Category: Articles

The two sides of January

Most investors have heard of the January Effect which is the observation that January has historically been one of the best months to be invested in stocks. However there is another January Effect which states that, “as goes January, so goes the year”. While January has produced positive performance 66% of the time between 1968 and 2017 for the S&P/TSX Stock Index, it has also produced negative performance one-third of the time.

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What is striking is that in years when January had a positive return, those returns were well above average relative to the returns in other months of the positive January years. For example, of the 33 Januarys with positive performance, the S&P/TSX was up an average of 4.3%. The next best performing month in those years, as can be seen in the table to the left, was December which returned half that amount at 2.1%. Conversely, when January had negative returns, -3.5% on average; the remainder of the months of the down January years produced better returns. Although in total only 7 months had positive returns, they were more than enough to lift the overall years performance into positive territory but still well behind the 50 year average market performance and still further behind the years where stocks came roaring out of the gate in January.The chart below depicts the average annual cumulative returns for months that had positive Januarys and negative Januarys net of the S&P/TSX average annual return for the period. While the relative performance between good and bad months of January time periods did narrow over the course of the year, it clearly shows that the opening month of the year often sets the pace and influences the remaining months of the year. We then looked at how these markets performed for the full year. In those years where January was positive the S&P/TSX (including dividends) returned 12.6% versus an average of 10.7% for all 50 years reviewed; a 17.8% improvement. On the other hand, negative Januarys underperformed the market as a whole by -39.3%. These numbers confirm that “as goes January, so goes the year”, translating into above or below average annual performance in those years.

The most widely accepted explanation for the January Effect is tax-loss selling. The tax circumstances of taxable investors are often more important than a security’s fundamental valuation, as such investors will sell whatever securities are required at the end of the calendar year to establish capital losses for income tax purposes and then repurchase the shares after a prescribed waiting period. As the waiting period most often expires early in the next year, the repurchase orders flood the market in January, hence creating abnormal returns in the month. In addition to tax issues, researchers have also suggested other reasons for the January effect. One is “window-dressing”, as portfolio managers unload their embarrassing stocks at year-end so that they don’t appear on their annual report, and then redeploy the proceeds in January. Another reason, which we may see more of in 2018, is short sellers covering their successful short positions early in the next year so they usually do not have to pay taxes on the gains until April of the following year.

Whatever the explanation, predicting the future is impossible (even if it is only one month’s prospects), but it is good to know the end result is just a question of how large the annual gain will be on average. Because it is clear that investors should not be out of the market if January is a good or bad month because the returns over the rest of the year are just a question of magnitude. Of course one must always bear in mind that past performance does not mean this trend will continue. It will be interesting to see how it plays out in 2018.

Market Data

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

VANISHED – CANADIAN STOCK VOLATILITY

Investors had taken most of the summer off as the S&P/TSX stock index drifted aimlessly, trading between 15,500 in May and 15,000 at the end of August, but since then it has undergone a steep 7.5% increase. Of course for those investors who closely follow the market, it seemed to be moving in all kinds of directions, falling for a week, rallying for two and jumping about like a chicken on a hot tin roof the rest of the time.

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If investors were to glance at volatility measures however, they would come away yawning. The socalled “fear gauge” has been nothing but a sea of tranquility. The best level of fear gauge for the Canadian stock market is the Montreal Exchange’s Implied Volatility Index VIXc (or MVX prior to October 2010) which measures the implied volatility of the iShares CDN S&P/TSX 60 Fund (XIU). VIXc is a good proxy of investor sentiment for the Canadian equity market: the higher the Index, the higher the risk of market turmoil. A rising Index therefore reflects the heightened fears of investors for the coming month. A high VIXc is not necessarily bearish for stocks, as it measures the fear of volatility both to the upside as well as the downside. The highest VIXc readings will occur when investors anticipate large moves in either direction. Only when investors anticipate neither significant downside risk nor significant upside, will the VIXc be low.

