Author: Transcend

Uniquely Canadian

Around the world, particularly since the bottom of the stock market crash of 2008 (which occurred in February 2009), growth stocks have lead the recovery – but not in Canada. Global value stocks have traditionally produced greater gains during good quarters and bigger declines through bad quarters but Canada is different in this regard than the rest of the world. In this we are uniquely Canadian.

Growth indices include stocks with higher price-to-book ratios and faster than expected earnings growth rates. The value index includes stocks with lower price-to-book ratios and slower earnings growth rates. A quick glance at the three main sectors for Canada versus the U.S. and EAFE markets show exactly why our market marches to a different beat:

Canada – Financial Services (36.5%), Energy (19.4%) and Materials (11.7%)
U.S. – Information Technology (24.7%) Financial Services (17.4%) and Health Care (13.8%)
EAFE – Financial Services (23.6%), Industrials (14.6%) and Consumer Discretionary (12.6%)
Not only does Canada have one of the most concentrated stock markets in the world, it is also highly value stock orientated. Unfortunately for the past 10 years that has been a very bad combination.

By looking at the cumulative total return chart to the right (all values in U.S. dollar terms) investors might conclude that for the past 20 years Canadian value stocks (especially) and growth stocks would have been the place to be. And they would be absolutely correct except this timeframe can be divided into two distinct periods; before the 2008 market crash and after. As the data to the left shows, over the last 20 years we were world-beaters; after February 2009 (the market bottom of the crash) not so much. The U.S. stock market has absolutely dominated the rest of the world and growth stocks (everywhere but Canada) have ruled the roost.

Growth has normally been the better strategy in this bull market which could be coming to an end in the not too distant future. Bull markets have been greatly supported by the stimulative policies of the world’s central banks, which increased the money supply and kept interest rates at historically low levels for nearly a decade.

Value stocks do their job for the most part (everywhere but Canada) as a defensive play during the last cycle of rising interest rates. This time around, inflationary pressure, brought about by rising rates as demand for workers increases could force the central banks to be more aggressive. In Canada, we simply do not have many growth stocks so value stocks lead the way over most market cycles and distort the Canadian stock market relative to most other countries.

Despite the runaway success of growth stocks globally over recent years the reality of rising interest rates could mean a comeback for value stocks beginning this year as investors flock to defensive investments. During the last period of sustained interest rate increases Canadian value stocks have reeled off 10 straight quarters of outperformance. And for a country like Canada where value stocks are king and historically outperform the rest of the world, we might just be able to break the back of the sustained period of weak relative performance and once again become the world-beaters we used to be. In that way being uniquely Canadian may work in our favour once again.

Market Data

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results.

While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only

The Downside of Market Timing – Missing Out?

Trying to avoid a bear market can come at a very steep price: missing out on further gains if you get it wrong. Market timing can be a costly mistake since correctly timing the market is virtually impossible. The potential mistakes are just as severe whether you are trying to time the market to sell high or buy low. Because of this, investors who are troubled by the current state of the stock market may want to take a long term view and hold tight.

A bear market is typically defined as a 20% drop from a market peak, or twice as severe as the threshold for a correction which is just a 10% decline. The last year of a rally is sometimes referred to as a “melt-up” or a move higher that is driven by investors being fearful of missing out on past gains. The final years of a bull market are usually the best years of the economic cycle and staging an early exit from stocks to avoid a coming downturn can be a damaging long term mistake. In particular, equities tend to see steep gains in the 12 months before the start of a bear market. Double digit gains have historically been seen in the year leading up to a bear market, as the gains in the last year of a bull market make for a much more pronounced rally than is seen earlier in the cycle. There have been nine significant market corrections since 1970 (using the Canadian stock market as the reference, see the dates of the market peak on the left). The chart to the right shows the asset class returns late in a bull market for various periods prior to the various security types reaching their apex.

