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TriDelta Insight Q2 Commentary

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Overview

While it’s undoubtedly been a difficult first six months of the year, there are still positives. A strong job market, companies buying back their own stock, signs that pessimism had gone too far, and strong bank balance sheets have helped provide some support. The consumer has also largely continued to spend, helped by rising wages.

On the other hand, investors are particularly focused on rising interest rates and the possibility of a recession. Central Banks globally have continued with their interest rate increases. That shift has pushed bond yields higher and squeezed stocks. Earnings estimates have held up for most individual stocks and sectors, but the concern is that with Central Banks raising rates, it could spur an economic downturn, forcing earnings forecasts to fall and pushing stocks lower.

In this quarterly review, we will look at:

  • Bear Markets
  • Inflation & Central Banks
  • TriDelta’s current view on stocks, alternative investments, bonds, and preferred shares

Year to Date Market Returns

The unavoidable reality of investing is that markets do drop. Bear markets arrive. There is nothing any of us can do to control this so we must focus on what we can control. While we can’t force the economy and stock markets to be any better than they are, we can control how we respond in times like these.

After all, panic is not an investment strategy. To overcome these periods of stress, we build investment portfolios directly tied to your time horizon and specific circumstances which leads to a diversified portfolio of stocks, bonds, preferred shares, and alternative investments. No one likes to see the value of their investments declining but it helps when you have been here before and can look back at history as a guide for what may be to come.

So, what is a bear market? A bear market is typically defined as a period where prices have fallen 20% from a recent peak.

The S&P 500 officially entered a bear market June 13th and while it may be tough to see any positives when stocks are falling, a look at past bear markets shows there is good news and bad news for investors once the S&P 500 has crossed that largely symbolic threshold.

This year’s declines have marked a quicker-than-average descent into bear territory, at 111 trading days since the S&P 500’s January 3rd record high, according to Dow Jones Market Data. Among the past 10 bear markets, only the 1987, 2009, and 2020 versions took fewer trading days to achieve a 20% drop. The S&P 500’s average bear market peak-to-bottom decline has been almost 36% taking about 52 days to bottom after reaching this 20% threshold. That would put the bottom in roughly late August. The key word is roughly.

No two bear markets are the same and while no one knows when we will reach a bottom, history suggests the long-term returns after reaching a bear market are quite positive. In bear markets since 1950, the index has been higher 75% of the time three months later, by an average of 6.4%. A year after falling into a bear market, the S&P 500 has been positive 75% of the time and climbed 17% on average.

While we don’t know what the next few months hold, we do know that bear markets don’t last forever and often offer the most attractive opportunities for those looking long term.

Inflation & the Central Banks

It remains our view that the inflationary pressures will begin to fade later this year, but we don’t expect it to be smooth. Central banks have continued to raise interest rates globally to fight inflation with Canada’s benchmark rate presently 1.50% and the US Fed at 1.75%. To the end of June headline inflation in Canada stood at a multi-decade high of 7.7% and 8.6% for our neighbors to the South.

The higher cost of borrowing is now starting to slow economic activity, but the subsequent slowing of inflation can take even longer.

One question we receive frequently is how long these interest rate increases will go on for and how high will they get. While it is nearly impossible to predict with perfect accuracy, the below chart shows us that in the past 30 years there has been six tightening cycles and, in each case, rates came right back down within two or three years.

 

Source: Bloomberg

The key takeaway is that over the past 30 years, Canadian rate hikes have not been a one-way street.  There has usually been a corresponding decline to each period of rate hikes and people should not be fearing long term significantly high interest rates. History suggests that we may have a relatively short window of ‘high’ rates.

Central Banks continue to walk a very fine line. Too much too quickly can trigger a recession while too little too slowly can propel inflation out of control leading to even more aggressive action. This is an area we are watching closely and are beginning to see a possible opportunity in bonds, but also believe the stock markets of the world cannot see a bottom until Central Banks begin to ease the reins of the current rate increase cycle we find ourselves in.

What we are doing and why

Equity

The market stress in the second quarter was focused on global Central Banks’ ability to achieve a so-called “soft landing” or raising interest rates just enough to slow inflation without triggering a recession. June was particularly difficult for equities as the markets expectation for a recession has grown and while, in some areas, stocks still do not look cheap, they are becoming increasingly attractive despite the potential for near-term volatility.

The one-year forward price-to-earnings multiple, an estimate to gauge future relative value, for the S&P 500 dropped from 21 times at the start of the year to around 16 times last month. (Since 1990, the median multiple is 15.4 times.) This doesn’t mean equities are cheap, but value has improved.

