Download The Rally that started on the Ides of March 09

September 2014
The Rally that started on the Ides of March 09
Five and a half years later to the month, many investors still remember that deep sinking feeling
when their portfolio values had declined anywhere between 15 to 40%. Ironically it was on March
15th of 2009, the anniversary of the Ides of March (ie when Brutus assassinated Caesar) that
marked the turning point. It was also the morning after the IMF announced it would make $1
trillion of emergency funds available should any of the eastern European countries fail. That was
the bottom and the rebound since has certainly been far more lucrative than most pundits
predicted.
Post this 2008-09 experience, a number of investors did retreat to more conservative investing
favoring fixed income. Thankfully for them bonds did provide some return at around +31% (or 5%
annually). Nonetheless this was nothing like the equity markets (MSCI World in $Cdn) that have
since soared 110% or about 15% annually. The US market (S&P500) did lead at +18.0%, followed
by Canada (TSX) and the International (MSCI EAFE) markets at around 13.5% each, and the
emerging markets at 11.8%.
Another factor helping stocks appreciate has been lower long term rates, a factor that further
enhances stock multiples and therefore valuations. Meanwhile the corporate world did find its
footing again post 2009. In spite of a weakened global demand, corporations were able to rebuild
significant earnings growth through access to cheap cash as well as low labour costs both at home
and abroad. Of late the USA has also added gained a significant advantage, the growing domestic
supply of shale oil and gas, one of the cheapest energy source within the G20 countries.
At this juncture it is also clear that certain parts of Europe (France and Italy in particular) are
stagnating economically under an inflexible labour force and higher taxes. This is holding back
Europe’s economic recovery, which forced the European Central Bank earlier this month to lower
its bank rate to 0.15%. The ECB is also seriously looking at Quantitative Easing (QE) measures for
the end of 2014. This is similar to what the Federal Reserve did three years ago.
It is worthwhile to note that in spite of a quasi-assurance that the FED will start raising rates at
mid-2015, long term yields have actually declined further. The 10 year US treasury yield currently
stands at 2.4% down from 3.0% at the start of 2014. It is fair to say that the markets certainly seem
positioned for an extended period of low longer term interest rates. On one side this is very
positive for the equity markets but on another, presents a singular risk for stocks and bonds alike,
in what we would call “surprise” inflation. We would define this as inflation that would rapidly
creep back up to 3% or higher starting in the USA. The probabilities while low are likely higher than
what the market is pricing in. It is a singular risk that we must be aware of and carefully monitor.
What are investors to do? At this juncture first and foremost maintain the equity overweight bias
since the return to risk potential remains positive. With plenty of cash still on the sidelines, limited
investment opportunities in fixed income and solid corporate earnings growth, there remains
plenty of additional fuel to push equity markets higher. Short of a major negative geopolitical
event that would shake the global economy, corporations have rarely had it better. Low inflation,
low wage pressures, a steady global economy and access to cheap cash. The equity overweight
recommendation favours US and Far East equities.
While European Equities may have better valuations, the earnings momentum there is uncertain
due to its stagnating economy. Of late the impact of sanctions on Russia, the general uncertainty
caused by Ukraine, the turmoil in the Middle East, growing migration protectionism, and this
week’s independence vote in Scotland are further undermining the European economy.
Meanwhile investments in bonds are not only low yielding but are also uncertain (see risky!) as any
surprise jump in the inflation will certainly have an impact. We do observe a number of “possibly”
non-recurring factors that are helping keep inflation in check at the present time. For one, metal
prices as a group have softened considerably as a result of the slowdown in China. Then there was
a near record global harvest this past year that has filled inventories and brought corn and wheat
prices down to near 4 year lows. Even of late oil prices are seen softening as a result of excess
supply. Finally and while wage demands in the USA have remained low overall, some sectors are
seeing their first serious increases in years. The common thread to these factors is that many if not
all could just as easily reverse six months or one year from now.
As mentioned, investors should be aware that “surprise inflation” would adversely impact both
fixed income and equity investments. Neither would be spared, at least not initially. The question
therefore is, other than cash, where else one might diversify from this singular risk.
Real return bonds, gold and certain commodity stocks would seem as good offsets. Infrastructure,
Real Estate and certain alternative strategy (hedge) funds would also better hold their values. Due
to the current growth trend within the North American economy, corporate/high yield bonds
should also be considered as a safer haven. Benchmark clients are invested in many of these
strategies and in some cases entirely at the expense of traditional bonds.
We do hope you enjoy the upcoming autumn colors, for some election season, thanksgiving, wine
fairs, perhaps oyster parties & all.
Marc
Marc Lalonde
Partner – Benchmark Investment Consulting
506-391-0932
www.benchmarkIC.com