Investment Fees Are Coming Into Focus


Investment fees are being scrutinized more often these days than in the past for a number of reasons. This can be boiled down to two main areas: Market performance and value relative to fees paid, and fee disclosure.

When the markets perform well, people do not care as much about costs because the high returns on their investments cover the expense. The fees can also be justified more easily as the returns would not be enjoyed without having this advisor or institution generating them. When the markets go south or stay flat, the psychology switches to the idea that the fees are not justified. Even though wealth is being lost, fees are still being paid! Markets do fluctuate so this phenomenon does not happen within months or a few years of poor performance. It may happen after the 3 year or 5 year mark as the “what have you done for me lately?” mantra sets in. The 5 year time period is the typical benchmark for when performance is scrutinized for “long term” results.

Fees are also being scrutinized because they are discussed more frequently than in the past and people are more aware of them. Many people do not realize how much they are paying for their investments because fees are subtracted from the returns for both advice and products they are investing in. The evolution of the Client Relationship Model (CRM) Phase 2 in January 2017 will make the fees more visible and more understood. Expressing fees as a percentage seems bland to most people because the percentages are small. Apply a small percentage to a large dollar balance, and now you have a large number of dollars being paid out each year.

The other side of the equation becomes: What am I getting for these dollars being spent? Another dimension to the fees is that there are many types of fees for different purposes. The challenge will be to get a handle on the total cost that you are paying and then ask the question of value. There are fees to the advisor (sales loads or commissions), the institution holding the accounts (account fees), the fees embedded in the product (management expense ratios or MERs) and fees for referrals and people helping the process (trailer and referral fees). If you cover these 4 areas and sum them up, you will have a good idea what you are paying.

Analyzing what you are getting boils down to answering some questions: How long does it take to manage my money? What skill is required in my case and in terms of my portfolio? In my case is key because if you have a simple portfolio that is relatively small in size, paying high fees will not be worthwhile. What other options are there in managing my money? Doing it myself? Doing part of it myself? Having a robo-advisor do it? Having my employer do it by contributing to my pension plan? You may also want to consider switching who gives you the advice – many institutions can do it – banks, insurance companies, brokers, discount brokers, fund companies, professionals like accountants, money coaches and flat-fee or fee-only advisors. Paying down debt may also be an option which is simple, cheap and effective for return if you have a lot of debt with a high interest rate. You also want to ask whether you are receiving good service and are having your financial needs met. Do you place a premium on expert advice and reassurance about your portfolio? Do you want the backing of a large institution handling your money? All of these considerations make up the value component of the fees.

Doing this analysis over time will reveal things like: Is your portfolio being churned? (Are your investments being traded frequently for no reason even though the original investments were sold to you as “buy and hold”?) Match up the decisions made about your portfolio with the fees being generated and if there is a correlation, it is time to ask why these securities were recommended.

The bottom line is that investment fees should be examined as a whole each year and over time. This amount should be weighed against what you are receiving in terms of return, service, how you are treated and how you feel about the experience.     

The Markets November 2016 A.T. (After Trump)


The behaviour of the markets before Donald Trump was elected as President of the United States of America is vastly different compared to after the election result.

Before the election, the following expectations were in place:

Bonds were in a low to zero interest rate environment prior to Donald Trump being elected. The belief was that even though rate hikes were discussed for 2 years by the Federal Reserve, not much has happened and not much will happen. Ultimate chaos was expected to happen in the equity markets due to the uncertainty that a Trump Presidency would bring compared to a relatively stable, predictable Clinton Presidency. Gold and silver were shoe-ins to hit multi-year highs of $1400 per ounce (USD) and $25 per ounce (USD) respectively. The US Dollar was expected to tank as world leaders would not endorse Trump and money would flee the US to places like Europe and gold.

After Donald Trump was elected we find:

Bond yields are accelerating because the talk is that Trump will spend a lot of money on infrastructure and allow inflation to accelerate. Markets actually rose the next day after Trump was elected not just in the US, but around the world as well. Sectors that were down like energy, pharmaceuticals, infrastructure and financials were up strongly after the Trump election victory. The reason for this is that Trump is believed to reduce regulation and create a lot of future business. With respect to gold and silver, after the initial highs, both metals are down significantly. The US dollar is stable and is trading slightly stronger.

