Making Haste Slowly - Investing at TD TD Wealth


Making Haste Slowly - Investing at TD TD Wealth
Market Outlook
Investment Strategy Quarterly • Spring 2010
Making Haste Slowly
After a wild ride in 2009, characterized
by a stomach-churning drop that was
followed by a euphoric rebound,
investors were confronted by a fresh
bout of financial market schizophrenia
in the first quarter of 2010 (see Chart 1).
Chart 1 - Q1 Canadian &
U.S. Market Performance
Investors, while relieved that holiday
season sales had generally exceeded
modest expectations, soon expressed
new concerns.
First, China took several measures to
tighten monetary policy, increasing
banks’ reserve requirements and shortterm interest rates to moderate demand
for credit and forestall a bubble in
Chinese real estate. Fears of further
tightening quickly weighed on global
stock markets.
Second, the phrase “sovereign debt
crisis” entered the popular lexicon
as Greece’s excessive government
debt and deficits confronted nervous
foreign investors, who own about 75%
of Greece’s debt, as did the need to
re-finance most of that debt in the next
few years. This made credit markets
decidedly uneasy and prompted a selloff in Greek bonds along with fears
of a contagion effect in other southern
European countries such as Portugal,
Spain and Italy. All this put pressure on
equity markets, which saw the S&P 500
Index and S&P/TSX Composite Index
retreat 8.13% and 7.19%, respectively,
from their January highs.
Investors quickly shook off these
concerns in February and were
heartened by strong Canadian and U.S.
GDP data, improving retail sales and the
fact that about 75% of S&P 500 Index
Q4 earnings exceeded expectations.
Equity markets resumed their recovery
and recorded a moderate advance in Q1.
This tempered pace is consistent with
our view that investors now have higher
expectations than was the case last year;
the period of P/E multiple expansion is
over and further advances in the equity
markets will be predicated on corporate
earnings growth and the sustainability of
the current economic recovery.
Rising Tide Now Lifting Most Boats
In our last column, we outlined how
the more volatile sectors of the stock
market, which were hardest hit in the
bear market, had led the market recovery
to date. At the same time, the more
defensive sectors that held up much
better in the downturn had lagged in the
market rebound. The outlook, we felt,
was for the laggards to start showing
better relative performance as part of a
rotation of market leadership.
Continued on Page 2
Market Outlook Summary Table
Area of Focus
Investment Question
Equity/Fixed Income Split
Are stocks or bonds more attractive?
Equities still hold greater potential than bonds, despite diminished
attractiveness. Our overweight position has been reduced, based
on a more cautious stance.
International Equity Split
Are Canadian, U.S. or International stocks
most attractive?
We expect returns among major regions will converge and are
maintaining our neutral geographic split.
Bond Split
Are investment grade Canadian corporate
bonds or government issues more attractive?
We continue to recommend an overweight in corporate bonds,
recognizing the degree of outperformance will be much more
currency exposure
Will foreign currency exposure add or detract
from total returns?
Prospects for further significant gains in our currency are limited
and should not detract from foreign diversification.
Market Outlook • Investment Strategy Quarterly • Spring 2010
Making Haste Slowly Continued from page 1
Q1 results support the view that the
suggested shift in leadership has begun.
Many of the defensive sub-indices, such
as Consumer Durables, Telecom and
Utilities in Canada, along with Staples
and Healthcare in the U.S. showed much
better relative performance in Q1 while
more volatile sub-indices like Energy and
Materials have come back to the pack
(see Table 1).
Table 1 - A Change in Leadership
Has Begun
Canadian Market Sectors
U.S. Market Sectors
*YTD is as at March 16, 2010
Source: Thomson Baseline
Much of the improved performance of
the above-mentioned defensive sectors
reflects their attractive valuations based
on P/E multiples, Price/Cash Flow
etc. At the same time, many investors
are searching for yield and companies
with relatively high, secure and
growing dividends hold great appeal.
As highlighted in our last issue, this is
particularly so given current bond yields
which are very low relative to dividend
Chart 2 illustrates an example pertinent
for many investors, the relationship of
Canadian banks’ dividend yields versus
the GOC (Government of Canada)
10-year bond yield. Historically, the
banks’ dividend yield has been well
below that of the GOC bond cited. Today,
notwithstanding the rally in bank shares
over the past year, their dividend yield is
high, by historical standards, relative to
the GOC bond yield.
