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Market and Portfolio Update

Hello and Happy Friday!
 
We sent an email last Friday, providing a market update to clients given concerns over market volatility and the devastating events occurring in Ukraine. Our hearts, thoughts, and prayers continue to go out to the Ukrainian people and Canadians of Ukrainian descent. In this regard, I am also pleased to inform you that BMO Financial Group has made a donation of $200,000 to the Canadian Red Cross Ukraine Humanitarian Crisis Appeal supporting humanitarian needs related to the situation in Ukraine. BMO Announces $200,000 Donation to Red Cross to Support Ukraine Relief Efforts
 

Equity Positioning

As of yet, we do not have much to add to last week’s market update. Stock markets have been bouncing wildly, though in a net sideways motion for the past few weeks as they struggle to confirm a bottom of support before moving higher. We may finally begin to see them push higher from here as the war progresses. Markets have historically been most volatile leading into such geopolitical events. That said, our measure of volatility (VIX) is still above 30 - and we do not like to see it move above 20. We are in the Yellow Zone in our Equity Action Call, and cash has moved higher in our Stoplight Matrix. Furthermore, all signals including our short term technical “Footsteps” are still indicating that we must continue to practice a great amount of caution. We are currently positioned at 30 -35% cash in the equity component of portfolios and we are fully “modelled” to get reinvest should conditions and signals improve.
 
It is important to note that we would not have gone to all cash recently as our signals did not indicate to do so. We must wait for our signals to confirm either direction, as markets can just s quickly return to their highs. Should markets however fall from here, the next step down could be quite significant. We would like to reiterate - we would rather miss some upside than catch more downside.
 
Since commodities and U.S. stocks currently are at the top of our matrix (pictured below) dominating the possible asset classes we can own, we continue to focus on stocks and ETFs that reflect that.
 
Even when we return into the market fully, we will look to add to commodity positions like oil, gas, metals (such as gold, steel, and nickel), chemicals, and agriculture, which all tend to do well in an opening and/or expanding market. This is because companies need raw materials to build and expand. In turn, if the economy of a country is growing, the public will spend increasingly on products and food. 
 
We are looking for the opportunity to profit from these assets, even as stock markets decline or move sideways. We do so, however, with a longer term note of concern. As stated, these assets tend to do well in a growing economy. They also do well as markets begin to peak, during which economies reach their potential maximums. We saw this in the late 90’s and into 2008. We will look to enjoy any ride up, and it could be for many months or even years. But as always, we continue to watch our indicators should they signal a final breakdown in this 13-year bull market.

Fixed Income Conundrum

We've Only Just Begun 

Yes, that is a 1970’s Carpenter’s flashback! That was when we first saw interest rates in the U.S. begin to spike 9.25% with the “stagflation” and oil crisis, then pulled back a bit before spiking again in 1980 and leading to a nasty global recession.  Canada followed suit. Bank of Canada Interest Rate 1935-2022 & 2022 Forecast | WOWA.ca
 

Rates have come down ever since, to historic lows…. Until now!
 
Canada raised rates by 0.25% on Wednesday. We were expecting as much as a 0.5% increase. The U.S. is likely to follow suit later this month. Bond market rates around the globe also moved higher. The positive side of this is the effects of the war and uncertainty are quelling some of the inflation concern by central banks, potentially reducing the speed and need for rising interest rates.
 
“The Fed is still on track to hike rates, but expectations for a big jump have eased. As war continues in Ukraine, investors' expectations for an aggressive 50 basis-point rate hike this month have fallen to near zero, and Fed Chair Jerome Powell said he's inclined to propose an increase of 25 basis points this month.”
- Business Insider
In similar situations, like in 2008, central banks raising rates too fast could lead to the dreaded R word: recession. Should the Feds of the world better navigate the inflation issue, there will be a lesser likelihood of a major market breakdown. Again, we will be watching this closely.
 
However, the negative side of market interest rates moving higher is that the value of Fixed Income instruments and bonds decline. If you remember, Fixed Income is typically the “safety piece” of a portfolio. Bonds, like bank GICs, pay a fixed and guaranteed rate of return. But if rates increase, the value of a bond we already own, as well as its income stream, declines. For example, a $100,000 GIC at 2% would be worth less than a $100,000 GIC at 3%. In a GIC we buy from the bank, we rarely see those fluctuations because the bank does not show the day-to-day values – typically since we cannot touch the GIC until it matures. If we saw those actual day to day values, like we can with a government or corporate bond, we would see those values fluctuate even if we do not sell them. Why am I telling you all this?
 
Towards the end of last year, and so far this year, we have seen market interest rates rise. And though we still receive their income stream, the value of fixed income in portfolios is dropping. As we have stated over the last few years, rates have been declining since the 80’s to historic lows, and so the value of fixed income has been rising.
 
For the next twenty years, however, interest rates will be on the rise, and the safety piece of the portfolio could potentially suffer. Therefore, we continue to overweight stocks to the maximum of their mandates, even in more conservative portfolios. We have also seen Bonds as an Asset Class move to the bottom of our matrix – even below cash. As such, we will be looking to make some changes to the Fixed Income component of portfolios. It may reduce the income stream, but it will also reduce the risk of loss in the safety component of the portfolios. We expect to be increasing cash or short-term interest rate vehicles with less price volatility going forward, so that our safety piece continues to be just that.

 
Bottom Line:

We are in the Yellow Zone and in a period of heightened caution for both stocks and fixed income. We do not like to be in cash, nor negative on the outlook. Most importantly, this does not mean we cannot profit from here. Other assets classes such as commodities and energy can provide safe and suitable alternatives. We look to places of strength, including cash if need be, which was instrumental in protecting your portfolios in 2020. We do not subscribe to buy and hold. As always, we simply need to follow our rules and discipline, and listen closely to what our signals are telling us.

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