The chart below shows the VIXc values as well as the S&P/TSX Stock Index. Currently the VIXc is trading around 8.2 which is very low and confirms that the market is not anticipating any dramatic swing in volatility for the foreseeable future. Low levels of implied volatility are often good periods to enter the market as the risks are relatively low. Equity markets tend to disconnect from their underlying values in periods of high volatility as investors scramble quickly to trade those shares that are coming in or going out of favour. On the other hand, a peak in volatility in down markets can be a useful indicator as it closely precedes a market bottom. Think of 2008 when the VIXc spiked to 88 nine days before the market bottomed, in 2011 the VIXc spiked to 37 the day before the market bottomed and in 2015 the VIXc spiked to the 33 which was the day the market bottomed. Following the years the Canadian stock market experienced significant declines, the VIXc shone the light on the pending major stock market recovery.
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Another factor to consider when assessing the timing of a move to equities is the current cash on hand. Not only are retail investors switching from cash and bonds into equities, but hedge funds and institutional managers have been moving this way for some time. Back in 2009 hedge funds and experienced investment managers were well ahead of the retail crowd in buying up equities early in the rally, as they covered short positions and began accumulating long positions. The amount of cash on the sidelines currently has the potential to drive forward a long term equity rally. While it is difficult to say when a rally will begin, savvy investors may want to use this period of low volatility to add to equity levels.

Market Data

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Range Bound No More

After every major bull market, stocks typically become range bound and experience a sideways pattern with many optimistic and pessimistic periods before exiting 15 to 30 years later at about where it began. This has occurred in the U.S. five distinct times since 1870: 1870 to 1900 (lasting 30 years); 1902 to 1927 (25 years); 1935 to 1950 (15 years); 1965 to 1980 (15 years) and of course the most recent starting in 2000. Although Canadian stock market history does not extend back quite so far the pattern is very much the same, which should be expected since we march to the same drummer. Ultimately, the advancing economic recovery results in enough earnings growth that stocks that once seemed expensive are now bargains, and triggers a new bull market when stocks break through the upper constraints of the range.

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Back in 2008, following a robust record high equity bull market, investors were feeling optimistic. Not surprisingly the flows into equities were significant. This was when the current sideways market began with a bull market peak of 15,073 in June 2008 for the S&P/TSX index. Seven years later in April 2015, the market was barely higher at 15,451. The market continued to oscillate for the next two years, unable to climb above 15,500. However, this began to change over the last two months.

History is a reasonable guide for what might occur next and it has suggested a new bull market is fully established once the range is broken. Only those perceptive enough to see though the market “noise” will be rewarded by the time the new upward trend is well entrenched. And it appears the markets have now finally broken out of this range by firmly establishing new highs.

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As is evident in the chart to the right and in the table to the left, the equity market’s gyrations over the last 10 years have produced little tangible gains unless investors were astute enough to tactically determine the right time to buy and sell stocks. History suggests that investors with a long term horizon will achieve better returns in equities (probably 6% to 9% annualized) than in most other investments.

Investors have been pulling money out of equities and adopting bonds as the “must have” alternative, which was part of a broader trend that has been going on since the middle of the last decade. The financial crisis of 2008 made investors increasingly more risk averse and drove them to higher yielding investments as a way to maximize their returns in an era where longer term gains from the prices of stocks alone had proven elusive. With a record 21% of the workforce now aged over 55 and growing quickly, the asset mix of the general population is structurally biased towards instruments that generate an income stream as concerns over retirement percolate. This had put more pressure on stock valuations and dampened the desire for riskier assets.

Following extended periods of weakness, history shows that the future should be quite bright. After all of the worst performing 10 year periods since 1926, the following 10 year average returns were close to 11% and the lowest of those subsequent returns was still over 7%. Logic would dictate that investors should take profits in those asset classes that had performed the best, which in Canada were bonds and real estate, and seek returns in the weakest asset class, which has been equities. In the midst of the current equity rally, ten year government bonds are yielding less than 2% so a potential annualized return of 7% in equities over the next 10 years would be very attractive.

