Building Wealth

For the first 30 or so years of working, saving and investing, you’ll be first in the mode of getting out of the hole (paying down debt), and then building your net worth (that’s wealth accumulation.). But don’t forget, wealth accumulation isn’t the ultimate goal. Decumulation is! (a separate category here at the Hub).

Vanguard 2022 Outlook projects lower 10-year returns for 60/40 portfolios

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Vanguard Global Economist Joe Davis: Vanguard.com

Returns on the traditional 60% stocks/40% bonds balanced portfolio are expected to be roughly half of what investors realized over the last decade, according to the Vanguard Group’s 2022 Economic and Market Outlook, which is being released today (Monday, Dec. 13).

Global stocks are expected to outperform U.S. stocks bonds significantly over the next ten years while US and global bonds will be in the range of 1.3% to 2.4% annualized ,

Here are Vanguard’s 10-year annualized return projections:

  • Global equities: 5.2% – 7.2%
  • U.S. equities: 2.3% – 4.3%
  • Global bonds: 1.3% – 2.3%
  • U.S. bonds: 1.4%– 2.4%

The report issued by Valley Forge, PA-based Vanguard is titled Striking a better balance: ironic given its projections for performance of balanced portfolios.

“The road ahead for investors promises to be a challenging one,” said Joe Davis, Vanguard’s global chief economist and co-author of the report. “Global markets will test investors’ discipline as they navigate the risks of unwinding monetary policy support, slower growth, and rising real rates.”

In an advance webinar aired last Thursday, Davis said: “Wage inflation will dictates the pace of rate hikes in 2022.” He said the US Federal reserve is likely to raise rates to at least 2.5% this cycle in order to maintain price stability. As for stocks, we are in an era of “high valuations and low rates,” which creates a “fragile backdrop for markets ….[which] will chip away at future returns.” Better valuations are in developed markets outside the US, small-caps and Value. More stretched valuations are in Emerging Markets, the US, Growth and Large-cap, Davis said.

US equities have not been this overvalued since the dot-com bubble, Davis said, adding that a secular decline in rates has been three decades in the marking.

For Bond markets, best values is in TIPS and short-term treasuries. Most stretched are long-term treasuries, mortgage backed securities and international credit. In between are intermediate treasures and high-yield bonds.

Policy accommodations

In Monday’s press release, Vanguard said challenges are likely to be most evident with the unwind of monetary policy, a critical factor in 2022 as central bankers assess a rapidly evolving economic landscape. Inflationary pressures have sharpened the focus on monetary policymakers as these pressures may drive changes in central bank communications and actions. Vanguard projects that central banks will largely try to avoid sharp and unexpected shifts in the timing of policy changes, particularly of policy rate increases, but that conditions will force them to act in 2022 and quite possibly by more than markets are anticipating.

Economic outlook

With the global economic recovery expected to continue in 2022, Vanguard economists foresee the low-hanging fruit of rebounding activity to give way to slower growth, regardless of supply- chain dynamics. In both the U.S. and the Euro area, Vanguard expects economic growth to normalize to 4%. In the U.K., Vanguard expects growth of about 5.5%, and in China, expectations are that growth will fall to about 5%.

Inflation

Vanguard expects labor markets will continue to tighten, with several major economies quickly approaching full employment. Vanguard estimates the cyclical effects of supply constraints will persist well into early 2022 and then normalize as the structural deflationary forces of technology and unemployment take hold again. These factors contribute to expectations that inflation will trend higher for some time before slowing in the second half of 2022.

Don’t fear a “lost decade” for US stocks but a lower-return one

Vanguard’s long-term outlook for global asset returns for 2022 and beyond remains guarded, particularly for equities where valuations are high and low real interest rates continue to act as a strong gravitational pull on future returns. Investors should not fear a “lost decade” for U.S. stocks, but rather, a lower-return one, it says. For fixed income, low interest rates mean investors should expect lower returns. However, because rates have risen modestly since 2020, Vanguard’s outlook is commensurately higher.

International equities will outperform US in coming decades

Given the differences in valuations between the U.S. and non-U.S. developed markets, Vanguard projects international equities will outperform U.S. equities in the coming decades and value stocks will outperform growth in the U.S.

It says investors are best served in a broadly-diversified portfolio, including international equities.

