Foresight - Fall 2024

As we look forward through the Fall of 2024 to the prospects for 2025 and beyond, we think it is worthwhile to first look back at where we have come from over the last 5 years.  In the summer of 2019, the then-current bull market was over 10 years old and, although we did not know when it would end, we certainly did not expect it to end with a global pandemic in February/March of 2020.

Imagine in the summer of 2019 that an investor was given a forecast that in the next 6 to 9 months there would be a global pandemic that would shut down the global economy resulting in the first bear market in 11 years,  creating global supply chain shocks in healthcare, technology and food products …causing  a spike in inflation we haven’t seen in close to 40 years … resulting in the US Fed Funds Rate going from .25 of 1% in February 2022 to 5.5%  in July 2023 … and triggering the second bear market in just  2 years … followed with a multiyear cloud of worry over when, or if, we are already in the next economic recession. 

Imagine then that investor is told that in 5 years portfolios with an allocation of 70% bonds/30% equities will be 25% higher, or 40%-45% higher with equity weightings of 60%-70%. In fact, that is what our client portfolios have experienced over the last 5 years to June 2024. We are always hesitant to pick specific time frames to talk of returns in limited periods as we do not want to be seen as cherry-picking statistics. Given all that has occurred over the last 5 years, we believe that equity markets have been very good to portfolios.

We now turn to the future. The Bank of Canada has already started to cut interest rates and the US Fed looks set to start cutting in September. This bodes well for portfolios, as equity markets tend to perform well over the 12-18 months following the first interest rate cut by the US Fed. Bond portfolios will also perform well as bond yields fall. This is fine in the short term, but what about the next 3, 5 and 10 years?

When we look out to the major themes that we believe will drive economic growth in the coming decade, we observe that: not much has changed! First, climate concerns and the more efficient use of energy will be a large driver of economic growth in the coming years. There are several threads to this….through renewable energy sources like solar, wind and hydro, efficient energy through improved technologies like energy storage (e.g. batteries) or production (e.g. wind turbines or solar panels), clean transportation through increased penetration in commercial and personal vehicles as well as marine and aerospace (planes and drones) and recycling through the more efficient utilization of the finite resources of the planet.

Second, infrastructure spending, especially in North America, has already started to ramp up after decades. This type of government spending has a powerful positive multiplier effect on local economies. Third, after the supply chain shocks of the 2020 pandemic, a reverse theme of “deglobalization of supply chain” has emerged, which is bringing production back home to generate local employment and to ensure security of the supply chain, especially in areas of technology, healthcare and food. Fourth, with most major global economies experiencing an aging population and forecasts for declining work forces, there will be a need for increased investment in automation in business and governments to cover the reduction in their respective workforces.

The investing strategy simplified to “Buy low! Sell high!” is hard to argue with, but a bit more complicated to execute. Accordingly, we manage portfolios on a monthly basis using various proprietary “Calls To Action” indices. For visual efficiency, these are summarized on a Dashboard.

Our fundamental portfolio construction begins with a Strategic Asset Allocation (“AA%”) Plan, specific to each portfolio. Drilling further down, allocations are also set for the economy’s industrial sectors and for geographic diversification around the world. Each month-end, the actual allocations at market are measured against these allocation plans, and thus identifying the variations from Plan.

This is where our Calls To Action indices (CTAs) come in, following a hierarchical order. The first index is the overall deviation from Strategic Asset Allocation Plan...the “ReBalancing CTA”. It has two parts. The first part is about Cash CTA deployment. This means that cash has built up in the portfolio, from either incoming dividends and interest, bond maturities or cash infusions. This index also keeps an eye on necessary cash reserve where the portfolio supports monthly draws to its owner. The AA% Plan tells us where the cash should be deployed to – fixed income or the market. However, the present state of those deployment calls may not be attractive at that time; thus, the cash may remain idle. If this uncertain condition may prevail for a while, the excess cash may be deployed in a high-interest savings fund.