Despite the uncertainty surroundings businesses, a report from BMO determined earnings expectations have largely held firm, with 2022 profit growth for S&P 500 companies expected at just under 10% compared to 9% at the start of the year.  One of the keys moving forward will be examining the impact Central Bank tightening has on earnings forecasts potentially forcing stocks lower.

Global stocks have fallen for many of the same reasons we are seeing in North America but amplified because of the conflict between Ukraine and Russia. One of the bright spots have been China. In June China posted one of its best months since July 2020 as the government eased COVID lockdowns and eased their extended crackdown on the tech sector.

While we acknowledge it has been a difficult year investing in equities, we remain focused on owning high quality businesses we feel are well positioned to perform regardless of how their stock price does in the near term. During COVID some businesses saw their revenues more than cut in half yet rebounded very quickly. We would argue the businesses we own are even better positioned today to weather the economic storm clouds above.

Into the last half of 2022 TriDelta Funds continue to be highly active to take advantage of attractive opportunities.

  • We echo other market commentators that the market likely will not see a bottom until we have greater clarity on when interest rates will peak.
  • Contrary to the start of the year, commodities struggled in the second quarter and while we still see value in this asset class. we had trimmed some of the top performing energy names in favour of other areas which had been oversold.
  • We have continued to reduce exposure to cyclical stocks and throughout the quarter increased exposure to the US while decreasing exposure to Canada.
  • Defensive companies and those with the ability to pass along rising costs to consumers have provided some support.
  • We have remained flexible with the amount of cash in the Funds to allow us to take advantage of opportunities in the markets. We began the second quarter with 8% cash which increased to 12% in April and is presently at 5%.
  • Our team is closely watching company earnings reports to better gauge company health, inventory and supply chain issues, as well as gain a better picture of the resilience of the economy as a whole.

Bonds

Uncertainty remains around bonds, but if the focus shifts away from interest rate increases towards weakening economic data, we would expect this to provide support for bonds and potentially equities if markets view that the current interest rate hiking cycle is fully priced in.

  • Our view is that bond markets have priced in the current interest rate hiking cycle, even more than what the Central Banks have indicated.
  • Presently, we see government bonds being traded close to fair value while, for corporate bonds, we prefer high quality investment grade bonds. Concerns remain over potential defaults in light of weakening economic data and because of this we have stayed away from low quality investment grade bonds in danger of credit downgrades.
  • We continue to keep a close eye on credit spreads for corporate bonds and see a wider spread from where we are today as a positive indicator to increase portfolio weightings to bonds.
  • High yield bonds have done very poorly as lower grade credit has been heavily hit with higher rates and a slowing economy.
  • We remain focused on short duration bonds to provide insulation from rate hikes as we stay patient for an attractive entry point.

Bond prices have fallen dramatically this year, which means their yields have risen sharply. These higher bond yields are becoming increasingly attractive following the selloff in the first half of the year.

Look no further than Apple as an example on the corporate bond side. It’s one of the most creditworthy U.S. companies — sitting on loads of cash — and its bonds are trading for 70 cents on the dollar, down from around 100 last fall. Yielding around 4%, compared to 2.7% when Apple issued them last August, this is one of the increasingly attractive opportunities in the asset class.

Preferred Shares

Preferred shares have remained volatile since our last quarterly commentary but, on a relative basis, have held up slightly better than broader equity and bond markets.

The asset class has benefited from continued redemptions of existing preferreds. So far in 2022, $6.7 billion have been redeemed which equates to 10% of the entire market. We see this as one of the key factors for why preferred shares have performed well.

  • Rate Resets, which should be more attractive as rates rise, have yet to perform as we would expect.
  • Institutional participation has shown little enthusiasm this year and some investors are opting for conventional asset classes at cheaper levels (bonds and equities). This has created liquidity issues in the market.
  • We continue to hold our allocation steady with a focus on picks we believe may be redeemed in the next six months. Along with the income component, we see this as a significant value add in taking advantage of the market dynamics which are pushing the asset class to shrink.
  • The rate pressure is the greatest challenge for Fixed Rate Preferred Shares.

Alternatives

Alternative investments have been one of the brightest spots for portfolios this year and have helped to reinforce why they are an important component in a diversified portfolio. Our primary focus has remained in Real Estate and Private Credit.

On Real Estate,

  • High quality apartment buildings continue to see strong demand. The lack of supply in Canada and abroad remains which has made this an increasingly attractive space for investors.
  • Broadly speaking, rents are rising everywhere in North America as people are priced out of homes and increases in interest rates have made mortgages out of reach.
  • Despite rising interest rates impacting individual homeowners, large real estate managers continue to be well positioned for the inflationary environment we find ourselves in.