“While the economic recovery is expected to continue through 2022, easy gains in growth from rebounding activity are behind us, and policy will replace health as the leading consideration for investors,” Davis said, “Despite a potential low-return environment, we are still expecting a positive premium for bearing equity risk. Investors should continue to focus on what they can control, and if they have the patience to weather potential periods of underperformance, we believe accepting some active risk offers the opportunity to offset low future returns.”

Inflation: Transitory with a Twist

At the advance webinar, Vanguard America’s Senior Economist Roger Aliaga-Diaz projects inflation to be “Transitory with a Twist.” He foresees only a modest decline in inflation in 2022. Central banks, including the Fed, will have to normalize sooner than later. “We may see next week [i.e. this week: Dec. 13 to Dec 17] accelerating tapering but not likely to hike rates.” He expects “one or two” hikes in the second half of 2022. Inflation will be around 5% early in 2022 but this should be in the low 3s by the end of 2022. Continue Reading…

Marty Zweig and the Inflation Boogeyman

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Outcome Metric Asset Management

By Noah Solomon

Special to the Financial Independence Hub

The continued rise in stocks, real estate, and almost every other asset class on the planet can be attributed to three things: liquidity, liquidity, liquidity. According to legendary investor Marty Zweig:

“In the stock market, as with horse racing, money makes the mare go. Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major direction.”

In today’s markets, you don’t have to look very hard to find strong evidence of Zweig’s theory, which explains why stock markets were making fresh highs during successive outbreaks of Covid-19 and spiking unemployment. It also explains why approximately two thirds of stock returns over the past decade are attributable to multiple expansion rather than earnings growth. It’s hard to envision things turning south when real interest rates remain highly negative, and money is so freely available.

Something is happening here but it ain’t exactly clear what

For the first time in decades, the inflation genie is threatening to escape from its bottle. The abundant global liquidity that has been the primary driver of markets is threatened by the potential need to combat inflationary pressures, which have been rearing their head after a several-decade slumber.

Despite some disconcerting inflation readings over the past several months, it is possible that this phenomenon turns out to be a Covid-induced disruption in supply chains that will prove temporary. If this scenario prevails, then rates will remain fairly low, as will the probability that stocks will crater. Conversely, it is entirely possible that the recent uptick in inflation marks the beginning of a longer-lasting trend, in which case rates could rise materially, thereby increasing the chances of a severe decline in risk assets.

There are certainly some signs that suggest that at least a portion of the recent surge in inflation may have staying power. Bridgewater, the world’s largest hedge fund, recently wrote a research report called “It’s Mostly a Demand Shock, Not a Supply Shock, and It’s Everywhere.” The authors contend global production is back to normal levels following last year’s Covid-related disruptions. On the other hand, they claim global demand has exploded. Bankim Chadha, Chief U.S. Equity & Global Strategist at Deutsche Bank Securities, summarized his recent discussions with company executives:

“Most companies noted that supply chain issues kept them from fulfilling the underlying demand, which was much stronger than they had expected. They didn’t plan their supply chains to have a sustained surge in volume for 18 months. Labor availability and cost pressures show no signs of abating any time soon, a development that is new and not welcome. Companies are however very confident in their ability to raise prices.”

Although rates have risen modestly over the past few months, they have yet to rise materially. Both central banks and market participants remain skeptical that inflation will become a serious concern, which has prevented rates from spiking and provided stocks with sufficient “cover” to remain buoyant. On a rolling 10-year basis, equities are beating bonds in the U.S. by the largest margin since 1964. As long as the money is coming the mare will keep running. Continue Reading…

Stocks expected to keep outperforming bonds next 10 years: Franklin Templeton

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Investors should expect North American and international equities to continue to outperform bonds over the next ten years, according to senior portfolio managers for Franklin Templeton Investment Solutions. As the accompanying chart illustrates, expected returns for equities the next 10 years range from a 4.6% for US stocks to a high of 6.5% for Emerging Markets stocks. Canadian stocks are expected to do almost as well, at 6%, and EAFE equities will also outperform US stocks, with retiring expectations of 4.9%.

Returns for bonds are more modest: Franklin Templeton projects 1.8% return for Government of Canada Bonds and 2.4% for Global Investment Grade Bonds. The chart shows the volatility, topped by Emerging Markets at 16.9% and Canadian equities at 15%.

