This article appears in the February edition in the Financial Post Magazine. Go to the iTunes store to download the iPad edition from the month’s issue.
Investors did not have a simple amount of it in 2015. From oil’s price slump despite rising and omnipresent tensions in the centre East and Russia’s invasion of Ukraine towards the exit by Greece in the eurozone and technical recessions in Canada and Japan, stock and bond markets rode wave after wave of volatility and many investors finished up at a negative balance. How bad was it? Cash outperformed most asset classes for the very first time since the 1990s.
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Unfortunately, 2016 didn’t begin much better. Inside the first couple of trading times during the January, contagion from China’s latest stock-market tumbles destroyed US$4 trillion in equity value worldwide. The S&P/TSX Composite Index, meanwhile, fell right into a bear market, having dropped 20% since its September 2014 high. Further coming loom around four rate hikes using the U.S. Fed, continuing its trend toward tighter monetary policy since the American economy recovers, even if few others economies are showing just a weak symptoms of life.
“Persistent weak global growth is intensifying,” says Bruce Cooper, TD Asset Management’s chief investment officer, chalking that around aging demographics on your lawn and China along with high levels of debt, whether that’s government, corporate or consumer, in lots of parts of the planet. Both factors result in weaker aggregate demand, which leads to slower economic growth and, ultimately, poorer investment returns – something investors will have to obtain knowledgeable about unless tips to show things around.
Much of the portfolio’s performance over time is driven more by macro-economic factors and much less by stock-specific factors.
In the meantime, headlines scream that specific event or other will overwhelm on portfolios. But that is just a little simplistic. “The market doesn’t let you know why it did something,” says David Kaufman, president of Westcourt Capital Corp., a Toronto-based portfolio manager concentrating on traditional and alternative investment. “One macro affects another, as well as the world keeps spinning in order that it can make it difficult to determine things that suffer from multiple factors.” Nevertheless, according to him, more clients are asking him how events inside the U.S., China and other places affect their investments in your own home.
“Much of the portfolio’s performance with time is driven more by macro-economic factors and fewer by stock-specific factors,” says Pramod Udiaver, co-founder and CEO of Invisor Investment Management Inc. in Oakville, Ont. “And why? Because the global economy is really well integrated nowadays, that the great deal of people do not really appreciate once they consider investments.”
That insufficient appreciation might be since the effects aren’t often direct ones, and often it’s just the perception that they should change things. But that does not make sure they are less real, there numerous big macro-economic factors which have and may still play a role. “Investment securities are valued based on expected future performance, and not on the way a clients are doing within the with time,” Udiaver adds. “And the long term performance is actually based on these larger macro factors.” Most of which, for the moment, appear to be headwinds rather than tailwinds.
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The red menace
China, for instance, once fuelled the world economy and stock markets, specially in Canada. China economy for a long time has been investment-driven, which needs a great deal of natural resources to create. Helpful information on example oil, wood, potash and lots of metals like nickel and copper that Canadian companies supply commonplace were needed. But a few things in China are occurring that makes it a genuine continue global growth and, hence, investor portfolios in your house. The country’s GDP growth is slowing in the 8-10% range to 7% or less – and, bear in mind, those are government numbers, which might overstate actual growth – and it is trying to transition its economy to at least one driven by consumption as opposed to investment. “Clearly, they can’t sustain the 10% growth number and markets have to comprehend might then adjust our valuations,” Udiaver says.
China could be the world’s second-largest economy, responsible for about 20% of worldwide GDP, that is Canada’s second-largest trading partner, so any slowdown may cause problems. “China isn’t causing this low-growth world, though China slowing now, it’s exacerbating the low-growth world,” TD’s Cooper says. “It affects Canadians, obviously, because China is a huge consumer of commodities.” And, everyone knows, commodities continue to be about 30% within the Toronto Stock exchange, although that’s down a great deal from just a few short in the past. As China’s growth declines, they’ve less requirement of oil as well as other resources that Canada produces, meaning the costs of these commodities drops. Consequently, there’s less curiosity about the Canadian dollar, which depreciates. Live and consume the petro-currency, die with the petro-currency.
Another complication is the fact even China’s lower-growth profile assumes it’s economic transition goes well, that’s not confirmed within a government-led economy. State-owned enterprises certainly are a big part of the economy and act oftentimes like employment agencies, Cooper says. For instance, it’s many steel companies that should close down since they’re high-cost producers within the lower-demand environment. Closing them is smart if China really is trying to be driven by consumer desires, however it can’t because it would throw thousands unemployed and, therefore, hurt interest in services or products.
