Download Modest growth in investor confidence amid continued volatility

MDPerspectives
May 2012
Modest growth in investor confidence
amid continued­ volatility
Policy-makers remain central to shoring up confidence in economic growth
There was no fear that investor
optimism would grow unchecked in the
first quarter of 2012, but compared with
the very start of the year, investors were
feeling confident enough to send most
major indices higher over the quarter.
We see signs that investors are growing
ever more prepared to focus on positive
fundamentals and, at the same time, are
becoming less susceptible to reacting to
the latest headlines. However, investor
patience will no doubt be tested in the
second quarter as markets continue to
deliver volatile performance.
10-year benchmark government bond
yield is hovering near 2.0%, while Bank
of Canada core inflation came in at
2.3% in February, implying a negative
real yield for these bonds.
The news headlines have also become
somewhat more encouraging. The
eurozone still faces challenges, but,
for the time being, appears to have
avoided an economic meltdown. The
U.S. economy continues to send signals
that it is on the mend, with job growth
trending in the right direction. The Bank
of Canada’s Business Outlook Survey for
the first quarter found 58% of firms
expect their sales to increase over the
next 12 months—the best result since
early 2010.
Capital markets also inched toward a
more optimistic outlook as the quarter
unfolded. One important indicator of
this was that stock movements were
The S&P/TSX Composite Index was up
4.4% in the first quarter. U.S. markets
fared even better, setting the pace for
global equity markets. The S&P 500
Index was up 12.6% in U.S. dollar terms
and 10.5% higher in Canadian dollars in
the first quarter. It hit a four-year high in
March. The MSCI World Index finished
11.6% higher in local currency terms
and up 9.8% in Canadian dollars. The
MSCI Europe, Australasia and Far
East (EAFE) Index was up 11% in local
currency terms and 8.9% higher in
Canadian dollars.
Canadian fixed income, specifically
government of Canada bonds, continue
to be attractive to both local and
international investors. The Canadian
Highlights
} U.S. consumer picture slowly improving
} International trade grew for two consecutive months
} Tax-wise investing: Understanding asset allocation for the incorporated physician
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less correlated with other assets than
during the second half of last year.
In 2011, as nervous investors worried
about European defaults, different
investments moved in concert. Market
sentiment alternated—often daily—
between optimism and pessimism. On
days when optimism dominated, riskier
assets like commodities and stocks
rallied together. On days when investor
fears peaked, almost any investment
that was perceived as risky would
decline in value.
Meanwhile, emerging-market
economies continued to report gross
domestic product (GDP) results for 2011
that reinforce a story of growth that
outpaces developed markets. At the
same time, this growth has slowed since
March 2010, easing emerging-country
inflation pressures. Inflation remains a
key concern because, if emerging
economies show signs of overheating,
authorities will likely raise interest rates
to dampen growth—something that
would likely reduce demand for
exports in the long run from countries
like Canada.
On the aggregate, inflation in the
emerging-market economies continued
to decline, providing further flexibility
in terms of monetary policy. Chinese
inflation declined to 3.2% in February
from 4.5% in January, and is currently
well below the target rate of 4%.
Inflation in Brazil and Russia declined
to 5.8% and 3.7% in February from
6.2% and 4.2% in January. While
inflation declined for the majority of
emerging economies, India experienced
an increase of 7.5% in February, up from
5.3% a month earlier. One of the more
worrisome risks for inflation is that
energy, particularly oil, may get more
expensive because of escalating
tensions in the Middle East.
In this environment, we still believe the
global economy will continue to expand
at a two-speed pace, with emerging
economies leading the way. Comparing
first-quarter GDP annual growth against
the same period in 2011 illustrates this
point. First-quarter GDP was 2.2%
higher in Canada and 1.6% in the
United States. Meanwhile, China’s GDP
expanded by 8.9%, year over year, in
the first quarter. Over the same time
frame, India’s GDP expanded by 6.1%.
Longer term, Canada is well positioned
to prosper in this two-speed economy.
Over time, Canadian resource companies
will continue to benefit from the
stronger growth trend expected in
emerging economies compared with
developed markets. But, for now,
investors are more focused on policymakers’ efforts to contain Europe’s
debt crisis.
