Ignoring investment rules to achieve income

 

A few months ago, I asked readers for advice regarding a $300,000 inheritance. The couple are in their late fifties, debt free with little savings. Although, they are very fugal, they live paycheck to paycheck due to lack of steady full time work. Few companies want to hire older workers when they can hire young people for a lot less.

Being very good friends, they came to me for some free advice. After a few meetings, I realized that traditional investment strategies just wouldn’t work this couple. They have been dipping into their retirement accounts to pay bills. I recommended putting $100,000 back into their retirement accounts. The $200,000 into a joint investment account with a discount broker in order to split the income and save on fees.

Disregarding Asset Allocation guidelines

Based on their age and proximity to retirement, a 60% equities and 40% bonds mix would have been appropriate. However, investing in bonds with low interest rates, inflation and taxation doesn’t give them very much income.

Disregarding Diversification guidelines

Being Canadian, foreign dividends are taxed like interest payments similar to Canadian bonds. Plus, foreign assets are subject to currency fluctuations. The increased value of the Canadian dollar has wiped out all U.S dividends and most of the capital gains from owning U.S. stocks.

Disregarding suitability guidelines

This couple’s investment knowledge is very limited, their only investments have been in mutual funds with high management fees. After explaining how high fees will reduce their income, they agreed to take more risk in owning some individual stocks and exchanged traded funds.

Constructing a portfolio to maximize income and minimize risk

  1. I invested $61,418 in four Canadian Reits that generates $418.16 per month or $5,017.92 per year. The Reits income will be a combination of interest and capital gains. Compared to investing $120,000 in bonds yielding 3% per year or $3,600.00
  2. I invested $63,329 in three Canadian dividend stocks that generates $330.00 per month or $3,960 per year. Due to the couple’s low income, these dividends will be tax free income.
  3. I invested the balance of $75,253 into four covered call ETFs that generates $392.00 per month or $4,704 per year. The covered calls will produced capital gain income and the ETFs also has some dividend income in their monthly distributions.

Grand income total works out to $1,140.16 per month. The average annualized return on the $200,000 portfolio is 6.85% with a minimum amount of risk.  

This is only a temporary solution to achieve some monthly income until their work situation changes. Sometimes investment guidelines have to be broken because one size doesn’t fit all.

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10 Reasons to be cautious on equity markets

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David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.

Here are my 10 reasons to be cautious on equity markets right now.

Valuations are stretched

Trailing and forward price-to-earnings multiples are now in the top quintiles historically and the most expensive in 15 years.

Only in 1929 and the “Dotcom” bubble has the cyclically-adjusted multiple (CAPE) been as high as the case today.

We are heading into the ninth year in the cycle and have logged an epic 250-per-cent surge in the process. As retail investors now plow in to this market in the late innings, one could legitimately ask what it is they could possibly know that corporate insiders do not, considering the latter have been selling their company’s stock this year at a pace not seen since the data began to be published in 1988.

Extended leverage

U.S. margin debt has surged at a 27-per-cent annual rate since immediately prior to the election to stand at $513-billion, the highest level on record (eclipsing the high from April 2015).

Retail inflows

After an eight-year hiatus ($200-billion of net outflows), private clients have thrown in the towel and plowed nearly $80-billion into mutual funds and ETFs since the November election.

Remember Bob Farrell’s Rule No. 5: “The public buys the most at the top and the least at the bottom”.

Narrowing leadership

For the past four sessions, we have seen more new 52-week lows than new highs (the longest streak since Nov. 4) — a technical sign of a toppy market.

Moreover, the Russell 2000 index is now flat for the year and off 4 per cent from the high — again, we know from history that the generals tend to follow the privates.

Tack on the fact that the S&P 500 recently traded as much as 10 per cent above the 200-day moving average, and we have a market ripe for a near-term correction.

Complacency abounds

From a VIX of 11.9 to nearly 60-per-cent Bulls in the Investors Intelligence poll — though this has begun to roll off its highs in a sign of the “smart money” beginning to take profits.

The S&P 500 has gone 57 days without so much as a 1-per-cent intraday swing, something we have not seen in at least 35 years. The proverbial calm before the storm.

The Fed is in play

The front-end Treasury yields are rising discernibly — the two-year T-note yield has gapped up to nearly 1.4 per cent and futures market is in the process of pricing in an extra two rate hikes after the likely March tightening (the overnight index swaps market currently has priced in 70 basis points of tightening by year end).

The Fed has met its twin objectives and the fed funds rate consistent with that is 3 per cent, not the 0.75 per cent currently.

By the time the Fed reaches that level, the yield curve will likely have inverted long before and that’s when the clouds will come rolling in.

This could be next year’s story, which means a forward-looking market begins to discount this prospect sometime later this year.

Inflation pickup

Cyclical price pressures are showing through, with the core PCE inflation rate at a 30-month high of 1.738 per cent year over year.

As was the case in 1990, 2000 or 2007, this likely is not sustainable, but is a classic late-game signpost nonetheless.

