Investing the Down-Cycle

Since the beginning of 2009, we have been in a global business up-cycle. That's nearly ten years of growth this business cycle—driven in large part by massive central bank monetary policy. It has been a great time for investors so far, but we know every up-cycle is followed by a down-cycle.

You can almost think of the business cycle (and corresponding investment cycle in many cases) like a wave. The cycle tends to build slowly, driving the economy higher and higher. But eventually there is too much weight at the top and it crashes back down—often much harder than we would like.

Edited Photo. Source: Flickr - Warrick Wynne

If we read the pundits, there are varying opinions on the length of this particular business cycle. Normally, a "bull market" is considered to be over if the market-weighted equity index drops 20 percent or more from a peak.

That technically happened in 2011 and some argue it also happened in 2015-2016. I don't really buy that argument since the underlying business cycle was still in recovery by many metrics, especially in 2011. In 2015-2016 we saw a pause in the cycle, but there was not a real business cycle downturn.

We were in rock-bottom interest rates in both of these quick downturns. Unemployment was still extremely high in 2011 and loan growth was still quite low. Residential real estate was still in decline in 2011, usually an indicator of consumer confidence and financial capacity.

The 2015-2016 downturn was a little different. I think it was a situation where a business cycle downturn was very possible, but it was arrested by the world's major central banks. As a result, most of the common indicators did not fall 20 percent and the recovery was quick and very calm.

Regardless of the technical arguments, every day we are coming closer to the next real business down-cycle. That is a downturn marked by debt crisis, unemployment spikes, manufacturing and trade shrinkage, and a multi-period economic recession.

This unquestionable reality makes me think about how to invest during the next business and equity market down-cycle without losing a significant amount of the wealth I've gained in the past few years.

The Current Investor Paradigm

One of the biggest shifts and characteristics of this investor half-cycle (the upwards portion of the full cycle) has been the movement to low-cost index investing in a static portfolio allocation style.

These portfolios don't have a significant amount of thought process in their management. Assets are simply re-balanced on a regular interval, or sometimes on a somewhat strategic basis such as deviation from the target.

This movement goes by many names: Couch Potato investing, Bogle investing, Vanguard investing, passive investing, permanent investing, robo-investing, indexing, and so on. They all typical represent the same broad style and depend on the same elements for success.

The style is so pervasive that many retail money managers and financial advisors have moved their entire practice over to this investing style. The effortless portfolio has effectively become the fiduciary industry standard for professional money managers.

This passive investing approach has certainly performed well during this past business cycle. Backtests are pretty decent too when examined over extremely long time periods. However, I believe the sharp historical downturns are being largely ignored by investors who have adopted this approach.

It is reasonable to believe that many passive investors are going to get whacked hard in the next downturn. Almost no investor I know of is investing with caution, such as allocating heavily to Treasury bonds and gold. Instead, investors boast of 75 percent or higher equity allocations!

Some of the best models on future returns are suggesting a portfolio of market-cap weighted stocks and bonds will drop substantially. U.S. stocks may see a 60 percent decline to get back to historical valuations!

An investor with a 75 percent allocation to U.S.-centric equities may see their portfolio fall 45 percent. It's easy to brag about the high past returns seen with high equity allocations, but what about the future?

Many models are telling investors to count on your portfolio not being worth a dime more ten years from now. At the same time, advisors and passive investors are banking on returns of 7 percent or more compounded annually.

It is important to note that not all is bad with this move to passive investing. Investor costs are much lower and advisors have become slightly more ethical in many ways. Charging fees based on assets is much better for most clients than earning commissions from selling products.

Thinking About Protecting My Portfolio

I don't want to give the impression that I'm completely against index products, or even passive-style investing. I use index ETFs for much of my own investing—they're truly great products.

I just want to avoid the high levels of ignorance that I commonly see. Banking future success on well timed re-balancing, quick recoveries, and bond allocation counter-movements is not a strategy in my book—it is a wish.

Another issue is being realistic about my timeline. While 30 year returns can look impressive, it can be extremely difficult to think about the next three decades when my portfolio is half of the value it used to be.

Going all-in on stocks at the low point takes extreme confidence. If you can remember back to 2009, the world was very pessimistic. Upwards moves in stocks were dismissed as "dead-cat bounces" and the 2011 stock slide was widely believe to be the next leg down. 2008 all over again.

My objective is to try avoid a massive slide at the minimum and try squeeze out some profits if good opportunities are there for the taking.

I believe my goals are achievable with a combination of the two strategies I employ: Dual Momentum and trend investing. While Dual Momentum is a long-only strategy in global stocks or bonds, trend investing allows me to go long or short in anything. That said, I am much more cautious going short.

