With this commentary, we plan to communicate with you every month about our thoughts on the markets, some snap-shots of metrics, a section on behavioural investing and finally an update on some of the people at MacNicol & Associates Asset Management (MAAM). I hope you enjoy this information, and it allows you to better understand what we see going on in the market place.
“Successful investing is about having people agree with you … later.” – Jim Grant
Market Commentary: Easy Money
Yesterday, the Bank of England cut its key interest rate 25 bps to 0.25%, citing that they would do whatever it takes to ameliorate any negative impacts or uncertainty revising from the Brexit vote. This announcement coincided with details of a purchase program worth ~$190 billion, consisting of both government and corporate bonds, as well as additional $130 billion loan programs for banks, in order to ensure continued lending. Central bank governor Mark Carney also indicated his willingness to increase this plan or cut interest rates further if need be. This announcement is in confluence with recent activity and statements made by the European Central Bank (ECB), who has recently increased their Quantitative Easing efforts. The ECB meets next month, where they are expected to increase the magnitude of their initiative further. On the other side of the world, Japan has further increased their unprecedented easing program, unveiling $73 billion of new spending on infrastructure and cash disbursements. The Japanese government now holds nearly half of the ownership of outstanding Japanese ETFs and nearly a third of the outstanding Japanese Government bonds. Although the US has temporarily paused their outright Quantitative Easing efforts, statements from within the Fed indicate that they are willing to reinitiate their efforts should the need arise; with a much weaker-than-expected second quarter GDP figure, we do not believe this to be out of the realm of possibility.
The resulting effect of this global quantitative easing effort has been a fundamental distortion of the global equity markets and – even more significantly – the global credit markets. Exhibit 1 below, which was referenced in our Debt Fund Presentation (a recording of which can be found on our website), aptly displays how these global easing programs have suppressed international interest rates.
This chart shows that approximately 25% of global sovereign debt is trading at negative interest rates, due largely to massive international quantitative easing programs. This has resulted in citizens and institutions necessarily searching elsewhere for their fixed income investments, with the US treasury and corporate debt markets being the primary beneficiaries. A recent Wells Fargo study estimated that nearly 40% of US corporate debt is now held by foreigners, contributing to a storyline that we have referred to in the past as the ‘zeal for yield’.
Due to this strong demand, US corporations have been able to borrow at historically cheap levels and have, in turn, ratcheted up the leverage of their balance sheets. For example, Apple now has $85 billion in debt, Microsoft has approximately $55 billion, and Intel and IBM both have $24 billion and $44.5 billion of debt, respectively. It was not long ago that all of these companies were significantly under-levered, or even debt-free. Fundamentally, this would not be bad, as long as the investments made with those funds were lucrative and returned greater value than the cost of the debt; however, many of these funds were used for temporary measures such as stock repurchases or dividend increases. We believe that investors should be wary of companies which have significantly increased their leverage profiles, and that they should pay particularly close attention to where those funds where spent.
Although we still believe there are pockets of value left in the current stock market, we are becoming increasingly cautious of the strong undercurrent of uncertainty at play, and as such, we are becoming increasingly attracted to gold positions. Aside from the oft-mentioned ‘flight to safety’ value in uncertain periods, the gold market also has a few added catalysts in the near-term, which are displayed in Exhibits 2 and 3 below.
Exhibit 2 displays the seasonality of gold prices, and how, historically, gold bullion has performed the strongest in September. This is a key reason why, despite gold’s recently strong performance, we still believe current prices to be a decent entry point. Exhibit 3 shows the number of notable gold deposit discoveries (as the bars), and how they have been rapidly decelerating over the past 10 years. The blue line represents capital expenditure allocated to exploration (a key component required to find new deposits), and how it has fallen sharply over the last few years as well. Both of these indicators are bullish for a slowing – or even declining – supply of gold, while global central banks are increasing their demand at a feverish pace. It is our belief that the uncertain environment, mixed with the strong demand and weak supply of gold, will result in strong moves in bullion prices in the medium to long term.
Viewing the market in its entirety, we will always be of the belief that there are spots of opportunity. However, we believe, as prudent managers, that we must aptly address building concerns in the market associated with the unprecedented level of international quantitative easing and slowing gold. We strongly believe that appropriate precious metal allocations are the best way to protect against this.
Behavioural Investing: Illusion of Control
In the investment industry it is easy to come across those who believe they can predict the future, as well as those that believe the fate of their investments over a relatively short time period to be entirely in their hands. The truth is, the market is a fickle beast, and the short-term moves of prices are often wildly unpredictable; however, this does not stop those from believing that they are in control. This is known as the ‘Illusion of Control’ bias.
Put simply, the Illusion of Control bias references the tendency of human beings to believe that they have larger control than they do in regard to certain outcomes. In reference to investing, this particular bias can be quite damaging, as it can result in investors moving too far on the risk curve. They believe that they have control over their portfolio, so tend to have higher confidence and less aversion to concentrated positions or inherently risky industries. The eventual potential risks of such behaviour can be easily discerned. This phenomenon can also be particularly strong in familiar situations, or with situations that provide regular positive feedback. An example would be when an investor enters a position, and it initially increases in value. This would be equivalent to positive feedback that their future prediction of the outcome is correct.
The most important thing to keep in mind, in order to avoid this fallacy, is that certain things are not inside of your control, and that’s ok. Don’t pretend to know the future with certainty, and be prepared for multiple outcomes. Frequent introspection is important, as well as a well-defined internal definition of control or predictability. A well-diversified portfolio inherently benefits from multiple outcomes, and is not reliant on one specific occurrence or event.
We are very pleased and proud to announce that our Portfolio Administrator, Erin O’Connor, got married recently! Erin got married on July 16th to Pierre, her partner of 9 years in a beautiful greenhouse up in Newmarket. Diane and I had the opportunity to attend the wedding and it was a great day filled with so much love. After the wedding, Erin and Pierre went on their honeymoon to St. Lucia, where they spent 8 days relaxing at Windjammer Landing Resort.
We wish Erin and Pierre all of the best in their new adventure!
David A. MacNicol, B.Eng.Sci., CIM, FCSI
MacNicol & Associates Asset Management Inc.