All one needs to see is the latest blow-off in the commodity complex, which is now on pause, to notice how late cycle we are. Remember what oil did, for example, in 2008?

Lofty expectations

The survey data are at extremely high levels at a time when actual economic growth is running barely above a 1% annual rate.

Gaps like this, once again, are classic near-end-of-cycle developments.

The prospect of there being huge disappointment over the pace of policy change in Washington is also very high.

Over-ownership

While households were not net buyers of equities until very recently, the near-quadrupling in the stock market has still boosted their exposure to a 21.1-per-cent share of total assets. Only five times in the past 16 years has the share been this high or higher — this is 42% above the norm.

Frothy credit markets

Bonds lead stocks, just know that. And the risk-premium on U.S. high-yield corporate bonds very recently approached lows for the cycle at a super-tight 335 basis points.

However, they now are widening again, and with the overall narrowing path of the Treasury curve, this is well worth monitoring for those equity investors who are still long this market.

Nobody ever lost money by booking a profit, especially for a cycle that is now heading into year number nine.

Do you think that David is right?

Being Canadian, I am worried about the Federal Budget scheduled for March 22 because there are rumours of an increase in the capital gains tax. I have been taking some profits in my taxable accounts and for investment club just in case. I do believe it is impossible to time the market so I am still fully invested in my tax sheltered accounts.

 

Gold as a hedge against Trump’s Border Tax

Talk of a “border adjustment tax” has gone from the sidelines to center stage in Washington, which has a lot of people asking: What is it exactly?

Currently, U.S. corporations are taxed on their worldwide profits at 35 percent. The House GOP plan would change that radically. The new tax formula would tax domestic revenue (minus domestic costs) at a much lower rate of 20 percent. The net effect would be one that favors exports over imports.

The change would convert the country’s tax system to a “territorial” system rather than a worldwide tax system. It’s meant to create incentives for domestic production because companies also would no longer be able to reduce their taxable income by deducting their overseas expenditures.

The plan would essentially subsidize exports and lead to a 20 percent tax on imports for corporations.

Retailers are very opposed to a border adjustment tax because a large percentage of the products they sell are imported. The end result is Americans will pay higher prices for consumer goods including imported fruits and vegetables.

Now economists who support the tax say the policy would lead to a sharp rise in the value of the dollar. As a result, retailers’ costs will go down so much that it will be a wash to consumers. However, many CEO’s worry whether the economists are right in that assessment.

In the past, gold and gold stocks have been used by money managers to hedge against inflation, currency risk and world chaos. For years, financial advisors recommend having 5% to 7% of your portfolio in gold or gold stocks.

Unfortunately, we have been living with deflation so gold as an investment has not performed very well over the past five years. The chart below compares three ETFs – gold bullion GLD, large cap gold miners GDX and junior gold miners GDXJ

gold

The border adjustment tax could change all that. It could cause mayhem in world trade, leading to higher inflation and extreme volatility in currency markets. The chart below illustrates the 2017 year to date price movements in the above mention ETF’s

gold-1

The biggest risk to owning gold or gold stocks is if the Fed’s interest rate policy changes and they are more aggressive in raising rates. This could cause the value of the U.S. dollar to increase which would be bad for gold.

Fed watchers believe that the June meeting would be the earliest date for an increase in interest rates. The stock market has only priced in two rate hikes for all of 2017. President Trump’s immigration ban and talk on renegotiating trade deals will be in the news for the next few months making investors nervous.

I am considering three short-term trades in gold

  1. Dollar cost average: Buy 300 shares of GDX  at 24.50, Sell 3 Apr 26 call options for $1.20 & Sell 3 April 24 put options for $1.50 (Total investment = $6540.00 U.S.) 
  2. Covered call: Buy 100 shares of GLD at $116.20, sell 1 April $118 call for $2.25 (Total investment $9,370.00 U.S)
  3. Call spread: Buy 5 GLD April $110 calls for $7.10 & Sell 5 GLD April $118 calls for $2.25  (Total investment =$2,425.00 U.S.)

 

The problem with using options in these trade choices is the VIX that measures volatility is quite low. Having to wait until the April 19 expiration date reduces the profit potential. That being said, I think that the first trade is less risky, if I am wrong on the direction of the price of gold. I would own 600 shares of GDX at an average price of $ 22.90 but could then sell more call options.

Do you own any investments in gold stocks or gold ETF’s?

 

Disclaimer: These are not recommendations, please do your own research before investing.

 

 

 

 

 

 

The Trump Rally: Buy on rumor, Sell on news?

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Never in a million years did I think that Trump would not only win the election but that the stock market would rally afterwards. It proves once again how difficult it is to time the stock market.

Trump’s promise of a big stimulus package, tax cuts and less regulation has boosted the dollar and triggered a selloff in the bond market. The “Trump trade” has become the reflation trade with investors buying cyclical stocks and selling bonds. Financials have benefited as well as industrials.