The penultimate year of a bull market has seen a 31.3% gain for Canadian stocks on average, which on its own would more than compensate for the pending market correction. More importantly this level of return confirms the fact that typically Canadian stocks are very much late cycle stocks and their performance dwarfs what is achieved elsewhere. For example, U.S. stocks “only” averaged 16.1% in the year before the stock market correction occurred, while bonds eked out 7.3% over the same time span. Comparatively, in the year before that and the two years before the peaks (meaning the period that is between 24 and 36 months before the start of the bear market), U.S. stocks were clearly the better overall investment. This sounds very familiar to what has been occurring over the much of this economic cycle. Should this 40-plus year pattern continue and if the current market uptrend is winding itself closer to a market correction or a bear market, it is possible that Canadian stocks could make up much of their relative underperformance versus U.S. stocks over the past few years.

Certainly, the concerns that stock markets could be looking at weak future results, if not necessarily a bear market, have been growing. However, stocks are not seen as overly expensive right now and the first quarter earnings season has been strong, although the market’s reaction to them suggests investors have not been impressed. The final stages of a bull market can be lucrative for investors and an early exit can be detrimental to an investor’s long term results. Current economic data supports the case for continued economic recovery and further stock market gains. Despite what could happen in the coming years, the best course for most investors is to stay put, getting the benefit of compound growth and not making short term trading decisions.

MARKET DATA

 

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Q1 2018

MARKET COMMENT

The turbulent start for financial markets so far in 2018 has left few places to hide. Investors have had a lot thrown at them; escalating tensions over global trade, major tech sector wobbles, increasing turmoil at the White House and an onslaught of stock volatility. Certainly, the markets were overly greedy and downturns are normal but what has investors in a tizzy is the abrupt and perhaps savageness of the swings. However, while the ride was bumpy the final outcome was not overly hideous or cataclysmic.

Last year the Canadian economy expanded at a much stronger pace in comparison to the previous year and the outlook for 2018 remains positive. However, it is likely to march along at a slower pace due to increasingly uncertainty. As there are ominous signs ahead due to U.S. trade and tax policy as well as weakening investment fears related to the unknowns of U.S. corporate tax cuts and NAFTA’s renegotiation. None of which is expected to overcome the steadily rising employment, cool inflation and manufacturing and service industries expansion at their highest pace of growth since 2011. What is particularly positive is the fact that the biggest contribution to growth in 2017 came from the natural resources extraction sector, which has been in the doldrums for years.

The U.S. economy has been like a tortoise; slow but steady. Last year was the ninth year of this expansion, the third longest since 1900. Near term risks to the economic outlook appear roughly balanced. Corporate earnings have been quietly spectacular and the future impact of corporate tax cuts will only boost them further. Inflation has picked up slightly last year while interest rates remain low and stable despite the sixth hike since the credit tightening cycle began in December 2015. The Fed is trying to keep a tight labour market from overheating without raising borrowing costs so fast that it would stifle the economy. While the tax cuts could lead to rising budget deficits and ultimately even higher interest rates, growth is expected to remain on an upward trajectory in the coming years.

As central banks around the world slowly withdraw policy support and raise interest rates, economic growth should accelerate and stabilize. Europe is growing particularly fast thanks to a still undervalued currency, rising confidence and considerable pent up demand. The U.K. appears to be weathering the impact of Brexit better than many had feared. Rebounding demand for commodities continues to be positive for Latin America and Australia, while Chinese growth has ebbed slightly as authorities try to restrain financial speculation. Japan’s economy expanded for the eighth straight quarter, its longest consecutive period of expansion in 28 years. All-in-all, the global economy is growing everywhere but booming nowhere adding a welcomed level of stability.

Clearly, the markets have been more volatile this year versus last year, which were all calm seas and blue skies. But markets run on fundamentals and the fundamentals look very, very solid. After a surge in stock markets in January, most of the returns were given back in the latter half of the quarter, such that without the appreciation of the Canadian dollar (up 2.5% for the quarter) most foreign markets would have been negative. Emerging markets were the best performers, climbing 3.6% (all returns in Canadian dollar terms); while other International stocks were up 1.1%; and U.S. stocks rose 1.7%. The worst market was Canada where stocks declined 4.5%. Surprisingly, Canadian bonds managed to eke out a small gain on the quarter at 0.1%.

With Europe coming off a stellar year, Japan maintaining its longest expansion in years, the U.S. growth still on solid footing and the emerging economies in good shape, the synchronized global growth acceleration appears to be shifting into another gear. Of course, this business cycle is relatively mature but global monetary conditions should remain accommodating enough to leave plenty of room for future gains.