On Private Credit,

  • Private Credit returns remained favourable and, in many cases, have offered protection from rising interest rates. Loans in this space tend to be shorter term, and in some cases floating rate, which helped returns.
  • The borrowers engaged with these lenders often work closely with each other, which provides these managers unique insight into giving strategic business advice to assist companies in a variety of market environments. To date, we have not seen any notable increase in defaults.
  • Rising interest rates can make it more difficult for small and medium sized businesses to borrow from the large banks which have helped to increase the pool of potential borrower’s credit managers have access to.

TriDelta Recognized as Top Wealth Manager


We were pleased to be selected as one of the Top 10 Wealth Managers in Toronto for 2022 by AdvisoryHQ. AdvisoryHQ has a strict selection process that is designed to identify the best financial advisory firms in multiple cities across Canada.

 

In conclusion

Since WWII there have been 12 different bear markets, all with specific reasons or fears around what was happening at the time. While no two bear markets are the same, the biggest mistake people have made time and time again is letting emotion take control over logic and reasoning.

Panic is not an investment strategy, and you would not drive your car looking out the rearview mirror. Our focus remains on looking forward and building portfolios suitable for each individual and family we work with. Managing risk in good times and bad is one of greatest value adds we can provide but almost more important is helping keep emotion at bay and focusing on the things we can control. No one can say what tomorrow will look like, but we do know the current bear market, like all others, will come to an end.

History has shown repeatedly that in the long run there will be more good days than bad and, in our experience, the best days in the market often come right after the worst.

Source: S&P 500 Index, Bloomberg.

As always, we are here to help. If you have any questions, please don’t hesitate to contact your Wealth Advisor.

Financial Post / Rechtshaffen: Hang on a minute: Inflation is actually good for some people

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Don’t fear inflation if you have low or no debt, higher assets and are receiving some form of indexed income

There are few words in the financial world scarier than inflation.

Many remember the early 1980s and mortgages of 20-plus per cent, but if you are a student of history, or even lived in certain countries during periods of hyperinflation, you might recall these unbelievable cases: in Venezuela, consumer prices grew at 65,000 per cent from 2017 to 2018; in Zimbabwe, the daily inflation rate was 98 per cent from March 2007 to mid-November 2008; in Hungary, the daily inflation rate was 207 per cent between August 1945 and July 1946. Now that is an inflation problem.

In North America, our inflation rates have never really topped 20 per cent annually. I am not suggesting 20 per cent is nothing to be afraid of, but for many of you, inflation may actually be your friend.

One of the fundamental components when we do a financial plan for clients is a fair estimate of annual spending. If the client doesn’t have any debt, then this annual spending number is the only part of the plan that is negatively affected by higher inflation. For example, if someone spends $100,000 a year and inflation is 10 per cent, then the same level of spending would be $110,000. They now have an extra $10,000 of costs to worry about.

Now let’s look at parts of the plan that will be helped by higher inflation.

Let’s say this same client, a couple both aged 70, does not have a defined-benefit pension to fall back on, but they receive full Canada Pension Plan (CPP) and partial Old Age Security (OAS) benefits that total $50,000 a year. This income is fully indexed to inflation and, based on the 10-per-cent inflation rate, it will now go up to $55,000 a year. This couple would have $5,000 of that extra $10,000 covered by index increases in their government pensions.

Next, the couple has $2 million in investment assets and likes to keep $150,000 in high-interest savings accounts and money market funds. These were earning one per cent in a low inflation environment, but in a 10-per-cent inflation world, they are now perhaps paying six per cent. The extra five percentage points on $150,000 is $7,500, which puts them in a positive cash flow position.

Next, they have another $1.85 million of investments. In a high inflationary world, you want to invest differently than in a low inflationary one. It isn’t as easy to mathematically show a net benefit or negative in this part of the portfolio, but there are some ways that we would manage investments differently (we are doing so to some extent now) that can add net dollars.

Let’s start with bonds. For most clients, we have already been holding significantly lower weights in bonds than usual. The reason was that yields on bonds were so low, and there was a heightened risk that rising interest rates would hurt bond returns. This has been the case.

However, there will be a time when holding bonds goes back to traditional weights or even higher. If inflation is 10 per cent, yields on bonds will be much closer to 10 per cent than they are today. Simply owning bonds and collecting the coupon payments will generate much higher income. In addition, at 10-per-cent inflation, the odds of interest rates going back down to more normal levels from there would be much greater, and this would also add to bond returns.

