US GDP is growing faster than their debt

Two veteran money managers are interviewed by Consuelo Mack. You might be surprized by their comments regarding US and government debt. They suggest you cannot consider government debt as you do personal debt – it serves a different purpose. I highly recommend you view the video if you want to understand the complexity of government debt and its impact on the economy. Go here for the interview.
Consumer Debt a Problem but not a Crisis

I picked up Macleans magezine a few months ago and the cover page said, “Canada’s Real Estate Market – why it’s officially time to panic.” Doubt panic is the right response – maybe caution – but panic??? Consumer debt has also been in the news but not the worry the media is suggesting. Go here for the article.
Saudi-America is becoming energy independent faster than many realize

Once again those “Peak Oil” warnings of 10 years ago continue to be an example of meaningless dire predictions. The US needs less oil from outside North America every year. Go here for the article.

Corporate Canada in Excellent Shape
Article

10 Lesson from Einstein

Article

The first quarter of 2012 represented the strongest start for the U.S. stock market since 1998; with Japan turning in its best first quarter gains in 24 years. This was largely driven by a reduction of fears about an extremely negative outcome in Europe, as well as stronger economic data in the U.S.

The reason given by the financial press for April’s pull back was: equity prices highly vulnerable to slowing in earnings growth, Spain’s interest rate hike, the Israelis possibly blasting Iran’s nukes and a slowing of China’s growth. Given a 30% rise in the equity market over the last 6 months, a pull back is expected.

What the financial press seems to ignore is that equity valuations (at least in the US) have never really gone up during one of the strongest earnings growth periods in history. For example, the S&P500 at 1400 has an average Price to (2012) Earnings estimates of only 14 when the 20 year average is around 16-19!

Of course, there are some challenging issues still to be addressed. This article provides perspective on some of these issues, and outlines some thoughts on what we can expect for the balance of 2012 and beyond. As part of that, I have included recent comments from Ben Bernanke and Warren Buffett, as well as Christine Lagarde; managing director of the International Monetary Fund and the Wharton School’s Jeremy Siegel, today’s leading market historian.

Click here to read further …

Before getting into their views, here’s a summary of market performance in the first quarter, all in local currency so as to exclude currency fluctuations. Even with strong first quarter returns, most markets with the exception of the United States are underwater over the past 12 months. Canada’s resource exposure has meant that we have lagged global markets over the past year.

……………………………………………………………………………..Emerging              Global
………………………..Canada   US       Europe     Japan          Markets              Returns
January………………..5%       5%         4%             4%                 7%                          5%
February………………2%      4%         5%            11%                 5%                          5%
March…………………-2%       3%         0%            3%                 -1%                         2%
Q1 2012……………….5%      13%       9%             19%               11%                        12%
Last 12 mths………..-11%      7%       -4%              1%                -4%                          1%

Growth projections:

…………………………………..Actual              Projections              Changes from Sept 2011
……………………………….2010    2011         2012    2013                   2012      2013
World                              5.2%   3.8%         3.3%   3.90%               -0.7%     -0.6%
Advanced                       3.2%   1.6%           1.2%   1.9%                  -0.7%     -0.5%
Emerging                       7.3%    6.2%          5.4%  5.9%                   -0.7%    -0.6%
Canada                           3.2%   2.3%           1.7%   2.0%                   -0.2%    -0.5%
U.S                                  3.0%   1.8%           1.8%   2.2%                    0.0%    -0.3%
Euro                                1.9%    1.6%          -0.5%  0.8%                  -1.6%    -0.7%
China                              10.4% 9.2%           8.2%  8.8%                   -0.8% -0.70%

The IMF’s view: A reduced forecast for global growth:

The single factor that more than any other will drive stock markets over the mid-term is the path of global economic growth; Europe in particular remains a question mark. In early January, the International Monetary Fund reduced its forecast for global growth, and predicted that continental Europe would see a mild recession in 2012. Here are excerpts from the IMF’s January forecast for economic growth:

Bernanke & Lagarde: Sign of improvement … but efforts must continue ….

Since this forecast was released in January, actions by global governments have changed the European outlook for the better. Indeed, it was greater optimism about a resolution to Europe’s issues that fueled the first quarter’s strong market performance.

There is still much work to do, however.

