Entries from June 2019 ↓

Who’s right?

RYAN By Guest Blogger Ryan Lewenza

First the important stuff. I have to give a shout out to our Raptors, the 2019 NBA champions! Being a long-time fan and a proud Torontonian, I couldn’t be happier for our team who played their butts off and showed incredible grit, determination and team work. We can all learn something from that team and their season. Now let’s re-sign Kawhi and go back-to-back next year, when we’re all collectively chanting “let’s go Raptors!”

Ok, now on to nerdy market stuff.

Since the beginning of the year we’ve seen a peculiar and unsettling trend of both stock and bond prices moving up together. As seen below the S&P 500 has rallied roughly 15% while the US Government 10-year bond yield has declined from 2.9% to 2.1% (bond prices move inversely to yields) or over 25%.

Normally you see bond prices declining as stocks rise since the economy is generally strong causing the Fed and other central banks to hike interest rates. This time it’s different with both moving up together resulting in conflicting messages from the stock and bond markets. Stocks are suggesting more growth while bonds are signaling a slowdown/recession. Which one will prevail?

Stocks and Bonds Are Rallying. Who’s Right?

Source: Bloomberg, Turner Investments

Why are bond yields declining?

I believe it’s largely due to two factors – recent weaker US/global economic activity and Trump’s ongoing trade war with China.

Look at the chart below. I overlaid the ISM manufacturing index – a great leading indicator of manufacturing activity in the US – with the US 10-year yield. Note the strong correlation and recent declines in both. This chart illustrates that the decline in bond yields is being driven by softer economic data. The key question is what is driving this (Trump’s trade war or just a natural slowdown in the economy) and what will the Fed do in response to this economic soft patch?

Bond Yields Are Down On Slowing Economic Growth

Source: Bloomberg, Turner Investments

Will the Fed cut rates?

What a 180 degree turn from late last year when the Fed was signaling that they would continue to tighten monetary policy and hike rates further. Many economists were calling for 2-3 rates hikes this year (I was on record saying one and done for this year) and now the market is pricing in 2-3 rate cuts. Currently Fed Funds futures are implying an 84% probability of a cut at its July meeting.

Either the economy has slowed more than the Fed expected or Trump’s ongoing threats to Fed Chairman Powell are having the desired effect leading the Fed to backpedal faster than the NBA sportscasters who said the Raptors had no chance against the Bucks and Golden State!

I believe the pendulum has swung way too far to the bearish side. The fact remains that the US/global economy is still in decent shape. For example, the US unemployment rate stands at a 60 year low. If that doesn’t suggest a strong economy then I don’t know what does?

I see economic data stabilizing and bond yields starting to move back up as investors realize they overshot and the economy is not going to hell and a hand basket. Plus I continue to believe a US/China trade deal could be hashed out as it’s in everyone’s best interest and Trump will want a big win ahead of the 2020 election.

Given this I see the Fed cutting at most once this year and it’s more of an insurance policy rather than a signal of a more protracted downturn.

Fed is Expected to Cut Rates at July Meeting

Source: Bloomberg, Turner Investments

What does this mean for the stock market?

To me both scenarios are bullish for the stock market. Either I’m correct on the economy and it stabilizes, which would be bullish for corporate profits and the equity markets overall. Or I’m under-appreciating the slowdown in the economy and impact of Trump’s escalating trade wars, in which case, the Fed will cut rates more than I expect thus are adding more stimulus and support to the stock market.

We used to talk about a Greenspan or Bernanke Put on the markets (they would cut rates to support the stock market). Now it looks like we have the Powell put! And the one thing I’ve learned about the markets and investing, it generally does not pay to bet against the Fed. So just like we said earlier this year, block out the noise and position portfolios for more upside, but do so with more defensive investments like high-quality dividend payers and healthcare stocks just in case I’m wrong. It does happen from time to time.

Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.