We aren’t there yet, and may not get there, but the point is that when inflation and interest rates reach a high enough level, bonds once again become a good investment option for almost all clients and that hasn’t been the case for a few years.

As a quick example, the Fidelity Canadian Bond Fund in its first five years from 1988 to 1993 returned an annualized 8.7 per cent. The same fund is negative over the past five years, with a five-year annualized return of -0.31 per cent. If $200,000 was invested in this fund during higher inflationary times than we’ve had during the past five years, the difference at the end of five years is more than $106,000, or over $21,000 on an annual basis. That would certainly have a big impact on the extra $10,000 in costs that high inflation brought to bear.

In terms of other investments, you traditionally want to be more in value than growth stocks during high inflation periods. The main reason is that growth investments rely on a high value of their future potential. If interest rates are high, a dollar in five years will be worth much less than if interest rates were low. As a result, many growth stocks (good and bad ones) are getting hit hard this year.

Value stocks generally include sectors such as utilities, consumer staples, some real estate and commodities. These hard assets have traditionally been less reliant on high future growth, and more reliant on quarter-to-quarter profits and stable-to-growing dividend payments. As a firm that leans towards value investing, we certainly don’t mind a little inflation.As a quick aside on value vs. growth, a 2016 study by BofA Securities Inc. found that the average annual price return of value stocks since 1926 was 17 per cent versus 12.8 per cent for growth stocks. It found that value outperformed growth in roughly three out of every five years during this period. Since 2016, there is no question that growth has meaningfully outperformed value, but that has turned in the past year. We believe, based on this history, there might be a long period of value outperformance ahead.Getting back to real estate, this is one hard asset that people sometimes say will benefit from inflation, while others say it will decline due to higher interest rates. Both are right, which means you need to be careful in terms of how you invest. For example, a real estate investment trust with a larger ratio of debt would be in for a rougher ride than one with lower debt.

One private REIT we currently invest in is Rise Properties Trust, which is focused on residential rental properties in suburban Seattle and Portland. Its rental income is tied much more to inflation than Canadian residential properties, because of the relative lack of rent control in those markets and a culture that moves more frequently, thereby allowing average rental income to be more closely tied to current (inflationary) rates.

Of course, many people do suffer from rising inflation. If you have high debt and low assets, as many younger people do, rising inflation is a real risk and concern. However, don’t fear inflation if you have low or no debt, higher assets and are receiving some form of indexed income (including CPP and OAS). It is actually your friend.

Reproduced from Financial Post, June 14, 2022 .

Ted Rechtshaffen
Provided By:
Ted Rechtshaffen, MBA, CFP
President and CEO
tedr@tridelta.ca
(416) 733-3292 x 221

Market Commentary for June 2022

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Two Important Sources of Value – Stocks and Emotions


In May, the S&P500 dropped as much as 11% in the first 3 weeks and ended the month roughly flat.  In a month like this, and in a year like 2022, it is very important to start with investments that are valued at least somewhat reasonably, and then to avoid emotional decisions.  These two concepts form the theme of this months’ commentary.

There is a famous quote from author Mark Twain which states: “History doesn’t repeat itself, but it does rhyme.”

Famed investor Howard Marks used this quote in his most recent memo discussing the behavioural attitudes seen in bull and bear markets and lessons that can be learned from these ups and downs throughout the market cycle.[i]  Not since the COVID crash of 2020 have we seen such sustained downward pressure on the markets and in comparison, this certainly feels like a much different environment than just a couple years ago.

Even before COVID, some had referred to the decade long bull run as the “everything bubble”.  It wasn’t about picking winners and losers, but rather who was going to win the most in an environment full of optimism.  This often reached exuberance like we saw after the markets March 2020 low.

Market analysts and economists couldn’t help but draw comparisons to the early 2000’s tech bubble where euphoria had encapsulated everyone hearing about the gain’s others were making on their investments. In hindsight, taking stock recommendations from neighbors and taxi drivers was the sign of the end of those good times. It’s important to note that not all those companies during the tech bubble were bad businesses. I’m sure anyone would happily go back and invest in Amazon or Apple if they had the chance. The harsh reality that many learned at the time was that valuation matters.

If you could go back to the year 2000 and I told you about a company that over the next 21 years would nearly double their annual revenues, increase their earnings per share by over four times, and grow to have a market capitalization of $187 billion you would probably say this is a no brainer. Now what if I told you that had you bought at its peak in March of 2000 and held it until May of 2022, you would have lost 21% of your investment…This example refers to Cisco Systems (Ticker: CSCO) and although it’s just one example there are others like it.

