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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

 

 

 

 

 

 

 

 

 

 

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

TriDelta Insight Q1 – Managing through change

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Overview

The world is a difficult place to navigate in the best of times, and Q1 2022 was certainly not the best of times.

In this quarterly review, we will look at:

  • Interest Rates and Inflation
  • TriDelta’s current view on stocks, alternative investments, bonds and preferred shares
  • Some personal finance highlights from the recent Federal Budget – including Flow Through Shares

Q1 proved a difficult three months for many stock, bond, and preferred share markets globally but did also give rise to some positives and opportunities. While March was largely a positive month and provided a recovery from the first two months of the year, the U.S. had its first negative quarter in two years while Canada remained positive. Canada’s outperformance can be attributed to our greater concentration in Energy and Materials sectors which outperformed the broader markets. Notably, the US indices have less concentration in these sectors while our lower concentration in higher growth tech sectors provided further protection from the market turbulence.

Source: Bloomberg.

Q1 Market Returns

Interest rates and Inflation

The economy is at a delicate moment in which high inflation could become entrenched. That has created a new urgency to raise interest rates, itself a source of risk for markets and the economy. Central Banks around the world have signaled more aggressive steps to fight inflation and here in North America we are no different as both the Bank of Canada and U.S. Fed raised rates in March with further expectations to do so throughout the year. There has also been a focus on reducing the size of balance sheets in recent months with the U.S. Fed stating they intend to cut their bond holdings by about $95 billion a month – nearly double the pace implemented five years ago when they last shrank their balance sheet. Financial markets now expect much steeper hikes than previously in the year. Higher rates from these Central Banks will heighten borrowing costs for mortgages, auto loans, credit cards and corporate loans. In doing so, they hope to cool economic growth and rising wages enough to rein in high inflation, which has caused hardships for millions of households and poses a severe political threat to those in power.

We are still positioned for higher inflation and higher interest rates but are open to buying into sectors that may be oversold. We continue to place a premium on active management in the face of immense uncertainty and volatility. The two TriDelta equity funds have performed well in comparison to global equity markets, with what we view as much less risk. The TriDelta Pension Fund was up 0.86% on the quarter, while the TriDelta Growth Fund returned -0.44% for Q1. This outperformed our benchmarks (which include Canada, the U.S., International and Emerging Markets) by 2 to 3 percentage points on the quarter. Outside of Canada, major equity markets globally fell as much as 5% to 15% in some cases.

TriDelta equity view – what we are doing and why

Three risks dominated headlines this quarter: the Omicron wave, the spike in inflation/Fed rate hike fears, and the war in Ukraine. Due to these concerns equity markets had a difficult quarter with high growth companies and those exposed to the Ukraine conflict suffering the most. The focus has continued to be on quality as investors have prioritized profitability, stability and realized growth. Coupled with a strong balance sheet there are companies which are still well positioned despite the risks moving forward.

The move in commodities has also been notable over the past three months. Energy, in particular, had a great move to the upside, justifying the gains in the equities and helping the TSX manage this tough quarter. Prices have been driven higher because of the lack of capital provided to this sector over the past few years and the sanctioning of one of the largest commodity-producing countries.

Into the remainder of 2022 TriDelta Funds continue to be nimble and active to take advantage of attractive opportunities.

  • We continue to view this as a rangebound market and are focused on adding equities when oversold and trimming when overbought.
  • In the funds, we are becoming more concerned about the cyclical sectors and have been trimming some cyclical exposure and adding to underperforming sectors like technology, consumer discretionary and financials.
  • The world seems to be coming to the realization that the transition to clean energy will not happen over night and we will need a period of transition. Energy has been the leader, but we should also see strength across the materials sector going forward.
  • There has been a common theme among many multi-national companies who have stressed the need to reorganize their supply chain to help insulate themselves from the issues currently being experienced. This will have a significant impact on these businesses and has been dubbed “de-globalization” by many influential investors and business leaders.

 

 

TriDelta Alternative View – what we are doing and why

The Alternative asset class provided greater insulation relative to being invested in a typical stock and bond portfolio.

