corporate fundamentals. S&P 500 companies have already delivered four consecutive quarters of negative sales and earnings growth and continue to warn about future delivery. While this has lowered the bar on earnings expectations for future reporting periods, we believe aggressive portfolio positioning without actual earnings improvement is akin to walking across thin ice — it can be navigated, but mistakes can result in treacherous outcomes.

Some well-respected market watchers currently suggest that in the near term the markets might have 5% upside potential, but 20% downside potential. Once again, this is a time to be very careful.

The last couple of months have been very exciting for us. The portfolios continue to evolve and this was a great opportunity to see how various investments behaved during a serious market correction. While we have been hunkering down in a more conservative stance, we have been making some significant changes to our portfolios and our process. These changes will allow us to better protect the portfolios as we enter these questionable periods in the future and will also give us greater upside potential when we get the green light from our technical indicators.

In the long run, we believe equities offer the best return potential and we are looking forward to the time when it makes sense to be fully invested again. The indicators are more neutral at this point and we will likely increase our exposure to equities shortly. We will, however, continue to be more cautious until our indicators actually turn positive.

Our Indicators Said It Was Time to Get Out of Equities…

Last week we moved a significant portion of all our discretionary client portfolios to cash.

Under normal circumstances, we do not want to carry high cash balances. However, when our indicators show strong bearish signals, it’s time to do our best to protect our clients’ capital.

On Friday, January 15th, one of our key equity indicators turned red. As we have said for the last few years, a red signal means the risk involved in remaining exposed to equity markets is significantly higher, and greater caution is warranted. On Monday, January 18th, we sold $42 million of equities across all of our discretionary accounts.

What did we see that made us move to cash?

 

Our key technical indicator doesn’t move into the red very often: it happened most recently near the beginning of 2008 and again shortly before the US lost its AAA credit status in August 2011.

What caused the indicator to turn red this time? It is difficult to pinpoint the exact cause (US Fed? China? Oil?), but when it does move into the red, it is safer to move to the sidelines and protect assets. Note that in 2008, a red signal was first received in January, but the markets didn’t really get ugly until Lehman Bros. went under in September.

2015 was a rough year for markets and the first couple of weeks in 2016 were worse. Most equity markets dropped at least 15% over the past year – and markets have been significantly more volatile since August. Fortunately, we made some good calls over the last year and most clients who have been in our discretionary portfolios have had positive returns over that time.

The technical research we use says that we should be out of equities. What do the fundamental analysts say? Myles Zyblock, Dynamic’s Chief Investment Strategist, is someone we follow closely. Right now, he is about as bearish as we’ve ever heard him. His view is that markets may be a little oversold, but the current macro-environment does not support a sustainable rally.

Could the markets rebound 5%-10% in the coming weeks? That’s possible of course. Is it worth being fully invested with the indicators we are seeing? Not now. We believe that, at this time, it is more prudent to preserve capital and wait until it is safer to “go back into the water.”

Of course, we are watching the markets continuously. We want to be more fully invested, and are doing our best to determine when, from a risk/reward perspective, it appears best to re-enter the markets; But if these forecasts hold true and 2016 proves to be a difficult year for equity markets, we want to do our very best to protect our clients’ capital.

CONNECTPLUS Conference 2016

Andrew Chowne, representing our team in Miami at HollisWealths CONNECTPLUS 2016 conference.

Andrew joined 250 other HollisWealth Advisors from across Canada, to hear the opinions of some of the top financial analysts in the world. The four days of intense sessions are timely with the volatility we are seeing in the markets.

Learning from our colleagues to represent our clients strongly in 2016.

Major Changes To Our Discretionary Portfolios

Most of the time, we believe a portion of your portfolio should be invested in equities. Numerous studies show that equities should provide the highest return in the long run. However, there are times when it simply makes sense to reduce the risk in a portfolio, because of changes in the markets, or the economy, which make the risk/reward of equities unfavourable.