Receiving tax-advantaged dividends
that are increased regularly, provide a
hedge against inflation and support rising
share prices hold great appeal for many
investors. This is particularly so when the
alternative is a relatively low stream of
interest, fully taxable as ordinary income,
which is static and offers no protection
from inflation. As a result, we fully expect
stocks displaying these traits to do well as
2010 unfolds.
Chart 2 - Big Five Banks Average Dividend
Yield vs. GOC 10-Year Bond Yield
Market Outlook
1. Equity/Fixed Income Split
We continue to have a positive view of
stocks’ prospects versus bonds though
we are cognizant of impending changes
to the financial landscape.
Viewed in relative terms, valuation
comparisons of bond and stock markets
remain supportive of equities. Chart 3
demonstrates that the S&P 500 remains
undervalued versus government bonds.
Chart 3 - Stock/Bond vs. Fed Model
Source: Ned Davis Research
As at March 12, 2010
In this environment, stocks historically
perform well. Viewed in absolute terms,
equity valuations can be characterized
as fair, with the S&P 500 continuing to
trade around 15 times forecast operating
earnings, in line with the historical
Credit markets continue to support
the equity markets as well. Chart 4
depicts the differential between longterm and short-term interest rates,
which has increased dramatically since
the credit crisis struck in mid-2007.
A yield curve with this steep a slope is
a positive indicator for both the stock
market and the economy. This picture
is about to change. Monetary policy
around the globe is beginning to shift
from extremely accommodative to
normal as illustrated by tightening in
China, India and Australia. We should
begin to see the same pattern in North
Chart 4 - Shape of the Canadian
Yield Curve
America in the second half of this year
as we have witnessed the bottom in
short-term interest rates for this cycle
with a flattening of the yield curve on
the horizon. This will not likely prove a
hurdle for the equity markets for some
time but we need to recognize that the
monetary policy tide is turning and will
not be as supportive as time goes on.
Continued on page 3
Market Outlook • Investment Strategy Quarterly • Spring 2010
Market Outlook Continued from page 2
Slow Moving Train
Looms Large
In financial market terms, a slowmoving train is a major, highlyvisible issue that moves forward
inexorably, with the power to
crush much in its path. Today,
sovereign debt fits that description.
Governments have incurred large
deficits as a result of stimulus
programs designed to pull their
economies out of recession. When
added to large, existing national
debts, the results are very high
Debt/GDP ratios (see Table 2).
Moreover, many government
deficits are structural in nature and
will prove difficult to eliminate or
sharply reduce. Failure to do so will
likely cause currency debasement,
while addressing the issue, though
ultimately beneficial, will inevitably
cause some dislocation and pain.
Sovereign debt is one of the key
issues of our time, which we are
monitoring closely for shifting asset
allocation implications.
Table 2 - Debt/GDP Ratios (%)
Source: IMF November 2009
Market sentiment, which was very
negative and counter-intuitively bullish
for the stock markets in the early stages
of the recovery, is now neutral and no
longer the positive factor it once was.
In a similar vein, liquidity, or cash on the
sidelines, remains significant but is not at
the very high levels seen only months ago.
In the U.S., money market fund (MMF)
assets have fallen about US$400 billion to
less than US$3.1 trillion in recent months
and Canadian MMF assets have also
declined sharply as investors have shifted
into longer-term funds in search of both
higher yields and total returns. Latent
buying power is therefore less than was
the case not long ago.
At the macro level, monetary policy
is still accommodative, as mentioned
above, as is fiscal policy. GDP data has
been on the high side of expectations
of late in both Canada and the U.S. and
leading economic indicators point toward
continued recovery, though at a slower
pace than evident in Q4 2009.
Chief economic concerns include global
fiscal imbalances highlighted above,
U.S. commercial real estate, which will
likely get worse before it gets better
plus U.S. housing, which has probably
bottomed but is still in the throes of
record foreclosures. We will therefore be
watching the employment data closely
in the months and quarters ahead in
order to gauge the ability of the private
sector (both consumers and businesses)
to sustain the cyclical recovery.
