June 2021 Newsletter
· Short term: We are in the Zone and waiting to see which way this sideways market will move. Is the ‘pause’ in market growth enough to restore investor confidence before another push higher, or is it the market rolling over before a more notable pullback? We may start to see some movement after mid-June, following the Central Bank meetings.
· Mid & Long-term: We are still in the Zone looking out to the end of this year, but beyond 2022, market strength is more questionable.
Active & Strategic Management:
The bottom line is we remain positioned for growth in the majority of the portfolio and continue to outperform and/or remain in line with our portfolio’s benchmarks. We have proactively raised some cash in the portfolio for greater downside protection until the short-term market direction becomes more clear.
Although there has been significant rollover in the various sectors, back and forth for the past six months, the strongest relative sectors have remained relatively the same over the last few months: Financials, Industrials, Basic Materials, and Energy. We continue to focus on investments in these sectors, while limiting positions in more historically volatile industries and limiting the number of positions in each sector to ensure proper diversification in the portfolio.
We have developed and tested a robust set of rules to filter out unattractive investments, leaving us with a portfolio of high quality investment options. We will only hold positions that meet the particular size, liquidity, risk, and return parameters, which serves to reduce volatility and mitigate risk, while still allowing investment in growth oriented investments. We regularly test the portfolio’s equity risk exposure, which is currently sitting at approximately less than half (½) of the risk of the market. This is a significant reduction. Controlling unnecessary risk is a key component to protecting your funds.
As a repeat from our last newsletter, we want to once again point out that our decision to limit ultra-short term trading in the portfolio has been a positive one. It has reduced trading activity and allowed us to persevere through minor market fluctuations with more consistency. This has been a significant factor in our ability to maintain returns above the portfolio’s benchmark. We have been sticking to our rules and we cannot emphasise enough the importance of having a disciplined investment approach. (see more in the ‘Understanding the industry & standards you should expect’ section).
MARKET & ECONOMY
Fundamental Perspective: An economic analysis considering the overall state of the economy, industry trends, and influences propelling the market.
Expectations are for the economy and market to experience continued growth through the rest of this year and likely into 2022. The main factors threatening this outlook continue to be the pandemic, financial stimulus, and interest rates.
Inflation and interest rates have been a main topic of interest in news outlets lately and for good reason. To support your understanding, we want to highlight the relationship between inflation and interest rates.
Inflation refers to a general increase in price levels (costs of goods), which is primarily caused by an increase in the quantity of money (ex. financial stimulus or faster growth in money than productivity in the economy).
- Central banks today primarily use inflation targeting in order to keep economic growth steady and prices stable.
- With a 2-3% inflation target, if prices rise faster than the target, central banks tighten monetary policy (increasing interest rates) to try to restore that target.
- Raising interest rates and /or restricting the money supply are both contractionary monetary policies designed to lower inflation. Higher interest rates make borrowing more expensive, curtailing both consumption and investment.
- As interest rates increase, consumers have less discretionary money to spend and investing in fixed income becomes more attractive causing money to move away from the equity market, both of which hurt the economy and market. More importantly, higher interest rates can slow the economy dramatically if they rise too fast making the cost of borrowing more expensive, and more difficult for consumers, corporations and governments to repay the large amount of debt that has been incurred since the bottom of the last recession.
Due to the significant impact of raising interest rates, central banks are very particular about both the timing and size of change. Historically, the decision to increase rates is done at a time when the economy has enough stability to handle the change, and the increase is done slowly. As this decision can have a dramatic impact, the central banks are very cautious about their communication around such decisions. It is typical that we start to see the narrative change slowly as the decision to increase rates approaches, allowing the economy and market to start reacting in advance.
As of right now, communication is very clear that there is no intention to increase interest rates until the middle of 2022. This paves the way for more economic and market growth throughout the rest of 2021 and into 2022. Increasing interest rates is widely anticipated to be a leading indicator and catalyst for significant downward pressure on the market.
Interest Rate Outlook for Canada:
The Canadian Central Bank’s inflation measure as of April 2021 was 3.4%, which is beyond the target rate. However, this was expected, as noted in the last Central Bank announcement;
“Over the next few months, inflation is expected to rise temporarily to around the top of the 1-3 percent inflation-control range. This is largely the result of base-year effects—year-over-year CPI inflation is higher because prices of some goods and services fell sharply at the start of the pandemic... As slack is absorbed, inflation should return to 2 per cent on a sustained basis sometime in the second half of 2022... Even as economic prospects improve, the Governing Council judges that there is still considerable excess capacity, and the recovery continues to require extraordinary monetary policy support. We remain committed to holding the policy interest rate at the effective lower bound until economic slack is absorbed so that the 2 percent inflation target is sustainably achieved. Based on the Bank’s latest projection, this is now expected to happen sometime in the second half of 2022.” https://www.bankofcanada.ca/
2021 will be the next Canadian Central Bank announcement on interest rates and Monetary Policy.