Market Data

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Retirement Income on Steroids

Short term interest rates are near 60 year lows which makes it hard for fixed income investors to earn a decent income. Couple this with the fact that the average investor has an aversion to investing in long term bonds because of the belief that higher interest rates are on the horizon and it becomes nearly impossible to earn much more than money market rates. So what are the options for clients looking for good yields while being able to take advantage of higher returns in the future?

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With over $300 billion in assets, Guaranteed Investment Certificates (GICs) account for a huge share of fixed income sales in Canada. This is due to the advantages that many investors feel GICs offer over bonds: a predictable and guaranteed income stream, the principal value won’t decline and no fees mean every penny earned is theirs to keep. For these benefits clients are subjected to returns that can be low and, after inflation, the returns are actually negative. This is not a great situation as people are living longer. Sometimes the safety investors are seeking becomes just another form of risk.

After GICs, bonds are the next popular vehicle in adding returns to an investor’s portfolio as they have very different characteristics but do offer distinct advantages. Interest rate changes affect bond values so that as rates fall, bond prices increase and as rates rise, prices fall. However, if held to maturity bonds repay the full principal. Another essential difference is liquidity. Bonds can be bought or sold at any time with price determined by each bond’s individual characteristics and current market conditions. While bond returns are impacted by the cost of purchasing and managing the portfolio, this can be offset by the higher returns bonds can achieve. They offer the distinct possibility of higher yields and capital gains.

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Taking it one step further and incorporating other types of fixed income vehicles into the mix can be quite rewarding for conservative investors. For example, constructing an optimized High Yield Fixed Income portfolio consisting 15% of a 10 year Corporate Bond Ladder, 7.5% REITs, 20% High Yield Bonds, 15% High Yield ETFs, 20% Mortgages and 22.5% Fixed Income Hedge Funds leads to a very attractive alternative. Certainly the degree of risk investors assume with this type of portfolio are higher, but so is the potential for greater returns. The real question is, is it worth it?

Given current low interest rates this may be a good time to consider these strategies. Current 5 year GIC rates (based upon the average rates of the Schedule A chartered banks) are 1.6%. Using bonds with a similar term structure (represented by 50% FTSE Short-Bond Index and 50% FTSE Mid-Bond Index) shows how an all bond portfolio would perform. While the returns for the outlined High Yield Fixed Income portfolio is clearly superior. As the chart above shows, over the past 10 years the one year rolling performance of these two portfolios consistently produce higher returns when compared to 5 year GICs (outperforming 83.3% and 88.1% of the time, respectively). The data to the left shows these advantages both on a quarterly and annual basis; while doing so with very low correlation to GICs of 0.22 and -0.24 respectively.

With today’s very low yields and increasing interest rates, investor returns on GICs after inflation, fees and taxes are minimal. So unless investors are comfortable with only safe harbour investments and unconcerned with the less than stellar returns going forward, the only realistic solution is to explore other options. The decision to be safe is making many investors less safe and creating a whole new level of risk, running out of money. With this situation bearing down on many investors, the proposed High Yield Fixed Income structure is a solution that plays it safe, but still generates meaningful returns.

Market Data

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Playing it Safe is Risky

The law of unintended consequences is defined as the actions of people (especially governments) that will usually have an unanticipated impact. In fact, the harder we try to achieve something quite often the exact opposite occurs. In the investment world it is very hard to foresee outcomes beforehand, so the final results can sometimes be surprising.

Some of the greatest investing blunders of all time came from the consequences of unforeseen events. Since one of the primary objectives of investing is to grow your wealth, unintended outcomes are very dangerous to investors’ future wellbeing. While the traditional culprits for potential disaster are “get-rich-quick” schemes or penny stocks, a historically safe harbour is slowly entering the lexicon of potential problems for many investors; bonds.

Traditionally, bonds have been seen as safe, low risk investments and the principal means of preserving wealth. They are also viewed as being an excellent way to diversify your portfolio. While this is normally true over the long run, there are distinct periods where bonds have been simply ineffective at building wealth. Considering today’s very low yields and increasing interest rates, investors’ returns on bonds after inflation, fees and taxes, are minimal. So, unless investors are comfortable with only the safe harbour feature of bonds and unconcerned with the less than stellar return opportunities going forward (or you have more money than you need), the only realistic solution is to hold a higher weighting in equities.

