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          The unwinding

          Financial markets have done well lately, proving those who sold last month may have taken losses for nothing. Looks like there’s more to come. Simple reason. Trump.

          He just had a tough week. Trump pandered to Rocket Man Kim but now there’s evidence North Korea lied about blowing up its missile sites. Satellites just found a new one. So much for his high-stakes deal-making, as it looks like the president was played.

          And after more than a month of mayhem, the shutdown in Washington ended in absolute failure for the White House. Trump shed credibility, the economy lost momentum and Congress didn’t cough up a single cent for that ridiculous wall. He played the bully card, gambled with hundreds of thousands of federal workers, air safety and public respect, and lost. For nothing. Then on Friday his long-time political mentor and buddy Roger Stone was indicted. One more Trump insider headed for trial, courts or turning into a rat.

          The Mueller investigation has momentum, as do the Democrats who control the House of Representatives for the next two years. After less than a month, they have tasted Trump blood and seen his fallibility. The field of candidates for the 2020 presidential election will be vast, crowded and energized. Being who he is, Trump will respond by mocking them all, becoming more extreme as 2019 rolls by.

          But what does this have to do with your portfolio?

          Lots.

          Since being elected Trump has consistently used the stock market as a proxy for his presidency and its ‘accomplishments.’ For most of 2018 equities were at record highs, before the big swoon in Q4. That hurt. Mueller and the shutdown made it worse. Then China’s growth slowed – thanks to Trump’s trade war – and the Fed raised rates yet again. Stocks shed a quick 20%. The national mood turned sour.

          Face it. Trump’s in a heap of trouble and is unlikely to recover, once Mueller reports. If he runs in 2020, he’ll lose, especially if a guy like Michael Bloomberg stands as an indy and splits the vote, or Mitt Romney gores the party by challenging his nomination. If Trump knows he can’t win, he probably won’t run, but either way he’ll be desperate for an economic legacy. Robust growth, record-low jobless rate, low taxes, high profits and soaring stocks.

          This is one of the reasons 2019 will likely be a far different year than the last one. Look for a trade deal to be inked with China, for example. Better relations between the two biggest economies in the world could ignite markets. Plus, Trump is highly unlikely to shut down government again, despite his threats, in order to get his wall. That tactic won’t work any better the second time, so he’ll go for an emergency declaration instead. Interest rates will rise this year, but less aggressively than in 2018. Corporate profits are on track for an increase of more than 8%. The Trump-Xi deal will fuel expectations of better global growth and help push commodities higher. Look for oil to spurt.

          All this is positive for portfolios. So will be the end of the Trump era itself, however that plays out. Two years after cheering him as an agent of growth, inflation and earnings, the sitting president has become the market’s pariah. Attacking the Fed was the final straw in December. Wall Street would rather have monetary policy it can count on than a president it can’t.

          As stated, things have changed a lot, fast. Valuations of many assets have improved in the past month, but are still sitting lower than they were last summer. This is called ‘a sale.’ For example, if you thought Apple was a great company at $230 a share, then it’s probably better at $150. (Of course buying individual securities augments risk, while investing through diversified ETFs reduces it – but you get the point.)

          Trump was fun while he lasted. It wasn’t long. Markets now see how the unwinding may take place. He was an interlude, not a trend. There’ll be no reverting to 19th Century economic policies of walls and barriers. Nationalism may be exciting and charismatic, pure nectar for those longing for times past, but in this world it’s a failed concept.

          Yep. Globalists, 1. Trump, 0. So stay invested.

          Finding your niche

          ?By Guest Blogger Doug Rowat

          As the explosive growth of the ETF industry continues, we’ve seen a predictable development: greater and greater ETF specialization. As The New York Times put it recently, the ETF industry is carving up the stock market “into ever thinner slices for investors eager to find other next big things.”

          These niche, ‘thin slice’ ETFs are typically focused on the technology sector (robotics, cybersecurity or artificial intelligence, for example), but this is becoming less so. In Canada, for instance, specialized ETFs focused on the marijuana industry are, of course, currently all the rage. There are now four weed ETFs listed in Canada versus none less than two years ago. The largest, by far, being the Horizons Marijuana Life Sciences ETF (HMMJ).