CANADIAN EQUITIES

Global economies and markets started the year with plenty of optimism that the synchronized momentum exhibited in 2017 should continue in 2018. Though optimistic, there were concerns over rising protectionism from the U.S. along with its disruption to global free trade. There was also some concern for the upward trajectory of interest rates. Some of these fears materialized as cracks erupted in February and March with the VIX (an index that measures market volatility) more than doubling from its level in 2017. The double digit returns that markets around the world posted in 2017 quickly evaporated in the first quarter as almost all major global indices ended with negative returns despite the fact that most economies are still growing.

Canada, in particular, saw its economy expanding for most of 2017 with 3% GDP growth (highest of the G7 countries), but it unexpectedly shrank in January coinciding with the biggest job decline since 2009. Though the outlook remained positive as the economy entered the “sweet spot of the business cycle” according to Bank of Canada, the cumulative effect of these interim shifts may continue to pull the Canadian market down. The S&P/TSX composite index had no reprieve in any of the months during the quarter as each one ended in negative territory. Overall the index returned -4.5% in the first quarter on a total return basis, making it one of the worst performing major global indices.

Although the Canadian economy started slowly for the year, it is still slated to record decent GDP growth in 2018. The relatively good shape of the economy has even pushed up the inflation rate a little over Bank of Canada’s target 2% rate; the highest since 2012. Additionally, the 5.8% unemployment rate is close to a 40 year low. Despite some 88,000 job losses in January, the job market added an impressive 283,000 positions over a twelve month period. Nevertheless the Canadian equity market and corporations are still exhibiting price/earnings (P/E) compression.

The lower ratio is not because of business fundamentals but rather due to NAFTA uncertainties as well as household indebtedness. Current pessimism appears overdone and the TSX should rebound to its fundamental value once these concerns abate.

The succession of impactful events was very swift in the first quarter. Although a correction was expected and overdue since the beginning of the bull market in 2009, especially in the U.S., investors’ reactions appear to be overdone. For instance, February, the most tumultuous month of the quarter, contributed to the biggest loss for the TSX amid a volatility surge that pushed the VIX past 35. This is a situation that has occurred only ten times since 1988. Yet 60% of the TSX companies’ results were positive on their top and bottom lines with upbeat outlooks for earnings revisions. This evidence seems to infer that continued underperformance of the Canadian stock market is not consistent with the true valuation of the underlying stocks.

FIXED INCOME

During the first quarter of 2018 the Canadian FTSE TMX Universe Bond Index gained 0.1%. The Bank of Canada raised its key lending rate in July and September of 2017 and again in January by a quarter point to 1.25%. Interest rates are recovering from the once record lows of last summer in response to signs of an improving economy. The central bank has taken a cautious stance on rate adjustments but investors are pricing in at least two more hikes by the end of this year. The recent increases overwhelm the two rate cuts introduced in 2015 which were to help cushion and stimulate the economy from the collapse in oil prices. In the U.S. the Federal Reserve raised interest rates in March for the sixth time since the financial crisis and signaled that at least two additional rate hikes are coming in 2018. The U.S. central bank increased its benchmark interest rate target range by 0.25% to a new band of 1.5% to 1.75%.

At a speech in early March, the Bank of Canada’s Deputy Governor Timothy Lane made a number of comments as to why the central bank decided earlier that month to put any rate changes on hold for the time being. The decision was grounded on their assessment of developments in the Canadian economy and what that meant for the outlook for inflation which is key to their decision. In that regard, global and Canadian economic data had been coming in as expected which gave them greater confidence that inflation will remain sustainability near their 2% target.

US EQUITIES

The Standard & Poor’s 500 index fell 0.8% in U.S. dollars but rose 2.0% in Canadian dollar terms over the first quarter of 2018. The loonie finished the first quarter with a 2.8% loss after gaining almost 6.6% in 2017. The first quarter of the year injected a spike of volatility into the nine year bull market as fears regarding protectionist trade policies from the White House, tightening monetary policy and heightened regulation on the tech sector, including President Donald Trump’s desire to take on Amazon and its founder Jeff Bezos, have dragged the market down.