For the vast majority of investors, a balanced approach to asset allocation is normal. Historically, as clients age and approach retirement, they become more conservative and seek safety. Traditionally, this has meant more bonds and fewer equities. This is exactly the wrong approach for efficient portfolio growth or to even maintain the purchasing power of assets given inflation. However, this way of thinking is completely opposite to most aging clients’ mindsets of protecting what they have achieved over their lifetime. So a battle is brewing between the markets and peace of mind and unfortunately the markets are always right.

Retirees or near-retirees are scared to death of losing the value of their assets so they have in the past shifted the majority of their assets into GICs and bonds for “safety”. Of course, for the first few years of retirement this works fine. However, with the steady onslaught of inflation, fees and taxes they are slowly dwindling their nest egg. With people living longer and spending more years in retirement the probability of running out of money increases. The decision to become safer has made them less safe and has created a whole new level of risk; running out of money.

There is no such thing as taking no risk. There is only the choice of which risks to take and when to take them. The risk from owning bonds shows up later in your investment life, while the risk of owning equities can show up earlier. Without assuming risk, meagre results are all that is left to investors. In fact, there is a famous quote from Benjamin Franklin that summarizes this nicely: “those who give up return for security deserve neither return nor security.”

While bonds in the near future are not likely to be wealth builders, they are however necessary. The question is: how much? They do dampen volatility during downturns and are an excellent source of liquidity. Also, since investing often comes down to an emotional decision rather than an analytical one, bonds can act as a form of insurance against panicking when things turn ugly in the markets.

With this situation bearing down on all investors, we have created an entirely new fixed income investment structure that benefits from the strengths of bonds (risk reduction) and the benefits of equities (potential for higher returns). The Provisus Multi-Strategy High Yield Fixed Income Fund is designed to target the risk of short term bonds, but generate greater performance. It attempts to provide an attractive cash yield and stable returns, while investing in a broad range of non-equity assets: corporate bonds, convertible bonds, preferred shares, income trusts, REITs, mortgages, secured real estate backed lending, infrastructure products and alternative investment strategies.

It keeps fees client-friendly using the Pay-for-Performance™ model with a fixed annual management fee of 0.25% (which is less than the pro-rata average MER for all the fixed income ETFs in Canada, 0.28%) plus a performance fee only if the fund outperforms a pre-set benchmark (50% FTSE Short Bond Index and 50% FTSE Mid Bond Index). This fee philosophy provides a very strong incentive for the fund to achieve positive results for clients. In this day and age, it may be one of the few solutions available that plays it safe but still generates meaningful returns.

Crisis Are Buying Opportunity

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While it is sad to say, there is always some sort of crisis cropping up around the world and more often than not they can lead to fear as investors become overly pessimistic. Such crises inevitably lead to panic selling and selling into a panic is always a bad idea. In fact, the panic lows in the wake of a crisis are far more often than not a good buying opportunity.

The growing concerns about North Korean’s nuclear threat and terrorist attacks in Europe have caused many investors to try and gauge the risks to the stock market. While every event is different and no one knows which crisis will escalate and which ones will fizzle, stock markets have generally sloughed them off and recouped initial losses. The Canadian stock market has proven remarkably resilient, so doing nothing is almost always the best investment strategy during a geopolitical crisis.

The clear conclusion that can be drawn from the most momentous geopolitical crises of the last 47 years is that stock markets strongly rebound from their post-crisis panic lows, so much so that within six months they are actually higher than where they stood before that crisis erupted. And one year after the event, markets have gained on average 10.1% from the market lows. The average percent decline in the S&P/TSX Canadian Stock index following major international geopolitical crises from 1970 to 2017 was -4.9% for the 17 crises listed to the left. Obviously the list of crises can be debated, but even going further back in time, the pattern of sell-off and recovery holds during such crises as the Fall of France 1940; Attack on Pearl Harbor, 1941; Outbreak of Korean War, 1950; Cuban Missile Crisis, 1962; and the Kennedy assassination, 1963.  Canada has had its share of domestic crises as well: Munsinger Affair – Canada’s first national political sex scandal, 1960; Airbus Affair – PM Mulroney was implicated in a kickback scheme, 1995; and the Sponsorship Scandal – a major misuse of funds by the Liberal governments of the 1990s, yet none of these had a major impact internationally.