The second part of the first index is ReBalancing CTA, net cash and it highlights the call to re-balance between a) a rising/falling stock market and “safer” fixed income and/or b) rising/falling stock markets in Canada versus the rest of the world.

The second index is the “Sector CTA” which reflects the interplay of the industrial sectors. In the ebbs and flows between a booming economy and a recession, the industrial sectors do not all move in sync. Some are “leading indicators” and some are “lagging indicators” of which direction an economy is moving. There is an investing approach that follows this path and replaces “Strategic” with “Tactical”, whereby over-weighting occurs in the sector(s) associated with (the guestimate of) the direction of the economy.

The Sector CTA Index aggregates all of the over/under-weights of the sectors to a single number. By definition of the economy, all of the sectors will never be perfectly on Plan. Accordingly, we set a de minimis of 3%. When the 3% is exceeded, our data flags the notable over/under for each sector. An “over” suggests a sell-down from a rising sector, and an “under” suggests a buy in a “beat-up” sector. These inputs are only inferential. Further market analysis is required to confirm this information before action is taken. The Rebalancing CTA informs us whether the sale proceeds should be re-allocated to fixed income, or whether one of the “under” sectors should be investigated for a buy.   

The third index is the “Regional CTA”.  We set geographic targets for the economic zones around the world. Similar to the Sector CTA, this index aggregates all of the over/under-weights around the world to a single number. Again, we set a de minimis amount. When the Rebalancing CTA calls for buys or sell-downs of foreign equity, the Regional CTA may direct the geographic action location.

Note the “double-double” when a foreign equity is being bought or sold- it affects both the Regional CTA and the Sector CTA. Our proprietary systems identify both of these impacts proforma in real time to assist our decisions.

When we buy or sell equities to achieve the purposes called by the CTA indices, we must then select which security to achieve that. There are two issues here: first is the choice between ETFs and direct stock-holdings. Second introduces the concept of “shotguns” and “rifles”. All ETFs have a “theme”: regional (eg Canada, the US, the world) and/or sectoral (eg broad-basket across many/all sectors or directed to just one, like technology). So…the “world” or “broad-basket” would be a “shotgun”, whilst “the US” or the “tech sector” would be a rifle.

 Stock-holdings tend to be “rifles”; however, some stocks are “conglomerates” operating in many sectors. Some stocks are geographically localized (eg Canadian telecoms) and others are involved in  world-wide commerce. The universe of ETFs broadly offers both shotguns and rifles.

Tax-smart investing principles also bear on these transactions. If we are selling a security (because it has gone up!), it matters tax-wise which account the security is in.

Capital gains tax treatments, by account type

Trading account*	TFSA	RRSP/RRIF
Half-taxed as a capital gain in the year	Tax-free	Fully-taxable but only as funds are drawn out

*Currently subject to new tax laws in 2024

Obviously, the TFSA is the best result - tax free, whilst the Trading account will incur tax in the year, but only on one half of the gain. The gain in an RRSP/RRIF is fully taxable…but deferred. It could be argued that the capital gains are the very last dollars withdrawn from a RRSP/RRIF; therefore, the time benefit of tax deferral could be very long. If the taxable gain is not large in a Trading Account, then the tax hit is likely immaterial to the decision. Also, the taxpayer may be carrying capital losses forward from the past, which can offset the current year gain. We track our clients’ availability of loss carryforwards from their prior tax returns.

Another constraint is that, perhaps, the rifle security that needs to be sold is only held in one of these accounts; thus there is no choice in the decision! A final constraint relates to the buy call on the deployment of the incoming cash from the sale. We deploy “tax-smart investing” principles in the overall portfolio construction. Inter alia, this includes a heavy weighting of (foreign) equity in TFSAs. If the call in the Rebalancing CTA is to sell equity and buy fixed income, we are pulled away from our tax-smart investing objectives in buying fixed income in the TFSA. Our response is a judgment call. Sometimes we let the AA% call trump tax-smart investing, and buy fixed income; other times, we park that cash in a high-interest savings fund and give the markets some time to call an equity buy. 

