Video - Market trends July 2014
Economic and financial outlook
Welcome to this economic and financial outlook presentation. My name is Michel Doucet, I am a Vice President and Portfolio Manager. What I propose is, over the next few minutes, to discuss the economic and financial backdrop that we are currently seeing in North America, Europe and the emerging markets.
(The) first question that comes to mind when looking at the markets is who’s right? You look at the S&P 500 and you are going from top, to top, to top, and this market is pretty much saying that everything is great, there are no hurdles down the road. If you look at U.S. 10-year Treasuries, you close the year 2013 at 3.03%, around 2.8% on the 10-year Canada’s, and on May 29th (2014) yields fell to a yield of 2.4% to close the first half at 2.6%.
So, basically the bond market is telling you otherwise than what the S&P 500 is saying. The bond market is saying, "Hey, I’m concerned here, are we secure that this economic backdrop is as solid as the stock market is saying," or is the bond market going the wrong way? Are they crying wolf and there is really nothing to cry about. Is it because you had some pension funds or insurance companies that came to the market early this year – they were looking at a 4% return or yield and they got that 4% buying a 30-year bond – maybe that’s it. Could we have seen traders that were doing an arbitrage trade between a 10-year German bunds or 10-year Treasuries and by doing that they forgot that the U.S. and Europe are not in the same economic cycle?
Bottom line to it, the S&P 500 index is right, but is it vulnerable to a setback here now that we broken the 17,000 level on the Dow Jones and that we are close to the S&P 500 2000 psychological level? Could the market (here) take some profits and take a breather before heading back up? In my opinion the answer is definitely yes to that question, but having said this, let's go back to the drawing board.
(Back to the drawing board)
What you have before you is the average of economic cycles since 1974, which we divided into
What you see in Phase 1 is you are coming out of a recession, investors are saying "Yes, finally we’re out of a recession," and we’re seeing strong numbers and the stock market starts booming.
In Phase 2 the market is saying, "ok, we’ve had quite a good run. Can you confirm that actually this will continue?" Then economic numbers continue to come in on the positive side and then we go into Phase 3.
Phase 3 is a phase where everything goes well, you don’t ask any questions, over an average of 77 weeks, the market is going up about 35-38%, and then you go into Phase 4.
Phase 4 a period where you have a setback, investors are questioning the numbers, they are looking at the economic fundamentals, they are looking at company financials/fundamentals and they are saying, "can this really continue?" And, as the good numbers keep coming in you are going into Phase 5.
Phase 5 is the last leg of this bull market, it will last about 70 weeks with returns of about 40%. Then you head into
Phase 6. Phase 6, is the beginning of a bear market.
(No recession! No bear market!)
Having said this, "no recession, no bear market."
As you can see on the chart with the blue shaded areas, which are all recession periods, the stock market has never gone into a bear market phase until the economy went into a recession. (except in the 60s).
(Monetary policy still very accommodative)
Also, if you look at monetary policy, since the 80s the stock market has not gone into a bear market until monetary policy has become tighter. Can you say that at 0% south of the border and 1% in Canada, monetary policy is not loose? Even if the Fed terminates its quantitative program this fall and begins tightening rates sometime around June 2015, and then goes every other month with a quarter point increase.
Just to bring that rate to the neutral level, let’s put that at 2%, it will take at least a year and a half, and that’s not even a policy that begins to be tighter.
So, the stock market has some legs and the bond market, in my opinion, is walking on shaky ground.
(On the agenda)
What's on the agenda between now and year end, or even going into 2015?
Tapering – as I just mentioned, it will probably come to an end anywhere in the fall of 2014.
U.S. economic growth to gain momentum – we had a very bad first quarter, Mother Nature worked against the markets or against the economy. It was cold, consumers stayed in, companies were de-stocking during that period, so we had a downturn in economic growth. Having said this, the second quarter bodes well in terms of economic growth. You’ve had about 1.3 million jobs that where created in the first half, retail sales are doing really well – car sales are cruising at about a 16 million pace at this time. Things are looking pretty good for the U.S. economy in the 2nd quarter.
Bond yield to normalize – Bond yields have not normalized as of yet because Mother Nature did what it had to do, in terms of weather. The bond market went south instead of going north. (Because economic growth slowed, bond yields fell to a low of 2.4% in the States as of May 29th, and 2.1% on the 10-year Canada’s.)
European economy back in the saddle – They just came out of recession, it's going to take time. If, after 5 years, U.S economic growth is averaging 2/2.5%, do you think it will take Europe the same amount of time to gain that type of momentum? The answer is yes. Let’s give this economy some time to grow out of its misery. Having said this, remember in March 2009 the U.S. economy was just beginning to move and the stock market was already in a transition phase, so opportunities are now there to invest in Europe.
Structural changes in emerging markets – things to consider. China right now is having some difficulties with structural changes that need to be addressed. What to look for, again it’s a transitional year; let’s take our time when looking at emerging markets.
Having said this, I’d be neutral in my asset mix towards emerging markets, while being overweight for Europe and the U.S. and underweight as to Canada.
In terms of my asset mix, I would be 20/25% cash, 25% bonds, and 50% stocks. So overall, when looking at my asset mix, or my structural asset mix, I would be overweight cash and stocks and underweight bonds, at this time.
You know, summer is the best time to take a breather, to take a step back, to go back to the drawing board, ask the real questions and to ask yourself: "who am I?"
Who am I, what are my real investment objectives, how much am I willing to risk? This is a simple question that we ask investors. Take the time to ask yourself how much you are wiling to risk, not in percentage terms but in dollars. If you have a million dollars in your RRSP right now, how much can you sincerely say you could lose? If you say I can take a 10% loss, that’s one thing, but 10% is $100,000. When you put it in dollar terms, it really brings you back to the impact that it has on your portfolio.
The next thing you should consider: "What is my financial plan, what is my investment policy?" Talking with your investment advisor will bring you back to these basic questions.
Then, we can move on to your strategic and tactical asset mix, and as we are doing now, you can review the economic and financial backdrop. Where should I invest in the world, what sectors should I be buying, what style should I be looking for in my portfolio? What mix should I have between cash, stocks, bonds and any alternative investments?
Ongoing monitoring: though we look at our portfolios on a regular basis, when speaking with your investment advisor, it really brings everything back to the drawing board. Maybe it’s time to re-question your strategy; maybe it’s time to rebalance.
Summertime is the perfect time to ask the real questions. Take the time to call your Investment advisor.
(Expected returns according to profile)
Portfolio returns: what can you expect? Over the long term, someone who would have a prudent portfolio, 80% bonds and 20% cash, should be looking for a return of about 4.5 to 4.75%.
Someone with a balanced portfolio, 40% bonds and 60% stocks, could expect 6.5 to 6.75%, and if you are growth investor with 80% stocks and 20% in cash/bonds, a return of 6.75/7.0%.
Having a great summer includes asking the real questions and coming back to your investment advisor to revise: who you are, what is your investment profile, and to review where we should be heading over the next couple of months/years.
Again, have a great summer.