Yahoo Finance 3 risks many investors seem to be ignoring when placing their money
It is my job as a risk manager to identify those factors that have the potential to have a negative effect on a portfolio, as well as to ensure emotions don’t compound any damage that results.
With that in mind, here are three major risks over the next 12 months that many investors seem to be ignoring or, worse, adding more of to their portfolios, whether intentionally or not. Keep in mind, it isn’t too late to protect yourself.
Political risk
Desperate people do desperate things, which can be very dangerous. For example, Prime Minister Justin Trudeau’s government is reaching record lows in the polls, so rather than dealing with an escalating affordability crisis and a worsening economy, it is doing the exact opposite by trying to shift the blame.
Canada recently recorded one of the largest-ever declines in foreign direct investment (FDI) in the first three months of this year, falling by $3.4 billion, according to data released by Statistics Canada in May.
The capital gains tax changes Trudeau is imposing will impact at least 20 per cent of Canadians over the next 10 years, according to six major business groups. Instead of enticing people to deploy their capital into this country, he is doing the opposite by forcing a lot of people to move their capital outside the country.
As a result, Canadian direct investment abroad jumped higher to $32.6 billion in the first quarter, well above the historical average.
One impact on investors will be the Canadian dollar. As the economy continues to shrink on a per-capita basis and the gap widens with our powerhouse neighbour to the south, Canada will have to cut rates at a faster pace. Combine this with capital outflows and the outlook for the loonie isn’t good.
Therefore, we’ve been increasing our U.S. dollar-denominated assets and continue to be overweight as a hedge for our clients.
Bond oversupply risk
The flow of cash into bonds has been accelerating as investors look to benefit from interest rate cuts, according to TD Securities. Global bonds just had a 24th consecutive week of inflows, and the second-largest inflow since July 2021, at $17.8 billion. European government bonds had their strongest inflows since February 2023.
But the long bond trade has been what we call a classic value trap. Over the past seven years, nearly all the annualized gains in the 60/40 U.S. stock/bond portfolio have come from the stock side, according to Charlie Bilello, chief market strategist at Creative Planning LLC, with the S&P 500 gaining approximately 11.6 per cent per year versus around 0.8 per cent per year for bonds.
We think interest rates down south will head lower, but they will likely fall faster in jurisdictions outside the United States, which is already starting to happen, given the first cuts by Canada and the European Union. These regions don’t have the luxury of having the world’s reserve currency, so they need to cut rates and increase taxes to finance their large deficit spending. We just are not keen on being on the other side of that trade.
We think the U.S. will continue to flood the market with debt issuance, potentially keeping their interest rates higher for longer. Overwhelming Treasury issuance and inflation will pressure the long end, creating a major risk for those chasing duration.
Therefore, it isn’t as easy as it sounds when it comes to calling the end of the bear market in bonds since there is a currency risk that needs to be managed along with duration risk. We don’t see many advisers addressing this, but we sure are, primarily by using structured notes as a fixed-income replacement.
For example, we just implemented a large fixed-income structured note with 100 per cent principal protection, denominated in U.S. dollars, that pays an 8.37 per cent coupon if interest rates fall below where they are currently.
Market concentration risk
The equal-weighted S&P 500 relative to the S&P 500 has now fallen to its lowest level since March 2009. Up to the end of May, the S&P 500 had gained about 10 per cent while the equal-weighted index rallied just three per cent.
The top 10 stocks had a market cap of US$15.09 trillion, which represented about 34 per cent of the S&P 500. The previous record level of concentration was 32.87 per cent, which occurred in 1963. Torsten Slok, chief economist at Apollo Global Management Inc., said 35 per cent of the S&P 500 market cap’s increase since the beginning of the year comes from one stock, Nvidia Corp.
We’re just not playing this game and have been taking advantage of the options market as a way of adding insurance. This is extraordinarily cheap, given the current level of complacency in the U.S. market.
Investors have similar options (pardon the pun) since firms such as BMO Global Asset Management are offering buffered exchange-traded funds as a way of staying long on this market, but with embedded downside protection.
Never let your ego get in the way of your success or your portfolio
Ottawa should do more of what works and less of what doesn't
We also don’t think it hurts to look at certain segments of the Canadian market, but we do so whenever possible in U.S. dollars.
Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc., operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning. The opinions expressed are not necessarily those of Wellington-Altus.
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