The markets have rallied assuming that Donald Trump is pro-growth. However, he was also the same guy who talked about tariffs and tearing up trade deals, things that are anti-growth. The stock market is currently ignoring the negative side of Trump’s campaign promises.

Now, I’m not convinced it’s a one-way street. Under the surface, the trend has certainly changed. Whatever you thought about stocks before the election, you have to like them a little more and whatever you thought about bonds, you have to like them a little less.

Could this be the start of the “Great Rotation’” out of bonds into stocks?

Almost $2 trillion has been wiped off the value of global bonds since Trump was elected as the next U.S. president, sparking a reassessment of growth and inflation views.

JP Morgan notes that over the past week, a record inflow into U.S. equity exchange traded funds (ETFs) was accompanied by a record outflow from bond ETFs.

Within equity markets,  a sharp rotation out of so-called “bond proxies”, dividend-paying sectors such as utilities, telecoms and healthcare which were favored by investors for their yield and a move into more cyclical sectors such as banks, industrials and some commodities-related sectors is already underway.

Before you jump on the bandwagon, there’s a flood of economic data in the week ahead

  1. update to third-quarter GDP on Tuesday
  2. OPEC meets on Wednesday and it will decide whether to curb output
  3. Thursday is ISM manufacturing data and November auto sales
  4. jobs report on Friday expected to show 175,000 nonfarm payrolls

Now, the bond market has already priced in expectations that the Fed is on track to raise interest rates Dec. 14 by a quarter point. Next week’s economic data will be evaluated to determine future rate hikes for 2017. If inflation expectations are overhauled than so are perceptions about the rate outlook. Money markets are starting to price in one or more Federal Reserve rate hikes for next year.

Good economic numbers could cause a further selloff in the bond market next week which would be positive for U.S. stock markets. Plus many active fund managers have underperformed their benchmarks, there could be some performance chasing until year end.

Unfortunately, President Elect Trump is unpredictable and somewhat scary. If he shuts the borders because the anti-trade Trump comes out, we’ll have a recession and the market will go down. If that side stays quiet and he manages to convince congress to cuts taxes, it could be up a lot.

My gut tells me that we could be in over bought territory and that we could see some market consolidation. My fear is that Janet Yellen could spark a stock market selloff like she did in December 2015 when she indicated the possibility of 4 rate hikes for 2016 which didn’t materialize.

Are you buying into the Trump rally or are you a seller?

 

 

 

Trump economics could be hazardous to bonds and dividend stocks

Trump’s stunning victory for the White House may mark the long-awaited end to the more than 30-year-old Bull Run in bonds, as bets on faster U.S. growth and inflation led investors to favor stocks over bonds.

There has been a sentiment shift in the bond market. The stampede from bonds propelled longer-dated U.S. yields to their highest levels since January with the 30-year yield posting its biggest weekly increase since January 2009. The 10-year German Bund yield rose to its highest level in eight months, while the 10-year British gilt yield climbed to its highest level prior to Britain’s decision to leave the European Union on June 23, known as Brexit.

“I’m the king of debt. I’m great with debt. Nobody knows debt better than me,” Trump told Norah O’Donnell in an interview that aired on “CBS” “I’ve made a fortune by using debt, and if things don’t work out I renegotiate the debt. I mean, that’s a smart thing, not a stupid thing.”

Global bond markets worldwide have already lost more than 1 trillion dollars.  Speculation is that Trump’s tax cuts and stimulus spending could increase the national debt by trillions of dollars. The chart below is the iShares 7-10 Year Treasury Bond (IEF)

bonds-10-7

 

TIPS appeal

While investors dumped most types of bonds after Trump’s victory, they piled into Treasury Inflation-Protected Securities as a hedge against a pick-up in inflation. Investors poured $1 billion into TIPS in the week ended Nov. 9, the second-biggest inflows since records began in October 2002, data from Thomson Reuters’ Lipper service showed on Thursday.

Higher bond yields could have a negative effect on dividend stocks

Bonds have historically enjoyed a lower risk premium than dividend stocks. Higher bond yields could attract investors away from owning dividend stocks. Consumer staples and utility stocks have already fallen based on the Fed raising interest rates in December. Some experts believe that the Federal Reserve will be forced to increase rates even more in 2017.

The good news is that this could be just a knee jerk reaction to the shocking election results. In a subtle effort to lessen fears, President Obama suggested Monday that the office of the president has a way of opening one’s eyes to the realities of governing and decision making.

“Regardless of what experience or assumptions he brought to the office, this office has a way of waking you up,” Obama said.

“My advice, as I said to the President-elect, was that campaigning is different from governing,” Obama said Monday. I think he recognizes that I think he’s sincere in wanting to be a successful president. I think he’s going to try as best he can to make sure that he delivers not only for people who voted for him but the people at large.”

It remains unclear how Trump’s promises translate into policy and the degree to which they would affect the economy. So far, the rally in U.S. stock markets suggest whatever Trump may do with the help of a Republican-controlled Congress would give a lift to the U.S. economy, which is growing at about 2 percent this year.

cautionHigher interest rates could cause a U.S. recession!