Dual Momentum

Roughly half of our money is invested in the Dual Momentum model. I'm quite confident of the downside protection that Dual Momentum provides.

Historically, Dual Momentum has not fallen more than 25 percent. Recoveries are fast and effort is low. The model makes a lot of sense to me in many ways.

I always count on a maximum potential loss being 25 percent higher than the backtested maximum loss in any model. For this reason, I am counting on a drawdown of 32 percent in my Dual Momentum accounts.

Since my Dual Momentum accounts form a little under half of my net worth, that translates to a theoretical loss up to 15 percent of my total portfolio.

Macro-style Trend Investing

In my non-registered accounts I invest much more dynamically and am open to exploring a broad range of choices to protect my portfolio. This includes use of long-dated call options and put options to bet on both sides of the move while limiting losses.

So far, I am almost entirely out of equities. My Brazilian stocks trade is still in play, but is very close to my stop loss mark as I write.

On the protection side, I have invested in 1,700 GLD call options and 10,000 ounces via silver futures to get exposure to precious metals. Given the depressed price of precious metals, along with the forming up-trend, I am not too worried about this position in a business cycle downturn.

I have also initiated put options trades betting on a decline in U.S. Real Estate (IYR) and Natural Gas (UNG).

U.S. Real Estate has held very well relative to stocks in the past months. Apparently many see it as a safe haven. I think it looks more like a ticking time bomb given the enormous amounts of debt sloshing in the system. It failed to make a new high this past month and dropped below the October low.

Natural gas had a crazy spike this fall which wiped out an options seller who didn't see "rogue waves" coming towards his ship. Prices are starting to drop quite substantially.

Given the long downwards trend in natural gas, I would not be surprised if we see new lows in UNG. However, I am watching my stops carefully on this one and used options to limit my maximum loss if an uptrend is solidified.

I am also exploring a more substantial focus on currencies and commodities, likely via futures contracts and futures options for better risk control, liquidity and access to leverage.


Currencies are extremely liquid markets that can move quite substantially during business cycle downturns. We are already seeing this in emerging currencies like the Turkish lira, Argentine peso, Mexican peso, and many others.

We can also see big moves in the larger currencies such as the Euro, Swiss franc, British pound, and Japanese yen against each other and the U.S. dollar.

Since options are not available on standard currency trades, I have to move to currency futures contracts to access the same kind of leverage and efficiency of cash deployment. My account is large enough at this point to trade currency futures and meet my risk parameters.


As mentioned, I already have exposure to gold via LEAPS options in GLD—a highly liquid gold ETF with significant options volume and tight price spreads.

Unfortunately, there are no good choices for trading any other commodities in ETF form, especially on the up-side moves. This means I must look to other instruments to get exposure to things like corn, wheat, lumber, oil, silver, and copper.

Again, I believe the answer lies in futures contracts. The futures markets were made for commodities, so they are extremely liquid. Again, the leverage opportunities are fantastic, so I can get exposure to commodities with very efficient capital deployment.

With agriculture commodities at very low prices and copper, lumber, and oil falling substantially, there are some opportunities building in this sector. I want to make sure I've developed my trading abilities to take advantage of the price moves these commodities can make down the road.


In the meantime, I am not ignoring the value of cash in my portfolio. Most of my portfolio is in cash (U.S. dollars at the moment), earning a small amount of interest each month.

The gains from cash are certainly not great. But I would rather have money in the account doing nothing than trying to be busy in a market with lousy opportunities.

If we are entering the down-cycle stage of the full business cycle, I would be very happy to come into the next up-cycle with my current account net worth.


Right now I'm putting a lot of my focus on protecting what I have in the portfolio. Although it is not yet confirmed, we would need a major shift in investor sentiment to avoid slipping into a business cycle downturn in the coming months.

A large portion of my portfolio is currently in U.S. stocks, as per the Dual Momentum signal for December, along with cash and gold exposure. If U.S. markets continue their pattern for the rest of the month, it looks almost inevitable that Dual Momentum will be signaling "Bonds" for January.

Given the lack of good opportunities in this market environment, I am being very patient with my investing activity. I've got a lot of U.S. dollars in my account and am quite happy with cash in my account generating a small amount of interest income.

In preparation for moves in commodities and currencies that I anticipate may materialize in the coming years, I am exploring the futures markets. Futures can give me access to commodities and foreign currencies with reasonable cost efficiency, unparalleled liquidity, and access to ample leverage.

In future years, I can see my trend portfolio moving to LEAPS options on highly liquid ETFs like SPY, EFA, and EEM. In addition, I will use futures contracts to trade commodities like corn, oil, lumber, silver, and copper.

I will also use futures contracts to trade emerging market currencies like the Mexican peso, South African rand, Indian rupee, and Brazilian real.