Interest Rate Outlook for the U.S.:
The U.S. latest inflation measure was 4.16%, which was not a concern for the Federal Reserve as of their April 2021 meeting;
“The path of the economy will depend significantly on the course of the virus, including progress on vaccinations... The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time… (with past inflation being low, they have room to let inflation run at higher levels for a while)... The Board of Governors of the Federal Reserve System voted unanimously to maintain the interest rate… The committee expects it will be appropriate to maintain this target range until labor market conditions have reached [higher levels]”. https://www.federalreserve.gov/monetarypolicy/files/monetary20210428a1.pdf
will be the next U Federal Reserve meeting.
An analysis of market trends and patterns, as well as pressures on price to gain insight into the future direction of the market.
After a rather typical and systematic climb up from the start of this year, we have seen market growth paused since mid-June. The market trend
has been moving sideways and we continue holding on to some cash positions as we wait to see if this market will continue upwards as expected for the remainder of 2021 or if we will see a more significant pullback.
We have been expecting a short term pullback in the near term, which would test the strength of the market, but perhaps this ‘pause’ in growth will be enough to restore confidence in investors. The longer the market goes sideways, the greater the chances of “shaking out” the market speculation and overbought scenarios.
The price of the market
and trading volume
in the market are relatively insignificant at the moment. Neither are pushing any notable boundaries or causing much attention. Although these measures are important data points, at present they aren’t telling us anything noteworthy to act on. Also worth noting is the historically low trading volume typically seen in the summer months, so this low volume may be the new normal in the coming months.
The Volatility Index
(VIX) is roughly 16.76, which is one of the lowest numbers we have seen since the start of 2020. What this tells us is that investors are comfortable with where the market is and likely waiting to see where this market will move next. We may see an increase in volatility and trading volume after notes from the Central Bank meetings in the first half of June are released.
UNDERSTANDING THE INDUSTRY & STANDARDS YOU SHOULD EXPECT
It is incredibly important to ensure your money is being invested based on a defined strategy and that there are rules behind the execution of that strategy.
Without a well-defined and well-executed strategy, investment decisions are taken over by emotion. Even the best investor has emotion and needs to maintain rules and discipline to be effective.
Questions to ask;
- Can you or the professional managing your money define your investment strategy?
o It should be written, easy to communicate, and detailed. Any struggle to present the definition is a sign that more work needs to be done.
- What are the rules behind what you buy and sell, and equally as important what you don’t buy?
o Rules should already be written, easy to communicate, and detailed, as should the ‘do not buy’ list.
- What are the rules behind when you buy and sell?
o Rules should already be written, easy to communicate, and detailed.
- What is the disciple to ensure rules are followed?
o It’s great to have the rules, but what is the process to ensure the rules are being followed in a timely manner. This discipline should be equally as detailed, and the answer should include regular scheduled evaluation meetings, ideally with another individual to support executing the rules.
PLANNING & ORGANZING YOUR WEALTH
Many individuals are sitting on higher than ideal levels of cash, nervous to get back into the market and hoping to time their re-investment at the bottom of the next pullback. However, there is a flaw in this approach.
The market typically has pullbacks of 5% or more during the course of the year. Since the bottom of the market in 2020 we have seen seven normal pullbacks, which is a healthy testing of market strength. This frequency of pullbacks has caused people to think they should wait until the next pullback to deploy cash, but it is important to remember the market often first increases before a pullback. Therefore, there is no assurance of buying at a cheaper level. Even if you could time the market perfectly, you may still be buying in at a price higher than today. It’s common that investors end up in a state of analysis paralysis and finally buy in much later than they should have.
Typically, we advise clients looking to deploy cash to pick a time frame, perhaps three to nine months, and then we allocate these funds into the market in equal installments over that time. By using this ‘drip investing’ approach you get the benefit of averaging in and if you do get a pullback over that window of time then you can accelerate the pace of investing. Waiting until a pullback which might never come or may come at a higher level isn’t historically a good or a consistent strategy.
A disciplined strategy of investing must also include rules on how to invest new funds.