The U.S. market correction began on January 26 with the selloff reaching 10% on February 8. It has since been followed by heightened volatility as equity markets again struggled at the end of the quarter with ongoing weakness in technology weighing on broader market sentiment. The wave of selling brought the U.S. indices down near their 200 day moving averages, levels that held during the early February selloff. The setback seemed to be particularly unsettling, largely because it was sudden, deep and followed a long period of low volatility.

Stocks have been pulled down by a number of factors, including growing fears of a global trade war following weeks of heated rhetoric and threats between the world’s two biggest economies, the U.S. and China. Beijing imposed tariffs of up to 25% on 128 U.S. imports worth $3 billion a year, including fruits and pork, in retaliation to U.S. duties on steel and aluminium. President Trump has repeatedly railed against China’s massive trade surplus over the United States, promising during the U.S. election campaign to slash the U.S. deficit.

Republicans are pouring government stimulus into a steadily strengthening economy, adding economic fuel at a moment when unemployment is at a 17 year low and wages are beginning to rise. The $1.5 trillion tax cut that President Trump signed into law late last year is likely to lift growth in 2018, though the Fed and most analysts see little long-term boost, if any, to the economy.

Nevertheless the agreement to increase federal spending by hundreds of billions of dollars should deliver a large short term fiscal boost. There are many reasons why the U.S. equity market underwent a setback lately but the health of the U.S. economy isn’t one of them. Despite a five year running tradition of consumers pulling back on their spending in the first quarter, the U.S. economy looks to be doing just fine and should strengthen this year thanks to the brisk fiscal tailwind. The concern for investors is not that the U.S. economy will slow this year but that it will grow too fast thanks to the fiscal expansion. At this stage it appears that this correction may well turn out to be just another dip in the long running bull market.

INTERNATIONAL EQUITIES

The global economic expansion looks to be on track for some pretty impressive gains going forward as the world becomes more synchronized despite escalating trade tensions. Trade wars are aimed more at punishing other countries than protecting domestic producers and they will inevitably cause pain for domestic consumers and import consuming industries. While collateral damage could be widespread, likely in the form of more volatility being unleased on stock markets around the world; eventually saner heads should prevail and co-operation will likely unfold. We can only hope, anyway.

Europe finished off last year with robust economic growth while confidence among businesses and households suggests there is no slowdown in sight. After years of suffering from the consequences of a sovereign debt crisis, unprecedented stimulus by the European Central Bank has turned Europe into a pillar of the global economy, recording its fastest rate of growth since 2008. Yet, despite this economic upswing, inflation remains muted. Employment is expanding at a vibrant pace. The Euro has recently climbed to a 3 year high against the U.S. dollar. However this is threatening to throw a spanner in the works and will likely force the Central Bank to wait until the year end before ending its asset purchase program or meaningfully contemplating raising interest rates.

Japan, the world’s third largest economy, saw manufacturing activity expand at its fastest pace in almost 4 years. Stock prices are at their highest in 26 years and corporate profits are near an all time high. Japan is seeing strong export growth, which could be impaired by a strengthening currency and simmering fears of a trade war. Add in the fact that labour shortages and a dwindling working age population have pushed the jobless rate to a near 25 year low, concerns remain about the future of the country’s economic turnaround. Still, with domestic demand accelerating and inflation remaining low there is little sign that any sort of correction will happen in the short term.

China has been experiencing unexpectedly robust growth in the first part of the year. The trade situation with the U.S. is obviously a rising risk and a relatively new challenge. While the risk of increasing trade tensions exist, the overall economic damage is likely to stay contained. Still, China’s growth will be moderate this year weighed down by a cooling property market and the government’s clampdown on riskier lending practices. While infrastructure remains a main engine behind China’s investment growth, high tech manufacturing has also expanded rapidly and now accounts for 43% of the total exports to the U.S., so it could be vulnerable to punitive U.S. trade measures.

In many cases the world stock markets reached new highs in January. Unfortunately, volatility swept over the global stock markets and they have since retreated 6.1% (all returns in U.S. dollar terms), at least temporarily from their highs. Collectively, all international stock markets declined 1.4% in the first quarter. Outside of Emerging Markets which gained 1.1%, all other regions generated negative returns; European stocks fell 2.6% and Asian stocks dropped 1.4%.

