Hoping readers have a pleasant and profitable 2024. Retirees should be cheered by the fact CPP and OAS payments rise 4.7% as of today as explained here.
And of course, as of today, you can add another $7,000 to your Tax-free Savings Accounts or TFSAs.
And there’s other inflation-related good news on tax brackets, the OAS clawback threshold and contribution limits on other tax-sheltered retirement plans, as outlined in my last MoneySense Retired Money column, which you can find here.
The Hub will resume its regular blog scheduling this time tomorrow. In the meantime, time to make that TFSA contribution, even if you can’t actually invest it until markets re-open Tuesday.
Jeremy Siegel recently wrote, with Jeremy Schwartz, the sixth edition of his popular book, Stocks for the long Run: The Definitive Guide to Financial Market Returns and Long-Term Investment Strategies.
I read the fifth edition nearly a decade ago, and because the book is good enough to reread, this sixth edition gave me the perfect opportunity to read it again.
I won’t repeat comments from my first review. I’ll stick to material that either I chose not to comment on earlier, or is new in this edition.
Bonds and Inflation
“Yale economist Irving Fisher” has had a “long-held belief that bonds were overrated as safe investments in a world with uncertain inflation.” Investors learned this lesson the hard way recently as interest rates spiked at a time when long-term bonds paid ultra-low returns. This created double-digit losses in bond investments, despite the perception that bonds are safe. Siegel adds “because of the uncertainty of inflation, bonds can be quite risky for long-term investors.”
The lesson here is that inflation-protected bonds offer lower risk, and long-term bonds are riskier than short-term bonds.
Mean Reversion
While stock returns look like a random walk in the short term, Figure 3.2 in the book shows that the long-term volatility of stocks and bonds refutes the random-walk hypothesis. Over two or three decades, stocks are less risky than the random walk hypothesis would predict, and bonds are riskier.
Professors Robert Stombaugh and Luboš Pástor disagree with this conclusion, claiming that factors such as parameter and model uncertainty make stocks look riskier a priori than they look ex post. Siegel disagrees with “their analysis because they assume there is a certain, after inflation (i.e., real) risk-free financial instrument that investors can buy to guarantee purchasing power for any date in the future.” Siegel says that existing securities based on the Consumer Price Index (CPI) have flaws. CPI is an imperfect measure of inflation, and there is the possibility that future governments will manipulate CPI. Continue Reading…
The 60/40 portfolio has been long considered the prototypical balanced portfolio. This strategy consists of the portfolio investing 60% of its capital to equities and the remaining allocation of 40% in fixed income.
The two segments in the portfolio each have its unique purpose: equities have provided growth and fixed income has historically provided stability and income. When combined, it allowed a portfolio to have stable growth, while generating steady income.
In the last decade, however, the 60/40 portfolio has been challenged on two fronts. The first has been due to the lack of yield available in the bond market, as interest rates have grinded to all-time lows. As a result, many looked to the equity market to generate higher dividends in order to make up for the yield shortfall left by fixed income.
The second shortcoming of the 60/40 portfolio has been the higher correlation between bonds and equities experienced in recent years, which has limited the ability for balanced portfolios to minimize volatility.
However, the resurgence of bond yields in the recent central bank tightening cycle has breathed new life into the 60/40 portfolio. Suddenly, bonds are generating yields not seen since the pre-Great Financial Crisis era. A higher sustained interest rate environment also means a slower growth environment; that means equity risk premiums (the expected excess returns, needed to compensate investors to take on additional risk above risk-free assets) will be lower. This means fixed income may look more attractive than equities on a risk-adjusted basis, which may mean more investors may allocate to bonds in the coming years. Fixed income as a result, will play a crucial role in building portfolios going forward and its resurgence has revived the balanced portfolio.
Investors can efficiently access balanced portfolios through one-ticket asset allocation ETFs. These solutions are based on various risk profiles. In addition to the asset allocation ETFs, we also have various all-in-one ETFs that are built to generate additional distribution yield for income/dividend-oriented investors. Investors in these portfolios only pay the overall management fee and not the fees to the underlying ETFs.
How to use All-in-One ETFs
Standalone investment: All-in-one ETFs are designed by investment professionals and regularly rebalanced. Given these ETFs hold various underlying equity and fixed income ETFs, they are well diversified, and investors can regularly contribute to them over time. Continue Reading…
My latest MoneySense Retired Money column looks at one unexpected upside of inflation; the government’s indexing to inflation of tax brackets, retirement savings limits and OAS thresholds. You can find the full column by clicking on the link here: Inflation a scourge for retirees? Ottawa’s silver lining(s)
TFSA room rises to $7,000
Fans of the popular Tax-free Savings Account (TFSA) will experience this as early as Jan. 1, 2024, when the annual maximum contribution room rises to $7,000, up from $6,500 in 2023. As of January 2024, someone who has never before contributed to a TFSA now has cumulative contribution room of $95,000.
In November Kyle Prevost’s weekly Making Sense of the Markets column included an item titled Make inflation work for you. “We shouldn’t ignore or discount the more advantageous aspects of inflation, such as increased government benefits and more contribution room in our RRSPs and TFSAs.”