March 20th featured a press conference by Christine Lagarde, Managing Director of the International Monetary Fund and, formerly Finance Minister in France. She painted a more positive but still cautious picture. Here’s how her remarks began:

“In terms of global economic outlook, we are certainly not, and I do say not in as bad a situation as we were only three months ago; and there have clearly been some significant improvements.”

“Coupled with an uptick coming out of the United States of America, it gives an overall picture (for Europe) that is slightly more positive than it was three months ago; not to say that all the difficulties have been cleared. If I have one message, it’s that the reforms and the efforts underway in advanced economies have to continue and that the same vigorous rigor has to be applied by Governments in the programs and the efforts that they have undertaken.”

The very next day, Ben Bernanke spoke to the House Committee on Oversight and Government Reform about the Federal Reserve Board’s views on Europe. He pointed to improvement in Europe and focused on three positive steps on the continent to increase stability. He also discussed favourable results of stress tests of banks in the event of a severe pullback in the U.S. economy.
But his closing comments echoed Christine Lagarde’s note of caution about the need for further action to address Europe’s structural issues:

“The recent reduction in financial stress in Europe is welcome given our important trade linkages. The situation however remains difficult and it’s critical that European policy leaders follow through on their commitment to achieve a lasting stabilization. I believe our European counterparts understand the challenges they face and they’re committed to take the necessary steps to address those issues.”

Should you be interested in watching them, here are links to the comments from Ben Bernenke and Christine Lagarde.

Also, you can click here to go to the IMF’s most recent global growth forecast.

From my own point of view, it’s worth noting that given European issues and a slowdown in China, there is broad consensus that the next five years will see “2, 6 and 4” growth; an average of 2% in developed countries, and 6% in emerging economies, leading to 4% global growth overall. It’s this divergence in growth between developed and emerging countries that is driving increased focus by multi nationals on faster growing emerging economies.

Warren Buffett: “America’s best days lie ahead:”

In the face of challenges for developed economies, there is a persistent view of America as an “empire in decline.” This was reinforced by last year’s downgrade of US debt and by the stalemate in Congress over dealing with America’s deficit and debt challenges.

As I look at recommendations for my clients, I don’t believe America is in decline. Without dismissing its issues, the biggest competitive advantage for the United States is its vitality and capacity for change and innovation. It continues to dominate in high tech, and remains a magnet for the best and brightest talent from around the world.

I’m not alone in this view. Here’s an excerpt from Warren Buffett’s annual letter to investors released in February:

“In 2011, we will set a new record for capital spending, $8 billion and spend all of the $2 billion increase in the United States. Money will always flow toward opportunity, and there is an abundance of that in America. Commentators today often talk of “great uncertainty.” But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001. No matter how serene today may be, tomorrow is always uncertain.”

“The prophets of doom have overlooked the all-important factor that is certain: Human potential is far from exhausted, and the American system for unleashing that potential, a system that has worked wonders for over two centuries; despite frequent interruptions for recessions and even Civil War remains alive and effective. We are not natively smarter than we were when our country was founded, nor do we work harder. But look around you and see a world beyond the dreams of any colonial citizen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.”

You can read Warren Buffett’s full letter to investors HERE.

A long term perspective on valuations:

While economic growth enables long term increases in corporate profits as a whole, in the short and mid-term we dont want to over pay for the companies we buy. Anyone who invested at the peak of the U.S. market valuations in 2000 learned a hard lesson about the perils of losing focus on what we pay for a dollar of earnings.
There are few more hotly debated issues on Wall Street than whether today’s market is overvalued, undervalued or priced just right. In looking at all the available data, my own conclusion is that the market is slightly to somewhat under-valued.

That’s not to say it doesn’t face some speed bumps in the period ahead. But I was interested to see a March 29 interview with Jeremy Siegel of the Wharton School. Author of Stocks for the Long Run, which examined almost 200 years of market data, in this interview Siegel looks at historical precedent; and sees significant upside potential at today’s stock valuations. To see his interview, click here.

What this means for your portfolio:

While all portfolios are customized to clients’ specific needs, there are three guiding principles to the advice that I offer.