Of course, the Canadian stock market did not quickly recover in all 17 cases. However, even in those that did not, the market still rallied meaningfully from the lows. As the chart to the right illustrates, major crises can be disconcerting but they do not spell the end for markets or investment strategies. It seems clear that staying invested through volatile episodes can help keep portfolios on track to achieve long term goals.

Perhaps the most valuable lesson from this analysis is that business cycles have far more influence on the market’s reaction than periods of crisis. The crises that took place during healthy economies are more the exception than the rule. The conflicts that have triggered the biggest declines tend to be associated with economic weakness, something that is not on the horizon at the moment.

The bottom line is that history tells us that the stock market tends to be resilient to crises. So even if a military conflict with North Korea does erupt, investors should not compound the crisis by doing something ill-advised with their portfolio. As always, patience is often rewarded.

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Stocks Rally After Rate Hikes

monthly_insight_aug_graphThe Bank of Canada (BOC) has just implemented its first interest rate hike since 2010 which means a lot of investors are grabbing their crystal balls trying to forecast the future course of the stock market. Historically there has been a strong inverse relationship between interest rates and stock prices. Specifically, when interest rates rise stock prices eventually fall. But equity bull markets do not end after the first rate hike. The data confirms that stock markets have continued to appreciate for extended periods after an initial central bank interest rate hike.

When central banks raise rates there is a reduction in the amount of money in circulation which makes borrowing more expensive. The initial result of a higher bank rate is that commercial banks increase their rates for borrowing money. Individuals are affected through mounting credit card and mortgage rates which decreases the amount of money they have to spend. Businesses are affected as they also borrow money to run and expand their operations so they have less to spend which results in less profitability. This of course makes the stock market a less attractive place for investors which will eventually lead to reduced stock prices.

The BOC has kept its benchmark overnight interest rate at 0.5% since it started cutting rates in January 2015 but had been expected to reverse its effort to hold down yields. Investors had become antsy about the timing of the rate hike and the implications for the market even though a BOC rate increase does not have a direct impact on stock prices. No one can accurately predict a market top or correction. There are many reasons for stocks to drop in a rising interest rate environment and many of these factors are interrelated. As the chart below and data to the left shows, markets continued to appreciate after an initial interest rate hike. Looking at nine Canadian stock market recoveries since 1970(with the exception of the recovery from May 1988 to August 1989 which was omitted since the period did not have an interest rate hike) there are two distinct periods, from 1970 to 1989 and from 1990 to 2014, as reflected by two factors; the time interval between the initial rate hike and the next stock market decline, and the amount stocks rose over that interval.

Over the entire 47 year history, stocks continued to gain on average for 16 months after the initial rate hike and gained 26.7%. However these numbers are highly skewed by the 1990 – 2014 period where the average time interval from rate hike to market decline was 26 months and the average gain was 41.4%, compared to 5 months and an 8.2% gain in the 1970 – 1987 period. It is not clear why there is such a pronounced difference but the first interval was subject to high inflation which could be a factor. These distinct periods are emphasized by two different shades of grey in the chart and table.

Interestingly, the Materials sector outperformed all other sectors of the market over the first three months of the last five periods of interest rate hikes, with an average return of 9.7% versus Financials which gained 1.8%, Energy which gained 0.6% and the benchmark which added 2.4%. While a rising interest rate environment may not be detrimental to equity market returns initially, there is no disputing the ultimate outcome. Despite this there are many defensive stocks and measures that can be taken to mitigate a downturn. Though, clearly investors should be hoping that the nearer term history is more likely to repeat itself.