On Real Estate,

  • Real Estate continues to perform well and include critical inflation protection and steady yields.
  • Many of the partners we work with were able to pass along the added costs of inflation to tenants in 2021 with some increasing rents 10-20% in some areas.
    • Property types with short lease durations can reset lease rates more frequently and are in a more advantageous position to grow cash flow. Concurrently, lease structures offer inflation protection with built-in rate increases tied to inflation.
  • North America continues to be a top performer while Europe and Asia have struggled.
  • Moving forward North American Residential and Industrial Facilities are poised for further growth while high quality Office Space may be well positioned to attract tenants. We also share the view that the fragmented Self-Storage market offers an attractive opportunity.

On Private Credit,

  • Private Credit returns remained favourable and, in many cases, offer protection from rising interest rates. Loans from these managers tend to be shorter term which offers them the ability to provide new financing terms to reflect the increase in interest rates.
  • These managers continue to see increased deal flow and expect further opportunities as traditional bank lenders restrict capital to small and mid-size businesses. Moving forward, we see this as an ample opportunity.
  • Borrowers continue to look to the private markets due to its relatively greater speed and certainty of execution, after many were burned by public markets and banks pulling back capital during more uncertain times. Equally, borrowers value the adaptability and partnership of private lenders.

Yields on Private Credit and Real Estate remain much more favourable than investing in traditional bonds.

Source: BofA Securities, Bloomberg, Clarkson, Cliffwater, Drewry Maritime Consultants, Federal Reserve, FTSE, MSCI, NCREIF, FactSet, Wells Fargo, J.P. Morgan Asset Management. *Commercial real estate (CRE) yields are as of September 30, 2021. CRE – mezzanine yield is derived from a J.P. Morgan survey and U.S. Treasuries of a similar duration. CRE – senior yield is sourced from the Gilberto-Levy Performance Aggregate Index (unlevered); U.S. high yield: Bloomberg US Aggregate Credit – Corporate – High Yield; U.S. infrastructure debt: iBoxx USD Infrastructure Index capturing USD infrastructure debt bond issuance over USD 500 million; U.S. 10-year: Bloomberg U.S. 10-year Treasury yield; U.S. investment grade: Bloomberg U.S. Corporate Investment Grade.

TriDelta bond view – what we are doing and why

While we remain at historically low interest rates and ultimately view increased interest rates as necessary, the Central Banks walk a thin line with very little room for error. Here at TriDelta we share several views moving forward:

  • Central Bank logic is twofold – (1) to rein in inflation (which is evidently no longer transitory) and (2) to raise rates surrounding a strong economy.
    • Many perceive them to be too late on this front; we agree in terms of the underlying economic conditions, but not on inflation as, unlike other periods of outsized inflation, the drivers are largely structural, such as the inefficient deployment of physical capital and labour forces due to the COVID mitigation measure, the shifting landscape (including work from home), economic warfare, and ESG shifts are raising costs.
  • Lowering the demand for money through raising the price of money does not address these long-term supply issues. This is occurring while the underlying economy, particularly in the U.S., is already slowing.
    • Consumer demand has softened into 2022; corporate spending was already reduced; mortgage rates are up 1.75% year to date in the U.S.
    • Coupled with fiscal support being withdrawn this year poses a significant risk to the economy.
  • While it is possible to have a recession without monetary tightening, the opposite does not hold true; monetary tightening always happens with a recession.

In recent updates we have continued to share our preference towards using a tactical approach to bonds and owning short term bonds for their greater protection in a rising interest rate environment. As you can see in the chart below this has proven the correct approach.

Source: Purpose Investments

We continue to view bonds as an important component of a diversified portfolio and advocate for a focus on being selective and tactical in our approach.

On Bonds,

  • Central Bank intentions are clear, but they will not likely be able to raise rates as much as intended before underwhelming economic performance and falling markets derail their efforts.
  • We believe we are at or near the highs in government bond yields.
  • As opposed to 2021, the 1-5 year bonds represent the best value in our opinion as the yield curve has become exceedingly flat.
  • The outlook for riskier bonds is uncertain. Spreads have widened in the high grade and high yield spaces and are likely to continue to do so as corporate bond supply is continuing to be issued while the extent of an economic slowdown has not been fully recognized.

