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There’s been more and more chatter in the media about whether we’re entering a new “Roaring Twenties” now that the pandemic recedes. I’m not entirely sure that’s a good thing, because yes the decade after the 1918 flu pandemic ended saw record economic expansion and rampant stock market gains, but it also famously ended in the crash of 1929 which began the Great Depression. Not completely convinced that’s history we want to repeat.
But hey, now that we are officially at the halfway point of 2021, let’s see how our portfolio has been doing…
For the purposes of this checkup, we are only going be looking at Portfolio A, which is the original portfolio we retired on. Portfolio B contains the money we earned after retirement and are still contributing to, so it’s not as easy to get a read on how its investments are performing.
At the beginning of 2021, we made some important changes to Portfolio A. First, we got rid of REITs and redirected it into the dividend stock ETF PDC. We also switched over our aggregate bond ETF ZAG to a short-duration bond index ETF ZSB in order to blunt the effect of higher interest rates. So right now, our portfolio targets look like this.
|BMO Aggregate Bond Index ETF||ZAG||25%|
|BMO TSX Composite Capped Index ETF||ZCN||16%|
|Powershares Canadian Dividend Index ETF||PDC||9%|
|Vanguard Total Market Index ETF||VTI||25%|
|iShares MSCI EAFE ETF||EFA||25%|
And how are we doing so far this year? Well…
Yowza. Portfolio A started off the year at $1,227,000, so this represents an 10.3% increase year-to-date. That is a pretty stunning performance for only six months. Keep that up and who knows where we’ll end up at the end of 2021. Granted, we are all one bad variant away from everything shutting down again, so it’s important not to spike the football too early, but still. That ain’t bad.
So what happened? Why did the portfolio perform as well as it did so far?
Hot Vax Summer
The big bet that Wall Street is making is that there will be a massive economic recovery as people get vaccinated and stores reopen. For the past 16 months, world governments have been printing money and handing it to their citizens in the form of stimulus checks, wage subsidies, or unemployment insurance benefits. The result has been a massive buildup in cash in people’s bank accounts. The American savings rate has gone up from a steady state of 5% to a stunning 35% at the height of the pandemic.
And in Canada, our banks are reporting $212 BILLION dollars of cash deposits just sitting in people’s checking accounts at the end of 2020.
That money is being saved, economists reason, not because of people’s prudent financial habits, but because that money had nowhere to go. Once the economy opens up, that cash is going to get blown, and blown hard.
The optimist in me likes to believe that people are taking their stimulus checks, going to our Investment Workshop, and learning how to invest their cash and turn it into a passive income source that will let them retire in their 30’s, but the realist in me acknowledges that the economists are probably right. A tiny percentage of people (you guys, specifically) might do something smart with their money, and everyone else is going to blow it on jet skis and ketamine (in that order). Hot Vax Summer, baby!
And the data bears it out. Check out the American vaccination rates…
Now compare it to the shape of VTI, Vanguard’s US Total Market Index fund…
It’s hard to deny a striking resemblance. And as the rest of the world plays catch up with the Americans in their vaccination rates…
We can expect those countries stock markets to start to look a lot like the US too.
The Canadian Catch-up
Here’s something I wasn’t expecting. Because so much of our pre-retirement income was Canadian, we have a fairly significant allocation of our equity exposure in the Toronto Stock Exchange, or TSX. We like to keep it split about evenly between Canada, the US, and the MSCI EAFE (Europe, Australia, Far East) Index.
This has, annoyingly, caused us to underperform our American counterparts for a number of years as our stock market would just keep getting ignored by worldwide investors while poring money into the American stock market.
Well, this year it’s come roaring back. Here’s VTI’s YTD performance for 2021…
And here’s the TSX overlaid in red…
FINALLY. We get to beat the US at something. We may not be able to kick your ass militarily, or at football, or basically at anything cool, but this year we get to claim victory in politeness, maple syrup production, and the TSX! Ha! Take that! In your face!
And now that I’ve said that, the US stock market will probably take off and leave us in the dust over the next 6 months, but you know what? We’re Canadian. We never get to win against you guys at anything. So just let us have this one, OK?
Seriously though, what gives? What’s going on with our stock market? One of the reasons is vaccination rates. If we overlay Canada’s vaccination rate over that previous chart…
We can see that we’ve actually overtaken the US and Europe! Apparently, we have a LOT fewer anti-vaxxers up here, and that’s definitely a competition we are happy to lose against the Americans.