1. The first relates (as always) to the allocation between stocks and bonds, and comes from Benjamin Graham; the Columbia professor who was Warren Buffett’s teacher, and who is considered the father of value investing. In a recently discovered 1963 talk, Graham had this to say on asset allocation:

“In my nearly fifty years of experience on Wall Street, I’ve found that I know less and less about what the stock market is going to do but I know more and more about what investors ought to do. My suggestion is that the minimum amount (of the investor’s) portfolio held in common stocks should be 25% and the maximum should be 75%. Consequently the maximum amount held in bonds would be 75% and the minimum 25%; any variations should be clearly based on value considerations.”

With low returns expected on bonds and relatively low valuations on stocks and depending on whether one is accumulating assets or withdrawing, my general recommendation is to allocate the least possible of long term assets to fixed income and at durations (maturities) of 5 years or less and well diversified between government and corporate, domestic and global bonds.

2. The second principle relates to, barring a significant change in circumstances, sticking within the investment framework that we’re decided upon.

In early 2009, during the worst of the market decline, my mantra was, “The Recovery is Inevitable” as we faced what appeared to be an end of the world scenario and some stocks hit lows they hadn’t seen in 20 years. At that time, I urged clients to maintain their core level of equity exposure and it proved to be the right strategy as the market recovered in 2010. (same with the 1998 and 2002-3 decline)
While I am always happy to discuss this on a case by case basis, I track allocations carefully and do feel client portfolio’s have the appropriate equity allocation needed.

3. The final principle relates to the role of equities in our portfolio’s and what we can expect over the next 20+ years. In an environment where our cost of living will likely triple over the next 2 and 1/2 decades, growth beyond the rate of inflation is needed to preserve our purchasing power and lifestyle. Equities have done this better than bonds for the past 200 years. Despite the appearance that, “ this time it’s different” and “global economies are changing for the worse”, I continue to have faith that businesses will prevail and continue to increase shareholder value causing a reversion to the mean and a positive long term average growth of their shares.

The 20 year average growth of a 100% equity portfolio ending in June 2011 is about 8.1% (after a 10 year flat return!) Going forward my expectation by 2020 is we will see a similar 20 year return.

Should you have any questions on anything I’ve covered in this note or on any other issue, please feel free to contact myself or one of the members of my team directly. And as always, thank you for the opportunity to serve as your financial advisor.

I’ve read that one of the characteristics of those that are truly happy have purpose in their lives or something I like calling, “my life’s work”. It does not have to be something as dramatic as saving Africa’s gorilla’s or finding a cure for cancer – although it could be. It doesn’t have to earn you income, although if it does, you could start it when income is still needed. It just needs to be something that we are truly passionate about, is meaningful to us, provides us with purpose and does not feel like “work” when we do it.

The benefit to us of having “a life’s work” is significant. Having purpose in life, something all to ourselves, is immensely meaningful and fulfilling. It could keep us mentally and physically active long into retirement.

With greater numbers of baby boomer retiring each year, the need for each of us to find greater meaning in our lives would benefit both us and and society. So, have you thought of finding your life’s work?

It’s been 3 ½ years since Sept 2008 when we first experienced the start of the global financial incident and the following market decline and recovery. Portfolios are currently close to, or at pre-decline levels but we still need to make up for the 3 ½ years of the growth we expected. Global government debt levels have made the recovery volatile and challenging for us, believing a recovery would occur given the media coverage and predictions.

Investing requires patience and a double dose continues to be required of us now. When we look at the fundamentals of the businesses we are investing in, (P/E, revenues, sales, balance sheets) the eventual direction of their shares must be up. Changing our long term strategy now will impact our long term returns negatively.

We are experiencing something that has only happened once, maybe twice in investment history. Stocks are at valuations not seen other than at the bottom of market declines, businesses are increasing their dividends because they have strong balance sheets, with lots of cash and unlike governments, low or manageable debt. Bonds have ended a 30 year bull market with low interest rates predicted for some time. The global and US economy continues to grow slowly – against all odds. The only reason equity markets are lower than they should be is due to the high government debt in Europe and North America, who have on average, debt to GDP ratio’s not seen since after the second world war. This has caused many to be concerned with the value of our currency with governments printing money to stimulate growth.

