Saturday, April 28, 2018

This is no time to be a financial hero

Investing is about being prepared for the unexpected. Things always change. In that investing is very similar to ,another favorite of mine, geology: the data is always insufficient to make a truly fail proof decision. You have to row with the oars you have.  That is a Dutch expression and I must say that its meaning has not been lost in my brilliant translation 😊

A way of dealing with the uncertainty is by using several investment scenarios or ‘what-if’ cases and then implement a strategy based on your estimated likelihood that such scenarios will play out. You continuously review your what-if cases and your strategy. So, right now, I have two extreme scenarios, yes you guessed it: Bullish and Bearish. Let’s start with the good news – being an optimist [really?] I want the upside first.
We are in a bull market that started way back in February 2009. Many investors are still anxious because of that traumatic event and many didn’t recognize right away for what it was: one of the longest bull markets in history. Unless you consider some nasty corrections mostly centered around the European debt crises and slow growth.  In 2016, there was in the U.S. an ‘earnings recession’ most of us weren’t even aware off. And we haven’t seen the same market euphoria as we experienced in the Dot-com boom which ended somewhere in 2001. But I remember some of that downturn which, like today, was not based on a broad market advance. In fact, Warren Buffett was nearly apologizing for Berkshire’s underperformance in the late 1990s.  Except for the low interest environment, today’s markets under the FAANG leadership are not that different. The 'low interest rate' exception is also a basis for my bearish scenario.
There is a good chance that we are near a peak in the FAANG stocks or that they at least will lose the market leadership. The 1990s lead-up to the Dot-com boom was under Clinton and it was a time of depressed resources. Oil and gas and gold were performing at the extremes of my patience. We seemed never to recover from the crashes in 1982 (when oil and gold peaked) and in 1986 during which my then-wife lost here oil-patch job. Unemployment amongst new geology graduates was something like 90%. The TSX had been underperforming the U.S. markets for years and Canada’s government debt was compared to that of 3rd world countries due to the excesses of Trudeau Senior and due to excessive high inflation. Inflation peaked around 1982.  It took literally decades of decline until we arrive today at semi-deflationary conditions (depending on to whom you talk). From the Dot-com bubble crash until 2008 or 2011 (depending on your views), we had a resource industry boom in Canada and the TSX and my wealth shot up ‘like enormous’. Canada overtook U.S. stock market performance like a rocket and my portfolio performance left good old Warren in the dust.  Strange how things seem to repeat.
Since 2011 we have been in a resource bear market and Canada is being outperformed by the U.S. stock markets dramatically. There is no stopping of the U.S. market indexes which, just like in the 1990s, are led by the High Techs now named FAANG. And resources have been in a Gold bear market, especially when seen in U.S. dollar terms, and oil & gas bottomed in January 2016. During these years, coal, uranium, copper and others having been leading lives of pure angst and misery.  In the Dot-com age, they said, there was a ‘new paradigm’; there was a new economy of PCs, internet and of course Jeremy Rifkin’s Hydrogen Economy. In the following years, high tech was healing its bloody wounds and we returned to stock market and economic old-school fundamentals. Now we have an economic revolution again with the ‘death of retail’ and Canada as well as other governments and corporations are taking on excessive debt in a negative interest environment. But things are about to come to a crashing halt.
Interest rates have bottomed and like Bill Gates around 2000, it is now Jeff Bezos who is the richest man on this planet. Amazon has peaked near a $1600 share price. It even has caught the evil eye of the Donald. Just like the monopoly charges against Microsoft between 2000 and 2008. The smart phone cycle is peaking as well. Apple and Samsung have kept consumer interest in their products by coming out with model updates annually. Now the cloud is coming into the spotlight like internet e-business and smart phones under BlackBerry leadership were appearing just under the economic surface around the Dot-com era. The consumer is getting tired of those annual product updates that no longer stir their imagination.
Many indicators point to a change in market leadership. We’re going back to resources – China and India and other large-population economies have not matured yet and they will be the source of a lot more resource demand. People will start to realize that the self-driving car and Elon Musk dreams of solar and electric cars are, I wouldn’t say pipedreams, but rater exaggerated delusions that may or may not become reality just like Canada’s Ballard engine so admired by Rifkin and others. Guess who today is the cheerleader for electric cars and the end of combustion engines? Yes, that same Jeremy Rifkin who now salivates at the solar panel dream. If Mr. Rifkin is a leading indicator then start investing in oil and gas.
The market leadership will likely change and after we have taken care of the financial ruins left behind by Trudeau Jr (the repeat pattern from father to son is uncanny) we will likely see a major resurgence of Canada’s resource economy and a looney on par with the U.S. dollar and/or Euro.  Maybe this new boom in resources (in which the U.S. currently has such a high stake) will repair a lot of the U.S. and Canada’s balance sheets. Just like Toronto and Vancouver have enjoyed excellent prosperity in recent years, it will be soon Alberta and the West (with lifestyle driven BC Fraser valley in the doghouse) that resumes the economic leadership in Canada. Automation and the decline in North American manufacturing making Toronto and Ottawa economically and politically less relevant. Western Canadian population is much younger and likely to grow much faster over the coming year. With the traditional Eastern Canadian powerhouses decline, Canada’s power distribution will become more balanced. Maybe today is the last time that we experience the colonial attitudes of the East towards the West and maybe we will have a more balanced future in years to come.