Concerns over a potential trade war are beginning to weigh on confidence around the world and could potentially slow the economic dynamic during the coming year. However, this increasing uncertainty will likely strengthen central bank resolve to hold the line in future interest rate hikes and take a more cautious approach to exiting most of the extraordinary fiscal measures that are still in place. This should be enough to allow the world’s economies to withstand most of the tit-for-tat gamesmanship that appears to be unfolding.

The Downside of Market Timing – Missing Out!

Trying to avoid a bear market can come at a very steep price: missing out on further gains if you get it wrong. Market timing can be a costly mistake since correctly timing the market is virtually impossible. The potential mistakes are just as severe whether you are trying to time the market to sell high or buy low. Because of this, investors who are troubled by the current state of the stock market may want to take a long term view and hold tight.

A bear market is typically defined as a 20% drop from a market peak, or twice as severe as the threshold for a correction which is just a 10% decline. The last year of a rally is sometimes referred to as a “melt-up” or a move higher that is driven by investors being fearful of missing out on past gains. The final years of a bull market are usually the best years of the economic cycle and staging an early exit from stocks to avoid a coming downturn can be a damaging long term mistake. In particular, equities tend to see steep gains in the 12 months before the start of a bear market. Double digit gains have historically been seen in the year leading up to a bear market, as the gains in the last year of a bull market make for a much more pronounced rally than is seen earlier in the cycle. There have been nine significant market corrections since 1970 (using the Canadian stock market as the reference, see the dates of the market peak on the left). The chart to the right shows the asset class returns late in a bull market for various periods prior to the various security types reaching their apex.

The penultimate year of a bull market has seen a 31.3% gain for Canadian stocks on average, which on its own would more than compensate for the pending market correction. More importantly this level of return confirms the fact that typically Canadian stocks are very much late cycle stocks and their performance dwarfs what is achieved elsewhere. For example, U.S. stocks “only” averaged 16.1% in the year before the stock market correction occurred, while bonds eked out 7.3% over the same time span. Comparatively, in the year before that and the two years before the peaks (meaning the period that is between 24 and 36 months before the start of the bear market), U.S. stocks were clearly the better overall investment. This sounds very familiar to what has been occurring over the much of this economic cycle. Should this 40-plus year pattern continue and if the current market uptrend is winding itself closer to a market correction or a bear market, it is possible that Canadian stocks could make up much of their relative underperformance versus U.S. stocks over the past few years.

Certainly, the concerns that stock markets could be looking at weak future results, if not necessarily a bear market, have been growing. However, stocks are not seen as overly expensive right now and the first quarter earnings season has been strong, although the market’s reaction to them suggests investors have not been impressed. The final stages of a bull market can be lucrative for investors and an early exit can be detrimental to an investor’s long term results. Current economic data supports the case for continued economic recovery and further stock market gains. Despite what could happen in the coming years, the best course for most investors is to stay put, getting the benefit of compound growth and not making short term trading decisions.

MARKET DATA

market data imageThis report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

There is more to risk than meets the eye

The  term  risk  often  gets  thrown  around  in  the  investment  world.  But this  term  goes  far  beyond  market  volatility.  Here  are  five  types  of  risk  to  consider  and  you  put  together  a  portfolio:    

Interest  rate  sensitivity  risk   
As  bond  yields  have  been  on  the  decline,  this  has  become  an especially important type  of  risks  for  investors.  It  is  a  measure  of  how  much  the  price  of  a  fixed-income  asset  will  fluctuate  in  response  to  interest  rate  changes.  Securities  sensitive  to  this  risk  tend  to  have  larger  price  fluctuations  than  other  securities.    

Political  risk 
A  hot  topic  lately,  especially  with  new  trade  directions  out  of  the  US,  but  overall  it’s  the  risk  associated  with  government  or  social  action  that  could  result  in  loss  of  value.  Political  risk  can  impact  an  investor  both  nationally  and  internationally.

Credit  risk 
Since  bond  yields  have  fallen  they  have  decreased  in  popularity  which  means  the  credit  curve  is  affected  as  well.  The  lower  the  credit  curve,  the  more  a  portfolio  risk  increases. 

