Category: Monthly Reflections

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

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.

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.

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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

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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.

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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

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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.

Stock Sectors After Rate Hikes

Last year the Bank of Canada (BOC) implemented its first interest rate hike since 2010 and many investors reached for their crystal balls to try and forecast the future. While rising rates tend to signal stronger economic conditions and inflationary pressures, they can also have a meaningful impact on stock market sector returns. Changing the overnight interest rate, which is the cost that depository institutions pay to borrow money, is how the BOC attempts to control inflation. When the BOC increases the overnight rate, it does not directly affect the stock market but it does have a ripple effect that can rock the market. However some sectors benefit from interest rate hikes and others do not.

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A review of equity performance following previous BOC tightening cycles over the past 20 years shows that in five of the past six periods of hiking overnight interest rates; October 1997, November 1999, May 2002, October 2004 and June 2010 (July 2017 excluded), there was some deviation from normal results which provided excellent opportunities but there are grounds for concern. The conventional way of thinking is that cyclical sectors like Industrials, Materials, Energy, Information Technology and Financials do well in a rising interest rate environment. A healthy economy has more investment activity, increased profit margins for financial entities, improved employment and a healthy housing market; all of which allow consumers to splurge. Meanwhile, defensive sectors like Utilities, Telecom, Consumer Staples and Healthcare (which tend to be proxies for bonds and do poorly as interest rates climb) generally show weaker results when the world’s central banks take away the cookie jar.

At times Canada dances to a different beat and over the past 20 years our stocks have for the most part have done the opposite of what economic theory would forecast. Perhaps it is a weak Canadian dollar, the near term glut in crude oil or weak commodity prices, but whatever the cause, the unexpected has occurred. The chart on the right shows the net difference between the average annual calendar returns for the 10 Canadian stock sectors since 1998 relative to the average 12 month return for the same sectors after the BOC implemented its first rate hike. The data to the left shows the individual averages for both occurrences.

These performance numbers do not include the impact of dividends. These five sectors: Energy; Consumer Staples; Financials; Telecom and Utilities, have outperformed their long term averages after interest rates started rising, leaving the other five; Materials, Consumer Discretionary, Health Care, Industrials and Information Technology lagging. The degree of variance in some cases is quite glaring and the reverse of what was expectedValue stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

 

While a rising interest rate environment may not be detrimental to equity market returns in general, historically there have been clear winners and losers. Canadian investors who invest in our very unique stock market have been doing things differently for quite some time as conventional wisdom (at least with regard to domestic rate hikes) is thrown out the window. Perhaps rather than focusing on our own situation, many Canadians may be overly fixated on what is happening elsewhere; say to the south of us perhaps

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

Shifting Importance

Eventually this bull market will break its long winning streak but that does not mean you should be abandoning everything and running for the hills. What it does mean is that you should consider shifting your portfolio’s emphasis. Not all stocks react equally during good and bad times so the secret is to rearrange the deck chairs to ensure smoother sailing.

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History never repeats itself exactly but similarities do exist, particularly in the timing of economic events or cycles. These recurring ups and downs in economic activity (or market/business cycles) are made up of several years of peaks, recessions, troughs and eventually a recovery phase. The peak is when business activity has reached its maximum level followed by a slowdown or recession during which business activity reaches its lowest level. The final phase or recovery is when the economy again expands towards maximum output. The movements of the markets are closely linked to the business cycle. Stocks, bonds and commodity prices are heavily influenced by investors’ expectations of the future. Each financial market tends to peak and bottom at different points in the business cycle. An expanding economy is generally favourable for the stock market; a weak economy for bond prices; and an inflationary economy for commodities. The overall stock market tends to lead the general economy with stocks going up before the economy peaks and falling before a recession begins. However, the stock market is made up of companies from many sectors which rotate in and out of favour during the phases of the business cycle. The image below shows a typical market cycle and indicates which sectors tend to outperform the broader market at particular times.

Economic recoveries are often led by consumer spending so the retail sector is considered a leader of the broader stock market. It is usually one of the earliest sectors to peak and also to bottom. The same holds for the banking, housing and construction industries which are heavily influenced by interest rates. As interest rates are cut, demand in these sectors grows, as does their stock price.

