Good morning,

 

Most of you likely have at least heard of the popular calculation about how much of your portfolio should be in bonds: your age, expressed in a percentage. I’m 44 years old, so therefore I should in theory have 44% of my investment holdings in bonds with the remaining 56% in stocks. Someone who is 75 and therefore less in need of growth from their investments should therefore have 75% of their accounts invested in bonds. The problem with this ‘formula’ has been that for about the last 15 years, the returns from bonds have been awful. If you held high grade corporate bonds during this time, then you likely enjoyed income of about 3-4% per year, assuming the prices of bonds remained static. The FTSE Universe Bond index has averaged a 3.7% total return (income plus growth, if any) over the last 15 years up to the end of July. So a 75 year-old investor was supposed to have ¾ of their portfolio in an asset class that would only generate $30-40K per year in return on a $1 million… Stocks meanwhile have outperformed significantly over the same time, returning 5.44% per year for the TSX and 10.75% for the S&P 500. Taking the midpoint of those two returns, one would have received about $80K per year in returns from that same $1 million investment. Breaking the rule and being overweight in stocks worked out much more favourably, regardless of one’s age. What about today though?

I know this will read like a copy/paste of past letters to clients: inflation and interest rates continue to dominate market sentiment and investment headlines. Stocks, bonds, real estate, term loans, lines of credit, etc are all affected. I’d say that ‘we continue to manage things according to the usual criteria’ but that’s becoming less true, especially in our diversified income (balanced) strategy. I’ve mentioned that we’ve been buyers of short (1-3 year) term bonds lately and it continues to be the case. High quality bank bonds are now yielding over 5%, in some cases for maturities of less than 4 years. We’ve now even moved off some of our preferred share holdings to increase exposure to regular corporate bonds, as the risk/return picture has finally tilted toward the latter. It looks likely in our diversified income portfolio that the equity portion will be below 60% of the total strategy for the first time since that portfolio’s inception… finally bonds seem to have regained a place as a meaningful contributor of returns in a diversified portfolio, for the first time in a very long time!

That’s not to say that stocks aren’t still the best store of value and the best protection against inflation. Our companies, though down in value this year, generally have returned solid results. Despite concerns about inflation, labour shortages, rising wages, higher debt-servicing costs and recession concerns, our portfolio of companies continue to deliver very predictable quarterly results. Over time, I’m confident that we will be rewarded for our patience as we have always been in the past. In the meantime, I’m seeing more interesting investment opportunities where the shares of good companies are trading at very attractive valuations. This happens most often when most people are nervous about investing in equities. Like Warren Buffet, I’m at my most optimistic when others are fearful.

If I was to take a shot at predicting the next little while, I’d take the middle ground. That is I think we will stick with higher interest rates than what we’ve been accustomed to for a few years, but I don’t think rates will have to go meaningfully higher than they’ll go in the next few months. Inflation should abate as we start pacing data recorded after Russia’s invasion of the Ukraine. Remember inflation is a measure of growth over the previous year, so if prices from a year ago are already high, then it should hopefully result in lower growth rates, which should give central banks pause about needing to raise interest rates further. I think the labour market has already started to soften but I admit it hasn’t shown up as clearly in the data as of yet. Rate hikes are still fresh, however so this might take a few more months to sink in as well.

 

I apologize for the ‘economist’ feel of this letter. I’m happy to try to break it down into more simpler terms for any of you, if you’d like to have a call or get together. On that note, I do appreciate the fact that so many of you have made time to conduct reviews with either Shalu, Marta or myself. Our industry has moved toward mandatory annual reviews for every discretionary client (this is anyone who pays us a fee to manage their portfolio for them) which should result in us having a better understanding of your individual/family situation and also you having a better understanding of how your portfolio is invested with us. Lastly, I’m happy that I’ve recently been approved to start using the title of ‘Senior Portfolio Manager’ for the first time. I’d love to say it’s because someone is finally paying attention to our stellar track record but I suspect it has more to do with me managing money discretionarily for more than 13 years to this point! Either way, on behalf of our team, I’m forever grateful that you as our clients have been so supportive along the way. Please do not hesitate to contact us at any time. Enjoy these last few beautiful weeks of summer.

 

George Wright, CIM, FMA | Senior Portfolio Manager, Senior Wealth Advisor | CIBC Private Wealth Management