The question investors will have to answer for themselves is where to put their faith and long term future financial security:

1 – in paper currency by remaining in cash, GIC’s, and bonds.
2 – gold – a metal that produces nothing and increases in value when fear of the future increases
3 – real estate – which has a long term average of 4%
4 – businesses – who collectively have increased shareholder value through their profits and dividends averaging 7% long term

Against all odds and the predictions of so called experts, quality businesses (which can be purchased through diversified equity portfolio’s) have prevailed throughout history. In a free market, most businesses earn a profit over time and distribute that profit to shareholders through capital growth and/or dividends. Having faith that this will endure is a necessary quality of the modern investor.

The following are interviews and articles with a few industry experts giving their opinion on the current equity market.

The following is a video interview with Warren Buffet on the US economy: video

This is an interview with Scott Richard and Jeremy Siegel, Wharton Professors of finance, on the current US market.

video

Dow Closes over 1300 for first time since 2008. Article

The following letter is an excerpt from Warren Buffet shareholder letter explaining his opinion on stocks, gold and bonds.

Letter

Defining Risk

Most investors, with the help of the media, define risk as the potential for loss of market value within the next 12 months, or shorter. Calling these individuals investors is a misnomer – they are speculators.

Warren Buffet, chairman of Berkshire, defined risk in his annual shareholders letter as potential for loss of purchasing power. He is now warning that those investments the media is focused on are exactly the wrong place to invest.

Letter

“Right now bonds should come with a warning label.”
— Warren Buffett, February 2012

Dollar Cost Averaging Works

In my review of client portfolio’s and performance over the last 10 years of volatile markets, the one strategy that maximized returns most was dollar cost averaging.

The client portfolio where a regular small monthly investment was made through up and down markets (referred to as dollar cost averaging or DCA) produced the best overall return. These portfolios also often experienced the lowest volatility and least risk of the portfolio dropping below its original investment.

DCA automatically purchases investments through up and down markets and eliminates the investor’s emotional response to negative news. It also “pays the investor first”, another proven winning strategy.

If you are not already making your investments using a monthly automatic withdrawal, I recommend calling our office to set up a plan.

How Motivation Really Works

Studies have been done for some time confirming how we like to be motivated – and its not necessarily through financial incentives. This Ted talk reviews the results of current studies on motivation – a must read for anyone who manages people.

Ted Talk – Motivation

Email delivery of Statements – It’s here and you need to sign up!

Our dealer, FundEX is now required to deliver statements to our clients’ quarterly vs annually. To help eliminate the paper mail you receive, FundEX has created a new client website allowing each client to set preferences for delivery of their statements.

If you want to receive hardcopy statements four times per year you do not have to do anything.

If you would prefer the convenience of email notifications and on-line statements and having on-line access to your accounts you need to sign up!

You’ll see a notice included in your 2011 statement mailing regarding our new on-line website for accessing your account and making changes to your profile and preferences.

You will need one of your recent statements from each account with a different name (individual, joint, ITF etc) to sign up. These statements have your client number and your fund company number.

Webconnect sign in site https://client.fundex.com

Sign up before March 31st and get the chance to win an Ipad2!
As always, if you need help setting this up, contact Nancy at 1-613-271-9994.

Canada Pension Plan and Old Age Security benefits are changing.  The reason is simple – we are living and working longer then when these plans were designed.

The changes to CPP began January 1st of this year.  These changes may make it more attractive to delay taking CPP until later if you are health and having a greater indexed pension is preferred.  Here are the changes and their implications:

1 – Monthly CPP pension amount increases by a higher percentage if you take it after 65.  It becomes more attractive to take CPP later if an individual has other options to replace that income (like an RSP) or would benefit from a greater guaranteed and indexed pension for life.

2 – Monthly CPP pension amount decreases by a greater percentage if you take it before 65.  It becomes less attractive to take the CPP early if an individual has other options to replace that income (like an RSP) and if healthy and can expect a normal life expectancy.

3 – The number of low or zero earning years dropped from the calculation will increase.  With one less low income year impacting the calculation, a greater CPP benefit may result for some people.

4 – The “work cessation” test will not apply.  Now individuals will not have to stop work or reduce earnings to begin receiving CPP.

5 – A new “Post Retirement Benefit” is a new lifetime benefit and is indexed like the CPP.  If an individual begins collecting CPP and continues or goes back to work, they (and their employer) will have to contribute to CPP for this benefit.  The post retirement benefit will be added to CPP each year based on contributions and additional years worked.