This will be my last post of 2018. I'll be back in early 2019 with my usual Net Worth Update and Portfolio update.

Have a good Christmas and holiday season everyone!

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Tax Preparation 2018

As 2018 winds up, it is time to think about investment taxes and other financial housekeeping once again.

For the purposes of this post, make sure you complete any transactions no later than December 27, 2018 for them to settle in the 2018 tax year. If you execute the trade after this date, the tax gains or losses will apply in 2019.

Also, many of the investment taxation issues apply only to non-registered accounts. If your money is solely in a TFSA or RRSP, you don't need to worry about investment taxes.

However, if you are withdrawing from a TFSA or RRSP this year you will want to pay attention.

Re-balancing Portfolios

Given the market gyrations of 2018, you are likely to give some great opportunities for re-balancing and taking some tax losses.

Remember, in Canada capital losses can be carried forward indefinitely to offset future capital gains. They can also be used to offset capital gains already paid in the 2015, 2016, or 2017 tax years.

Leveraged Barbell Portfolios

If you are tracking one of the leveraged barbell portfolios which I share on this blog, you are likely to be down on a capital basis on your leveraged equity ETF (UPRO, SPXL, or HSU.TO) for this year.

If that's the case and you are investing in a non-registered account, it could be advantageous to book the loss now. To avoid superficial loss rules, you could buy a small cap leveraged ETF instead (URTY or TNA, for example). You could also buy the emerging markets leveraged ETF, which has dropped significantly this year (EDC).

Given the rise of interest rates this year, you are probably down on your bond holding as well. Again, if you are investing in a non-registered account consider booking the loss and buying a similar, but different bond ETF instead. For example, you could sell BSV and buy VGIT.

Make sure you re-balance correctly to your target allocation. Unless it is in your plan and you've carefully thought it through, do not increase your risk.

Couch Potato Portfolios

This year was an interesting year for Couch Potatoes as well. If you follow the standard CCP model ETF portfolio, you are holding XAW.TO, VCN.TO, and ZAG.TO as recommended by Dan Bortolotti.

Every one of these holdings are down for the year. Depending on when you started following CCP, you could have a capital loss on all of your holdings.

To book the losses and avoid the superficial loss rule in non-registered accounts, you could:

  1. Sell XAW.TO (which tracks MSCI Indices) and replace with VXC.TO (which tracks similar FTSE Indices);
  2. Sell VCN.TO (which tracks the FTSE Canada Index) and replace with XIC.TO (which tracks the S&P/TSX Capped Composite Index); and
  3. Sell ZAG.TO (which tracks the FTSE TMX Canada bond index) and replace with VAB.TO (which tracks the Bloomberg Barclays Canada bond index)

Regardless of taxes, the end of the year is always a great time to re-balance your portfolio back to your target allocation. Canadian stocks in particular have dropped quite a bit this year and should be topped up if you're following this strategy.

Tax Loss Harvesting

If you are investing in a non-registered account, now is the time to re-evaluate all your holdings and determine if you really want to keep them.

Many securities have declined quite drastically this year and, if they no longer fit in your portfolio, it is time to book the capital loss and use it to offset prior year, current year, or future capital gains.

If you like the current exposures you have, but you still are holding positions with a sizeable loss, you should consider selling anyways, booking the capital loss, and replacing the holding with a similar but different asset.

This could mean selling one energy asset for another, replacing gold (GLD) with silver (SLV), replacing BMO Bank (BMO.TO) with CIBC (CM.TO), and so on. Almost every asset on the market has very tight correlations with another asset.

Tax Gain Harvesting

In a prior post, I have gone into depth about the benefits of strategically harvesting capital gains in non-registered accounts when you are in a low tax bracket.

Unlike capital losses which are subject to the superficial loss rule in Canada, you can legally sell an asset, or part of an asset holding, for a gain and then repurchase the same asset immediately.

Doing this carefully at low capital gains tax rates can steadily increase your adjusted cost base and significantly reduce future tax liabilities.

This strategy is best done when you are not earning other income, such as employment income or RRSP withdrawals.

Ideally you want to realize capital gains when you are in the lowest tax bracket and you can offset the realized income with interest expense or other tax deductions.

Spousal Loans

Although the CRA prescribed rate has crept up this year, you can still make a spousal loan for just 2 percent annual interest.

Spousal loans can be a very tax friendly strategy for moving assets from a high income, high wealth spouse to a lower income spouse. Here are the steps to do this:

  1. The high income spouse writes a legal contract with the low income spouse for a loan meeting the conditions required by the CRA;
  2. They transfer the loaned money to the low income spouse;
  3. The receiving spouse invests all of the money in a non-registered account, buying income generating assets like stocks which pay dividends;
  4. The receiving spouse pays their partner the necessary interest payment at the end of each year, but can deduct that expense from their income at tax time as it is an investment loan;
  5. The high income spouse must claim the interest income and pay taxes on it.