Purchasing  power  risk 
Using  bonds  as  an  example,  if  inflation  rises  and  an  investor  has  invested  in  shorter  duration  bonds  with  a  lower  return,  it  is  likely  they  are  trading  equity  market  risk  for  inflation  and  overall, losing  purchasing  power.    

Sector  risk 
A  portfolio  that  is  based  on  an  investment  style  that  includes  a  focus  on  one  sector  can  be  extremely  vulnerable.  If  this  sector  experiences  any  kind  of  downturn,  a  portfolio  could  be  significantly  negatively  impacted.    In  conclusion,  while  investing  is  not  a  game  of  certainty,  understanding  the  fuller  spectrum  of  risk  helps  ads  some  important  safeguards.   

Closing The Gap

Dividend paying stocks have been very popular with investors in recent years due to weak returns in the bond market. That picture appears to be shifting in Canada for the first time in almost a decade. As the Bank of Canada has slowly tightened monetary policy, bond yields have naturally risen, yet still remain well below the levels seen before the financial crisis.  As bond yields rise, investors may cut their exposure to equities. Historically bull markets tend to end once interest rates have risen too much, too fast. The current long-lasting uptrend is beginning to show signs of entering the euphoria stage. If dividend yields drop below bond yields it could be another indication that the high-flying stock market is headed for a correction.

The ‘Yield Gap’ is the difference between the S&P / TSX Stock Index dividend yield and the 10 year Government of Canada bond yield. The yield differential between stocks and bonds has historically been one of the more attractive signals for many investors. It has signaled when equities were good value relative to bonds. However in the last few months that spread is becoming less favorable to equities and is giving many investors pause for thought. Higher bond yields could make stocks look more expensive. Additionally, higher borrowing costs could have an impact on corporate earnings as it becomes more expensive for companies to finance projects. Lower profits could result which would boost the price-to-earnings ratio and raise equity valuation concerns.

Before the 2008 financial crisis the yield on 10 year bonds was markedly higher than equities, before abruptly changing course during the depths of the crisis. In fact, for most of history, dividend yields have stayed below 10 year bond yields. During the 2008 financial crisis bond yields started oscillating around dividend yields for several years but have spent significant time below dividend yields since June 2011, as economic growth recovered and inflation concerns faded. As the chart above and data to the left illustrates, the dividend yield of the S&P / TSX has remained steady at around the 3% mark throughout the post-2008 crisis recovery period as companies have grown their dividends to keep up with increasing share prices.

For the past decade, investors have flocked to the stock market for higher yields as government bond yields have hovered at historic lows. The increase in asset prices can be partly attributed to low yielding debt instruments. Still dividend paying stocks tend to be a poor defense when rates are rising and stocks could be facing yield competition from bonds for the first time since the financial crisis. If and when the S&P / TSX yield falls below bonds it will not necessarily be bad news as most equity investors generally buy stocks for capital appreciation and not for steady income.

At this juncture, the case for stocks still appears to be favourable compared to owning bonds so yield seekers currently invested in stocks do not necessarily need to jump ship yet. As with all market measures, the consequences of the narrowing yield gap are hard to predict. While some risk averse investors might switch to bonds, for most investors dividend yield is simply one factor contributing to the total performance of owning stocks.

MARKET DATA

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Closing The Gap

Dividend paying stocks have been very popular with investors in recent years due to weak returns in the bond market. That picture appears to be shifting in Canada for the first time in almost a decade. As the Bank of Canada has slowly tightened monetary policy, bond yields have naturally risen, yet still remain well below the levels seen before the financial crisis. As bond yields rise, investors may cut their exposure to equities. Historically bull markets tend to end once interest rates have risen too much, too fast. The current long-lasting uptrend is beginning to show signs of entering the euphoria stage. If dividend yields drop below bond yields it could be another indication that the high-flying stock market is headed for a correction.

article table

The ‘Yield Gap’ is the difference between the S&P / TSX Stock Index dividend yield and the 10 year Government of Canada bond yield. The yield differential between stocks and bonds has historically been one of the more attractive signals for many investors. It has signaled when equities were good value relative to bonds. However in the last few months that spread is becoming less favorable to equities and is giving many investors pause for thought. Higher bond yields could make stocks look more expensive. Additionally, higher borrowing costs could have an impact on corporate earnings as it becomes more expensive for companies to finance projects. Lower profits could result which would boost the price-to-earnings ratio and raise equity valuation concerns.