From a planning perspective we need to consider when to begin withdrawing CPP.  Along with comparing the lifetime guarantee and indexing of CPP to our own investment returns, we need to consider our health and potential life span.  If we were to consider only the cumulative pension money paid out, we need to know the cross over point.

The “cross over” point is the age to which an individual must live beyond in order to benefit from taking the pension later vs earlier.  With the new changes the cross over point for taking the pension at age 65 vs 60 is now 73.

However, if we consider the CPP as one of the few guaranteed and indexed pensions available to us and we are in good health and expect an average to longer life expectancy, it may make sense to take CPP much later – possibly at age 70.  The cross-over point for someone who delays taking CPP until age 70 is now age 76.  In other words, the cumulative amount of pension money paid out from age 60 is exceeded by age 76 if started late – at age 70.  After age 76, the amount paid out increases significantly than what would have been received if started at age 60.

We’ve also read recently that the government is planning to increase the age at which Old Age Security is paid from age 65 to age 67 (for those currently 57 or younger).  This benefit is paid from general revenues to which all taxpayers have contributed.  Although clawed back at a specific income, OAS does not begin to be clawed back until an individual earns $69,562 for 2012.  Most Canadians would continue to qualify for OAS given this claw back limit.

The need for understanding the implications of the above on longer term retirement income has never been more important.

The Impact of Economic Policy

The key reason for the slow recovery is “economic policy uncertainty” according to Professor Steven Davis.  He suggests that the uncertainty of government direction regarding monetary and tax policy prevents the recovery from happening faster.   This study suggests the sooner governments clarify direction, the quicker recoveries may occur.

http://www.clientinsights.ca/video/prof-steven-davis-why-the-fed-committed-to-low-rates-for-three-years/type:investor

Dow 15,000 maybe 17,000 by end of 2013

According to Jeremy Siegel (professor of Finance at the Wharton School, University of Pennsylvania and author of several books) the Dow Jones index which holds 30 broadly diversified large company US stocks has a 2 in 3 chance of rising about 20% over the next 2 years.  He bases this on 141 years of stock market history which says periods of worse than average performance (that’s right, like what we’ve just had) have a tendency to be followed by periods of better than average performance.

For the whole article:

http://online.barrons.com/article/SB50001424052748704444604577207223617121572.html?mod=BOL_hpp_emc#articleTabs_article%3D1

National Housing Outlook – the Art of Analysis

This is an interesting article from a mortgage industry writer on recent housing market bubble projections of some economists in Canada.  Another example of economists looking at the same data and making different predictions.

http://tothepointwithbozic.com/mortgage/national-housing-outlook-the-art-of-analysis?utm_source=rss&utm_medium=rss&utm_campaign=national-housing-outlook-the-art-of-analysis&utm_source=feedblitz&utm_medium=FeedBlitzRss&utm_campaign=tothepointwithbozic

The Case for Emerging Markets

The following video is an interview with Gerardo Zamorano of Brandes Partners discussing the opportunities in emerging markets.

video interview

http://www.clientinsights.ca/video/gerardo-zamorano-the-emerging-markets-opportunity-2/type:investor

It’s not easy to be an optimist after a year like 2011. Canadian stocks sank more than 8%, led by a 52% drop in information technology. Even Canadian bank stocks offered less of a safe haven than in years past. Around the world, 2011 was a year marked by natural disasters, European and US debt and deficit problems, uprisings and protests. Time magazine asked in its December issue: “Is there a global tipping point for frustration?”

I believe there is – things that break often beg to get fixed, and challenges of any kind are often accompanied by opportunities. Here are my observations and comments for the year ahead:

Europe, US and China will continue to be the focus of 2012. Europe has made some progress but many suggest a recession there is likely, if not in place already.  It will take many years to solve their debt problems but we are beginning to see some leadership.  The US is in an election year with possible changes to its political landscape and real solutions not likely until after the election.  Fortunately we are seeing the beginning of sustainable but slow growth in the US economy. China is expected to have a lower, but still strong GDP growth of greater than 8%.