Whether our view of a two-speed
recovery, with only moderate growth
in advanced economies, plays out will
depend on three factors: policy-makers,
U.S. consumers and international
trade. Together, they hold the key
to understanding this year’s growth
picture. Policy-makers—including
politicians, central bankers and key
bureaucrats—will continue to be the
most important factor in keeping the
global economy on the path of continued
growth. It is also important to note that
policy-makers need to do more to
convince investors that their measures
to stimulate the economy and address
the European crisis are going to deliver
on their promise.
Policy-makers will remain under
intens­e scrutiny
Policy-makers will continue to have
significant influence on both economic
and market conditions. The uncertainty
resulting from the need for unusual levels
of intervention will be an important
influence on market participants.
They will continue to look for ongoing
reassurance of a return to stability in
the global economic environment.
Reform-minded political leaders in
Greece, Spain and Italy should help
reduce political shocks to the market
and provide needed reassurance about
a return to stability. Greece faces a
general election on May 6, however,
which could leave the two main parties
unable to form a government. In that
case, current Prime Minister Lucas
Papademos, a former vice president of
the European Central Bank and labelled
a “technocrat”, might be forced to
remain in power to resolve the situation.
This may not be unwelcome news if the
market sees Papademos as the one
person who can actually deliver on
promises of reform. In mid-February,
Papademos won cabinet approval for
deeper budget cuts needed to secure
a second package of international
financial aid.
Spanish bond yields faced renewed
pressure. The Spanish minister for the
economy, Luis de Guindos, has said
Spain may sell off public real estate.
De Guindos continues to stress the
country’s commitment to reform. Spain
remains under intense pressure from
Europe to curb spending, because of
growing fears that the European Union’s
fifth biggest economy may need
a bailout.
2 M D P E R S P EC T I VE S
Italy’s borrowing costs are also rising,
with the yield on the 10-year bond at
5.6% in early April. Markets are waiting
to see if Prime Minister Mario Monti,
another economist by training, like
Papademos, who was appointed to
lead a technocratic cabinet focused on
reforms, can deliver. He has angered
many with his plans for labour reform.
The idea of a more flexible job market,
along the lines of what is seen in North
America and the United Kingdom, has
given markets hope that Italy is on the
right path.
Closer to home, gridlock in the U.S.
political system has eroded consumer
and business confidence. While there
is potential for more uncertainty from
lawmakers, investors seem content to
focus primarily on economic data until
after the presidential election, slated
for later this year.
U.S. consumer picture slowly improving
U.S. consumers remain the world’s most
important economic engine. Spending by
U.S. consumers accounts for about 70%
of U.S. GDP, and this spending in turn
accounts for about 20% of global GDP.
Without sustained demand from U.S.
consumers, the global economy cannot
continue to expand at a sustainable rate.
Housing and employment are the two
keys to helping consumers recover.
Minutes from the U.S. Federal Reserve’s
last meeting showed policy-makers
backing away from the need to begin
a third round of monetary stimulus to
boost the economy as the recovery
gradually improves.
The March slowdown in hiring will
likely prove to be temporary, but job
growth was still strong enough for the
unemployment rate to edge down to a
three-year low of 8.2% in March.
The U.S. economy, in its third year
of expansion, is better equipped to
overcome rising energy costs and
a slowdown in European economic
growth. Growing business optimism,
based on improving sales and profits,
may give business leaders the
confidence to take on staff more quickly.
Home prices are a key component of
consumer wealth. Housing starts in the
United States were near a three-year
high and building permits rose in
February. This added to growing
sentiment that the industry that sparked
the financial crisis is finally stabilizing,
though at a low level. Demand for
previously owned houses advanced in
February to the highest level since May
2010, according to economists surveyed
by Bloomberg. Of course, the U.S.
housing market will not turn around in a
matter of months. But these recent
developments suggest that a slow
recovery could be unfolding.
Home prices are a key component of consumer wealth.
Housing starts in the United States were near a three-year
high and building permits rose in February. This added
to growing­sentiment that the industry that
sparked the financial­ crisis is finally
stabilizing, though at a low level.