Market Data

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

Commodities Bottom Out

Typically, commodity prices go through longer bear market cycles compared to bull market cycles while the opposite is usually true for stock prices. While Canadian equity markets are slightly off the record highs set in February 2017, commodities, relatively speaking, are dirt cheap. In fact, they are basically the cheapest they have been since the all-time high was reached in June 2008. Commodity prices have fallen 56.9%, based upon the decline in the S&P GSCI Commodity Index over the past 9 years.

This surprisingly repetitive pattern is starting to show that bargains in the commodity sector are present and many of the best Canadian resource stocks are at incredible discounts. In fact, commodity prices appear to be in the process of bottoming after trending lower during the last three years of this recovery following the OPEC decision in June 2014 to ratchet up oil production, which slashed prices. Given the potential of a hike in Canadian interest rates by the Bank of Canada (which appears to be just over the horizon) there may be an important shift in economic pricing power which has historically altered stock market leadership (i.e. commodities dictating the direction of the overall stock market).

The ratio of the S&P GSCI Commodity Index (which is priced in US dollar terms) to the S&P TSX Canadian Stock Index, which has historically pin-pointed peaks and valleys in commodity prices, is now very close to its lowest levels since 1990. The Gulf War of 1990 represents the very peak of this ratio and was the high point for commodity prices relative to the Canadian stock market. The chart to the right uses this date as its starting point to effectively illustrate how low commodity prices have fallen relative to the stock market over the past 27 years.

A significant decline in commodity prices during an economic recovery is very common. During the late 1970s, 1980s and 1990s recoveries, commodity prices suffered severe falls. Those economic recoveries continued well after the bottom in commodity prices was reached and did not end until commodity prices had substantially recovered all their losses. The current malaise looks very similar to the tech bubble of 2000. This can mean three things: stocks are expensive; commodities are truly cheap; or the financial market is correctly factoring in economic growth which no longer relies on commodities (highly unlikely).

transcend-tableLooking down the road, the strong historic relationship between the Canadian dollar and the price of oil has recently de-coupled as the potential for an interest rate hike looms. It is this disconnect that is showing that although oil prices are still very weak, they have been in a bottoming process since early this year. As such, commodity markets could soon embark on a multi-year advance which will likely alter leadership in the economy and in the stock market.

A significant decline in commodity prices usually points to stronger, rather than weaker, future economic growth. Moreover, once commodity prices do finally bottom, they have typically risen throughout the balance of the economic recovery. Keep in mind that successful investing is a marathon, not a sprint.

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This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied.
The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Motivated to Perform

How do you motivate people? Countless studies have indicated the same basic fact: people are not usually motivated by money alone. Of course everyone needs money to sustain their lifestyle and plan for the future, but it is often other factors that compel employees to come in each day and do good work to help their organizations succeed and their clients prosper. Likewise, the sense of satisfaction that advisors receive when they help clients achieve their financials goals trumps the remuneration they receive. Any payment system where rewards are based on the quality of service is a good one.

On the other hand, sometimes a select few receive tremendous rewards regardless of results produced. We see examples of these situations all the time in the business section of the newspaper. In these cases incentives have little chance of producing any lasting positive effects. If clients are left paying and paying without seeing results then the problem is exacerbated. Incentives need to be aligned.

The truth is that many investments provide little added value and once people realize that the Emperor is not wearing any clothes, they will eventually become extinct.

There are myriad of financial products available. Mutual funds are the most convenient form of investing as investors can allocate among different asset classes based upon different qualitative and quantitative parameters, not just performance. To really understand the industry you have to understand how fund companies and their portfolio managers get paid and for what. The concept of “pay-forperformance” among mutual fund managers barely exists; in fact, if there is one thing fund managers are not paid for, as a general rule, it is performance.

A ground breaking new study, “Are Mutual Fund Managers Pa id for Investm e nt Skill?” (February 2017 Ibert, Kaniel, Van Nieuwerburgh and Vestman), used publicly available tax returns of 529 mutual fund managers in Sweden to show the interests of fund companies and their portfolio managers are very much aligned; but the connection between the mutual fund managers and investors is muddled.