Those who bought shares in Cisco did so believing they would manufacture and distribute key infrastructure to support the growing internet revolution and be an important player for years to come. Despite being largely correct, those investors (if any held on) would have lost 21% of their investment in the company. At their worst, those investors would have been down almost 90% in that first two years as a shareholder. Over this same time period the S&P 500 Index generated a total cumulative return of 314%.

Source: Bloomberg.

Investors buying Cisco in 2000 did so when the company had a Price to Earnings (P/E) ratio, an important metric in judging a stocks valuation, of 382 times. In comparison, the S&P 500 Index has had an average P/E of about 15 times going back many decades.

The point of this example is to demonstrate that price matters. So far in 2022, 22% of the companies traded on the tech heavy Nasdaq have returned at least -50% since their highs. One would not need to look further than Cathie Wood’s Ark Invest. Wood gained notoriety during the pandemic as her flagship fund ARK Innovation ETF (Ticker: ARKK), which delivered extremely high returns for investors on the back of its bets on companies like Zoom Communications, Tesla, Coinbase, and others. At its peak ARKK traded at $132.50 and to the end of May 2022 traded at $44.57 for a loss of 66%. By no means are we implying all the companies held in this fund are bad companies but that buying even good companies at unreasonable valuations is not investing, it’s gambling.

Today we have seen firsthand, celebrities and social media influencers touting the next big “thing” whether that be a new cryptocurrency, NFT, or “meme stock”. We here at TriDelta are active managers whose focus is on generating a favourable long-term rate of return in line with your specific circumstances, always keeping risk in mind. To the end of May 2022, the TriDelta Growth and Pension Funds have returned -6.76% and +0.11%, respectively. In comparison the MSCI World Index, a collection of over 1,500 companies globally, is -12.86% for Canadian investors. We continue to focus on high quality companies at compelling valuations rather than letting emotion take hold and getting swept up in the moment. In comparison to the funds benchmark P/E ratio of 16.95, the TriDelta Growth and Pension Funds have a ratio of 10.78 and 14.79.

On the topic of emotions, one of the best ‘value adds’ provided by working with a TriDelta advisor, is keeping emotions in check in good times and bad. Russell Investments Canada developed a calculation to demonstrate the value of a full-service Canadian financial advisor and determined working with such an individual can add 3.85% to the value of a client’s portfolio, in large part because of their ability to coach behaviour in stressful times.[ii] We here at TriDelta make it our mission to have a deep understanding of what you are looking to achieve and ways in which we can help reach those goals.

Through comprehensive financial planning, investment management, and other services (TriDelta Family Doctor Model), we help you to manage the emotional responses to market volatility.

As we face future months like May 2022, we believe that our approach to value oriented investing and long-term planning will maintain your financial peace of mind.

[i] Behind The Memo: Bull Market Rhymes (oaktreecapital.com)

[ii] How much is a financial advisor worth to their clients? | Wealth Professional

 

 

 

 

 

 

 

 

Market Commentary for May 2022

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Why There is Reason for Optimism

In March of 2020 the markets suffered one of the steepest drops in recent memory. From peak to bottom, the S&P 500 fell 35%. In hindsight many people who had been through the Great Financial Crisis a decade earlier saw this as an excellent opportunity to invest, while others allowed doubt to creep up to the surface. Will COVID ruin the economy? How will Central Banks and Governments be able to support businesses large and small? What happens when a large portion of the population can’t go to work? How long will a vaccine take? Now, over two years later these questions have largely been answered and while uncertainty still remains around COVID’s impact on supply chains, long term health impacts, and lingering inflation, we find ourselves in a much different investing environment.

The Bad

So far in 2022 there have been very few places to hide. To the end of April, stocks are materially negative with the S&P 500 -12.14%, the TSX -2.17%, and MSCI World -12.35%. Bonds, historically a safe haven in times of declining stocks, have had one of their worst periods in decades with the FTSE Canada Bond Universe down 10.22%. Preferred shares have also been negative with the TSX Preferred Share Index down 9.29%. So, what’s behind the market’s latest tantrum?