The table to the left shows the performance of each sector during and after the tech bubble burst in 2000 and the financial meltdown in 2008. The first column has sector performance during these bear phases and the second is the initial recovery phase. The inverse relationship in this case is striking. Those sectors which performed the worst in the falling market tend to increase the most when the market rebounds. Conversely those that had done well during a falling market returned a relatively flat performance when the market recovered. There is a pattern to these rotations which investors can exploit. The industrial and manufacturing sectors usually follow the movement of retail and construction. As inventories become depleted, demand for more manufacturing and industrial output increases. Because the economic environment and news is often bad at this point, investors tend to be cautious and initially invest in companies with good earnings and cash reserves. As the bull market grows, investors tend to place money into relatively speculative stocks such as technology companies. In the later stages of expansion, when interest rates are rising, the capital goods, basic materials, and energy industries tend to thrive as they expand capacity and bid for increasingly scarce resources.

Value stocks tend to outperform by falling less during bear markets and growth stocks tend to outperform in the bullish phase. Of course, there are many permutations that push and pull markets. Being right all the time is next to impossible but shifting a portfolio’s exposure between sectors can go a long way to minimizing the damage when financial gravity reasserts itself.

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 two sides of January

Most investors have heard of the January Effect which is the observation that January has historically been one of the best months to be invested in stocks. However there is another January Effect which states that, “as goes January, so goes the year”. While January has produced positive performance 66% of the time between 1968 and 2017 for the S&P/TSX Stock Index, it has also produced negative performance one-third of the time.

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What is striking is that in years when January had a positive return, those returns were well above average relative to the returns in other months of the positive January years. For example, of the 33 Januarys with positive performance, the S&P/TSX was up an average of 4.3%. The next best performing month in those years, as can be seen in the table to the left, was December which returned half that amount at 2.1%. Conversely, when January had negative returns, -3.5% on average; the remainder of the months of the down January years produced better returns. Although in total only 7 months had positive returns, they were more than enough to lift the overall years performance into positive territory but still well behind the 50 year average market performance and still further behind the years where stocks came roaring out of the gate in January.The chart below depicts the average annual cumulative returns for months that had positive Januarys and negative Januarys net of the S&P/TSX average annual return for the period. While the relative performance between good and bad months of January time periods did narrow over the course of the year, it clearly shows that the opening month of the year often sets the pace and influences the remaining months of the year. We then looked at how these markets performed for the full year. In those years where January was positive the S&P/TSX (including dividends) returned 12.6% versus an average of 10.7% for all 50 years reviewed; a 17.8% improvement. On the other hand, negative Januarys underperformed the market as a whole by -39.3%. These numbers confirm that “as goes January, so goes the year”, translating into above or below average annual performance in those years.

The most widely accepted explanation for the January Effect is tax-loss selling. The tax circumstances of taxable investors are often more important than a security’s fundamental valuation, as such investors will sell whatever securities are required at the end of the calendar year to establish capital losses for income tax purposes and then repurchase the shares after a prescribed waiting period. As the waiting period most often expires early in the next year, the repurchase orders flood the market in January, hence creating abnormal returns in the month. In addition to tax issues, researchers have also suggested other reasons for the January effect. One is “window-dressing”, as portfolio managers unload their embarrassing stocks at year-end so that they don’t appear on their annual report, and then redeploy the proceeds in January. Another reason, which we may see more of in 2018, is short sellers covering their successful short positions early in the next year so they usually do not have to pay taxes on the gains until April of the following year.

Whatever the explanation, predicting the future is impossible (even if it is only one month’s prospects), but it is good to know the end result is just a question of how large the annual gain will be on average. Because it is clear that investors should not be out of the market if January is a good or bad month because the returns over the rest of the year are just a question of magnitude. Of course one must always bear in mind that past performance does not mean this trend will continue. It will be interesting to see how it plays out in 2018.