In a nutshell, they discovered that there was a very weak relationship between pay and performance, but a very strong relationship between pay and the size of the mutual funds as measured by fee revenue. This makes sense because most mutual funds charge a flat fee on assets under management, so as assets grow the managers remuneration climbs along with it. Compensation was only weakly related to superior manager investment performance.

The study found no evidence that positive performance by a manager in a given year drove an upswing in funds under management in that year or the year after. However, fund managers were rewarded more for running additional funds or for taking over management of different funds with higher fees. The best performing fund managers are paid slightly better than the worst, but successful asset gathering was better rewarded. Consequently, closet indexing is becoming more rampant since performance and salaries are loosely connected. The real problem is while fund managers are protecting their own careers, clients are paying for active management to get indexlike results; minus the fees of course.

It is hard to blame investors who throw up their hands and just buy ETFs. Thankfully there is a true pay-forperformance model offered by Provisus Wealth Management for clients and their advisors on the Transcend platform that is set to revolutionize the investment landscape. Transcend’s novel spin on performance fees is to use them as way to present an attractively low base fee of 0.25% on equity funds to clients (lower than the fees charged by most equity ETFs in Canada). If the fund performs better than the benchmark, a performance fee equal to 20% of the fund’s performance above the benchmark will be charged. Operating on the philosophy that it will earn its fees when client portfolios outperform industry benchmarks, the firm is redefining the nature and delivery of financial services and directly aligning its interests with the clients. Pay-for-Performance™ will be a critical part of the compensation landscape going forward. Not because today’s investors need to be bribed to move their money into these types of vehicles. But, rather it will be because a static, inflexible, unchanging fixed fee strategy with no connection to the results achieved will be at distinct competitive disadvantage in a world as unpredictable and fast changing as ours.

Don’t Sell In May; Settle In

Stock investors often hear about “sell in May and go away” around this time of year. It implies that investors should sell their stocks in early May and buy them back in late October at a lower price. Since 1968 the S&P/TSX Index has risen an average of 8.0% (including dividends) from November to April but added only 1.5% from May to October. Interestingly enough, the “sell in May and go away” phenomenon appears to be universal across international stock markets.

Investors should be cautious about trying to trade around this phenomenon though. First, you would have to get two decisions right: the sell and the buy, which is extremely difficult. Second, the negative months in Canada were not that bad in absolute terms, so buying back the stock often cost you more. And finally, there have been multiple periods with good returns during the summer months (less than half of these months had negative returns).

Besides this phenomenon should be taken with a grain of salt, since most of the weakness was triggered by unpredictable events such as: Brexit last year; the Chinese equity market meltdown in 2015; the OPEC triggered oil price collapse in 2014; the world financial market selloff in 2008; and so on. All these were summer and early fall events.

In fact the really only bad month is September which, as seen in this chart, has posted an average decline of 0.38%. Only two other months, June and October, show any average loss. September is the worst month as the market fell more than 54% of the time, while over the same 49 year period stocks have only declined 42% of the time. October, feared as the crash month, shows an average loss of 0.11%, but it is the most volatile month. At the head of the pack was December with an average gain of 2.42% which was far better than the famed January effect.

Theories for September’s weakness are abundant: there is less money flowing into investments in the latter half of the year as bonuses and tax refunds came in early and frequently go into RRSPs; investors begin to pay more attention to investments after a summer off; and psychologically, when the leaves turn, vacations end and the days get shorter, there is a tendency for impatient investors to get rid of shares they had been thinking about selling. Then again it could be no more complicated than the fact that there are only 12 months in the year and there has to be a best and a worst one. Some month had to be September.

History shows investors could be better off rotating, rather than retreating. Investing in cyclical sectors (Consumer Discretionary, Energy, Health Care, Industrials, IT & Materials) from November to April and then gravitating toward defensive groups (Consumer Staples, Financials, Telecom & Utilities) from May to October could be rewarding. As the data to the left shows, the defensive stocks held up better between May and October, but only Utilities did better.

Reading too much into past trends can be a mistake however. The September market downturn is ultimately just a sort of emotional malaise. It is interesting to note that September’s negative seasonal bias is much less pronounced in years when the market is up year-to-date, as is the case this year.

MARKET DATA

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.