3 M D P E R S P ECT I V E S
International trade grew for two
consecutive­months
World trade volume grew by 0.9% in
January, following a revised rise of 0.9%
in December, according to data released
in late March by the CPB Netherlands
Bureau for Economic Policy Analysis.
Imports expanded strongly in most
advanced and emerging economies,
most notably in Japan. But in emerging
Asia, imports declined. European
imports grew for the first time since
August. Regional differences are also
more stark when it comes to exports,
with strong figures for the United States
and Japan, a decline in emerging Asia
and a continuing decline in Europe.
These trade figures are largely in
keeping with our central scenario of
two-speed economic growth. We still
believe the global economy will
continue to expand, with emerging
economies leading the way.
Cautious optimism tempered by
expectation­s of volatility
We are tempering our cautiously
optimistic stance about economic
growth, as the ongoing global economic
recovery grinds along. We continue to
expect the global economy to grow
slowly over the next four or five years.
Volatility will remain a fact of life,
given the many uncertainties facing
the world.
Looking beyond the headlines and
focusing on investment fundamentals
remains the correct approach. We
continue to encourage you to work
closely with your MD advisor to focus on
your portfolio’s purpose and time horizon,
with a view to rebalancing so that your
current mix of investments matches
your long-term strategic asset mix.
Now is an ideal time to revisit your longterm financial plan and ensure that you are
up to date with the appropriate strategic
asset mix. To make sure that you are in the
best position to keep your financial future
on track in the face of emerging economic
opportunities, talk with your MD advisor,
or call MD at 1 800 267-2332 to be put in
touch with an MD advisor near you. n
Tax-wise investing:
Understanding asset location
for the incorporated physician
As an investor, you are already familiar
with the concept of asset allocation:
the investment strategy that attempts
to balance risk and reward by adjusting
the percentage of each asset in an
investment portfolio according to your
risk tolerance, goals and investment
time frame.
And you likely already know that once
you have selected the appropriate asset
allocation for your situation, the next
step is to implement the appropriate
asset location, or choosing where to
put each kind of investment.
That is because different types of assets
give rise to different forms of investment
gains, such as capital gains and dividends
(for equities) and interest income (for
bonds and other fixed income)—and
each of these is subject, in turn, to
varying tax treatment. In brief: Interest
is generally taxable at your highest
marginal rate as it is received, while
both capital gains and dividends receive
preferential tax treatment, compared
with interest income.
Beyond asset allocation—
to asset location
The varying tax treatment of different
kinds of investment return means that
tax-wise investors will locate their assets
in accordance with the tax treatment
they will get in different kinds of
investment accounts.
As a general rule, you would probably opt
to hold investments that produce interest
income in registered accounts, such as
RRSPs, which allow you to defer tax on
this income until you begin to withdraw
from the account—and you would put
investments that are expected to produce
capital gains and dividends in nonregistered accounts. Of course, these
general rules have exceptions. Our
advisors can provide helpful insights
to apply to your specific situation
and preferences.
Impacts for the incorporated physician
So, how does all of this affect the
physician who is incorporated? At the
most basic level, adding a corporate
investment account means you have
one more location to house your assets.
As a general guide, while maintaining
the same overall portfolio risk and
adhering to the overall asset allocation
strategy you have already selected,
tax-wise, investing for the incorporated
physician will continue to guide us to put
investments that are expected to produce
capital gains in your non-registered
accounts—which now includes your
corporate account.
How we can help
In addition to the asset location decision,
there are a number of other important tax
implications associated with investing
inside your professional incorporation.
Whether you have made the decision to
incorporate or not, it can be useful to
understand how incorporation can affect
your asset location decisions. MD has the
in-house expertise and tools to help
guide you through these issues—which
can be important, as getting the right
input at the outset could save you
thousands of dollars in taxes over the
course of your investing life. We are also
experienced at working with your
professional tax advisor to apply the
proper insights to your specific situation.
We will help define a strategy to set you
on the right course.
Contact your MD advisor today.
n
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The information contained in these documents is not to be considered investment advice. Please consult your MD advisor before making investment decisions or
implementing any investment strategy.