Market Data

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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

VANISHED – CANADIAN STOCK VOLATILITY

Investors had taken most of the summer off as the S&P/TSX stock index drifted aimlessly, trading between 15,500 in May and 15,000 at the end of August, but since then it has undergone a steep 7.5% increase. Of course for those investors who closely follow the market, it seemed to be moving in all kinds of directions, falling for a week, rallying for two and jumping about like a chicken on a hot tin roof the rest of the time.

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If investors were to glance at volatility measures however, they would come away yawning. The socalled “fear gauge” has been nothing but a sea of tranquility. The best level of fear gauge for the Canadian stock market is the Montreal Exchange’s Implied Volatility Index VIXc (or MVX prior to October 2010) which measures the implied volatility of the iShares CDN S&P/TSX 60 Fund (XIU). VIXc is a good proxy of investor sentiment for the Canadian equity market: the higher the Index, the higher the risk of market turmoil. A rising Index therefore reflects the heightened fears of investors for the coming month. A high VIXc is not necessarily bearish for stocks, as it measures the fear of volatility both to the upside as well as the downside. The highest VIXc readings will occur when investors anticipate large moves in either direction. Only when investors anticipate neither significant downside risk nor significant upside, will the VIXc be low.

The chart below shows the VIXc values as well as the S&P/TSX Stock Index. Currently the VIXc is trading around 8.2 which is very low and confirms that the market is not anticipating any dramatic swing in volatility for the foreseeable future. Low levels of implied volatility are often good periods to enter the market as the risks are relatively low. Equity markets tend to disconnect from their underlying values in periods of high volatility as investors scramble quickly to trade those shares that are coming in or going out of favour. On the other hand, a peak in volatility in down markets can be a useful indicator as it closely precedes a market bottom. Think of 2008 when the VIXc spiked to 88 nine days before the market bottomed, in 2011 the VIXc spiked to 37 the day before the market bottomed and in 2015 the VIXc spiked to the 33 which was the day the market bottomed. Following the years the Canadian stock market experienced significant declines, the VIXc shone the light on the pending major stock market recovery.
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Another factor to consider when assessing the timing of a move to equities is the current cash on hand. Not only are retail investors switching from cash and bonds into equities, but hedge funds and institutional managers have been moving this way for some time. Back in 2009 hedge funds and experienced investment managers were well ahead of the retail crowd in buying up equities early in the rally, as they covered short positions and began accumulating long positions. The amount of cash on the sidelines currently has the potential to drive forward a long term equity rally. While it is difficult to say when a rally will begin, savvy investors may want to use this period of low volatility to add to equity levels.

Market Data

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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

Range Bound No More

After every major bull market, stocks typically become range bound and experience a sideways pattern with many optimistic and pessimistic periods before exiting 15 to 30 years later at about where it began. This has occurred in the U.S. five distinct times since 1870: 1870 to 1900 (lasting 30 years); 1902 to 1927 (25 years); 1935 to 1950 (15 years); 1965 to 1980 (15 years) and of course the most recent starting in 2000. Although Canadian stock market history does not extend back quite so far the pattern is very much the same, which should be expected since we march to the same drummer. Ultimately, the advancing economic recovery results in enough earnings growth that stocks that once seemed expensive are now bargains, and triggers a new bull market when stocks break through the upper constraints of the range.

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Back in 2008, following a robust record high equity bull market, investors were feeling optimistic. Not surprisingly the flows into equities were significant. This was when the current sideways market began with a bull market peak of 15,073 in June 2008 for the S&P/TSX index. Seven years later in April 2015, the market was barely higher at 15,451. The market continued to oscillate for the next two years, unable to climb above 15,500. However, this began to change over the last two months.

History is a reasonable guide for what might occur next and it has suggested a new bull market is fully established once the range is broken. Only those perceptive enough to see though the market “noise” will be rewarded by the time the new upward trend is well entrenched. And it appears the markets have now finally broken out of this range by firmly establishing new highs.

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As is evident in the chart to the right and in the table to the left, the equity market’s gyrations over the last 10 years have produced little tangible gains unless investors were astute enough to tactically determine the right time to buy and sell stocks. History suggests that investors with a long term horizon will achieve better returns in equities (probably 6% to 9% annualized) than in most other investments.