Bleak points in history are not necessarily bad times to invest.  Investors can either have good news or good prices.  The worst time to invest is often when investors are overly optimistic and asset prices are unjustifiably high. When there’s worry and negativity, stock prices generally reflect that sentiment. Today, your fund managers are finding stocks of many high-quality companies selling at very attractive prices. The way I see it, global markets are offering investors an opportunity to upgrade the quality of their portfolios right now and this is what fund managers are doing.

U.S. companies have been remarkably resilient. Despite a less-than-robust economy, and a host of other problems, U.S. companies continue to rebound. The S&P 500 was up 4.6% in 2011, and U.S. corporate profits are at record highs by some measures. When you compare corporate earnings to what government bonds are yielding, it’s hard not to be optimistic about stocks.

Emerging markets are alive and well. Emerging markets have relatively little debt, access to capital like they’ve never had before, powerful technology and a rapidly growing middle class. That’s real growth potential. Many Canadian, U.S. and European companies that do business in emerging markets may also be well positioned, even if their local economies aren’t strong. It’s where a company does business, not where it’s based, that matters most.  Fund managers are seeking out and purchasing the stocks of these companies.

Innovative companies around the world are creating new products and solving the world’s problems. I think that’s what makes markets go up over time — it’s the effort of the individual companies solving problems. That’s a reason for optimism, as long as you’re patient.

The biggest risk right now could be over concentrating your portfolio. When we don’t know what’s going to happen, it’s often wise to invest in different types of securities. Many people end up owning too much of a “good” thing, whether bonds, cash or high dividend-paying stocks. My job is to make sure you stay properly diversified, even when the markets make you nervous.  Note that the 20 year return of a balanced portfolio of 60% equities and 40% bonds to the end of June 2011 (after 10 years of near flat returns) was 8.4%

The recovery is inevitable. This past decade has been difficult for investors but history suggests times like these do end and growth resumes.  We need faith in human desire and ingenuity and that the market does go through a cycle and it will once again recover.

If you feel you’re at your tipping point for frustration, let’s talk. And even if you’re not, it’s a good idea to check on your financial situation and any changes that may have occurred.  As always, I’m available to talk or meet and review your situation.

There is plenty of room for us all – we are getting better at everything.

Matt Ridley is a professor at Oxford who wrote a book called the Radical Optimist – How Prosperity Evolves.  He refutes the media view expressed so often to us that the world is spiralling downward.  This is one of his presentations and he makes a strong case for optimism.

http://www.ted.com/talks/view/lang/en//id/915

I can’t help but use the start of the year as a time to reflect on my life and came across these questions.   As Socrates said, “An unexamined life in not worth living.”  Here are 40 questions you may want to answer for yourself.

http://www.marcandangel.com/2010/03/29/25-beautifully-illustrated-thought-provoking-questions/

The wonderful thing about a new year is we can start afresh.

As European debt woes continue to dominate headlines, it’s hard for this not to have an impact on our mood and our outlook.  The equity market recovery is taking longer than hoped.  From most of the analysis I’ve read the short term continues to be daunting – and this negativity is already priced into stocks.  The mid to long term global outlook is more positive.

One of the best speeches heard in a long time was delivered Dec 12th by our own Mark Carney, Governor of the Bank of Canada. Titled Growth in an Age of Deleveraging, Carney pulled few punches in laying out the background to today’s issues in blunt language not usually associated with central bankers.  A summary of his points are listed here and a link to the entire speech below.  I’ve read the entire speech and it provided me with an excellent picture of how the world got to where it are, the challenges we face and the likely solutions:

The end of the debt super cycle and a new era of deleveraging

Advanced economies have steadily increased leverage for decades. That era is now decisively over. The direction may be clear, but the magnitude and abruptness of the process are not. It could be long and orderly or it could be sharp and chaotic. How we manage it will do much to determine our relative prosperity.
Accumulating the mountain of debt now weighing on advanced economies has been the work of a generation. Across G-7 countries, total non-financial debt has doubled since 1980 to 300 per cent of GDP. Global public debt to global GDP is almost at 80 per cent, equivalent to levels that have historically been associated with widespread sovereign defaults.
As a result of deleveraging, the global economy risks entering a prolonged period of deficient demand. If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest.