Before the 2008 financial crisis the yield on 10 year bonds was markedly higher than equities, before abruptly changing course during the depths of the crisis. In fact, for most of history, dividend yields have stayed below 10 year bond yields. During the 2008 financial crisis bond yields started oscillating around dividend yields for several years but have spent significant time below dividend yields since June 2011, as economic growth recovered and inflation concerns faded. As the chart above and data to the left illustrates, the dividend yield of the S&P / TSX has remained steady at around the 3% mark throughout the post-2008 crisis recovery period as companies have grown their dividends to keep up with increasing share prices.

For the past decade, investors have flocked to the stock market for higher yields as government bond yields have hovered at historic lows. The increase in asset prices can be partly attributed to low yielding debt instruments. Still dividend paying stocks tend to be a poor defense when rates are rising and stocks could be facing yield competition from bonds for the first time since the financial crisis. If and when the S&P / TSX yield falls below bonds it will not necessarily be bad news as most equity investors generally buy stocks for capital appreciation and not for steady income.

At this juncture, the case for stocks still appears to be favourable compared to owning bonds so yield seekers currently invested in stocks do not necessarily need to jump ship yet. As with all market measures, the consequences of the narrowing yield gap are hard to predict. While some risk averse investors might switch to bonds, for most investors dividend yield is simply one factor contributing to the total performance of owning stocks.

MARKET DATA

market data image

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Great Expectations?

Asset allocation is one of the most important decisions investors will likely make. There are a number of risk factors related to the type of investments used as well as their mix which makes determining the appropriate capital market assumptions necessary. There are many firms which provide investment assumptions to investors with each making their own risk and return calculations so that clients can evaluate their investment decisions. Of course, these assumptions are not permanent and need to be changed over time.

Empirical evidence has not been favourable to market forecasters. Studies have shown that the vast majority of financial gurus do not do better in their predictions than simply flipping a coin. So, on the face of it, being able to accurately forecast markets 10 years out is extremely difficult. In a world of seemingly random events, all of which could affect assumptions, it is hard to figure out where to turn. Fortunately, in Canada, there is one semi-independent organization that touches upon almost every adult’s life to varying degrees; the Canada Pension Plan (CPP). The CPP operates throughout Canada (except in Quebec, where the Québec Pension Plan serves the same function) to provide pension benefits to Canadians. It is the responsibility of the Chief Actuary of CPP to form the capital markets assumptions used in the modeling that serves as foundation for their strategic asset allocation. So, it makes sense that their primary projections should be the bedrock of the return on investments for most investors. Fortunately, these are updated periodically and publicly available.

The data to the left illustrates the most current forecasted long term nominal returns for capital markets in Canadian dollar terms (i.e. returns before the impact of inflation). The chart to the right shows the historical evolution of those previous projections from the past 8 years. Clearly, the prospects for cash and/or other short term investments has been deteriorating over the years; as has the expectation for bonds since the significant tightening of credit spreads have lowered yields, thereby reducing the potential for future returns. These conditions could be made worse if the yield curve inverts as is broadly expected. Still not all bonds are created equal with government bonds expected to return just 3.0%, corporates 3.5% and high yield instruments 5.25%.

Similarly, assumptions for equities in general have trended lower; falling behind what history would suggest. Interestingly, Canadian stocks are no longer considered the shining light for forecasted performance. Increases in expected earnings growth and corporate profit margins outside of Canada has seen the expected returns for both major foreign and emerging market stocks jump, such that investors should be relatively indifferent as to which markets to invest for the best results. Although, the returns investors do actually receive will be ultimately determined by the crucial impact of dividends and buybacks going forward. Of course, most investors are not looking to just match the market but exceed it. Unfortunately, that then becomes a question of determining those that have the necessary skills to add value. However, that is a question for another day.

MARKET DATA

 

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.

Trends: Riding investment waves

Trends come and go in every aspect of life, including the markets. Trends spike media attention and huge amounts of public interest– everyone looking for a get rich quick solution. Now in vogue is marijuana and cryptocurrencies. Wanting to be part of this, or other trends, is fine but here are some pointers to keep in mind while trying to ride the wave.