Investors have been pulling money out of equities and adopting bonds as the “must have” alternative, which was part of a broader trend that has been going on since the middle of the last decade. The financial crisis of 2008 made investors increasingly more risk averse and drove them to higher yielding investments as a way to maximize their returns in an era where longer term gains from the prices of stocks alone had proven elusive. With a record 21% of the workforce now aged over 55 and growing quickly, the asset mix of the general population is structurally biased towards instruments that generate an income stream as concerns over retirement percolate. This had put more pressure on stock valuations and dampened the desire for riskier assets.

Following extended periods of weakness, history shows that the future should be quite bright. After all of the worst performing 10 year periods since 1926, the following 10 year average returns were close to 11% and the lowest of those subsequent returns was still over 7%. Logic would dictate that investors should take profits in those asset classes that had performed the best, which in Canada were bonds and real estate, and seek returns in the weakest asset class, which has been equities. In the midst of the current equity rally, ten year government bonds are yielding less than 2% so a potential annualized return of 7% in equities over the next 10 years would be very attractive.

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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

Retirement Income on Steroids

Short term interest rates are near 60 year lows which makes it hard for fixed income investors to earn a decent income. Couple this with the fact that the average investor has an aversion to investing in long term bonds because of the belief that higher interest rates are on the horizon and it becomes nearly impossible to earn much more than money market rates. So what are the options for clients looking for good yields while being able to take advantage of higher returns in the future?

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With over $300 billion in assets, Guaranteed Investment Certificates (GICs) account for a huge share of fixed income sales in Canada. This is due to the advantages that many investors feel GICs offer over bonds: a predictable and guaranteed income stream, the principal value won’t decline and no fees mean every penny earned is theirs to keep. For these benefits clients are subjected to returns that can be low and, after inflation, the returns are actually negative. This is not a great situation as people are living longer. Sometimes the safety investors are seeking becomes just another form of risk.

After GICs, bonds are the next popular vehicle in adding returns to an investor’s portfolio as they have very different characteristics but do offer distinct advantages. Interest rate changes affect bond values so that as rates fall, bond prices increase and as rates rise, prices fall. However, if held to maturity bonds repay the full principal. Another essential difference is liquidity. Bonds can be bought or sold at any time with price determined by each bond’s individual characteristics and current market conditions. While bond returns are impacted by the cost of purchasing and managing the portfolio, this can be offset by the higher returns bonds can achieve. They offer the distinct possibility of higher yields and capital gains.

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Taking it one step further and incorporating other types of fixed income vehicles into the mix can be quite rewarding for conservative investors. For example, constructing an optimized High Yield Fixed Income portfolio consisting 15% of a 10 year Corporate Bond Ladder, 7.5% REITs, 20% High Yield Bonds, 15% High Yield ETFs, 20% Mortgages and 22.5% Fixed Income Hedge Funds leads to a very attractive alternative. Certainly the degree of risk investors assume with this type of portfolio are higher, but so is the potential for greater returns. The real question is, is it worth it?

Given current low interest rates this may be a good time to consider these strategies. Current 5 year GIC rates (based upon the average rates of the Schedule A chartered banks) are 1.6%. Using bonds with a similar term structure (represented by 50% FTSE Short-Bond Index and 50% FTSE Mid-Bond Index) shows how an all bond portfolio would perform. While the returns for the outlined High Yield Fixed Income portfolio is clearly superior. As the chart above shows, over the past 10 years the one year rolling performance of these two portfolios consistently produce higher returns when compared to 5 year GICs (outperforming 83.3% and 88.1% of the time, respectively). The data to the left shows these advantages both on a quarterly and annual basis; while doing so with very low correlation to GICs of 0.22 and -0.24 respectively.

With today’s very low yields and increasing interest rates, investor returns on GICs after inflation, fees and taxes are minimal. So unless investors are comfortable with only safe harbour investments and unconcerned with the less than stellar returns going forward, the only realistic solution is to explore other options. The decision to be safe is making many investors less safe and creating a whole new level of risk, running out of money. With this situation bearing down on many investors, the proposed High Yield Fixed Income structure is a solution that plays it safe, but still generates meaningful returns.

Market Data

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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