Secondly, we can also glean some more insight by overlaying the performance of PDC, the Canadian dividend stock index we also own on top of the chart from before. If we do that, we can see that PDC (in purple)…
…actually outperforms both VTI and the broader TSX! PDC contains mostly large mature dividend-paying companies, so basically banks, insurance companies, stuff like that. Our financial sector is brimming with cash, not just from all the deposits they’re holding, but the mortgages they’ve sold to desperate horny Home Boners who’ve purchased at wildly overinflated prices out in the sticks because they thought they’d never have to commute into the city again.
That and our financial regulators has forbidden companies who’ve received financial assistance from raising their dividends, so while dividend payments have been frozen in place, cash has been building up on corporate balance sheets. Hence, higher stock prices reflecting this excess cash.
Honestly, it’ll all probably normalize once the regulators let companies spike their dividends again, but for now we can gloat at our southern neighbours in our technical, temporary superiority.
Honestly, as Canadians, it’s all we can ever hope for.
The Return of Dividends
Speaking of dividends, they are back, baby!
Our Yield Shield strategy states that by pivoting to higher-yielding assets and relying on dividends to fund your living expenses, you can avoid selling assets during recessions and hedge off sequence of return risk. However, this isn’t a perfect solution because dividends can be cut, which we acknowledge in our book. In 2008, dividends on our portfolio got cut by 10%, and then were restored the year after. And in year 2020, dividends on our portfolio got cut by about 5%, and it looks like they’re being restored the year after. Not only that, the pandemic caused our spending to plummet from $40,000/year down to $34,000/year, and with dividends of $38,000, we still managed to book a $4000 surplus.
I gotta admit, it feels good to be proven right. When we wrote the book we were pretty confident that no matter what happened we could always drop our living expenses by travelling (“If shit hits the fan, we’re going to Thailand”), but the pandemic combined with my dad’s cancer diagnosis at the same fucking time was totally unexpected, and took away our magic bullet of international travel for a year and a half. And yet the Yield Shield strategy still got us through it!
And now, with the pandemic receding, the few funds that cut dividends (looking at you, EFA!) have restored them, and our passive income is flowing as expected again. We run our math targeting an annual dividend yield of $40,000 from our combined portfolios, which according to Passiv, is right on track with $20,000+ at the half way point.
Shortening Durations Works
Durations on bonds is a bit of a confusing subject, and ever since I wrote this article articulating my thoughts on what we were planning on doing with our bond allocations in a rising interest rate environment, our inbox has been exploding with questions. I think that article just generated more confusion. *hangs head in shame*
Ok so to recap, when interest rates fall, bond funds rise. And when interest rates rise, bond funds fall. Note that interest rates don’t actually need to rise or fall for the effect on the bond market because just the expectation of interest rates moving one way or the other is enough for the bond market to react. Bond traders are trying to get ahead of the interest rate moves so they don’t lose money.
Bond durations are a measurement of how sensitive a bond fund is to interest rate moves (or rather, an expectation of interest rate move). If a bond fund’s duration is 10, and interest rates go up 1%, then the bond fund’s value goes down 10%. Conversely, if interest rates go down 1%, the bond fund’s value will go up 10%.
So when interest rates are expected to go up, you can expect bond ETF’s to go down. Because the pandemic is receding and interest rates are already at rock bottom levels, we can expect interest rates to go up over the short to medium term. That’s why a bond fund like ZAG has this shape.
This is expected since bonds are anti-correlated to equities, so naturally when equities rise bonds fall and vice versa.
ZAG is an aggregate bond ETF. It has a duration of 8.1. ZSB, which is the fund we switched into, on the other hand, only has a duration of 2.8, meaning it’s far less sensitive to interest rate moves. This is what ZSB’s performance looks like overlaid on ZAG.
Now, this better performance isn’t free. I did have to give up something for that. Specifically, ZSB has a lower yield than ZAG. ZSB’s yield is only 2.36% vs. ZAG’s which is 3%. So I gave up 0.6% of yield, but in exchange we will avoid similar drops like this in the future as interest rates continue to rise.
That being said, I will be returning back to my neutral bond allocation at some point in the future, and when I do, you can be sure I’ll tell you all about it on this weird little blog we’ve made, so stay tuned!
So have the Roaring 20’s begun? Maybe. I sure hope so. After such a miserable start to 2020, the rest of the decade has got some major catching up to make up for it. I don’t know about you guys, but we are going to travel SO HARD once borders open up, which look like they might do any day now, so yeah!
And on the portfolio front, it sure looks like stock markets are being primed for a pretty major expansion. Everybody who took all this government stimulus and exchanged it for a giant mortgage are going to miss out, but you know what? I’m totally OK with that.
We just all need to set a reminder for October 2029. If this Roaring 20’s ends the same as the last Roaring 20’s, that’ll suck hard.
But for now, wheeee!
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