Kaufman offers one caveat: if you think China will grow, and it is still, purchasing Europe and Canada is not as crazy because it seems now given that they are two least-liked markets. “Even once they would keep growth in-house this will let you massive trading deficit, they still need water, they still potash, they still oil, exactly what a thriving urban economy makes it necessary that they don’t have inside their massive geography,” based on him.
Slicker shock
It may be welcome news for that oil industry if China does keep on growing, even when more modestly. The initial reason for oil’s price slump was excess supply due to the explosion in shale oil in the U.S. as well as the inclusion of approximately countless barrels every day from Iraq last year. “Demand was very good, whilst not sufficiently best to overcome supply growth,” Cooper says.
Energy companies, specifically in Canada combined with the U.S., responded by slashing their capital expenditure budgets and workforces, which will curtail production growth in afterwards. Which will normally stabilize prices along with reverse downward trend, especially since tensions continue to be simmering in the centre East. But Cooper wonders when the slump in oil prices that renewed at the end of December and continued using the first week of January was a lot of slowing demand and fewer about excess supply. If true, that would prolong the power industry’s agony which in the investors.
Growth remains kind of crappy. One risk would be that the market loses confidence in central banks’ abilities to engineer a recovery.
The Canadian market, as stated, features a high and direct correlation with energy prices and there is a domino effect on all the related businesses that service that sector, including banks, possibly the last big bastion of strength over the TSX. “The banks have a knock-on effect even though the direct affect is small,” says Beth Hamilton-Keen, chair within the board of governors at CFA Institute and director of investment counselling at Mawer Investment Management Ltd. in Toronto. “For example, TD has 1% mention of the gas and oil lending – but the resulting job losses and defaults by people increase that secondary and tertiary effects,” She adds meaning the loonie will remain weak, as will the currencies of other countries that are heavily related to oil.
As an effect, Canadian investor portfolios it’s still hit. The S&P/TSX 60 index, for instance, includes a volume of blue-chip companies and have a large amount of exposure to oil or other commodities. If the visit oil impacted only energy companies and their investors, the 60 should fare best. And possesses, to some extent. The Composite index has actually dropped in the last 5 years, as the 60 is slightly up. But that is during what’s arguably been the most effective bull market ever. “If you believe this massive bull market was a sign of economic strength inside a post-crisis world, then you’d have to believe Canada might have done well because period of time,” Kaufman says. But, as is becoming very clear, this didn’t.
Rise in the Fed guardians
One economy that has strengthened throughout the post-financial-crisis world has been the U.S., somewhat aided, obviously, by three rounds of quantitative easing and rates of interest that have been slashed to close zero through the U.S. Fed. Nevertheless the Fed, after dithering for several quarters, finally raised interest levels having a quarter point in December to 0.5%, signalling its faith the U.S. economy was on an even keel. Some key data points for example employment, housing and consumer spending all indicate a somewhat healthy U.S. “Any interest rate increase can be a a valuable thing,” Invisor CEO Udiaver says. “It’s a good thing for your economy, because minute rates are only increased if you learn a longer-term expectation the economy is going to do well.”
It’s not surprising then the S&P 500 remains one of the stronger indexes within the last five years, but even that index struggled through 2015 and early 2016. That could be because investors believe growth rates will still be lower for extended, that ought to naturally translate into a low interest rate for that forseeable future. The Fed established that it expects to raise rates Four times during 2016, because the market seems to be pricing in 2. TD’s Cooper, however, is more pessimistic. He believes the Fed will either not raise rates at all or perhaps be pleased with one hike. “We think growth will probably be disappointing, so when growth is disappointing, minute rates are unlikely to enhance,” he says. “And the truth is at both short end, central bank administered rates, along with the yield curve.” Cooper highlights that 10-year Treasury yields actually declined following a Fed raised rates in December. Why? Since the U.S. economy is working at or near full capacity so there’s little extra growth available.
Again, that’s not ideal for equities. The hyperlink between growth and equity is really through earnings. Earnings rise in the U.S. has mostly been good for the past six years, excluding 2015, but Cooper expects it’ll be pretty tepid from this level on. “Part in the reason is the fact that with low growth, publication rack having issues growing revenue and they’ve already cut back a good deal and margins are close to all-time highs,” he says. “If your revenues aren’t growing along with already done all the cost cutting you’ll be able to, you would not expect earnings to build up much.”