Overall, equities hold greater potential
than bonds though stocks’ relative
attractiveness has diminished as detailed
above. As a result, we are taking some
risk off the table by reducing our equity
overweight position, reflecting a more
cautious stance for the months ahead.
2. Canadian/U.S./
International Equity Split
Our position heading into 2010, outlined
in last quarter’s publication, was that the
strong relative performance exhibited by
Canadian and emerging market equities
in 2009 would moderate in 2010. This
led us to a neutral stance among the
three geographic regions. Thusfar in
2010, this is playing out as the advance
of the S&P/TSX Composite has
moderated, due in part to a slower ascent
in commodity prices (see Chart 5). At
the same time, most emerging markets
are flat to down, reflecting concerns
surrounding monetary tightening.
Chart 5 - Q1 Regional Market
Performance (in local dollar terms)
The weakest region year-to-date
has been continental Europe, where
sovereign debt concerns have weighed
on all equity markets. Meanwhile, the
U.S. has shown relative strength, due to
strong corporate earnings and continued
signs of economic recovery.
We expect returns among the major
regions will converge to some degree
and are maintaining our neutral
geographic split.
Continued on page 4
Market Outlook • Investment Strategy Quarterly • Spring 2010
Market Outlook Continued from page 3
3. Corporate/Government
Bond Split
Chart 6 illustrates the sharp drop in
corporate bond spreads that took place
in 2009, giving rise to exceptionally
strong corporate bond returns last year.
At current spreads, investment grade
corporate bonds provide a worthwhile
yield pickup versus government issues
but the potential for a further, significant
reduction in spreads is very limited.
Chart 6 - Canadian Investment Grade
Bonds Yield Spread Over
Government Bonds
TD Wealth Asset Allocation Committee:
The TD Wealth Asset Allocation Committee
was established to fulfill a vital role in
delivering a consistent asset allocation
message across TD Wealth Management. The
Committee is the originating source for active
asset allocation advice and guidance across
TD Wealth Management. In fulfilling this role, the
Committee has three prime objectives: articulate
broad market themes, provide macro-level asset
allocation and identify the major risks on the
The information contained herein is current as at
March 16, 2010.
The information contained herein has been provided
by TD Waterhouse and is for information purposes
only. The information has been drawn from sources
believed to be reliable. Where such statements are
based in whole or in part on information provided
by third parties, they are not guaranteed to be
accurate or complete. Graphs and charts are used for
illustrative purposes only and do not reflect future
values or future performance of any investment.
The information does not provide financial, legal,
tax or investment advice. Particular investment
or trading strategies should be evaluated relative
The higher coupons of corporate issues
also reduces their duration and interest
rate risk, a benefit for investors wary of
possible rising bond yields.
Chart 7 - Q1 US Dollar Performance vs.
CAD, EURO & Basket of Global Currencies
We recommend a continued overweight
in corporate bonds but recognize their
degree of out-performance will be much
more modest going forward.
4. Canadian/Foreign
Currency Exposure
In 2010 to date, the Canadian Dollar has
been inching closer to par with the USD,
even as the U.S. Dollar Index has risen
(see Chart 7). The ascent of the Loonie
has reflected climbing oil prices and
positive sentiment toward Canada due
to our relatively good fiscal situation.
Meanwhile, the USD’s advance has
been chiefly versus the Euro, which has
weakened in the face of the sovereign
debt crisis.
As stated in the past, we hold a positive
view toward both commodities and the
Canadian Dollar. That said, prospects for
further significant gains by our currency
are limited and should not detract from
foreign diversification.
Wealth Asset Allocation Committee
Bob Gorman, MBA, CFA, Vice President,
TD Waterhouse
R.B. Kenneth Miner, CFA, Vice Chair,
Fixed Income, TD Asset Management
Geoff Wilson, CFA, Managing Director,
TD Asset Management
Bruce Cooper, CFA, Vice Chair, Equities,
TD Asset Management
Deborah Leckman, MBA, CFA,
Senior Vice President, TD Waterhouse
to each individual’s objectives and risk tolerance.
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Les Grober, MA, CFA, Managing Director,
TD Asset Management
Anish Chopra, CA, CFA, Vice President &
Director, TD Asset Management
Glenn Davis, CFA, Managing Director,
TD Asset Management U.S.A
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