Interest rates are on the rise, with the US Federal Reserve boosting interest rates by another 0.25%  (for the 17th time).    Even though a 5.25% Fed funds rate isn’t the end of the world, it’s indicative of a changing investment environment;   an environment where we should pursue a conservative approach.

Fortunately, all of my clients already have a very well diversified, conservative portfolio.  What I am recommending is a fine-tuning of the portfolio asset mix,  where equities are reduced to a smaller percentage of the portfolio.    For example, our average asset mix currently stands at  60% equity, 40% fixed-income.   I am recommending that investors consider a change to our  40% equity, 60% fixed-income portfolio or even  30% equity, 70% fixed-income portfolio (for our more risk averse investors).

Let me summarize some of my concerns regarding the US Economy , and why I believe the recent market volatility is indicative of some longer-term problems:  

1.   The ever-widening US Trade Deficit- expected to top $1 Trillion US dollars this year          

2.   The Total US Debt -    Now about to surpass $50 Trillion US dollars

3.   Reliance on the US housing bubble to continue to sustain US consumer spending

      (US consumers have refinanced at a record pace and now are over-indebted, overstretched financially, and are very susceptible to rising interest rates as most new debt is on a floating rate.  Remember, the US consumer is responsible for 70% of the US GDP growth.) 

4.   Federal Reserve Printing Money -   the US money supply has gone up over 50% in the last five years (a pace not seen since the 1970’s , which ultimately ended up with virtually 20% interest rates).  Printing money is artificial growth, like spending money you don’t have.  Its not long-term economic growth, like investing in plant and equipment.  Printing money artificially raises the prices of assets, ultimately creating much higher inflation and interest rates. 

5.   High Energy Prices and the ongoing threat of higher inflation

Back-to-the-Future

The last time the US economy faced these similar problems was in the 1970’s.   The Vietnam War had left the US government with a significant debtload (so big, that Richard Nixon cancelled the “Gold Standard” in 1971.   This left the door open for the US Government to start  printing money………at a record pace, which looks very similar to today’s money supply growth.    With the Oil Embargo of 1973, the cost of energy skyrocketed and brought with it, high inflation and much higher interest rates (which ultimately peaked in 1981 at almost 20%).    

The stock market in the 1970’s was volatile, with several corrections and market rallies.  Effectively, the market really traded sideways for most of the decade, not breaking this trend until 1982.    This was a very challenging time for the average investor. 

How to invest in this type of environment:

1.   Utilize a very conservative asset mix – ie.  30% equity 70% fixed-income

2.   Rebalance your portfolio -   this takes advantage of market volatility, allowing you to take some profits on market rallies and buying on market corrections.  This effectively reduces the overall risk of the portfolio and improves long-term profitability.

3.  Diversify Internationally-   the decline of the US dollar, indirectly strengthens other foreign currencies, such as our own Canadian dollar , the Euro, and the British pound. 

4.  Gold - the drastic financial mismanagement of the US Government will continue to force the US dollar lower against most major currencies.   Major creditors of the US , such as China and Japan, will be forced to diversify away from the US dollar (they currently hold over $1 Trillion US) by buying Euros and gold.    Ultimately, the US dollar could lose its “Reserve Currency” status, as other Central Banks follow the Asian lead. 

My team (Beatrice and Brian) and I look forward to discussing these issues with you at your earliest convenience.    Our number one goal is to protect your capital and secondly, to provide a rate of return on investment that exceeds inflation.  

Best regards,

Mike McGann

Director

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