Fixed transaction costs also can bear on these action calls…on both the sell and the buy.   

Lastly, we monitor two minor indices. The FI CTA tracks how much of the fixed-income portfolio is directed at “Alternate fixed income” instruments (non-government fixed income securities that offer the potential for higher yields than government and bank fixed income securities). Our target is 10% of the fixed income portfolio. The Janus CTA compares our Master equity portfolio of securities with each individual portfolio, and tracks the percentage of securities not held in the client portfolio. When equity buy calls arise, we determine whether the Janus missing securities answer the buy call, and further that the security is at a decent buy price. 

……..25 years behind us You should have received our letter in August announcing our move from Salmon House after 25 years. We have made an ever-so-minor change by moving approx. 3 minutes further up the hill to #100 2240 Chippendale Road. We look forward to welcoming you to our new digs.

30 years ahead of us………………. In September, as we settled into our new location, we ended our 30th year, and commenced our next 30 years….new building, new surroundings, all new furniture, new phone lines. Mike, Gary and Don look forward to securing your future and those of your next generations.

The Ploughman and the Astronaut

The Evolutionary Journey to WealthNess

Don began writing his first book in January 2020...just before Covid. For two and a half years, he spent the last week of most months ensconced in a writer’s retreat. The following nine months were spent pursuing a publisher. The next year and a half was spent on six different edits. The finished 260 page book hit the printing press in September 2024. The book launch event will take place at the Fairmont Chateau Whistler in late September. The front cover was designed and painted by his nephew.

This is a personal finance self-help book for the intellectually curious. It introduces a unique approach to appeal to a broad readership. It uses the ski-mountain protocol of circle, square and diamond for beginners, intermediates and experts. Throughout the book, topics are identified by these signposts to spare beginners from becoming glassy-eyed with topics that are overly complex for them and, similarly, to spare experts from boredom with things they already may know.

The structure of the book breaks into six chapters: Invocation, Chrematistics (Greek for the study of wealth as measured in money), Families & Finance, Financial Planning, Investing and Legacy. Each chapter has subtopics within. The Invocation chapter sets the stage and primes the pump to embrace change in your financial health. It closes with an invocation back from the reader to the writer: “Take me to places that I have never been and introduce me to thoughts that I have never had”. The Chrematistics chapter addresses money philosophy, root attitudes, purposes and sources, happiness and meaning and good decision-making. The Family chapter examines couples melding their money philosophies together and shaping those of their offspring. The Financial Planning chapter invokes deliberate practices to set goals, build financial silos and keep an eye on the horizon. This chapter finishes with an interesting look into the financial implications of today’s extended longevity. The Investing chapter dichotomizes between philosophy and strategy. It then introduces the concepts of design, house construction and journeys on a canoe and a train. It closes by introducing ground-breaking concepts for rates-of-return and adding a human factor to the retirement math in a financial plan. The Legacy chapter invites a more dynamic approach to affairs of estate: being more proactive with your heirs to prepare them to manage the “meteorite” of a bequest. The book closes with his Coda chapter as a summary Call to Action, hopefully ending with the reader declaring “I feel like I just earned a PhD in personal finance”.

Don’s eclectic 40-year reading list brings a polymath flavour to the narrative. He infuses a transmogrification across intellectual genres...bringing them all to the world of personal finance. Pathology, epigenetics, psychology, thermodynamics, ecology, design, entropy, meteorology, biology, chemistry, magic and neuroscience all inform the world of personal finance. Being a “quote-fan”, he adds colour with wise saws from many learned sources...all intended to create “ah-hah” moments for the reader. Further colour is added by way of real-life stories, called Sketches in Personal Finance, based upon Don’s 45-year career interacting with his clients and sharing in their lives.

The Ploughman is available through all the usual book outlets, including books.friesenpress.com/store/title/119734000364945759. Also visit the author website: www.donnilson.com.