What is happening here? Pollsters and the media had not predicted a Trump victory, let alone a landslide in the three areas of government (President, Senate and House). What happened to all of the fears that were present before the election? Does the market know after one day or one week what Trump is going to deliver? Do they see the landslide victory as positive because all of the houses will support him? The higher inflation expectations reflected in the bond market would lead to a large decline in bond prices which may be ugly. Why aren’t the equity markets factoring this in? Inflation is traditionally good for metals but they are down significantly. Inflation is presumed to happen with higher interest rates and more demand for goods. What is missing here? If the markets think inflation and higher interest rates are good – why wasn’t any of this priced in prior to the election? The expectation would have been that markets would go down significantly prior to an anticipated Clinton win, followed by a sharp rebound after the Trump win. The market focus has practically reversed on many key assumptions like interest rates and inflation. As an example, higher inflation is not good for business unless companies can pass on higher costs to consumers. Is that really easily achieved? If debt costs are going to rise, shouldn’t profitability be much lower for industries with higher debt? It will be very interesting to see how the markets react when President Trump is in office.

Can a Bank Run Still Happen Today?


A bank run is when an institution runs out of money to give depositors who are withdrawing money from the bank. This typically happens when a large number of people withdraw money at the same time. Is this still a problem today?

Bank runs would get started when depositors needed to withdraw money due to a catalyst such as a market crash. This would force people to sell assets or pay down loans suddenly creating a surge in the need for cash. This catalyst usually comes from outside the bank. The classic bank run mentality led to the fear that there was not enough money on deposit at the bank, causing an acceleration of withdrawals and leading to bank insolvency.

At the present time, there are new factors that affect how a bank run can happen. The first one is when the bank model of doing business is not profitable. A bank would typically collect deposits from savers and give them interest, and lend this money to borrowers and charge a higher rate of interest. What if a bank charges you money to make a deposit instead of giving you interest? This reality can come from  “negative interest rates”, and it is happening in Europe and Japan right now. It may happen in the U.S. and Canada at some point. The banks are being charged interest on money they park at the central bank for the purposes of keeping their “reserve ratio” intact. This reserve is money used as a backstop to fund large amounts of withdrawals that may occur at any given moment. The banks are charging depositors to keep money in accounts to try to recover these charges from the central bank. Mortgage rates would still be higher than the rates on deposit, but the difference between them would shrink. Depositors may in turn withdraw money from their accounts and keep it in cash because it is cheaper than keeping it in a bank. This effect would multiply resulting in a cash shortage at the bank.

The second challenge is the electronic form of money. Bank runs in the past involved physical currency and having to go physically to a bank to make a transaction. What if bank machines stopped working or accounts disappeared? This can happen as a result of hacking, computer viruses or a defect in the computer programming of the bank. If an event like this was made public, the ensuing loss of trust and possible panic could prompt a large number of withdrawals.

The third possibility is a bank “bail-in”. This is when banks lose so much money that they take money from depositors’ accounts to make them whole. Should this possibility arise, the classic bank run can happen is people may want to turn their account balances into physical cash to avoid it being confiscated. Many countries have passed laws allowing these types of bail-ins to happen. What about government backed deposit insurance? This did not exist in the past when there were many bank runs but it exists now. The issue with the insurance is: will it work? The insurance is akin to a type of government bail out of the banks by the taxpayer, similar to what happened in 2008 in the U.S. What if the claims on the insurance fund are very large? The insurer will run out of money quickly and the insurance may not pay out. In the case of the government, the national debt would rise and the taxpayer would be paying additional taxes in future years. This is similar to a large number of claims made against an insurance company and the company would have to raise premiums to recover the payout amounts.

A bank run can happen at any time since people may decide to withdraw money in large numbers for a number of reasons. The difference today is that the banking system has changed and there are other factors that have been added recently that complicate any predictions.

 

Is Inflation Set to Return to The Market?