Big challenges for Europe

In Europe, a renewed crisis is underway. An increasing number of countries are being forced to pay unsustainable rates on their borrowings. With a vicious deleveraging process taking hold in its banking sector, the euro area is sinking into recession. Given ties of trade, finance and confidence, the rest of the world is beginning to feel the effects.
Debt tolerance has decisively turned. The initially well-founded optimism that launched the decades-long credit boom has given way to a belated pessimism that seeks to reverse it.
In Europe, a tough combination of necessary fiscal austerity and structural adjustment will mean falling wages, high unemployment and tight credit conditions for firms. Europe is unlikely to return to its pre-crisis level of GDP until a full five years after the start of its last recession.
In most of Europe today, further stimulus is no longer an option, with the bond markets demanding the contrary. There are no effective mechanisms that can produce the needed adjustment in the short term. Devaluation is impossible within the single-currency area; fiscal transfers and labour mobility are currently insufficient; and structural reforms will take time. Actions by central banks, the International Monetary Fund and the European Financial Stability Facility can only create time for adjustment. They are not substitutes for it.
The route to restoring competitiveness is through fiscal and structural reforms. These real adjustments are the responsibility of citizens, firms and governments within the affected countries, not central banks. A sustained process of relative wage adjustment will be necessary, implying large declines in living standards for a period in up to one-third of the euro area. We welcome the measures announced last week by European authorities, which go some way to addressing these issues
Austerity is a necessary condition for rebalancing, but it is seldom sufficient. There are really only three options to reduce debt: restructuring, inflation and growth. Whether we like it or not, debt restructuring may happen. If it is to be done, it is best done quickly. Policy-makers need to be careful about delaying the inevitable and merely funding the private exit. Historically, as an option to restructuring, financial repression has been used to achieve negative interest rates.

Getting growth restarted

Americans’s net worth has fallen from 6 ½ times income pre crisis to about 5 at present. These losses can only be recovered through a combination of increased savings and, eventually, rising prices for houses and financial assets. Each will clearly take time.
The most palatable strategy to reduce debt is to increase growth. In today’s reality, the hurdles are significant. Once leverage is high in one sector or region, it is very hard to reduce it without at least temporarily increasing it elsewhere.
In recent years, large fiscal expansions in the crisis economies have helped to sustain aggregate demand in the face of private deleveraging. However, the window for such Augustinian policy is rapidly closing. Few except the United States, by dint of its reserve currency status, can maintain it for much longer.
With deleveraging economies under pressure, global growth will require global rebalancing. Creditor nations, mainly emerging markets that have benefited from the debt-fuelled demand boom in advanced economies, must now pick up the baton.
This will be hard to accomplish without co-operation. Major advanced economies with deficient demand cannot consolidate their fiscal positions and boost household savings without support from increased foreign demand. Meanwhile, emerging markets, seeing their growth decelerate because of sagging demand in advanced countries, are reluctant to abandon a strategy that has served them so well in the past, and are refusing to let their exchange rates materially adjust.
(Both advanced economies and emerging markets) are doubling down on losing strategies. As the Bank has outlined before, relative to a co-operative solution embodied in the G-20’s Action Plan, the foregone output could be enormous: lower world GDP by more than US$7 trillion within five years. Canada has a big stake in avoiding this outcome.

Implications for Canada

Canada has distinguished itself through the debt super cycle, though there are some recent trends that bear watching. Over the past twenty years, our non-financial debt increased less than any other G-7 country. In particular, government indebtedness fell sharply, and corporate leverage is currently at a record low.
Over the same period, Canadian households increased their borrowing significantly. Canadians have now collectively run a net financial deficit for more than a decade, in effect, demanding funds from the rest of the economy, rather than providing them, as had been the case since the Leafs last won the Cup.
Developments since 2008 have reduced our margin of manoeuvre. In an environment of low interest rates and a well-functioning financial system, household debt has risen by another 13 percentage points, relative to income. Canadians are now more indebted than the Americans or the British. Our current account has also returned to deficit, meaning that foreign debt has begun to creep back up.

Canadian firms should recognize four realities: they are not as productive as they could be; they are underexposed to fast-growing emerging markets; those in the commodity sector can expect relatively elevated prices for some time; and they can all benefit from one of the most resilient financial systems in the world. In a world where deleveraging holds back demand in our traditional foreign markets, the imperative is for Canadian companies to invest in improving their productivity and to access fast growing emerging markets.