Rising Interest Rates

There is a lot of uncertainty around rising interest rates at home and abroad. Rising interest rates have a lot to do with economic growth, and people and businesses have become accustomed to extremely low interest rates. As of April 13th, the Bank of Canada raised the overnight interest rate to 1.0% which has increased the interest rate consumers see on the Prime rate to 3.2%. This is up from 2.45% earlier in the year. As many have experienced firsthand, a rising interest rate means people are having to put more towards paying off their mortgage and other loans which leaves less disposable income to be spent elsewhere. This in turn can hurt companies’ sales and slow their growth which can cause them to reevaluate their own plans. These companies also take on debt to help run their business. Rising interest rates also have a direct impact on the bond markets. When interest rates rise, bond prices fall. Think of the bond investor who owned a bond paying 2.0% but that same company is now offering a similar bond for 3.0%. That investor is going to sell their 2.0% bond for the new one to lock in the higher rate. This also impacts a bonds yield. Bond yields are important because bonds are perceived as much lower risk investments relative to stocks. If the bond yield rises enough, it forces investors to consider if the expected return inherit in their stocks is sufficient to justify the risk. This hasn’t been much of a consideration the last several years because bonds were paying so little.

Ukraine/Russia, COVID, and Inflation

The ongoing conflict in Ukraine is also a key consideration for many businesses and countries globally. While the loss of life is tragic, this war also impacts countries who rely on Ukraine for the food they produce and Russia for the many metals and minerals they export. Not to mention the oil and gas which Europe had become so reliant on! This conflict and the lingering effects of COVID have continued to drive inflation. China offers an example of this in their Zero COVID Policy which continues to lock down millions of people in their homes in an effort to quell the rising cases. This in turn has impacted their trading partners who rely on manufactured goods from China creating even more scarcity in some of the goods we rely on. These factors have continued to make sourcing goods and materials very difficult for many consumers and businesses which have further driven higher inflation (evidently, less transitory than we were originally told). People are having to put more money towards their mortgage because of rising interest rates, spending more at the grocery store and the gas pump will drive spending patterns away from more discretionary purchases like a new car or home appliance.
Presently, Canada’s headline inflation rate is 6.7% while in the U.S. it is 8.5% versus the stated 2% target inflation rate. Key to the global economy will be whether these Central Banks can achieve a “soft landing” as they raise interest rates and unwind the pandemic stimulus to rein in this inflation.

The Good

While there certainly appear to be many negatives in the market right now there have been some standouts which have helped investment portfolios and offer positives for the economy overall.

Commodities and Alternative Investments

In any period, there are always those who perform relatively better than the rest. Today, hard assets like metals, oil and gas, and real estate have outperformed the broader market in general. At TriDelta we employ a diverse portfolio of Alternative investments which includes real estate. We recently hosted a webinar with three real estate funds which have performed quite well (TriDelta Financial – Webinars) and have helped to insulate portfolios from some of the broader volatility in the equity and bond markets. These three funds have returned +0.77% to +7.5% to the end of April. We continue to view commodities positively and as a diversifier for portfolios. Oil and gas (+49.10% & +120.28% year to date), already on an upswing, have been propelled higher by policy decisions to cut off Russian energy. Several metals have also been pushed higher due to the conflict and increased uncertainty elsewhere. Gold is up 5.09% since the start of 2022.

The Consumer

Unemployment in Canada and the US continued to fall to historic lows at 5.2% and 3.6% respectively. A strong labour market has continued to propel wages higher.

The Value of Active Management
We continue to place an emphasis on active management for investment portfolios. Equity markets have generally not performed well. In terms of Canadian dollars and to the end of April the returns of various markets are as follows:

Here at TriDelta we have two equity funds managed by our Head of Equities Cameron Winser that have outperformed many of these broader markets. To the end of April, the TriDelta Pension Equity Fund has returned -1.14% and the TriDelta Growth Fund -6.44%. While we never pretend to know what the markets will do tomorrow, next week, or next year, we see these portfolios as being well positioned moving forward to capitalize on the increased volatility in the market. Both funds remain highly active into the start of this year and have hovered between 10% to 12% in cash to help take advantage of near-term opportunities. We think the performance of these two funds speaks volumes as to why active management is so important in times of market uncertainty.

Significant pessimism is actually a buy signal

We closely monitor market sentiment and see an extreme level of pessimism among investors. While we cannot rule out new lows, the short-term level of pessimism we are seeing suggests that the odds are increasingly skewed towards a market rebound. As Warren Buffett says, “be greedy when others are fearful”.   From National Bank research yesterday, came this nugget of information:  “Over the past 15 years, when our National Bank sentiment indicator signaled an extreme level of pessimism (which happened only 3% of the time), the S&P 500’s returns the following month were positive 80% of the time and averaged 4.2%. Over three months, it was positive 85% of the time, with an average gain of 8.5%. In short, while we cannot rule out new lows in the short term and we must monitor inflation closely, the level of pessimism we are seeing suggests that the odds are increasingly skewed towards a market rebound.”

So, What’s Next?

