January 2018 Update

We continue to maintain a defensive position across our portfolios. We are holding a larger than usual amount of cash, government bonds, and precious metals and energy producers, with a reduced exposure to equities.

Over the past eight years we’ve witnessed a gradual shift in investor psychology, culminating in the “no fear” market of 2017. Over that time pessimism and doubt gave way to optimism and faith. Concerns about being over-invested in stocks gave way to concerns about being under-invested. Security valuation gave way to buying at any price. Due diligence gave way to companies adding “blockchain” to their names rallying +100%. Reducing debt gave way to a borrowing binge. Prudent capital ratios at the banks gave way to increasing leverage. Volatility gave way to a US market that climbed without so much as a 3% drawdown in the year. Top performing conservative money managers gave way to shutting down their funds after client withdrawals to chase the market higher. Concern about risk gave way to concern about reward. Simply, fear gave way to greed.

It is precisely in these moments of no fear that stocks, real estate, high yield bonds, and other “growth” assets are at their riskiest. Investors must always remember that no asset class enjoys the birthright of permanently high (or even positive) returns because all things move in cycles.

In 2018, it is my opinion that Canada will contend with a continuing decline in house prices, eroding household wealth and, slowing housing investment. I anticipate this will cause Canadian GDP growth to slow by about half, from 2.9% to 1.5%. In the US, tax reform will deliver a short term boost to GDP growth, yet long term effects will be muted as corporations use tax-windfall gains to buyback their shares and pay one-time dividends instead of buying capital investments. Few people remember that after the largest US tax cut in history in 1981, US stocks fell 23% over the next year as investors bought the rumour, and then sold the news. On both sides of the border, I anticipate higher short-term interest rates will slow credit growth and personal consumption. In sum, 2018 faces the double hurdle of rising short term rates and inflation plus lower long term growth – also known as stagflation. Without additional fiscal or monetary intervention, these conditions eventually lead to recession.

My focus coming into 2018 remains foremost on protecting capital by reducing investment risk, and secondly on maintaining upside potential through holding undervalued securities. Our holdings including cash, government bonds, commodities, and select “recession-proof” companies reduce risk in a rising-inflation-low-growth economy. Energy and precious metals companies benefit from rising short term interest rates and inflation. Long term bonds benefit from lower economic growth. Our “recession-proof” companies have demonstrated sustainable profit growth through past periods of economic contraction. A large cash holding gives us plenty of flexibility to take advantage of lower equity prices and better values ahead. I believe we are ideally positioned to thrive through these economic changes, and capture upside to make the best of the situation.

Interesting links:

The obstacle is the way https://www.farnamstreetblog.com/2013/01/the-path-of-amateurs/

How slower growth can produce a better result https://intelligentfanatics.com/forums/topic/yvon-chouinard-patagonia-controlled-growth/

Canadian shadow lending https://www.bloomberg.com/news/articles/2017-12-13/risk-shifts-to-shadows-in-canada-s-whac-a-mole-housing-market

Prepare for weaker bank results http://business.financialpost.com/investing/for-canadas-big-banks-a-housing-hangover-may-loom-in-2018

Investors are euphoric http://www.investmentnews.com/article/20171214/FREE/171219944/rias-struggle-to-keep-clients-grounded-amid-stock-market-euphoria

 

Cordially,

Ben W. Kizemchuk

Portfolio Manager & Investment Advisor
Wellington-Altus Private Wealth
www.growthandincome.ca
www.altusinvest.ca
(416) 369-3024

55 Yonge Street, Suite 1100
Toronto, Ontario
M5E 1J4

All opinions and estimates contained in this report constitute the judgement of Ben W Kizemchuk of Wellington-Altus Private Wealth as of the date of this report and are subject to change without notice. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur.