There may be a few ideas for anyone who, like myself, is in the “Retirement Risk Zone.” That’s the five years prior to and five years following your projected retirement date. If it’s 65, the traditional age, then the Risk Zone is between age 60 and 70. Based on the Hub’s demographic user patterns, a lot of people are in that category (although we actually have lots of millennial and Gen X traffic too on both sides of the border).
Towards the end of the blog, I talk about portfolio hedging. I have to credit my fee-for-service financial advisor for most of these concepts. He didn’t want to be named for the MoneySense blog but he is listed in the Hub’s “Guidance” section elsewhere in this site.
It took me awhile to accept that hedging — that is, using options or selling short certain ETFs representing the major indices — is as much a risk reduction strategy as it is a “risky” strategy.
Hedging means trading off some upside for downside protection
The best way I can describe it is that you’re willing to give up some upside in return for protecting the downside. In this respect, it’s not unlike asset allocation or a classic balanced fund. Naturally, a portfolio half in bonds and cash should be less volatile than one 100% in stocks. You’d expect the aggressive portfolio to have the highest returns in a continuing bull market in equities and if you were in a balanced fund would accept the lower returns that let you sleep soundly at night.
To my mind, hedging is similar. In the MoneySense blog I describe a hypothetical situation (close to my own) in which asset allocation across both registered and non-registered portfolios is roughly 50/50. Ideally, registered plans are mostly in fixed income (and my case some US dividend-paying stocks), and non-registered plans are mostly in stocks, especially Canadian stocks.
But when you’re in “The Zone,” you hardly welcome watching half your portfolio sink. Yes, we’re already down 20% and are firmly in correction or bear mode in most global markets. It could be that now is the proverbial buying opportunity, and that’s probably true for younger investors who have plenty of time on their side.
The Long Run eventually runs out
Not so we aging baby boomers. The deaths the past week of David Bowie at 69 and of the Eagles’ Glenn Frey at 67 should be sufficient reminder (“memento mori“) that we are all mortal. The concept of stocks for the long run is certainly a good foundation for young people and the middle-aged to build growth portfolios but as Keynes also reminded us, “In the long run we’re dead.”
Here at the Hub our slogan is to achieve financial independence “while you’re still young enough to enjoy it.” It’s hard to really enjoy Findependence when you’re worried about the stock market crashing 50% or more, as it did in 2008.
But as my adviser told me at the time — as he sailed through the financial crisis intact via his hedging strategies — you don’t need to stand helplessly like a deer blinded by headlights as markets go south. If you care as much now about capital preservation than growth, then it follows that you’re willing to trade off some future upside for a lower downside. Asset allocation may get you there and one of the regular contributors to the Hub is a firm believer in retirees relying on cash flow from high-quality individual stocks.
Partial hedge is still net long equities
Currently “we” are only a sixth to a third hedged so we’re still happy if markets recover. As the MoneySense blog warns, if you do start to hedge, it will be inevitable that you may get whipsawed. So if you choose to initiate a hedge by shorting ETFs covering the TSX or the S&P500 or EAFE ETFs, realize that if markets start to rise, you will be losing money on the the sell side of the hedge. (But if you’re net long you’re still “happy”).
Conversely, if they sink further, you will be glad you purchased the “insurance,” as those positions rise even as the indexes sink further.
No guarantees either way but when in investing was there ever a guarantee? And as the other blog notes, you don’t want to try this without the guidance of a good financial planner or investment adviser who is thoroughly proficient at risk management, options and hedging.
One of the more entertaining financial presentations at this week’s BMO investing conference in Chicago was a keynote talk by author and broadcaster Andrew Busch on who killed the global economy. (I qualify this with the phrase financial presentations because Rick Mercer’s talk was also highly entertaining but could hardly qualify as being financial).
By contrast, Busch had worked at BMO Capital Markets for 22 years earlier in his career and grew up in Chicago. His financial research is available free here.
Billing his talk as a “Murder Mystery,” he ran movie clips from various Film Noirs to illustrate his points.
Among his suspects; the ECB’s Mario Draghi, Japan prime minister Shinzo Abe, China president Xi Jinping and the Federal Reserve’s Janet Yellen. Busch played the role of “Private Economic Investigator.”
Resemblance to Greece?
Starting with Yellen, he submitted clue number 1 as the unemployment rate. With 3 million Americans underemployed, this fact shows up in sluggish wage increases so “we’re not seeing an acceleration in wealth gains so are not seeing inflation.” What jumps out from the latest job numbers is where they are located; 14 million Americans are employed in local government, another 2.7 million in the federal government and 5 million more in the states. “Now we know why it’s important to look at government spending,” Busch said, “We have to pay tax to have them employed.” Sequing to Greece he asked rhetorically “Are we more like them than we realize?”
Clue # 2 pointing to Yellen is GDP, which slowed down from 5% in the third quarter to 2.3%. “This quarter will be bad and earnings won’t be good.” So far, markets are ignoring pre-warnings as the S&P500 stalls around 2100 but the earnings hit will be “substantive,” Busch said. However, “Most are ignoring it for good reason: we will snap back in the second quarter with GDP growth close to 3% as warm weather comes and things return to normal but we will hear lots about potentially negative GDP in the first quarter.”
The slump in energy prices has curbed inflation, which is “short-term bad but medium-term good because of more money in consumer’s pockets.” Cheap oil helps middle-income earners heat their homes and fill their cars’ gas tanks. That should translate into a pickup in consumer spending and accounts for the recent strength of consumer discretionary stocks.
The Fed’s motive is to normalize interest rates and its first opportunity to raise them will be in June. But the Fed itself is still not sure when inflation and average hourly earnings will go up. “We don’t know what the Fed will do because they don’t know.” The process has begun with hikes in the minimum wage at major retailers like Walmart, Target and even McDonalds. “At some point the Fed will act and I believe it will be in June.”
Dead Man Walking
Busch then moved to Suspect #2 (Mario Draghi) by rolling another film clip. Clue #1 in Europe is that employment rates are just starting to tick down. Clue #2 is the GDP growth rate, which is above zero. “We’re starting to see some acceleration. That’s great but I’m not sure it will last.”
Clue #3 is a major problem: the “sinking feeling” on Europe’s inflation numbers. To avoid Japan’s fate of 15 years of deflation, Europe has mimicked the Fed’s Quantitative Easing program by launching its own QE program in March, lowering rates to zero. It’s bought 60 billion worth of Euros and added 1.1 trillion Euros to the balance sheet, moving beyond 3 trillion. The difference is that when it started its program, the Fed only had US$800 billion on its balance sheet, with QE eventually taking it to US$4.4 trillion. “I expect the ECB will mimic that and do it in three or four tranches.”
Suspects 3 & 4: Japan & China
Busch moved on to Shinzo Abe and Xi Jinping, showing a photograph of the two shaking hands and clearly uncomfortable with each other. Clue 1 is their unemployment rates but these can be safely ignored because the numbers are clearly unknowable. China’s unemployment rate has “magically” stayed at almost exactly 4% since 2012. Japan has horrendous productivity numbers and are “like zombies in the Walking Dead: they should be firing people.”
Clue #2 is GDP. China can force its banks to lend, which it did in 2009, when its high-velocity money stimulated economic growth in areas like infrastructure and housing. This resulted in inflation heating up and commodity inflation but the country is attempting to shift to more US-like consumer spending.
In the US, consumer spending accounts for 70% of GDP, while it’s only 40 to 45% in China. “They want it higher,” Busch said, so it relies less on infrastructure spending. In both countries, politicians “tell central banks what to do.” Abe shot the three arrows of huge fiscal stimulus, massive QE and economic reform in a bid to generate 2% inflation within two years. But last month inflation in Japan was “zero, so they missed the target. It’s vastly different from QE in the ECB and US. … It’s not surprising to see their (Japan’s) stock market reach 15-year highs this week as they reaffirm the QE path, and it won’t end any time soon.”
China wants to keep its currency weak relative to the US dollar and has cut rates twice. The results have been dramatic: Chinese stocks have been on fire since September.
And the murderer is:
In his finale, Busch concluded “the dame did it.” (Yellin). While he expects the Fed will start to raise rates in June, “Nothing is going to happen.” Busch said what happens next may be similar to the 1930s, when the Fed moved rates up several times aggressively. At first, nothing happened but they kept doing it until “eventually they killed the recovery. That’s analogous to what will happen here.”
Here, Busch ran a movie clip from Sunset Boulevard. “The first time the Fed shoots the guy nothing will happen. He’ll keep walking. But the third time they shoot you, you end up face down in the pool.”
So far, they’ve not yet killed the global recovery but central banks everywhere “want all of us in this room to go as far out on the risk curve as possible.” The Fed “won’t screw up this year or the first half of 2016,” Busch predicted, “My guess is that by the second half of 2016 or first half of 2017, as Europe and China stabilize they will feel good enough to act more aggressively.”
Below is the jointly written article that ran last week at the Hub:
By TSI Network and Jonathan Chevreau
TFSAs let you earn investment income—including interest, dividends and capital gains—tax free.
The federal government first made the Tax-free Savings Account (TFSA) available to Canadian investors in January 2009. These accounts let you earn investment income — including interest, dividends and capital gains — tax free. You could contribute $5,000 in 2009 to start your Tax-free Savings Account.
Every year until 2013, you could contribute an additional $5,000 to your TFSA. If you contribute less than the maximum to your TFSA in any given year, you can carry the difference forward. That means your TFSA contributions for 2009 and 2010 totalled $10,000, rising to $15,000 in 2011, $20,000 in 2012 and so on.
As of January 1, 2013 the annual contribution limit increased to $5,500, in line with the initial promise to adjust limits with rising inflation. It remains at $5,500 for 2015. That means that if you haven’t contributed yet (and were 18 years or older in 2009) you can now contribute up to $36,500. At some point, once the federal books are balanced, the Conservative government is on record that it will boost the annual TFSA limit to $10,000.
How to shelter your gains with a Tax-free Savings Account
Use your TFSA to complement your RRSP.
Generally speaking, your TFSA can hold the same investments as an RRSP. This includes cash, mutual funds, publicly traded stocks, GICs and bonds.
Contributions are not tax deductible, as they are with an RRSP. However, unlike withdrawals from RRSPs (or withdrawals for RRIFs to which most RRSPs are converted), withdrawals from a TFSA are not taxed. In this respect, RRSPs and TFSAs are mirror images of each other in the way they impact your taxes.
This makes the TFSA a good vehicle for more short-term savings goals, like saving up for a down payment on a first home. If funds are limited, you may need to choose between RRSP and TFSA contributions. RRSPs may be the better choice in years of high income when you’re in the top tax brackets, since RRSP contributions are deductible from your taxable income. In years of low or no income — such as when you’re in school, beginning your career or between jobs — TFSAs may be the better choice.
Investing in a TFSA in low-income years will provide a real benefit in retirement. When you’re retired, you can draw down your TFSA first, incurring zero tax liabilities. After that, you can begin making taxable RRSP withdrawals.
As a rule, I avoid reading too many financial books based either on Greed or Fear. Still, when you have a good chunk of your net worth invested in the stock market, it’s hard not to have a twinge of doubt when you encounter books like Thom Hartmann’s The Crash of 2016.
I paid no attention to this book when it was published late in 2013 but now it’s 2015, well, 2016 isn’t so far away now, is it?
Why am I writing about it now? I wasn’t responding to a belated PR campaign by the publisher (Hachette Book Group) but stumbled on it while searching for other books on Kindle. The Kindle sample on offer didn’t enlighten me much about the author’s thesis (that should have been a clue!) so I ordered it from the local library, not feeling any urgency to get my hands on it.
Indeed, the last time I read such a book was Harry Dent Jr’s The Great Crash Ahead and of course so far that prediction has yet to manifest. Read my 2011 review of the book, at which time Dent predicted the Dow might fall as low as 3,000. So far, no cigar: to the contrary, the market spent much of 2014 besting itself, racking up all-time-high after all-time-high. As I write the Dow is still hanging in above 17,000.
Still, as the saying goes, even a stopped clock is right twice a day. See also Barron’s piece at the time titled “Harry’s Dented Prophecies.”
No doubt, Hartmann – a prolific author with New York Times bestseller status – would view the current level of the market as the proverbial selling opportunity. For those unfamiliar with the former DJ turned entrepreneur and political commentator, here is his Wikipedia entry.
Hartmann’s focus is US economy, not stocks
Actually, somewhat strangely, Hartmann’s book is not chiefly about the stock market. It’s more about a general breakdown in the American economy and social safety net, and the reader is left to infer that part of that will involve some (or a lot) of air escaping from the still-elevated stock market. His theory is that these things go in cycles and every 80 years or so, civilization is doomed to repeat the last economic debacle once the previous generation passes away. This he calls “the great forgetting.”
“We are standing today at the edge of the Fourth Great Crash and war in American history. The previous three — each about eighty years apart — were gut-wrenching in their horror and bloodshed, but they ultimately transformed America in ways that made this a greater and more egalatarian nation.”
Hartmann’s “crash” consists of a combination of economic meltdown, war, environmental crisis, radical social transformation and the “gridlock of dysfunctional government.” He adds that “for some Americans, the crash is already well under way.” (Presumably he is talking about the unemployed or failed businesses).
Since there’s very little about the stock market in the book, there is likewise little or nothing about how one would go about protecting against a crash were one convinced that such a catastrophe truly was around the corner. Nothing on put options or reverse ETFs or ETNs, nothing on asset allocation, hedge funds, real estate, commodities and gold or alternative assets.
How Tax Cuts for the rich hurt the middle class
Hartmann’s beef is chiefly with what he terms the rich “Economic Royalists,” and particularly billionaires, who he believes should have all their wealth taxed away after their first billion. In practice, he’s referring to the Republican party and its allies, such as Fox News, and their joint success in watering down Obama’s agenda. Since Ronald Reagan, the “Royalists” have succeeded in rolling back the system of graduated income tax, with the result that the middle class is being squeezed. Hartmann has mined this terrain before, with books like Rebooting the American Dream and Screwed: The Undeclared War Against the Middle Class.
When the wealthy bore fairly high taxes in the years before Reagan, Hartmann theorizes that business owners chose mostly to reinvest in their businesses, plant and workers, so as to avoid taking income out of the business and being taxed at high rates personally. But with the Reagan tax cuts and those under subsequent administrations, rich business owners have been more inclined to pull more money out of their enterprises to be enjoyed personally.
Why late 2016?
So why the timing of 2016? Again, it’s about politics. As Hartmann explains, by late 2016 Barack Obama’s second term in office will be winding down, and politicians always do what they can to keep things rosy until they step down, don’t they?
“The Obama administration will do the same thing the Bush administration did when confronted with the forces of the ongoing of the oncoming Great Crash in 2007-2008. It will tinker around the edges, inflate as many bubbles as possible, and try desperately to hold things off until the November 2016 elections are safely in the bag. If it doesn’t all come apart before then, that will be the time of maximum vulnerability.”
So what to do about all this? If you agree with most financial advisers that timing the market is futile, then you should do little or nothing. On the other hand, if you agree with Hartmann’s thesis you might want to closely monitor things a year from now, perhaps lightening up by the summer of 2016. Of course, with the oil-related volatility we’ve been seeing of late, the wheels could come off long before 2016.
Ironically, back when he was writing the book in 2013, Hartmann was describing the perils not of falling oil prices, but of rising ones.
This book and the November 2016 elections may turn out to be so much noise; then again, remember the quip about forecasting pundits and stopped clocks. Once in a blue moon — or even twice a day — they are correct.