Fat tax

What are the fairest taxes? Dumb question. The ones other people pay, of course.

As we cruise towards a federal election in exactly four months and as the Americans wade into a presidential campaign, taxes are a big deal. In the last four years the Libs have gutted the contribution limit on the most popular tax shelter (the TFSA), raised taxes bigly with a new bracket for upper-income earners, assaulted the self-employed, eliminated small-business income-splitting and jacked taxes on stock options. If re-elected, the agenda may include higher capital gains taxes and lower dividend breaks. All in the name of fairness, of course.

The reason?

Simple. It’s the Gap. The income gap. The wealth gap. The 99% and the 1%. In a democracy nobody wins office promoting policies to assist the affluent, even if these are the folks forming companies and creating jobs. You gain power with ‘us’ vs ‘them’. In this case, you know who ‘them’ is. The more someone earns or has, the bigger the tax target they are.

The latest barrage comes, unsurprisingly, from Jagmeet Singh and his NDP. The “New Deal for People” platform, released days ago, says this:

To make our tax system fairer and ensure that the wealthiest individuals are paying their fair share, we will increase the capital gains inclusion rate to 75 percent. A New Democrat government will also boost the top marginal tax rate and ask the very richest multi-millionaires to pay a bit more towards our shared services with a new 1 percent wealth tax on wealth over $20 million.

Hmm. Increasing the cap gains inclusion rate would be a major change in tax policy and hit capital markets with a thud. As for the top marginal rate, it’s already over 50% in a majority of provinces, topping out as high as 54%. Should the state really take more than half what successful people earn? And then add a 1% wealth tax? (At least $200,000 more annually for the ten thousand people in Canada impacted.)

In fact, Jag’s got a whole video about tax ‘fairness’. Ensure you’re sitting down as you watch it.

In Canada, the lefties (which now embraces the Trudeau Liberals) and in the US, the Dems (AOC, Warren, Sanders et al) are out to exploit the Gap. The fiction is that there are so many rich people all government need do is prick them a bit more and, presto, money will flow for services and redistribution. Our political leaders portray upper-income dudes as coupon-clippers, trust fund kids, fat cat business owners, avaricious rentiers, slack-off professionals or privileged financial bloggers. In contrast, everyone else is a “hard-working Canadian”. Vote for me. You’ll get more. The other guy pays. How can you lose?

The experience so far?

The Trudeau eat-the-rich tax bracket was supposed to yield $2 billion in new revenue and pay for a teensy middle-class tax cut. But, whoops, didn’t happen. Seems rich people are like everyone else (who knew?). When you change the rules, they change with them. Because income morphed into other forms of compensation, the tax take has been pitiful. Meanwhile this erosion of the tax base has meant provincial coffers are also. The net impact of a tax increase has therefore been a reduction in overall government revenue. Obviously things are not so easy. Or voters have been lied to.

Well, as we lurch towards the election a poll finds 70% of Canadians support the idea of a wealth tax. If implemented, it might click in with assets at $20 million. Over time you can be sure the threshold would drop. Since ‘wealth’ includes the assessed value of a house as well as investments and the market worth of a business, the net would widen.

But it turns out that wealth taxes may be a bad idea, which is why only four countries in the developed world still have them. Now a study by the CD Howe Institute (yeah, I know – right wingers) concludes the Gap could be narrowed better by reforming existing taxes on capital, plus bringing in an inheritance tax. The study points out that real estate is already taxed according to its value by local governments, plus there are lots of people who have wealth but not much income. So how would a pensioner living in a house that the market pushed up in value pay? Is it fair to force them to sell?

Taxes in Canada have never been higher nor so pervasive. And yet the federal government spends far more than it takes in, adding the rest to the debt on which taxpayers pay gobs of interest. After giving billions to people to have kids, politicians are now peddling free pharmacare and hinting at a guaranteed income for all.

Telling voters the rich will finance this is fiction. It’s fraud. But it works.