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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A big disconnect between the Stock Market and the Canadian Economy

Canada’s economy is expanding at its fastest annualized rate in six years according to Statistics Canada. That’s a quarterly expansion rate of 4.5% which is the highest figure since the third quarter of 2011. It was led by the biggest binge in household spending since before the 2008-2009 global recession.

Economists had predicted Canada to grow around 3.7% and the Bank of Canada latest forecast was for GDP to expand at 3% in their July press release. When combined with the 3.7% expansion of the first quarter, it’s the strongest six month start in 15 years.

Why isn’t money pouring into the Toronto Stock Market?

Often times the equity market is moving well before the economy does and of course the Canadian equity market had a robust year in 2016. Investors may already have priced in all the good news last year, when Canada’s stock index gained 18 percent, one of the world’s best performances.

Part of the problem is that Canada’s stock market isn’t totally reflective of the economy, since it’s heavily reliant on energy and financials. Those two sectors account for 54 percent of the S&P/TSX Composite Index.

The outlook for oil is very subdued, it is still trading below $50 a barrel even with the shutdown of refineries due to hurricane Harvey. Global inventories continue to stay high and OPEC’s has lost its influence in cutting production. Crude oil prices in the future’s market are still below $50 a barrel for all of 2018 and part of 2019. Foreign investors are taking money out of the Alberta’s oil patch.

Continued growth in residential investments which was up an annualized 16 percent in the first quarter is also likely to fade as the impact of government measures to cool housing markets kick in. Although, bank earnings have beat expectations by a wide margin, loan growth going forward is expected to decline and loan losses are expected to increase. U.S. hedge funds are still shorting Canadian financials expecting the housing bubble to burst.

Investors believe that this robust growth will force the Bank of Canada to continue raising interest rates this year. It could add extra pressure to lowering consumer spending due to high indebtedness of Canadian households. It will also add a cooling effect to the hot housing prices in both the Vancouver and Toronto real estate markets. The rapid rise in the value of the Canadian dollar is added proof that currency traders are betting that a hike in interest rates is coming soon.

Uncertainty over NATFA  renegotiation

Global political developments aren’t helping, with renegotiation of the North American Free Trade Agreement which started in August, created a new spat with the U.S. erupting over aerospace manufacturing.

Already, data suggest investment into the country is cooling. Foreign direct investment in Canada dropped 25 percent to C$8.68 billion in the first quarter, according to separate data released Tuesday. The country relies heavily on foreign funding to finance spending — totaling C$130 billion over the past two years, according to balance of payment data.

Canada has benefited from a convergence of developments that include a coordinated global recovery and rising trade volumes. The bottoming of the oil shock in western Canada, along with federal deficit spending, rising industrial production in developed economies. Canadian consumers have benefited from a buoyant jobs market and rising home values, resulting in a surge in consumer spending.

Is this Sustainable? I think not!

Economists had been predicting a slowdown in growth to about 2 percent in the second half of this year, but are revising numbers up after the GDP report. I believe this surge in economic growth is temporary. The higher value of the Canadian dollar and higher interest rates will dampen economic growth.

The Toronto stock market returns for all of 2017 are flat which could indicate that foreign investors also believe the future going forward isn’t so rosy!

 

 

 

How has the Trump circus effective your investments?

As a Canadian, I think that the Washington circus is no longer funny. It has become “very scary”. We came very close to a nuclear war. Tensions regarding North Korea have lessen temporarily and the market sell off could have been a lot worse. So far, investors have ignored the noise coming out of Washington as U.S. corporate earnings have been better than expected.

Canadian and European investors with holdings in U.S. dollars have seen their investment returns reduced by the falling value of the U.S. dollar. For example, my investment club’s U.S. portfolio is up 10.2% as of the end of July. However, it is up only 2.3% when converted into Canadian dollars. The value of the Euro is also up 10% compared to the U.S. dollar.

The recent rally in gold is another sign of a weakening value of the U.S. dollar. A falling dollar not only increases the value of other currencies, it also increases the demand for commodities like gold. Investors buy gold as a hedge against a further weakening of the U.S. dollar.