Prevost linked to a spreadsheet posted on X (formerly Twitter) by financial advisor Aaron Hector, posted late in October, after the CPI announcement that Ottawa’s official inflation indexing rate for 2024 would be a sizeable 4.7%. While below 2023’s 6.3% indexation rate, it’s well above 2022’s 2.4% and 2021’s 1%.
Also quoted in the MoneySense column is Matthew Ardrey, wealth advisor with Toronto-based TriDelta Financial. “One of the main benefits is paying less taxes.” Income tax brackets increase with inflation each year. For example, in 2021 the lowest tax bracket in Ontario ended at $45,142 of income. “Starting in 2024, this lowest tax bracket now ends at $51,446. This is a 14% increase over just a few years.” Continue Reading…
There seems to be some confusion around what to expect for monetary policy in 2024. There’s a strong consensus that cuts are coming, but what is far less certain is how many – and why they are implemented.
Let’s assume that all cuts are of the traditional 25 basis point variety. Since the bank rate is adjusted every six weeks, there will be eight or nine opportunities to adjust it in 2024 in both Canada and the United States.
There are as many as three narratives making the rounds about what might be in store. Each narrative has a combination of rate cuts for monetary policy and corresponding outcomes for the broader economy. I attended a luncheon last week hosted by Franklin Templeton, where senior representatives outlined three possible scenarios with three different narratives accompanying them. A similar perspective was offered earlier this week by the Vanguard Group.
The three narratives are as follows:
#1 We have a soft landing.
The soft landing involves the economy remaining relatively robust, employment remaining strong, delinquency is modest, and rates are normalizing at a level close to but somewhat lower than where they are right now. Most people would suggest that scenario involves no more than two cuts in 2024.
#2 We have a routine recession.
To be more precise, the second narrative involves a garden-variety recession that lasts perhaps a couple of quarters that involves only modest reductions in economic activity over that time frame. Nonetheless, this scenario includes five or six rate cuts to stimulate the economy to the point where things can become stable going forward.
#3 We have a severe recession.
The final narrative involves massive cuts that are made out of desperation to keep the economy from plunging into an abyss. This scenario is not only the most drastic, but also seems to be the least likely. Nonetheless, if things get really ugly, seven, eight or nine rate cuts might be needed to stanch the bleeding. One or more of those cuts might even be for 50 basis points or more.
While I accept the logic associated with all three scenarios, I cannot help but notice that much of the financial services industry is conflating those scenarios in a way that strikes me as being intellectually inconsistent. The financial services industry has long been overly optimistic in the way it portrays outlooks and forecasts. It routinely engages in something I call bullshift, which is the tendency to shift your attention to make you feel bullish about the future.
There can be little doubt that stimulative cuts are positive developments for capital markets. What the industry seems disinclined to acknowledge is that cuts are often made out of desperation. People need to look no further then what happened throughout the entire industrialized world in the first quarter of 2020. Central banks in all major economies cut rates to essentially zero by the end of March of 2020 in the aftermath of the COVID pandemic. At the time it was seen as being both necessary and reasonable, given the severity and breadth of the challenge.
Reining in Inflation
As we all know, inflation became the primary public policy challenge by the beginning of 2022. Central banks needed to take what looked like draconian measures to rein in inflation, which had risen to generational highs and needed to be brought under control lest a sustained period of inflation like what was experienced in the 1970s were to recur. By the end of 2023, inflation is still higher than the high end of the range that is deemed to be acceptable for most central banks.
There is still work to be done, yet many pundits seem eager to take a victory lap, as if a reduction in inflation is somehow akin to bringing inflation under control. Much has been done over the past 20 months, but more work is needed. The admonition that rates will have to stay higher for longer is a very real constraint on economic activity and long-term growth prospects. We head into the new year on the horns of a dilemma. Bond market watchers are now suggesting that rate cuts will come no later than Q2 2024, whereas central bankers are insisting that those cuts will be modest and will only begin in Q3 of 2024 at any rate. They cannot both be right.
It gets worse. Most commentators have taken to suggesting that we will have both a soft landing and five or six rate cuts in the New Year. That strikes me as being fantastic – not to mention intellectually inconsistent. If we have a soft landing, it will likely entail the economy being remarkably resilient as it has been throughout 2023. There is absolutely no reason to have a parade of rate cuts in such an environment.
Stated differently, the financial services industry needs to pick a lane. If it believes we will have a soft landing in 2024, it should also be anticipating a very small number of very modest cuts in the second half of the year. Conversely, if it believes a recession is on the horizon, it should be forecasting multiple cuts only after it is clear a recession is underway. These would likely be needed to stimulate the economy in an environment where inflation will likely be modest as a direct result of economic weakness.
To hear the industry tell it, the economy will remain strong, but we’ll get multiple rate cuts anyway. You can’t have it both ways. I call Bullshift.
John De Goey is a Portfolio Manager with Designed Securities Ltd. (DSL). DSL does not guarantee the accuracy or completeness of the information contained herein, nor does DSL assume any liability for any loss that may result from the reliance by any person upon any such information or opinions.
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