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Transcript
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