I am not a fan of sequels.  It seems to me that little new is added to our understanding of the main characters, and the plot outcome seems predictable from the start. Many observers say sequels are never as good as the original hit, the exception perhaps being Godfather II.

The volatility and pressure in world stock markets is regrettable. Risk has manifested in providing little if any return for the past decade. It seems to me that this current downturn has been triggered by the perception of a lack of effective leadership on the part of governments around the globe.

Of the three main players in the economy – individuals, corporations and governments – the investment markets are concerned primarily with corporations. At this point, North American corporations as a group are much better off – as measured by balance sheet financial strength – than previous median levels. Companies have less debt and more cash than we expect them to have. This is a good thing that should be a source of investor confidence. On the other hand, many of the world governments are bankrupt: Iceland, Greece and Ireland come to mind.

Investment markets are concerned with predicting the future. In the bond markets, payback (yield) for investing in 10 Year Government of Canada Bonds is about two and a half percent. The same is true of 10 year U.S. treasuries.  Investors buying these yields are willing to take a return, after inflation, of less than zero for 10 years. That number looks worse after taxes. It is worth noting that in the case of Canada and the U.S., investors in government debt appear unconcerned about default.

Individuals in North America have more debt than usual and the unemployment rate remains relatively high. The recent recession has been a difficult and persistent one for consumers.

The agreement to extend US Government debt was essential in that all financial interests were served and every investor would have experienced losses if it had not been confirmed. The US Government is too big to fail. Essentially, all countries in the G10 are too big to fail.

Sellers in the stock market will see much slower growth in the future. In terms of national accounts, aggregate demand is a function of buying power. The pessimistic view is that individual consumers and governments are tapped out. Companies who might otherwise be expanding are reluctant to do so if, in the future, there are fewer customers willing to buy their products. The thinking is that with fewer customers there is no growth. This is an important assumption that may prove to be incorrect.

In my view, predictions of future corporate earnings are a poor guide to investment decisions. This poor predictive power holds true for those that use so-called top down (aggregate economy based) analysis or bottom up (individual company) focus. Professional analyst predictions are frequently wrong and show little persistence when they do get it right. I think the balance of investment return for appropriate risk assumed will re-establish. Stocks will outperform bonds in the future, just as they have in the past. Good companies will innovate to find new customers and are already doing so.

We will re-balance our allocations once things settle down and we can confirm how this recent decline has impacted the plans for your portfolio. We re-balance when we have the evidence to do so and avoid the trap of attempting to generate investment returns by predicting short term outcomes.

Thank you for being our client and please pass this along to any friends or colleagues who could use a little reassurance and understanding.

Best Regards,

Patrick