Don't fight the Fed?!

I am publishing the newsletter a few days early this week because we are heading back to the UK and for selfish reasons, I want to enjoy the week with family. If you happened to be on vacation throughout July & August and only recently checked your account balance, you wouldn’t think that anything happened this summer. The truth was that the market had a mini meltdown, somewhat like our son Cameron when he doesn’t get his way (not sure where he gets that from). After realizing it was fuss over nothing, Cameron & the market bounced back nicely. What happened in July was perfectly summarized below in a memo by debt investor Howard Marks:

“What’s Behind the Market’s Volatility?…in the real world, things fluctuate between ‘pretty good’ and ‘not so hot,’ but in investing, perception often swings from ‘flawless’ to ‘hopeless. That says about 80% of what you need to know on the subject.’” – Howard Marks

Howard also includes the cartoon below which incapsulates the daily rumblings of Wall St but quite frankly, what it has felt like writing a monthly note covering the financial news over the last 12 months.

The market was finally delivered some clarity on the direction of interest rates this month, coming via a speech by the Federal Reserve chairman, Jerome Powell. He spoke last Friday at Jackson Hole and it was widely covered by the financial media. I personally feel Barron’s summarized it best:

“Jerome Powell laid the groundwork for the Federal Reserve’s next phase of monetary policy in his speech Friday morning.

The chairman said he is ready to lower interest rates, citing a cooling labor market and inflation closing in on the central bank’s 2% annual target. Powell is confident that Fed will successfully thread the needle and deliver a so-called soft landing for the U.S. economy. It would be a rare feat, last seen in the 1990s. Getting there will require easing off from today’s high interest rates, Powell said.

His remarks all but confirm market expectations that the Fed will cut interest rates at the September meeting of the Federal Open Market Committee.”

So there we have it, the Federal Reserve is ready to cut rates and the US economy is looking like it will avoid a downturn. The Federal reserve could get it wrong, wouldn’t be the first time, but who am I to ruin the party this summer. As the adage goes; “Don’t fight the Fed!”.

It is worth remembering that financial markets are forward looking and while it’s clear what stocks think about the economic prospects, it is always worth reviewing what bond markets are pricing in. You might remember the chart below from previous newsletters. What it shows is the implied path of short-term interest rates, as of Friday in the US.

The bond market is currently implying interest rates to fall to around 3% over the next 18 months. The bond market isn’t always accurate, in fact it’s more often wrong than not as shown in the newsletter last month, but what I take from this chart is that the bond market expects there is a floor at 3%. Said differently, the bond market implies that the Federal Reserve will drop interest rates, but we won’t be going back to 1% or 0% anytime soon. This checks out with Jerome Powell’s message of a soft-landing and why stocks are having a good summer. If sentiment is positive, investors are willing to pay a higher price for a share of the same company in the expectation of higher profits.

Knowing the implied path of interest rates is valuable when making borrowing decisions. For example, a business that takes out a loan should be aware of the implied path that is embedded into the rate they pay to the bank, or investors. Similarly, homeowners renewing their mortgages can use this information to better understand the options when selecting the term and whether to go fixed or variable. To that end, I’ve posted the same chart below for Canada for informational purposes. The third chart shows the implied path for interest rates about a year ago. In effect, the market now implies that the Bank of Canada will take interest rates approximately 0.75% lower by the summer of 2026 than was priced in a year ago. If it comes to pass, this will be a huge sigh of relief for Canadian borrowers who are currently on variable rates.

If you, or a friend or family member, have an upcoming mortgage renewal and would like a framework to help you make your decision, let me know. I would be more than happy to share mine. To take it one step further, if anyone is making a borrowing decision of any kind (personal or corporate), I would be happy to chat.

Speaking of chatting, I have been happily surprised this summer by the number of children that I have spoken to this summer about finance. Whether its curiosity or a YouTube/TikTok craze, I have spoken to quite a few 7–11-year-olds about investing. If I can do anything to inspire the next generation of entrepreneurs, investors or financial advisors, I would consider my career a huge success. To that end, I’m wondering if there would be enough demand for a financial literacy and investment seminar each summer for children (parents welcome too). I could just be getting a little carried away but if you think your children would be interested in attending for a day or two next summer, please let me know.

The other reason I bring up the amazing children is because they were interested in the different ways to invest. I thought I would summarize what was discussed as a quick refresher for everyone reading. Interestingly, cryptocurrency didn’t come up once!

There are two primary ways to invest your funds: i) you can either be a lender, or ii) you can be an owner.

If you are a lender, you commonly provide funds for a set period, receiving interest as compensation for doing so. You receive your funds back at the end of the loan-period and need to decide what you would like to do with them. A bank is a lender of mortgages, car loans etc. but depositing your cash into the bank is also a very short-term version of a loan. You are lending the bank your cash, which they lend out to someone else. As the funds you put into the bank can be withdrawn at any time, they pay you a very small rate of interest for it. For anyone looking for a higher interest rate on cash balances within a corporation or personally, let us know and we can talk about High Interest Savings, cashable GICs or even short-term bonds. You will be pleasantly surprised with the interest rate we can achieve.

If you are an owner you buy an asset, but in this case we assume you buy a stake in a business. Shark tank is a good example where the sharks look for companies to buy a stake in. As an owner you do not have a maturity date on your funds and your investment return relies on the success of business. You have the claim to the profits of the business after all costs have been considered (including interest on loans to a lender). This happens in proportion to how many shares you own i.e. if you are sole-owner, you accrue all the value. If you own shares of a publicly traded company, you likely accrue a small portion of the millions (or billions) of profits.

If a company fails, the lender gets to take ownership of the business, sell assets, and recover as much money as they can. If you are an owner in this circumstance, you have very likely lost all your money.

These two investment styles have different risk profiles & also expected returns. For example, you should be compensated more for taking the risk of ownership (buying stocks) than lending your funds (buying bonds). If you are not willing or capable of accepting a higher risk profile, you should accept a lower return. I once heard someone say that volatility is the price of the admission ticket to the stock market. This is so true. If you cannot accept the hills & valleys, the stock market isn’t for you.

Deciding whether you should be a lender or an owner, or a blend of the two, is a difficult task. Furthermore, if you decide you are most suited one or the other, which businesses should you own or lend to? This is where a customized financial plan and professional money manager come into play. The financial plan provides the rate of return that is required to achieve your goals & objectives. Putting these together with your willingness to take risk, time horizon, income requirements and tax status, provides the initial information necessary to build a diversified portfolio suited to you. I won’t give any secrets away, but this is the start of every personalized wealth management plan. The primary objective is to achieve long-term goals. The way in which we do that, via investment & tax strategies, is the reason why my team (and many others) exist.

That is about all we have time for this month. If you have any questions about anything in the newsletter, or financial in general, please don’t hesitate to get in touch. I wish you a wonderful September. I will see you on the other side of the first interest rate cut in the US since March of 2020!

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Until next time,

Chris

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