The common thinking of the day suggests that the world is in a state of deflation. This is when prices for goods are going down in price. Inflation is when the prices for goods are increasing in price. The published numbers for the CPI in the developed world has been showing low numbers of inflation and occasionally deflation. There is disagreement on what the numbers mean and whether they are indicative of the state of the economy. Ignoring this possibility, is inflation set to return to the market as indicated by the CPI?

Where does inflation come from? There are two main theories. The first one comes from producing goods and the associated costs. The production of anything requires 3 main costs – labour, materials and overhead. There are some hidden costs like taxation and debt as well which are embedded in the cost of production. Looking at the trends, the cost of labour has been declining as well as the price of materials. The stagnation of wages and benefits as well as lower commodity prices are proof of these trends. The increase in automation is also adding to reduced costs for all of the inputs. The second theory involves the production of the measuring unit – money. This is what is called monetary policy, and the basis of this thinking is that if you add more currency units to an economy, the prices of goods will go up even though the actual labour, material and overhead costs have not changed. This is like issuing more shares in a corporation and diluting the value per share, even though the value of the company remains the same.

Using both of these theories, labour, commodity prices and debt servicing costs are at multi-year lows. Automation may continue to reduce the need for both of these things but there may be social consequences. Overhead costs are rising slowly – utilities, rent and taxation. On the monetary side, zero interest rates and large injections of currency units suggest that inflation will surface sooner or later. The central banks also want to have some degree of inflation because they believe it will create more consumption.

What is the future of these trends? The labour costs are not rising significantly. Commodity prices have risen in 2016, but they are down from their highs and are still relatively cheap. Overhead costs are rising somewhat due to higher real estate prices and utilities costs – but the underlying reason for this is the increased usage of debt. The debt costs are rising and may rise significantly along with the cost of taxation if interest rates rise. This is not evident in the trends but is a “black swan” event that may produce a significant increase in inflation. There doesn’t seem to be a predictable indicator of inflation returning to the market. Inflation is there within the numbers and can be unleashed unexpectedly however.

Should the Canadian Dollar Be Rising So Quickly?


The Canadian dollar was trading above 80 cents in U.S. funds before the oil shocks took place which sent oil tumbling to around $30 per barrel. The Canadian Dollar went down to around 67 cents early in 2016 before rebounding back to 76 cents where it currently trades. The Canadian dollar has been linked largely with commodities and oil in particular since Canada exports a lot of these things. The second large factor affecting the Canadian dollar in the past has been its fiscal policies and debt situation.

The common explanation for the movement in the Canadian dollar is the price of crude oil. The oil price has dropped from $100 per barrel 2 years ago to around $30 per barrel and now sits at close to $40 per barrel. The fall in oil is about 70% and the subsequent rise in oil is around 25% since its bottom. The Canadian Dollar topped out at 95 cents in U.S. funds two years ago and then bottomed out at 67 cents – it now sits at 76 cents. This represents a 30% decline followed by a 13% rise. The relationships seem to be consistent in terms of tracking the oil price to the Canadian dollar. Should oil return to $100 per barrel, this would correspond to an increase of close to 50% from its current level of $40 per barrel. If the Canadian Dollar follows this move, this would equate to a value of almost $1.2 U.S. Dollars for every 1 Canadian dollar. While this is not far-fetched, it shows that the proportions are a bit off.

In terms of the Canadian national debt, the last few years have not been very favourable. The collapse in oil is threatening to make the debt balloon much higher, combined with a new government that is promising tax cuts and higher spending.

A third possible factor is that Canada is known for is resources – mining and energy. The commodity complex has also crashed over the last two years and is only now getting looked upon for possible investment.

Comparing these results to the Australian Dollar, the picture is very similar. Since Australia is very similar to Canada in terms of its resources, export pattern and proximity to a large trading partner, the consistency is there among similar currencies.

Could there be other reasons this time for the Canadian Dollars’ trading pattern? Is the Canadian Dollar rising too quickly? It seems to be, but time will tell if the rates of change will hold up consistently in the future.

Is the Price of Gold an Indicator of Trust?