          But HMMJ embodies one of the key dangers of niche ETFs: concentration risk. The top four holdings of HMMJ total a 44% weight, for example. Not exactly broad diversification and, not surprisingly, HMMJ has five times the volatility of the broader Canadian equity market, which is itself risky. It begs the question: if you’re comfortable with this level of risk, why not simply buy the four stocks and save yourself the 0.75% MER?

          But not all investors make themselves aware of the risk, thinking instead that the ETF structure itself assures diversification. But specialized, theme-based ETFs are not only expensive but rival single stocks in terms of volatility. Interested in junior gold mining? The top five holdings of the VanEck Vectors Junior Gold Miners ETF (GDXJ) account for almost a 30% weight and the ETF charges 0.54%. Think the skies will soon be filled with drones? The ETFMG Drone Economy Strategy ETF (IFLY) charges 0.75% and you’d better learn all you can about Aerovironment because this company alone has a 12% weight. Believe consumers will abandon Amazon.com and head back to the shopping malls? The Pacer Benchmark Retail Real Estate ETF (RTL) charges 0.60% and just TWO holdings combine for a massive 30% concentration. And the list goes on.

          So, just as only holding a few stocks is a dangerous portfolio strategy, so too is only holding a few niche ETFs. SocGen recently highlighted that one in four stocks lose 50% or more during recessions (see chart). If you have only a few specialized ETFs in your portfolio, which typically focus on risky, emerging industries and have heavy weightings to only a few names, you’ll likely experience similar volatility. HMMJ and IFLY, for example, dropped 24% and 19%, respectively, last year and we’re not even in a recessionary environment. ETFs generally provide great diversification, but for theme-based ETFs, this isn’t the case.

          Recessions happen and concentrated investment portfolios can be devastated.

          Source: SacGen

          There’s also the opposite problem with niche ETFs: are they, in fact, targeting the right market areas? In other words, are they providing ENOUGH concentration? We had Coincapital knock on our door a few months ago plugging their blockchain ETF, Coincapital STOXX Blockchain Patents Innovation Index Fund (LDGR). Coincapital uses “a proprietary artificial intelligence (AI) algorithm to identify companies for the fund.” I’ve lost track of how often I’ve heard the term “proprietary” in sales pitches over the 20 years that I’ve been in the investment industry. Such language immediately gives me pause. When something’s proprietary, transparency becomes difficult and attempts at clarification inevitably result in Catch-22 dilemmas. “Proprietary” sales pitches usually end up something like this: it’s the best investment technology because nobody else has it, but we can’t fully explain it because then everybody would have it.

          However, our main difficulty with LDGR was simply that we had little confidence that it was offering direct exposure to blockchain technologies. Consider the ETF’s top holdings (below). Is the ETF investing in the niche blockchain space or will its performance be dominated by the much, much broader market forces affecting the US and Canadian financial and retailing sectors?

          Decide for yourself:

          Coincapital STOXX Blockchain Patents Innovation Index Fund top holdings

          Source: Bloomberg

          Overall, it’s not that these specialized ETFs are engaging in false advertising—after all, I discovered all this information because of what they disclose publicly—but problems occur when investors don’t take the time to research exactly what it is that they’re buying.

          In other words, if you’re thinking of purchasing a niche ETF, pop the latch and check under the hood.

          —————-

          Finally, I’ve written many times on this blog that rising interest rates don’t negatively impact Canadian real estate investment trusts (REITs). Here’s an example (http://m.zvhyzms.tw/?s=no+vacancy). Yet, what should come blasting across my smartphone to start 2019? Another misleading headline regarding REITs and interest rates:

          The Globe & Mail gets it wrong. REITs do great in rising rate environments

          Source: The Globe and Mail

          Strong REIT performance during periods of rising interest rates shouldn’t be a “surprise”; REITs perform well in these environments. And last year was proof of that. There were four rate increases from the US Federal Reserve and three from the Bank of Canada, but Canadian REITs advanced 4.9% in 2018 (including dividends) versus the MSCI World Index (global equities) which fell 8.2% on the same basis. And, as a long-term investment, REITs have returned 10.2% annually over the past 15 years.

          Just add ‘em to your portfolio already.

          Doug Rowat, FCSI? is Portfolio Manager with Turner Investments and Senior Vice President, Private Client Group, Raymond James Ltd.

           

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