The forecasts were provided Tuesday at a virtual webinar at the Franklin Templeton 2022 Global Investment Outlook.

3% Global Growth should keep pace with Inflation

Over the next 7 to 10 years, the firm expects 3% annual global growth, roughly keeping up with inflation, said CFA William Yun, executive vice president for Franklin Templeton Investment Solutions. Over that time, equities should outperform fixed income and non-US equities should outperform US equities, he said.

Looking to Canada, Canadian stocks should have slightly higher expected returns, albeit with greater volatility, said Senior Vice President Ian Riach. The outperformance will be because of lower  “more reasonable” valuations for Canadian stocks, he added. “We are quite positive on the Energy and Financial Services sectors.”
Continue Reading…

Opinions are like …

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

The old joke is that opinions are like noses – everybody has one. The other thing everyone says about opinions is that we’re all entitled to them.  If we’re speculating about how things that have never happened in the past might play out in the future, there’s also a bit of fun involved.  Friends can rib each other about which among them is the better prognosticator.  Adam Grant’s latest book, Think Again, encourages readers to rethink what is already known, which might just mean ‘what they believe.’

Grant says we should beware the “I’m-not-biased” bias: recognizing the flaws in other people’s thinking, but assuming you’re immune. He says the less biased you think you are, the less likely you are to catch yourself.  To paraphrase: “If knowledge is power, then knowing what you don’t know is wisdom.” It might also be handy to keep a mirror handy and question your own beliefs more often.

The next Bear market

I’ve recently completed an exchange with a friend about one of the most common financial advisor narratives and how those might play out if there was to be a prolonged and severe bear market.  To begin, although I personally think such an outcome is probable in the near term (which created a sense of urgency for the thought exercise), the important thing is to game out what we think and why we think it before the event happens.  Other than reading my thoughts into the record for posterity, the timing is inconsequential.  We may not have a large enough drawdown in the next 20 years, so we may not be able to test which hunches are closer to the mark during my career.

This exercise is especially interesting when we think of the lack of reliable counterfactuals.  Basically, advisors say they do a good job of keeping people invested in bear markets and naturally want to take credit for doing so.  The questions abound:

  • What would clients have done if they hadn’t worked with the advisor?
  • If the advice was consistent to hold and (say) 95% of clients held, is there culpability for the 5% who sold?
  • What if (say) 85% of the clients would have held if left to their own devices, anyway?
  • Combining the two hypothetical points above, the changed behaviour is felt for only 15% of clients, 10% who held when they would have otherwise sold; 5% who sold despite being advised to hold. Would that justify a narrative of ‘advisors adding value through behavioural coaching’?
  • If the drop is bigger and lasts longer, clients might behave differently, so what does this mean for advisor accountability? Taking or foregoing credit or blame regarding client conduct might change if one offered the same advice but got different outcomes as the situation dragged on.
  • Here’s a fun one: If an advisor gets credit for encouraging a client to hold through a 30% drop and then the market drops a further 30% and the advisor still encourages the client to hold, but the client sells, would it have been better for the advisor to have allowed the sell to have taken place sooner? If yes, is that advisor ‘worse’ for not allowing the client to sell sooner?

My concern in this exercise is a sort of first-derivative optimism bias.  I have a view that advisors are optimistic in general.  Continue Reading…

Q&A on Retirement Income with Finance prof and author Dr. Moshe Milevsky (part 1)

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The Retirement Quant: Dr. Moshe Milevsky

By Gordon Wiebe, The Capital Partner

Special to the Financial Independence Hub

Professor Moshe Milevsky wants us to re-think the metrics we use for retirement calculations. Instead of basing retirement income amounts on our age i.e.,  the number of orbits around the sun, Dr. Milevsky suggests we consider using our biological age.  What is your biological age?

Advances in science suggest our biological age is based on our actual physical shape or our personal physiology. Rock stars like Sting, Phil Collins and Ace Frehley were born in 1951. Their legal age is 70, but their actual condition may be substantially different from Mark Hamill (Luke Skywalker) or Dr. Jill Biden (U.S. First Lady) who also turned 70 in 2021.