Putting today’s challenges in context

In reading this talk and in sharing Mark Carney’s perspectives, sobering as they are, there are three considerations to bear in mind:

First, the most positive news is that Europe’s leaders appear to be coming to terms with reality. It does seem that not just Carney, but politicians and central bankers across Europe do grasp the gravity of the challenges; and are starting to implement strong measures in response.

Second, strategists universally agree that the market has priced in a recession in Europe. Unless things get much worse, virtually all of the challenges Carney outlines are reflected in current stock prices.

And finally; a reminder of the continuing divide between the bad news when it comes to debt and economic growth on the one hand and companies that are continuing to find ways to deliver strong earnings on the other. Just remember that at some point company earnings have to re-establish a connection with overall economic growth.

If you’re interested in reading more, here’s a link to the Globe and Mail column:

http://m.theglobeandmail.com/news/opinions/jeffrey-simpson/mark-carney-the-man-who-speaks-the-truth/article2270030/?service=mobile

And here’s the full text of Mark Carney’s speech:

http://www.bankofcanada.ca/wp-content/uploads/2011/12/speech-121211.pdf

Thanks to Eric Lascelles, Eric Lascelles, the Chief Economist at RBC Global Asset Management has written an excellent article on the current and future challenges of the countries in the European Union.

Based on the research he did, his article suggests the following:
-    Despite the recent bail out, Greece remains unsustainable and likely to go through an orderly default
-    Italy should remain solvent despite its recent crisis
-    The plan to recapitalize the European banks is undersized but workable
-    European leaders are not acting fast enough and typically will require a crisis to make headway
-    Likely candidates for the next crisis are Portugal, Ireland and Spain.
-    European bad news will continue for awhile and over shadow good news.
-    Global contagion on the scale of the fall of 2008 is unlikely

More of the same for awhile

Is Buy and Hold Dead?

Any investor who invested a lump sum 10 years ago in a diversified portfolio has likely not seen any returns and may even be negative.   Investors who have continued to invest regularly through the highs and lows over the last 10 years likely have some returns to speak of – but not the returns expected.  So does this mean the strategy of buying a diversified portfolio holding for the long term – still worth using?  Questioning once recognized investment strategies is common during periods of volatility and this time is no different.

Even the shares of the renowned investor Warren Buffet who says the ideal holding period for a stock is forever, finds the shares of his company Berkshire Hathaway are only selling for just slightly above book value, the lowest valuation in decades.  Proof investors are not interested in buying the shares of investment managers advocating a “buy and hold strategy”.

Note that in this context, buy and hold means the stock is purchased at the right price – typically below its true value and reviewed regularly for its potential future return.  If at any time the stock is perceived as over valued, it is sold; or if its business or market changes and its future potential value is eliminated, it is sold.

After World War II, the average American investor held stocks for about four years.  Given a stock is not just a piece of paper but a shared ownership in a business, this seems appropriate.  By 2000 stocks were held for about eight months on average.  The 2008 numbers suggest the holding period was just two months.  The mood over the last year suggest the average holding period is down to days if not minutes.

Value vs Price

Most investors agree that the value of a stock is the present value of its future cash flows over the life of its business.  The value is not then in next years earnings but in the cumulative profit of the business over decades.

This tenant of investing – that stocks are long duration assets, has been forgotten.  Is it even remotely possible that all the great businesses like Walmart, IBM, Abbot Labs, Nestle and Johnson and Johnson with a history of increasing earnings and dividends suddenly reverse that trend?  If that’s not likely, why does their stock decline in so called periods of uncertainty?  The answer is, of course, that the current investor focus has moved to the short term outlook which impacts the short term price of the stock but not its true value.

This presents the long term investor with tremendous opportunity.  If stocks are at historic lows in price but represent good value, buying and holding is the logical strategy.

“A serious investor is not likely to believe that the day-to-day or even month-to-month fluctuations of the stock market make him richer or poorer.
-Benjamin Graham,  The Intelligent Investor

Why Sir John Templeton’s protégé feels tremendous opportunities now:

http://advisoranalyst.com/glablog/2011/11/27/mark-holowesko-right-now-the-opportunities-for-investors-are-fantastic/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+advisoranalyst+%28AdvisorAnalyst+Views%29