Central banks globally are facing the deer in the headlights reality of sterile monetary policy – too afraid to normalize rates for fear of tanking the fragile economy.
Once rates are already so low, the benefit of making them even lower is marginal at best and likely more harmful. Last week we wrote about how the world's four largest economies – the U.S., China, Europe and Japan – are basically in recession were it not for deficit spending. The central bank narrative is beginning to shift toward fiscal spending as the next steps to get economies moving again.
Recent rhetoric from central banks this past week, including the Bank of Japan, the U.S. Federal Reserve, and our own Bank of Canada, say it's time for fiscal policy to take over because monetary stimulus may have reached its limits. Sadly, China, Japan, and the U.S. have been running massive deficits for years, so those espousing even more fiscal stimulus – increasing the debt burden on future generations – are not recognizing the new normal of slower growth. How fragile is the global economy that the Fed cannot raise the target rate from 0.25 per cent to 0.50 per cent? It appears that the Keynesian and monetary policies that have been guiding central banks and governments do not work well when debt is already too high, people are living longer, and the cost of social benefits will bankrupt the U.S. in the coming decades. Policies need to change and reflect the reality of the current combination of massive debt and aging demographics. Until that happens – lower for longer is the new reality for the world.
Bank of Canada Governor Stephen Poloz urged Canada's policy makers to press ahead with efforts to remove trade restrictions and spend more on infrastructure in order to boost sluggish long-term growth. He said that Canada's "potential" growth rate is now about 1.5 per cent according to Bank of Canada estimates, which, interestingly enough, is about the same as the $30-billion deficit that the Trudeau government is now running and expects to run for three more years. So basically, Canada now cannot grow much either without government deficit spending. The more they continue to pile on the debt as the solution, the worse the outcome will eventually be. Ontario is virtually bankrupt by any real definition. The Ontario Liberal government's deficit policies have been catastrophic in the past decade and it's placing a huge tax burden on our children.
I applaud Mr. Poloz (for a change) as it is good to see Canada's central bank beginning to open the dialogue about demographic headwinds. Now we need the government to pick up that conversation with Canadians. Governments need to be honest with Canadians that we face a very difficult future as it relates to economic growth. The current Liberal deficit spending polices will not likely work in generating jobs – the taxing of higher income-earning small business proprietors will likely cost Canada jobs.
In the meantime, his policy recommendation for savers is "to plan for retirement with different assumptions about longevity, interest rates and growth." What I took from this message is that passive approaches to your retirement savings will likely lead to disappointing outcomes. Low interest rate policies are the biggest tax hike on savers in modern history and are likely here to stay for decades. Consumers should be outraged – wait, they are, just look at the U.S. elections.
So while central banks may be out of bullets, you do not have to be. The risk of lower than average returns for the next decade or two are very real. Investors need to think global as Canada, with its commodity rich indexes and poorly diversified economy, are likely to underperform for decades.
When investing globally, currency exposure is by far your most important consideration. I love that exchange-traded funds have opened the door to global exposure with currency hedges. Learning how to use these types of ETFs that can help hedge your portfolio gives you a leg up on central banks and governments who will struggle to improve economic performance. You can use them to improve yours. A few of my favourites are BMO Europe High Dividend Covered Call Hedged to CAD (ZWE), BMO Low Volatility US Equity Hedged to CAD (ZLH).
I also love the unleveraged inverse ETFs to try to hedge and make money in your portfolio when markets fall. The Horizons BetaPro S&P 500 Inverse ETF (HIU) goes up at a ratio of 1:1 when the S&P 500 falls and the Horizons BetaPro S&P/TSX 60 Inverse ETF (HIX) goes up 1:1 when the S&P/TSX 60 falls.
Using inverse ETFs are not for everyone – markets do go up about twice as much as they go down. But I suspect the next decade that will be closer to even, so they are good things to have in your investor toolbox.
Investors should learn how to use these tools, and build what I call "smart ETF portfolios." ETFs have made asset allocation very cost efficient and elegant for investors. Smart ETF portfolios take the best insights from the institutional world and bring it down to a level that any do-it-yourself investor can understand.
Larry Berman is co-founder of ETF Capital Management. He is a Chartered Market Technician, a Chartered Financial Analyst charterholder, and is a U.S.-registered Commodity Trading Advisor.
Larry Berman