The cumulative effects of genes, lifetime dietary habits, exercise, social conditions and stress levels for instance, could lengthen or decrease life expectancy and therefore provide a better indication of future retirement income needs.  Recent scientific advances are helping make this information more available to seniors, advisors, researchers and policy advisors.

Background

TCP: From where does your passion for mathematics originate?

 M.M.  I guess it comes from my life as an undergrad. I was taking various courses including one on English literature and essay writing.  I handed in an essay and received a bad grade. The professor said, “You really can’t write to save your life, you might want go into math.”

I did and I got an undergraduate degree in mathematical physics. Then, I went to graduate school and studied math and statistics, but I was really interested in gravitational physics. That was my thing, like how a golf ball moves after a drive, the arc that it makes, etc.

My thesis supervisor said, “Moshe, you’ll never find a job with that kind of specialty. You might want to go to business school.” So, I moved into business and finance and it’s where I’ve been for the past 25 years.

TCP: You also have a passion for financial history. Is there a period in history that strikes you as particularly innovative or ingenious?

M.M. There is. I’m interested in the 17th century, specifically 17th century Europe and the evolution of financial products, instruments, and economics.

Anything from the crowning of James II in 1685 until the ascension of George II in the mid-18th century.

TCP: I’m not that familiar with that era. Does it line up with the advances in math, probability, and statistics?

 M.M.  It does. There was this interesting alignment of people interested in mathematics and statistics and they developed the basics of probability theory, economics, and finance. It was an alignment of interests that led to many of the instruments we use today.

You know, nobody would say that 1690 was the origin of the i-Pad or the i-Phone or the laptop. But, many of the financial instruments we use, whether it’s pensions, annuities, stocks, bonds, mutual funds, they all kind of originated in the late 17th century. You can almost trace back a direct line. I’m fascinated by that. It interests me and I’ve spent a lot of time looking at history from that period.

TCP: Among other things, the pandemic has shown how segments of the population struggle with basic math principles. Are you surprised by the lack of financial literacy?

M.M. It is a problem the pandemic has brought home. I think it’s a problem that finance has brought home. A lot of people are incapable of mathematical reasoning and that’s not healthy in today’s very quantitative, data driven environment.

Thousands of years ago, you had to make sure to out run the dinosaurs and get home in time for dinner. What did your brain have to do? Nobody was asking you to solve calculus problems.

Now, we have to evolve to deal with these very quantitative issues and make decisions and I think the pandemic has brought that home very starkly. There’s some completely irrational decision making because of a misinterpretation of probabilities and the odds. Just look at Toronto.

There are 300 infections, and everybody is walking around like it’s Ebola and every other person has it. In some sense, you have to step back and say, “Wait a minute. What are the probabilities? Do you understand all of the things you’re sacrificing?” It’s all probabilities. Those things all come down to mathematical reasoning.

I do think the educational system should focus more on some of these statistical, data driven issues. I think financial literacy is an absolute must.

My bread and butter is teaching undergraduate students at the university.  Undergraduate Personal Finance. That’s a course I’ve been teaching now for almost twenty years.

It’s basic personal finance. You know. What’s a tax return? What’s an insurance policy? How does a mortgage work? What’s an RRSP?

Why do I have to teach this to 22-year-olds? Why don’t they know this from high school? Why isn’t this covered before I see them? And, why are only the ones that I teach in Business School getting this? What about the rest of the students who are studying something else? Why is this not considered a national emergency? People are wandering into the world without the requisite tools.

TCP: Carrying credit card balances in perpetuity, putting 5% down on million-dollar homes …

M.M. Let alone, just verify that what they’re paying is correct, right? Nobody’s able to do that because it’s all coming from calculations that are being done by algorithms that nobody wants to or even knows how to verify. So, there are a number of things that worry me.

The Mathematics of Retirement Income

TCP: I haven’t had a chance to watch the movie “The Baby Boomer Dilemma,” yet. I’ve just seen the trailer.

M.M. Yes, that’s an interesting one. I’m not sure how I got dragged into that, but I now have an IMDb movie rating. I am now officially a Hollywood actor (chuckling). Go figure.

TCP: On the trailer you say, “what’s been happening over the last few years is our accounts have been growing. It looks like we are getting wealthier. But, the income that we can get from that sum of money is shrinking.” What did you mean by that? Continue Reading…