As mentioned above, no one can say with absolute certainty what the markets will do tomorrow, next week, or next year and anyone who makes those claims is not someone you would want to be associated with. No one can control what the market is doing or will do but what we can control is our emotion in times like today. Using history as a guide shows us that, over time, there have been more good days than bad and the key to seeing a favourable return is the ability to ride out the bad and stay invested with a long-term perspective.

The chart below shows that a $10,000 investment can become $2,933 by missing out on just 60 of a market’s best days over a 35-year period.

In times like today something we frequently hear is “I will invest when things calm down.” What people mean is they will invest once markets start to go up. The problem is that it is those first few days and weeks of significant recovery that get missed when you wait until “things calm down”, and that is precisely when someone can miss some of the very best days in the market.

“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”
— Warren Buffett in his letter to shareholders, 2009

 

 

 

 

 

 

 

 

 

 

FINANCIAL FACELIFT: Can Brandon and Michelle achieve financial independence in six years’ time?

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Below you will find a real life case study of a couple who is looking for financial advice on how best to arrange their financial affairs. Their names and details have been changed to protect their identity. The Globe and Mail often seeks the advice of our VP, Wealth Advisor & Portfolio Manager, Matthew Ardrey, to review and analyze the situation and then provide his solutions to the participants.

gam-masthead
Written by:
Special to The Globe and Mail
Published May 6, 2022

Inspired by the FIRE movement, Brandon and Michelle – both in their mid-30s – have built a portfolio of income-producing properties and dividend-paying stocks they hope will free them soon from having to work. Characterized by extreme saving and investing, FIRE stands for “financial independence, retire early.” It helps if you earn a good income.

Brandon earns $127,000 a year plus bonus and employer pension plan contributions, while Michelle earns $92,000 a year. Their combined employment income totals $238,000.

Michelle has a defined benefit pension plan partly indexed to inflation. They have two children, ages one and three.

Their aspirational goal is to “become financially independent, non-reliant on employment income, before 40,” Brandon writes in an e-mail. Ideally, they could live off their dividends and rental income. Their more realistic goal, perhaps, is to have enough rental and dividend income to allow them to work part-time – “resulting in about 50 per cent of current pay” – in five years or so, Brandon writes.

Their retirement spending goal is $120,000 a year. Achieving it on half the salary will be a challenge.

“When can our passive income cover our expenses?” Brandon asks.

We asked Matthew Ardrey, a vice-president and portfolio manager at TriDelta Financial in Toronto, to look at Brandon and Michelle’s situation. Mr. Ardrey holds the certified financial planner (CFP), advanced registered financial planner (RFP) and chartered investment manager (CIM) designations.

What the expert says

Brandon and Michelle are looking to pull back from full-time work in mid-2028, Mr. Ardrey says. “Before engaging in what would seem like a pipe dream for many Canadians in their mid-30s, they want to ensure they are on secure financial footing,” the planner says.

In addition to their principal residence, they have four rental properties. They also rent out an apartment in their home. Their rental properties generate $1,100 a month, net of all expenses including mortgage payments, and the unit in their home another $1,600 a month. Brandon earns $400 a month for managing a relative’s rental property.

Dividend income from their non-registered accounts is about $2,500 a year, Mr. Ardrey says. Brandon’s $15,000 of employer-matched contributions is going to a defined contribution pension plan. As well, they maximize their tax-free savings accounts and contribute $2,500 per child to their registered education savings plans each year. They have no unused contribution room in their registered plans.

“After all of these savings and their spending, they still have a $50,000 a year surplus, which they put toward non-registered savings,” the planner says. He assumes they divide this surplus 50/50 to maximize tax efficiency. “This amount grows annually at a projected 4.9 per cent rate until they reach semi-retirement and have to use some of it to supplement their lower income,” Mr. Ardrey says. Inflation is projected at 3 per cent.

In mid-2028, he assumes Michelle and Brandon reduce their work by 50 per cent. Brandon will be 39, Michelle 41. Brandon’s bonus and employer contributions to his DC plan end. Michelle’s DB pension contributions drop by half. Brandon is assumed to maximize his RRSP each year based on 50 per cent of his current salary.

Adjusted for inflation, Brandon will be earning $78,000 a year and Michelle $56,000. They’ll have $3,000 in dividend income, $6,000 in property management income and gross rental income of $93,000.

At the same time, their spending is forecast to increase, the planner says. “They feel that in another five years’ time, things will be drastically more expensive. As well, less work will provide more leisure time and increased expenses. Thus, they have requested we estimate spending of $10,000 per month starting when they semi-retire in 2028 and continuing thereafter, adjusted for inflation.”