Anyone who has heard us speak about our investment approach understands that we believe a portion of every portfolio should be in equities when we have a “green” signal…and we want to be completely out of equities when we have a “red” signal.

Markets became more volatile in August – something we saw reflected in our client portfolios through the fall. Our research indicators recently moved to the “yellow” (neutral) zone. This alone doesn’t mean we should get out of equities; but it does tell us that more caution is warranted. We have no way of knowing whether the next market move will be back into the green zone or down into the red. After much discussion, we decided to make two major changes to our portfolio models.

  • First, on November 12 we sold all of the individual stocks that were part of our models in all client portfolios and moved the equity allocation to low volatility ETFs (exchange traded funds). This change in investments should still allow the portfolios to rise if the economy and the markets improve, but should also provide greater downside protection if conditions worsen and we fall into the red zone. Given the indicators we were seeing, this seemed like a more prudent way to get exposure to equity markets.
  • Second, we decided to overweight US equities and the US dollar. Our relative strength indicators pointed to this move as did common sense. There is a good chance the US Federal Reserve will raise rates in the US, and higher interest rates will likely attract money flow into US dollars. Additionally, our new Liberal government in Canada has committed to deficit spending over the next few years, which may make Canada look less attractive to outside investors.

We take the management of your investments seriously and are constantly looking to improve. On that November morning, we sold about $30 million worth of individual stocks. Foremost in our minds was protecting your capital when the outlook was uncertain and our indicators were neutral at best.

The effort also confirmed the capability of our discretionary team. We sold over 2,400 individual positions across almost 400 accounts. The smoothly-executed bulk sale meant that every client account was repositioned without a hitch – illustrating the nimble, proactive money management approach we espouse. We could only have quarterbacked these coordinated transactions on a discretionary platform.

Markets have been challenging this year, but we are doing our best to mitigate the risk to your capital, and we are very pleased to witness the continued success of our strategy. We especially look forward to watching how the strategy performs in a more “normal” year when the major indices are up!

Our View on Financial Markets Today

Despite a strong month in July, the third quarter was a tough one for financial markets. The S&P/TSX Composite Index dropped 9.1% and the S&P 500 Index dropped 7.1%. The increased volatility seemed to be linked to the combination of commodity weakness, the risk of US monetary tightening and concerns surrounding Chinese economic stability.

Given the volatility in the markets, we thought it might be useful to:

  • provide our views on the market outlook;
  • comment on our recent decision to sell Valeant Pharmaceuticals; and
  • include a video discussing the outlook for Q4 with Brian Belski, chief market strategist at BMO Capital Markets.

We believe this will prove to be a short term correction and a healthy pause in the bull market cycle. Worldwide, central banks continue to hold rates near historic lows. Leading indicators suggest that GDP will not contract, but rather will grow modestly.

Corrections tend to be short-lived: multiple sizable corrections within a calendar year are actually quite common throughout history. But deep and lasting selloffs usually happen only when the economy is in, or is on the cusp of, recession. We expect financial markets to rally in the fourth quarter, and we believe equities will outperform bonds over the next 9-12 months.

Despite the volatility, we’re pleased with how well our Discretionary Platform investment process has been working. We continue to see the stronger companies on a relative strength basis outperforming the broad markets. In fact, our model portfolios probably would have been positive for the quarter if the Democrats — in the midst of a US election campaign — hadn’t decided to target drug companies in the last week of September. Valeant dropped almost 20% on September 28th. Most of the other drug companies dropped significantly as well. As a result, Valeant fell out of our top stock choices and, as our investment process demands, we sold it.

Of course we would have preferred to sell Valeant even one day earlier, but there was no way for us to have known the Democrats’ plans. The sale of Valeant from all client portfolios, however, does provide a good example of how quickly we move when a stock falls out of our favoured list. Valeant may bounce back in the coming months or it may do poorly if the Democrats continue to go after the drug companies. At the end of the day, most clients on the Discretionary Platform enjoyed a nearly 45% gain since we bought it in our client portfolios last November. While we are sad to see it go, our discipline says to sell it and move on to something else which is showing greater strength.