My bullish scenario is a rotation in bull market activity with resources overtaking high tech performance. A period of higher inflation and less grey population due to the Millennium generation coming into its own and having experienced economic realities during their early family formation years. Will the Millenniums be as self-centered and influential as the Baby boomers?  Probably and they will have to fund our baby boomer pensions just like their kids will have to do for them.
My bearish scenario is kind of based on the same history as that which supports my bullish case.  The root lies in earlier mentioned government and private debt levels. A failure of China and India to step up to their potential with a return to corruption and dictatorship. Possibly even a 3rd world war if our political leadership is as stupid as they appear on tv and the media. I don’t want to mention the failure of the climate change fear mongers, I have discussed that plenty on this blog. But the negative economics for this carbon tax based fear-mongered irrational religion of CO2 poisoning instead of a balanced careful approach towards a truly sustainable economy may lead to a severely repressed and stagnant economy where government and corporate debt crises are hitting the wallets of all people. Ironically, the rich - in relative terms - will still be rich but it will be the poorer members of this society that cannot longer be supported by our social networks. Like happened in Europe, prolonged presences of liberal or NDP style governments will lead to a less vigorous and stagnant society. Or look ar South America, a near Utopia in early the 1900s. It is not for nothing that communist and socialist societies fail.
Look at Russia, Venezuela, Mexico, East Germany, Yugoslavia and another endless list of failed countries.  As discussed in earlier blogs, dictatorships, fascist or communist all find their roots in the same Marxist philosophy – the envy of the successful.  Strangely enough, the extremes between rich and poor is often rooted in interventionist governments.  I have no idea how we will work ourselves out of such a bearish scenario including the failure of fiat currencies.  I don’t think we will be left living in a world of civil disobedience and chaos as the black science fiction movies foreshadow. Speaking of which, I would love to live in a Star Trek world with an economy evolved towards a much more-just society with people of the highest morality. Somehow, I doubt such a vision becoming real as well. 
To survive and build wealth in such a drab economic scenario, you probably need gold and other precious metals as well as being schooled in the use of guns, martial art and bunker construction skills. Maybe not quite my dream-life. Likely, before a total collapse of societal functions we’d have a turnaround. But, yes new currencies – a gold based and real estate-based economy. I doubt it that most banks would survive (the leverage these companies use is mind-blowing) and I doubt people will lend money to government or big business when confidence in them has collapsed. Wall Street elites will definitely be in the doghouse or prison. I think in such an extreme downturn, physical assets maybe more important than anything else: farm or timberlands come to mind. Your own business and DIY skills would be most valuable. It would be a grim place because many may not have the opportunity to make an honest living and turn to crime or perish.
My strategy considers the bull case more likely but with a change in economic leadership from tech to resources, especially with so many pessimistic market gurus and investors around. Whether this will be seamless or interspersed with a significant downturn is hard to foresee.  A downturn much less severe as the bear-case though. So, yes build cash 20 to 30 percent until matters feel more certain; hold physical gold and silver. Hold stocks that are less dependent on falling interest rates or that benefit from rising real estate (Alberta). Rising interest rates may benefit landlords as it reduces home ownership and increases the number of potential tenants. Don’t write off ownership in rental properties. Commodities and resource stocks will likely do best – go overweight.  I would be underweighted in financial investments. A return to laddered GICs (federally insured) to park cash along with money market funds is more conservative but not without risk – stay short term up to 3 years max. Have enough cash to pay off your debt that might be much more secure than investing it in a bank or other financial institutions. Unfortunately, we cannot entirely do away with banks. Consider buying  long-term (1 – 2 year) stock market index put options. Sell off your ETFs this is probably the most vulnerable asset of todays markets because it is so easy to sell during market panics and they are overweight in FAANG stocks.
If there really would be a real estate crash in Toronto and/or Vancouver, most high-risk mortgage losses are not to be carried by the Canadian banks but rather by government insurance companies such as CMHC.  GICs are insured yet again by the federal government (FDIC) and as such are a lot ‘safer’ than equity (stocks) owned in banks. Bank equity that probably gets wiped out first before your deposit money disappears. The current year is crucial – it may not be a year of high returns but more of a changing financial climate with forward visibility reduced to just a few months. There is no clear vision of what may await at the other side of the financial cliff or how high that cliff may be.  This is not a time for playing investor hero.

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