They will still be about 17 years away from full retirement. They continue working part time until Michelle is 58, when she can get an unreduced pension. “At this point we assume they move to full retirement,” Mr. Ardrey says. Michelle will be entitled to an estimated pension of $37,845. Her pension is indexed 60 per cent to inflation, or 1.8 per cent.

In their first full year of retirement, Michelle’s pension will have risen slightly to $38,526, property management income $10,000 and gross rental income $154,000. The mortgages will be paid off.

At age 65, they will start collecting Canada Pension Plan benefits (estimated at 70 per cent of the maximum) and full Old Age Security. “Under these assumptions, they meet their retirement spending goal of $120,000 a year after tax,” Mr. Ardrey says.

“However, when we stress test the scenario under the Monte Carlo simulator, their probability of success drops to 77 per cent, which is in the ‘somewhat likely’ range of retirement success,” he says. A Monte Carlo simulation introduces randomness to a number of factors, including returns, to test the success of a retirement plan. For a plan to be considered “likely to succeed” by the program, it must have at least a 90 per cent probability of success.

“Looking at their portfolio construction, it is great for accumulation, but the inherent volatility of an all-equity portfolio is less desirable for drawdowns,” Mr. Ardrey says. They have a portfolio of exchange-traded funds with a geographic breakdown of 55 per cent U.S., 25 per cent international and 20 per cent Canadian.

As they approach semi-retirement, Brandon and Michelle could benefit by diversifying their portfolio by adding some non-traditional, income-producing investments, such as private real estate investment trusts that invest in a large, diversified portfolio of residential properties, or perhaps in specific areas such as wireless network infrastructure, mainly in the United States, the planner says. Such investments are not affected by ups and downs in financial markets.

“By diversifying their portfolio, we estimate they could add at least one percentage point to their overall net return – taking it to 5.9 per cent – and significantly reduce the volatility risk of the portfolio.” In conclusion, Brandon and Michelle are on track to achieve something only most Canadians can dream of,” Mr. Ardrey says, “semi-retirement by their early 40s and full retirement before 60.”

Client situation

The people: Brandon, 33, Michelle, 35, and their two young children.

The problem: Can they achieve financial independence in six years’ time, allowing them to work part-time and still spend $120,000 a year?

The plan: Keep saving and investing. Go part-time in 2028 and retire fully at Michelle’s age 58, when she gets her pension. Add some non-traditional, income-producing assets to their investments as they approach retirement.

The payoff: Plenty of time off to reap the benefits of their hard work while they are still relatively young.

Monthly net income: $13,910

Assets: Cash $14,000; exchange-traded funds $100,000; his TFSA $153,000; her TFSA $127,000; his RRSP $154,000; her RRSP $44,000; market value of his DC pension $188,000; estimated present value of her defined contribution pension $125,000; registered education savings plan $46,000; rental units $915,000; residence $605,000. Total: $2.47-million

Monthly outlays: Residence mortgage $1,700; property tax $385; water, sewer, garbage $145; home insurance $70; electricity, heat $255; maintenance $200; transportation $435; groceries $900; child care $415; clothing $230; gifts, charity $375; vacation, travel $300; dining, drinks, entertainment $555; personal care $50; pets $80; sports, hobbies $30; health care $75; communications $130; his DC pension plan $1,000; RESP $415; TFSAs $1,000; her DB pension plan contributions $1,000. Total: $9,745. Surplus $4,165

Liabilities: Residence mortgage $428,000; rental property mortgages $707,000. Total: $1,135,000

Want a free financial facelift? E-mail finfacelift@gmail.com.

Some details may be changed to protect the privacy of the persons profiled.

Matthew Ardrey
Presented By:
Matthew Ardrey
VP, Wealth Advisor & Portfolio Manager
matt@tridelta.ca
(416) 733-3292 x230

TriDelta Financial Webinar – Investing in Real Estate – Hear From the Experts – April 20, 2022

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Real estate is a hot topic frequently discussed in the media and in conversation. Will the price of my home continue to rise? How will rising interest rates influence the market? What sectors of real estate are poised to outperform?

TriDelta is pleased to welcome 3 leading industry experts in Real Estate who will share their thoughts on strategy and outlook for the future. On Wednesday April 20th we were joined by Greg Romundt, President & CEO of Centurion Asset Management, Dave Kirzinger, Chairman of Rise Properties, and Corrado Russo, CFA, MBA, Managing Partner & Head of Global Securities of Hazelview Investments. These 3 speakers have over 75 years of combined experience investing in Real Estate and over $8 billion of assets under management.

Hosted by:
Ted Rechtshaffen, MBA, CIM, CFP, President and CEO, TriDelta Financial

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