When Might We Recommend Getting Out Of Stocks?

Everyone loves a rising market. Financial news takes a back seat in the media. Investment statements look better each month. Life is good.

Then reality sets in.

Markets return to “normal” and begin to fluctuate. CNBC kicks into a higher gear, looking for answers from every expert they can find. More unsettling is when one declares, “Markets have peaked. It’s time to sell” while another states, “Things are better than we thought. It’s time to buy, buy, buy!”

We endured such a phase during the spring this year, and we’re experiencing it again today. The divergent messages can be confusing, frustrating and worrisome.

A couple of years ago our Team changed our entire investment process, because we believed we had found a better way to invest. Rather than getting caught up in the noise of “today in the markets,” we chose to migrate toward an investment model based on “relative strength.”

It’s not predictive research. It’s a structured process that ranks financial securities, and recommends changes, based on which ones are faring best versus their peers. Simply put: we want to own companies that are going up faster than their peers. Our back testing shows that choosing stocks with the highest relative strength helps portfolios significantly outperform over time.

At the end of the day of course, we are still investing in the equity markets. If the overall market declines 10%, a similar drop in the stock portion of our portfolios would not be surprising. For this reason, we include more conservative investments in most of our portfolios to provide a balance or a cushion.

We can’t know ahead of time when markets will correct. But even when markets are going down, we want to hold what we believe are the strongest companies at that time. Our research shows those companies ranking highest in relative strength tend to rebound faster and stronger when markets eventually improve.

Markets have corrected by at least 5% on 11 occasions since March 2009, the last market bottom. Most declines are smaller, and their downward movements are not sufficient to trigger a recommendation to move out of equities. However, there have been two occasions since January 2008 when our relative strength research recommended a complete move out of equities: July 2008 and August 2011. At those junctures, significant amounts of money were leaving the markets and a move to cash was recommended.

None of our indicators suggest moving out of equities now. Even though markets are down over the last couple of months, the relative strength research continues to recommend equities as the top asset class.

Our portfolios and our process have evolved over the last few years and will continue to evolve. We obviously still watch markets every day and we constantly seek other investments, or strategies, that can enhance or improve our process further.

We believe our investment process works better than any other strategy we’ve come across in 20+ years in the business. With this knowledge, we look forward to the next few years!

Making $ense of Vancouver Real Estate prices…?

House Sold House Sold

The most expensive housing market in North America?  Because we’ve heard it so often, most Vancouverites are well aware that the answer is our own city.  Others however, may not find the question so simple.

We know that by traditional measures, such as comparing our incomes to what we pay for housing, the Vancouver market is deemed to be 20-30% “over-valued” … but as James Surowiecki wrote recently in The New Yorker magazine, it seems the Vancouver market may now be priced according to more global parameters.  Our real estate market has been the beneficiary of an inflow of foreign money from China of course, but also from other countries including Korea, India and Russia.  In the first six months of 2013, nearly half of the twelve hundred luxury homes purchased in Vancouver were bought by foreign buyers.

Apparently, Vancouver may now not only be a “superstar” city (where high earners tend to cluster), but also a “hedge” city: one where social and political stability make wealthy people feel comfortable placing large portions of their cash.  Our accessibility to the Pacific Rim, and our large existing Asian population, make our city an attractive destination, particularly for Chinese investors looking to shift assets from a more uncertain environment at home.

This globalization of our real estate market means local fundamentals have less influence.  So perhaps our real estate professionals are right.  Maybe the Vancouver market isn’t in “bubble” territory.  Some very smart investors have decided our city is a good bet, or at least, is a better bet than many of their other options.

James Surowiecki: Real Estate Goes Global