Tag Archives: interest rates

I fought the Fed

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https://advisor.wellington-altus.ca/standupadvisors/

By John De Goey, CFP, CIM

Special to the Financial Independence Hub

The fed won.  I admit defeat. My point is that what just transpired was merely the most recent bout.  Circumstances were extenuating. I demand a rematch.  As soon as things begin to normalize, I absolutely believe I will win.  To provide a bit of context for how I feel now, here’s a groovy little two-minute ditty from the Bobby Fuller Four to help channel the vibe…

https://www.youtube.com/watch?v=OgtQj8O92eI

One of the oldest adages in finance is “Don’t fight the fed.”  In Canada, that translates into “Don’t fight the Bank of Canada.” That, in a nutshell is what I did.  I brought a knife to a gun fight and I lost.  Here’s why I lost that figh t… and why I absolutely expect to win the next one:

I took the position that markets (and especially the U.S. market) were expensive in early 2020.  Sure enough, markets tumbled a month or two later – not because of fundamentals or valuations, but because of a global pandemic that no one saw coming.  For five weeks starting in February, it looked very much like I had been vindicated.  I suppose I could have taken credit for being prescient, but in fact, I was merely at the right place and the right time.  By mid-March 2020, I was feeling pretty good about my call.

Then it happened.  Central banks mercifully came riding to the rescue.  It was the right thing to do when viewed through many lenses, including public health, economic stability, and small business viability.  They did so with such fury and determination that no one had ever seen anything like it before.  Interest rates were slashed to effectively zero.  Governments of all political stripes around the western world took advantage of their newfound monetary cover and started sending cheques to what seemed like anyone who could fog a mirror.  Before the end of March, markets hit a bottom and began an upward march.  A massive bull market was unleashed.

I don’t honestly think anyone could have foreseen what ensued.  There was certainly no precedent for markets dropping violently and then recovering equally quickly.  To have expected that outcome would be to have expected something that had no antecedent in all of history anywhere on earth.

For nearly 23 months now, interest rates have remained at effectively zero.  Pretty much everyone expects that to change in March.  If lowering rates is like giving Popeye can of spinach, raising them is like giving Superman a bag full of kryptonite.  Forgive many the pop culture references in this post, but I find it helps to make things accessible and vivid.  Basically, the artificial party that has gone on for nearly two years and has given almost everyone a false sense of confidence is going to end.  Soon.  Badly.  I’ll eat my hat if I’m wrong. Continue Reading…

Manage Fixed Income Uncertainty with Multiple Return Drivers

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By Mark Lindbloom and Travis Carr, Western Asset Management, a Franklin Templeton Specialist Investment Manager

(Sponsor Content)

The new investing year started with renewed uncertainty around the Omicron wave of the COVID-19 pandemic, inflation, central bank policy and the global recovery.

What are Canadians with fixed income investments to do? Our answer is to use diversified strategies in this market to find yield across a broad range of sources.

This is certainly a challenging time for an investment manager to arrive in Canada, but we at Western Asset Management welcome the challenge to help Canadians build fixed income portfolios with substantial yield advantages within their risk tolerance.

Western Asset is a Specialist Investment Manager of Franklin Templeton, with US$492.4 billion in assets under management as of December 31, 2021. Founded in 1971, we specialize in active fixed income investing — it’s our sole focus. All our attention and resources are concentrated on the bond market and active strategies for investors. We are a globally integrated firm with offices and senior investment professionals in North America, South America, Europe, Asia and Australia, which gives us direct knowledge of and expertise in markets around the world.

Investment Approach

Financial markets tend to move from euphoria to depression — sometimes quickly — and this affects the pricing of individual securities, sectors of the fixed income market, and interest rates. As a fundamental value investor, we strive to find opportunities in this mispricing by doing research and analysis of a security or sector. We want to buy when prices are below our assessment of fair value and when prices are likely to increase over time.

As we are an active manager, we work together globally to employ a top-down view of markets, economies and central banks and develop our macro and credit investment outlook. This will drive decisions on duration (a measure of the sensitivity of the price of a bond or other debt instrument to interest rate changes), yield curve, country, currency, sector, and subsector positioning. We also use our deep bottom-up research and analysis to make individual security selections, supported by rigorous risk management.

Four core beliefs describe our investment philosophy and drive how we make investment decisions:

  • Markets often misprice securities: Prices can deviate from fundamental fair value, but over time, they typically adjust to reflect inflation, credit quality fundamentals and liquidity conditions. Consistently investing in undervalued securities may deliver attractive investment returns.
  • We strive to identify mispricing: We try to identify and capitalize on markets and securities that are priced below their fundamental fair value. We do this through deep analysis to compare prices to the fundamental fair values estimated by our macroeconomic and credit research teams around the world.
  • Our portfolios emphasize our highest convictions: The greater the difference between our view of fair value and a market price, the bigger the potential value opportunity. The greater the degree of confidence in our view of fundamentals, the greater the emphasis of the strategies in our portfolios.
  • We seek diversified sources of investment returns: We aim to meet or exceed the performance objectives of our investors, within their risk tolerance. We seek to diversify investments and add value across interest rate duration, yield curve, sector allocation, security selection, countries and currencies. We deploy multiple diversified strategies that benefit in different environments so no one strategy dominates performance, which can dampen volatility. Continue Reading…

Inflation and Central Banks: Like having a Friend climb a Ladder

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By John De Goey, CFP, CIM

Special to the Financial Independence Hub

Various people have asked me to weigh in on our inflation situation with a particular focus on what central bankers should do about rates going forward.

The ‘what to do’ elements include queries about when to hike, how much, how often and to what end.

I like to use metaphors and the one that fits here is one of having someone you care about climbing a ladder.  In this scenario, the ‘friend’ is a mashup of the economy and markets (specifically, both the stock market and the real estate market), the ascension up the ladder is the seeming inexorable climb of prices and valuations, and the decision to tip the ladder over is the decision to raise rates.  Here’s the problem …

Let’s say someone you care about is climbing a ladder and you have been given the task of holding the ladder steady, stable, and firmly rooted on the ground while that person climbs.  In this case, “price stability” equals “ladder stability.” It’s a tall ladder and conditions are becoming increasingly perilous.  As your friend ascends, it eventually becomes clear to you that communication has been lost: your friend is now so far up that they cannot hear your pleas to reverse course.  It’s dangerous.  You know it, but your friend keeps climbing higher.

Central bankers caught in a dilemma

In this scenario, you know that if you were to tip the ladder over, your friend would be seriously hurt.  Conversely, you could do the ‘responsible thing’ and not tip the ladder over, but if you did that and your friend ended up falling from an even higher position, the consequences could be deadly.    Central bankers are caught in the horns of a dilemma. Continue Reading…

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…

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…