American investors with holdings outside of the U.S. have benefited the most from a weaker dollar. Corporations that generate revenue outside the U.S. will get an earnings boost from foreign profits.   Keep in mind that the bond market doesn’t believe the Trump growth agenda will get passed any time soon. The yield on 10 year treasuries has fallen back to pre-election lows. Returns in U.S. bond portfolios have been positive for American investors.

Biggest Market Risks

  1. More inflammatory tweets from Trump regarding North Korea
  2. The resignation of Trump’s key economic advisors, Gary Cohn and Steven Mnuchin
  3. The Fed increasing short term rates causing an inverted yield curve which historically causes a U.S. recession.
  4. In fighting within the Republican Party continues and they are unable to pass meaningful economic fiscal policy.
  5. Trump’s desperation for a win causes him to tear up the NAFTA agreement?

I find this very disturbing:

President Trump’s approval rating is at its lowest since he took office with only 35% of Americans giving him a positive rating, according to a Marist Poll released Wednesday.

Although he is still popular among Republicans, his key constituency, his job performance rating has dropped among strong Republicans from 91% in June to 79% now.

Hard to believe that 79% of Republicans still approve of President Trump!

Lets hope that American voters will come to their senses during the 2018 elections!!

The Amazon effect could still benefit the following companies

The “Amazon effect” is the ongoing evolution and disruption of the retail market, resulting in increased e-commerce. The major manifestation of the Amazon effect is the ongoing consumer shift to shopping online.

You don’t have to be a financial analyst to realize that card credit usage has gone up. Most brick and mortar retail establishments allow the consumer the choice of paying with cash, debit or credit card. Almost 90 % of all purchases that happen on line are with credit cards. Credit card companies are a popular choice because they will reverse any fraudulent purchases plus some offer extended warranties and all of them have reward programs.

The three most popular credit card cards world-wide are Visa (V), MasterCard (MC) and American Express (AXP). The chart below compares all three to Amazon over a five year period. It appears that investors think that Visa will benefit the most from the “Amazon effect”.

Keep in mind that Amazon has a rewards Visa card which earns users a rebate on all their purchases. Cardholders get 3% back for purchases made at Amazon.com, 2% cash back at gas stations, restaurants and drugstores, and 1% back on all other purchases which earns users a rebate on all their purchases.

Despite news that Amazon is buying trucks and planes to better service their prime customers, delivery companies FedEx and UPS will still benefit from the “Amazon Effect.” The chart below compares these two companies to Amazon over a five year period. FedEx is by far the clear winner for investors.

While there is a glut of malls in America, there aren’t nearly enough warehouses across the U.S. to support internet retailers like Amazon. Retail sales are not in decline, but rather shifting toward e-commerce so all retailers will require large amounts of warehouse space.”

When retailers reconfigure their supply chain to accommodate the shift in consumer behavior, the requirement for warehousing space will increase substantially. This is true incremental demand and not a displacement of existing demand for warehouse square footage. Companies like Wal-Mart, Alibaba and Wayfair will also have to invest in new warehouses to try to compete with Amazon over the next few years.

Industrial REITs such as Rexford Industrial (REXR), Terreno (TRNO) and Stag Industrial (STAG) are at the top of most buy lists. Other industrial REITs that you should consider include First Industrial (FR) and Monmouth (MNR). 

Amazon’s deal for Whole Foods will likely spur a “last mile” investment by the internet giant and its competitors, Jefferies’ Petersen has predicted. “Last mile” is a reference to the warehouse that is closest to a store, a crucial point of the distribution chain that makes same-day delivery possible.

“By analyzing all of Amazon’s ‘last mile’ facilities by size and population demographics against the Industrial REIT portfolios, we found that REXR and TRNO are best positioned to serve the ‘last mile,'” Petersen said.

Then, Amazon investing in so-called secondary and tertiary markets will benefit a REIT like STAG, he added.

One of the biggest risks in owning REITs is rising interest rates. Higher borrowing costs can reduce cash flow and effect their ability to pay dividends. It also makes the financing of new projects less profitable.

A lot of the “Amazon effect” is already priced in to all of these stocks but the long term upward trend is still there.