TriDelta preferred share view – what we are doing and why

Preferred shares have had a volatile start to the year, with many cross currents in play. Down roughly in line with bonds, Rate-Resets have outperformed Straight preferred shares by about 3%. This is a continuation of 2021 when Rate-Resets outperformed by a large margin. Many institutional preferred share investors have shifted out of the space and back into traditional yield markets or into equity opportunities.

In our 2021 Q4 update we referenced one of the challenges in the preferred share market being that the market is shrinking as banks and some oil and gas names redeem issues in favour of cheaper financing via specialized bonds. Perhaps shockingly, the first three months of 2022 saw several new issues into this challenging market at yield “concessions”, rendering existing preferred shares relatively expensive.

Moving forward there are important trends we continue to watch closely.

On Preferred Shares,

  • Higher rates should be a positive for Rate Resets and Floaters.
    • Wider credit spreads are not, and resets will likely take their cue from corporate bonds.
  • The shrinkage of the market is still a tailwind, and the recent selloff represents an opportunity.
  • We continue to hold our allocation steady and pick away on further weakness while being comfortable with near term volatility.
  • The rate pressure is the greatest challenge for Fixed Rate Preferred Shares but most of the backup should be behind the market.

Some personal finance highlights from the recent Federal Budget

  • Very few negatives.
  • No change to capital gains taxes.
  • Flow Through Shares were largely left alone. These continue to be a great tax savings opportunity for those with taxable income of $275,000+ or those with a Corporation where you are drawing out $400,000+. Be sure to talk to your Wealth Advisor if you are in that category.
  • There may be some changes to Alternative Minimum Tax in the Fall. It will be focused on those with taxable incomes over $400,000, who are currently paying less than 15% of Federal taxes.
  • New Tax Free First Home Savings Account in 2023. This is meant to provide savings room for up to $8,000 a year and up to $40,000 in total, that can be used for a first-time home purchase. While this isn’t a negative at all (other than the tracking and implementation of another tax- sheltered account), it will likely have very little impact for younger people in saving and putting in down payments on a first home.
  • There are all sorts of other details in the Budget, but these are the ones that would likely affect some of our clients.

In conclusion

The World is particularly complicated at the moment. In times like these, our general tilt is towards companies making solid profits, with reasonably low debt ratios, especially those with hard assets like real estate and commodities. Rate reset preferred shares and shorter term bonds, along with some higher yielding alternative investments, should work well in an increasing rate environment.

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

TriDelta Financial Webinar – TriDelta’s Up to the Minute Investment Thinking – February 17, 2022

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As the world turns, the conversation has meaningfully switched from the Covid-19 reopening to other areas of the market. In this webinar, you will hear about the investment impact of:
• Rising interest rates
• Rising inflation
• Global markets vs. North America
• Trouble in the Ukraine

We will speak to what TriDelta sees on the horizon and hear from TriDelta Portfolio Managers Cameron Winser and Paul Simon, and special guest Dana Love, Vice President & Senior Portfolio Manager at Dynamic Funds. They will discuss what we are doing to take advantage of these possible changes and where we think we are headed over the next 6 to 12 months.

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

TriDelta Financial Webinar – 12 Questions with Stephen Poloz, former Governor of the Bank of Canada – January 14, 2021

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As a new year is upon us, it is important to get a handle from the experts on key issues.

It is TriDelta’s pleasure to present Stephen Poloz, Special Advisor at Osler, Hoskin & Harcourt LLP and former Governor of the Bank of Canada from June 2013 to June 2020. Stephen will join us to share his views on the K-shaped recovery, offer his insights on interest rates, cryptocurrencies, the Canadian dollar, Canadian competitiveness and engage in an interactive dialogue on 2020 in review.

Stephen is a widely recognized economist with nearly 40 years of experience in financial markets, forecasting and economic policy, including 35 years in the public sector.

Hosted by:
Paul Simon, CFA, VP, Fixed Income, TriDelta Financial
Ted Rechtshaffen, CFP, CIM, MBA, President and CEO, TriDelta Financial

 

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