In this strategy, the high income spouse moves their wealth to the low income spouse via a legal contract. They get some taxable interest income, but at a 2 percent rate it is very minimal.

The lower income spouse gets almost all the wealth growth and pays much less tax on this wealth growth than the higher income spouse would if they had invested the money themselves.

In most cases this strategy should only be considered for individuals who have already filled their registered accounts, have a meaningful amount of excess money to loan to their spouse, and their spouse earns significantly less income.

TFSA Contributions or Changes

A few weeks ago, the government has announced they will be increasing the TFSA contribution amount to $6,000 for the 2019 year.

This means a couple will be able to invest $12,000 in their TFSAs and grow that money forever, but pay no taxes on the wealth growth.

If you're really rich, you can also put money into an adult child's TFSA, provided they earned some money and file a tax return.

Try to fill your TFSAs as soon as you can. You might need to transfer money from your non-registered account but, if you do this is January, you won't pay taxes on any realized gains for nearly sixteen months. Of course if you have capital losses you can realize, take them in 2018.

Moving Your TFSA

If you've been thinking about moving your TFSA to a new brokerage, now is the time to plan this carefully to avoid pesky over-contribution rules and penalties.

  1. Complete the paperwork to open a new TFSA account at your desired broker. I like Questrade and National Bank Direct for registered accounts—they each have their own advantages for different situations;
  2. Withdraw all the money from your existing TFSA account before the end of December, close the account, and hold the cash in your personal chequing account; and
  3. Deposit the money into your new TFSA account in the beginning of January.

You should be able to move TFSAs without incurring any fees aside from some trading commissions if they apply.

Always check first, but most good banks do not charge fees to close TFSA accounts. If they do, you could just keep them dormant forever with a few pennies in the account.

RRSP Housekeeping

Get ready for so-called "RRSP Season" which runs from January through the end of February. During this time you can make RRSP contributions and apply them against your 2018 income—saving you money on income taxes.

Unless you expect a significant pay raise in 2019, try use your RRSP room as soon as possible. This is especially true if you earn over $93,208 in 2018. There's no point in running a big tax credit with the government—they charge interest, but they don't pay it.

If you are retired, were a stay-at-home mom, took a sabbatical, or experienced a temporary loss of income, consider making RRSP withdrawals to take advantage of low tax rates.

As I often state on this blog, I am a big proponent of what I call "tax-targeting". Try realize as much income as possible at a reasonable tax rate given your personal situation.

If you can realize income at an overall tax rate of 10 percent, take advantage of the opportunity! You can use the withdrawn money to fill your TFSAs, non-registered accounts, or even pay off debts.

Smith Manoeuvre

If you've implemented the Smith Manoeuvre, the coming weeks are a great time to get your paperwork in order, make sure the strategy is running smoothly, and make any necessary tax adjustments for RoC distributions.

Given the amount of paperwork and running around involved in establishing a proper Smith Manoeuvre process, this time of year could be a good time to get things arranged for a new Smith Manoeuvre.

Although you should anticipate pretty meagre future returns in many equity markets for some time, the Smith Manoeuvre is a long term process.

Also, the biggest benefit of the Smith Manoeuvre is the tax savings—which are substantial over time! These tax savings can help you save more and invest more, growing your overall wealth.

Interest rates are still very low by historical standards and can drop significantly if we enter another recession. With the U.S. Federal Reserve indicating they are coming to the end of rate increases, I think HELOC rates in Canada are also unlikely to increase much more.

Blog Stuff

The blog continues to grow, albeit more slowly than before. I have shifted a lot of my posts over to a more technical and advanced perspective designed for more experienced investors.

I understand this might fly over the head of the typical Canadian who continues to pickle themselves in debt, live paycheque to paycheque, and pray for ever higher house prices (if they own a house).

I'm making this shift intentionally as there are countless blogs out there which preach personal finance basics, push Couch Potatoesque investing, and try sell you credit cards or other financial products. My target audience is the more advanced investor who hopefully has the basics taken care of.

During 2018, readers have come to the site more than 16,000 times. You have read more than 35,000 pages and left over 300 comments.

Thank you and I hope you will continue to be engaged, ask questions, and give me things to think about.

I truly believe my own investing process is getting better because of the things I explore; much of it inspired by comments and emails I receive from readers.

Comments & Questions

All comments are moderated before being posted for public viewing. Please don't send in multiple comments if yours doesn't appear right away. It can take up to 24 hours before comments are posted.

Comments containing links or "trolling" will not be posted. Comments with profane language or those which reveal personal information will be edited by moderator.