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October 30, 2018 | Dear Dr. Garth

A best-selling Canadian author of 14 books on economic trends, real estate, the financial crisis, personal finance strategies, taxation and politics. Nationally-known speaker and lecturer on macroeconomics, the housing market and investment techniques. He is a licensed Investment Advisor with a fee-based, no-commission Toronto-based practice serving clients across Canada.

“Love the blog,” writes Nick, genuflecting deeply. “Been a daily reader for years.”

“It’s been a little while since you’ve delved into asset allocation for new money to invest, and I was wondering if you could touch upon it, given the recent drop in global markets.

“My wife has recently changed employers and has had to take all her workplace investments with her, forced to cash out. She’s got about $75-$100k ready to invest. We are probably going to put it into the recommended balanced portfolio, but were wondering if you think any tweaks to the standard 60/40 are a good idea when buying in today’s somewhat depressed equity markets and increasing interest rate environment. Of course, feel free to use our situation on your blog as I’m sure many others are wondering if the recent events have presented new buying opportunities.”

So, Nick, tell us stuff.

“Married, mid 30s (me 32, she 34), DB pensions at work (hers better than mine), combined salaries of a bit over $200k before bonuses, house worth a little over a million with a mortgage of about half that, investment condo worth about $450k with mortgage of $200k (nets about $8-$9k a year after all taxes/expenses, not amazing the place may also double as our retirement home one day), combined investments of about $300k. No children and no plans to have any (wife wants a dog asap).”

The best time to invest is when you have the money. So why wait? In the sweep of time for two 30-somethings it matters not when you buy securities. But it’s even sweeter when you can do it during a market correction, which is now. Equities have lost about 10% from the highs of late summer, and will like keep on rocking-and-rolling until the midterm slugfest is over next Tuesday night. Following that, it would be reasonable to expect a relief rally. After all, nothing fundamental has changed about the economy, except higher interest rates – and we all knew those were coming.

As for your overall financial picture, $1.4 million in real estate and $300k in liquid assets is not exactly being balanced. Plus you have three-quarters of a million in debt to carry, destined to renew at higher rates in the future. And the condo is cash-flow positive? Nope. Not when you factor in $250,000 of equity which is earning nothing and may even erode steadily as condo values reset. Plus the income gained is taxable at your marginal rate.

Yes, she should invest now in exactly the portfolio this pathetic blog has outlined. Yes, you are doing well. Yes, you could do better. Sell the condo, pay down the house mortgage and get a dog.

Now, here’s Bob, a retired old fart millionaire of the kind Millennials hate. “First off, thanks for your blog.  I read it all the time and enjoy your perspective,” he says, earning points. “You’ve taught me a lot over the years.  I suspect that you put a lot of time into it.”

You have no idea, Bob. I come here every day to fight deplorables.

“So,  a quick question for you.  I’m just a dumb old farmer, so I hire gunslingers to handle my finances.  These guys have fancy models, fancy suits, and fancy offices.  I’m pretty conservative with my retirement plan, about 60% bonds and the rest in equities,  mostly US and foreign, maybe 15% Canadian.  Bottom line: there’s a few mill to play with, they’ve averaged about 8%.  Course, everyone is a genius in a bull market.

“But now things have changed a bit.  The Trumpinator has trade wars on his agenda, the US Fed and Bank of Canuck are raising rates, and as a result debt, deficits, and paying bills is more challenging for everyone – even Uncle Sam.  In September, my guys told me that they thought the party was going to last for another 18 months or so.  Based on what happened to stocks in 2008, I’m not too uncomfortable with a 1/3 drop in the value of my stocks in the next bear market.  What’s going to happen to my bond portfolio though?  It’s supposed to be high quality stuff and have laddered maturities.  Do you think the bond prices will compensate for the change in yield over time?  Or should I get out bonds completely for the next few years?

“The little devil sitting on my left shoulder is telling me to fire my experts, sell all the stocks and bonds – then just buy a triple short S&P500 ETF and hang on for the ride.  The little angel on my right shoulder is sayin that October is always a looney month, hang in there, and go suck martoonies on a warm beach somewhere cuz life is just too short to worry about mundane, unimportant things like money.”

Listen to the angel, Bob. Using big leverage to short the US index has the potential to put you back in the piggery shoveling slop. Interest rates will rise until they hit ‘neutral’ in the view of the central bank – about 1% more. This was evident a long time ago, so your suits hopefully got you into a mess of short-duration bonds which are not much impacted by rising rates. Longer bonds, of course, have been creamed. Prices move in the opposite direction to rates. Yields up, bond value down. Having two-thirds of your money parked there is excessive. So, yeah, you should get the smart guys to review them and justify the holdings. Laddering maturities is not such a hot idea. Did they explain that?

As for October, it traditionally brings increased volatility, nervousness and calls to the inner Chicken Little most people harbour. It’s all been accentuated by the Trump Referendum on November 6, and the same rising rates which have trashed your bonds. The bottom line seems simple. You are old. And rich. And clearly worthy of moister disgust. So just spend it all.

Finally, a few people have been asking about preferred shares which are supposed to rise in value when rates fall, providing some protection against what just happened to Bob’s bonds. So why have pref ETFs like CPD been falling?

Here is the word from my PM buddy, Ryan (of the yellow Porsche):

Definitely an overreaction. I think it’s a combination of a few factors. First, and most importantly is the current recent risk-off environment. With stocks down over 10% in the last few weeks, prefs being the next most risky are down as well. We’ve seen a small widening of credit spreads in the bond markets which captures this current risk-off environment (but nothing significant which supports our still positive view and our expectation for a bottom soon). Second, is we’ve seen increased issuance from the banks over the last few weeks so this is repricing the market. Third, there could be some tax loss selling. I’ve found that when prefs are down in the year you see lots of selling late in the year (generally in late Nov/Dec) to take advantage of tax loss selling. While these are good reasons prefs are down, I do believe it’s just irrational selling and will bottom soon. My favourite pref blog feels the same:

“Due to the retail nature of preferred share investors, the sector is prone to episodes like this, in which the market behaves irrationally for a while until people take a deep breath and look at the comparable after-tax yields. I just wish there was some way of predicting the outbreak and duration of such events!”

This chart of CPD shows how aggressive the selling has been and how deeply oversold the pref market is. We should stabilize soon, barring a recession, which we believe is remote over the next 9-12 months.


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October 30th, 2018

Posted In: The Greater Fool

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