If rates do keep rising inside the U.S. – home loan cut is much more likely in Canada – Hamilton-Keen says certain sectors for example insurance should do much better than others, with respect to the number and size those hikes. But, she adds, investors should have a well-balanced portfolio which has bets on sides from the rate equation along with bonds for ballast.
The last hike while using Fed didn’t cause much of a stir, but that is since it was well-signalled and regarded. “The more valuable thing for investors in Canada will be the trend, the consistency and magnitude of rates afterwards,” Hamilton-Keen says. Further hikes inside the U.S. rate can lead to a strengthening greenback as well as an indication the U.S. can be a rut – a scenario occupied by Canada throughout the fiscal crisis – so investors will flood to the country.
But hiking rates also hurts the wages of U.S. companies that derive a big part of their revenues from foreign countries, particularly if their cost is in dollars while their revenues have been in weaker currencies. The cost of capital also rises. Similarly, however, Canadian businesses that make the most from the revenue inside the U.S. while the prices are borne in your own home must do better. Manufacturing, for example, should benefit, even though it hasn’t so far because other countries’ currencies can also be depreciating in the U.S. dollar.
But within the portfolio level, Hamilton-Keen notes that any holdings investors have in U.S. or international equities have likely another return profile over a home-biased portfolio since currency gains could take into account as much as two-thirds of returns. “Those gains don’t really represent the specific profitability from the company, nevertheless the spread differential, which can be a headwind for those who have a portfolio heavily weighted in Canadian equities,” she says.
All which is why why investors pay a lot concentrate on any hints products the Fed along with other central banks might do. The end result from the actions on investor portfolios, as Hamilton-Keen suggests, may “well be blown from proportion,” however the considered macro-economic events might have just like strong effect on markets as reality can. Eventually, investors may realize that all the zero rate of interest policies and trillions allocated to quantitative easing haven’t done a great spur development in any case. “Growth is still kind of crappy,” Cooper highlights. “One risk is the market loses confidence in central banks’ abilities to engineer a recovery.”
Canada’s conundrum
Unlike the U.S., Canada’s central bank hasn’t taken more rate decreases the table. The economy flirted with recession in 2015 and stays weak, because the dollar has dropped 15% in the last few years, that’s not surprising considering the overhang from commodities and natural resources. “A slight rise in U.S. rates might weaken the Canadian dollar a bit, but wait, what sort of a lot more is a big question,” Udiaver says. “We think it’ll float over the current levels for almost any bit. We’ll most likely not visit a major alternation in rates. We might actually go to a further reduction or negative rates because the Bank of Canada governor has indicated.”
Of course, the BoC’s official rates are only 0.5% after it cut rates twice yearly ago, in order that it does not have much room left. Additionally, it suggested for January it’s content for your Canadian dollar to stay weak. Which can be good for some, however it doesn’t exactly establish confidence the economy features a chance of rebounding this season, plus some areas and sectors are already suffering.
Housing, for example, is weakening in Alberta, but it is strong in Toronto and Vancouver, where demand remains strong you will find space constraints. Any try and cool-down the latter two markets could possibly mean disaster for struggling markets like Alberta’s, although the authorities has made some measures in recent years to rein the marketplace. But it’s rates on mortgages rising that remain key and, whatever the Bank of Canada’s position on rates, RBC raised numerous its rates in January. For example, the five-year set rate rose to 3.04% from 2.94%. Is always that enough to tip the scales? Most likely not, even if the remaining banking institutions follow. But mortgage loan change of some significance as time passes could be the trigger for a lot of housing marketplace pain.
“A collapse in housing arises from desperation so what’s that desperation prone to seem like? It is going to arises from either rates rising and so people can not afford their mortgages, and when would you get so bad where they leave,” Hamilton-Keen says. “Other factors may be the ceasing of lending, weak economic position.” There’s, however, a savior: foreign investors still plow money into our country’s property.
Another positive for investors is the fact that many believe valuations are between picking out a fair, so investors can ride the expected bouts of volatility whether they can tune out a number of the noise, pick high-quality companies with strong balance sheets and cash flows, with some reference to the U.S. dollar through either equities or bonds, and many fixed income.
“We tell our clients they are walls of worry and walls of worry are frequently great for markets, as there is a lot of caution being exercised by investors,” Udiaver says. “But previously, we all know that markets often climb these walls of worry. What’s bad for market is a situation of euphoria and now we don’t believe we’re anywhere near close to that.”