The greater fool principal

Essentially, this means buying into something risky and uncertain with the hope that down the road, it will sell it at a higher cost than it was purchased for to a greater fool. This is the case for cryptocurrencies, like Bitcoin. No one is intending to hold onto it, rather to buy it up and then sell it off when its market valuation shows greater worth. It is more of a game of timing than it is an investment strategy.

Sky high valuations

Trendy investments tend to carry huge valuations that do not always make sense. Take marijuana stocks, in Canada the value of shares are huge, especially for companies who have yet to turn a profit. The attention, rather than the value, is what is driving up stock price in what can easily be an artificial market.

Pushing the boundaries affordability

 When a share is hot, the price is high and the media is talking about it, it creates a perfect storm of temptation for an investor to buy quickly. The issue with this is that many investors end up pushing their traditional boundaries of what they consider affordable because they want to get in the game at any cost. The result, dangerously, is often extremely overpriced eggs in one flimsy basket.

There is success in boring

There is a reason patience and diversification seem to always win in the investment field. There is no instant solution to getting rich and if there is, it probably lacks longevity. There is value in getting rich slowly and steadily, that may just win the financial race.

Want to learn more? Check out or perspectives section (link) where we dig deeper into the markets on a monthly basis.

Great Expectations?

Asset allocation is one of the most important decisions investors will likely make. There are a number of risk factors related to the type of investments used as well as their mix which makes determining the appropriate capital market assumptions necessary. There are many firms which provide investment assumptions to investors with each making their own risk and return calculations so that clients can evaluate their investment decisions. Of course, these assumptions are not permanent and need to be changed over time.

article table

Empirical evidence has not been favourable to market forecasters. Studies have shown that the vast majority of financial gurus do not do better in their predictions than simply flipping a coin. So, on the face of it, being able to accurately forecast markets 10 years out is extremely difficult. In a world of seemingly random events, all of which could affect assumptions, it is hard to figure out where to turn. Fortunately, in Canada, there is one semi-independent organization that touches upon almost every adult’s life to varying degrees; the Canada Pension Plan (CPP). The CPP operates throughout Canada (except in Quebec, where the Québec Pension Plan serves the same function) to provide pension benefits to Canadians. It is the responsibility of the Chief Actuary of CPP to form the capital markets assumptions used in the modeling that serves as foundation for their strategic asset allocation. So, it makes sense that their primary projections should be the bedrock of the return on investments for most investors. Fortunately, these are updated periodically and publicly available.

The data to the left illustrates the most current forecasted long term nominal returns for capital markets in Canadian dollar terms (i.e. returns before the impact of inflation). The chart to the right shows the historical evolution of those previous projections from the past 8 years. Clearly, the prospects for cash and/or other short term investments has been deteriorating over the years; as has the expectation for bonds since the significant tightening of credit spreads have lowered yields, thereby reducing the potential for future returns. These conditions could be made worse if the yield curve inverts as is broadly expected. Still not all bonds are created equal with government bonds expected to return just 3.0%, corporates 3.5% and high yield instruments 5.25%.

Similarly, assumptions for equities in general have trended lower; falling behind what history would suggest. Interestingly, Canadian stocks are no longer considered the shining light for forecasted performance. Increases in expected earnings growth and corporate profit margins outside of Canada has seen the expected returns for both major foreign and emerging market stocks jump, such that investors should be relatively indifferent as to which markets to invest for the best results. Although, the returns investors do actually receive will be ultimately determined by the crucial impact of dividends and buybacks going forward. Of course, most investors are not looking to just match the market but exceed it. Unfortunately, that then becomes a question of determining those that have the necessary skills to add value. However, that is a question for another day.

MARKET DATA

market data image

This report may contain forward looking statements. Forward looking statements are not guarantees of future performance as actual events and results could differ materially from those expressed or implied. The information in this publication does not constitute investment advice by Provisus Wealth Management Limited and is provided for informational purposes only and therefore is not an offer to buy or sell securities. Past performance may not be indicative of future results. While every effort has been made to ensure the correctness of the numbers and data presented, Provisus Wealth Management does not warrant the accuracy of the data in this publication. This publication is for informational purposes only.