The price of gold has been acting differently in 2016 than in the last few years. The reaction to news inputs has been either non-reactive or sometimes opposed to the way it was in the past. Some examples of the change are given below.

When a central bank announces stimulus which would lead to economic growth, the price of gold would typically fall since gold is seen as a safe haven. Negative interest rates as well as higher interest rates were seen as negative factors for gold since both would lessen the appeal of a safe haven. The negative rates would ensure that economic growth is more solid and the higher rates would mean the economy is already strong and would dampen economic growth. Recently, negative rates were announced in Japan, mentioned in Canada and the U.S. as a possibility and went further negative in Europe, but the gold price continued rising. The prospect of stimulus is usually a tonic for equity markets. While this has been true to an extent, a tonic for the gold price it is not. The Fed recently discussed raising rates as well. Higher rates usually indicate overheating and would exude a sense of balance in the economy. This would mean that times are good and the safe haven trade would not be necessary.

Warren Buffett announced recently in his company’s annual report the current generation of children are the most prosperous of any generation despite the high debt and subpar economic prospects. Gold rose following that announcement in spite of the fact that Warren Buffett is a well-respected investor and has significant sway upon the markets. The typical reaction would be that equities would perform strongly and safe havens would not.

There was some upbeat U.S. manufacturing data which usually points to a stronger economy. This translates into less fear and less need for gold. Gold is rising on days when “good news” is announced as well as on days when the markets tank. The U.S. dollar strength tends to be a negative correlator to the price of gold. Lately, these two entities have been rising together.

Most recently, the U.S. announced better than expected employment numbers. The equity market reaction was typical, but gold rose with it as well. There were economists saying that the numbers were not as strong as the headline numbers suggest, but the reaction in the gold price was very swift to the upside.

There are more blogs citing the lack of trust in economic data and in central bank policies. These blog posts are not new, but the reaction to this information is new. Is the gold price an indicator of a lack of trust – specifically in central bank and monetary policy? If it is, will the gold price indicate the faith that people have via future data releases? What is driving this behaviour in the price of gold? Gold has been cited as honest money since it is the only asset that is not someone else’s liability. Gold may be resurrecting to the level of a universal currency that it always was.

Have The Markets Lost Faith In the Dollar?


The last two weeks have witnessed a remarkable change in the market perception. Since 2008, the U.S. dollar and the central banks have been the authority on what the markets are guided to do. The last two weeks have been different. The U.S. dollar has been falling versus many currencies in spite of the fact that the markets have been going down quickly. Gold which has largely been ignored for the last few years in terms of safe haven appeal is now back in vogue. The same can be said for silver which has been at multi year lows. In recent news releases, reasons for the decline in silver prices were linked to the slowdown in China and the fact that commodities in general have been taking a hit. China is still slowing down as evidenced by the devaluation of the Yuan and the poor Chinese equity market performance. The world equity markets in general have also lost value while gold and silver have been rising. Another notable trend change is in oil prices. Typically oil, gold and silver are correlated due to the pricing of all of these commodities in US dollars. In the last two weeks, oil has plunged to new lows and gold and silver have been rising. On the other side of the argument, correlation does not equal causation. Correlations can also change from time to time and also revert to moving in opposite directions instead of the same direction.

What is more peculiar about this market activity is what the catalysts are for the market reactions. The fact that the markets are valuing a safe haven so strongly is also an indicator that something is not right.

This last Fed announcement on February 11, 2016 indicated that interest rates could still rise in 2016. This caused a fall in the US dollar and oil and a rise in gold and silver. This can be justified in that higher interest rates will slow down the economy further. In every other instance, the buying of U.S. Treasury debt and dollars would accelerate after such an announcement. This time, these instruments were down after the announcement. Has the Fed lost its credibility? If markets continue to signal the way they have over the last week, the answer is a “yes”. With the Fed credibility goes the strength of the US dollar. Add to this scenario the fact that more central banks are diving into negative interest rate territory, and you have a contradiction in perspectives. Most of the world is pleading for help in reviving their economies where the U.S. is saying that everything is not only good but needs to be restrained. This does not make sense given that global economies are heavily linked.