Many of you have no doubt seen the doom and gloom that is being professed on the evening news, newspapers and on the internet almost every day. The old adage is “bad news sells”, and boy, is it selling these days. So far, in 2011 the world stock markets have been volatile to say the least. With the Japanese earthquake, the debt crisis in Europe and the debt ceiling in the US, one would think the markets have plummeted this year according to the media. In fact, the S&P 500 is slightly up year to date and the TSX is down approximately 1%.
The objective of my blog today is to provide you with some facts around the situation in the US and in Europe. First, in the US the second round of quantitative easing (QE2 which is an increase in the money supply so public debt can be serviced by the government) ended at the end of June. The current debt ceiling in the US is $14.3 trillion. The US has reached this and requires this be raised on order to service upcoming maturing government bonds. The deadline to raise this ceiling is August 2. Currently, the US is in a presidential election cycle so there is a tremendous amount of political posturing going on between the Democrats and Republicans. Both are trying to increase their favor with the voting public. The Democrats are suggesting a combination of modest tax increases and cuts to government spending while the Republicans do not want to consider any tax increases. While both parties negotiate a deal, I am of the opinion there is very little chance that a compromise deal will not get done. The alternative to the US not increasing the debt ceiling is not in anyone’s best interest. If the world’s largest economy defaults on its debt this will result in a downgrade to their debt rating (the rating institutions have threatened this to hopefully motivate the decision makers) which will increase their cost of borrowing and reduce the value of all the US debt currently being held around the world – the largest holder being the Chinese.
The Republicans passed a motion through Congress that will most likely be defeated in the Senate and President Obama has promised a veto which called for a cut and cap in government spending. It would allow the debt ceiling to be raised by $2.4 trillion as long as Congress approves a balanced budget amendment to the Constitution. As recently as yesterday, a bi-partisan Senate proposal has been circulated with a $3.7 trillion debt reduction plan. At the end of the day a deal will be struck.
The US is currently attempting to grow themselves out of their deficit by keeping their dollar artificially low (helps manufacturers export their products) and keeping interest rates low so consumers can continue to service their debt and get their balance sheets in order as well as encourage spending with homes, etc. Once a new president is elected and during the first year of office in 2013, this will be the opportune time to begin increasing taxes – perhaps a Value Added Tax, etc as currently the political will is not there to increase taxes.
If we focus on some of the economic statistics that have come out over the recent weeks, it is clear that recovery continues albeit at a slow pace. In the second quarter the US experienced a normal mid-cycle slowdown. The balance sheets of the banks are in a lot better position than they were 2-3 years ago (same with corporations and individuals). The expectation for hiring is good and credit is available. Loan charge offs and delinquency rates are down indicating improved consumer health. The unemployment rate in the US continues to go down albeit at a slow pace. If we look back 50 years on previous recessions, employment has taken longer to improve in each successive recession due to technology and continued increase productivity. If we expand our view globally, we saw 4.3% in annualized GDP growth in the second quarter of 2011 (World Economic Outlook, April 2010).
THE EUROPEAN SITUATION
Now turning our attention to Greece. Early in 2010, Greece’s inability to service their debt became evident to the rest of the world and the threat of the country defaulting on their debt was a real possibility. Thanks to the intervention of the International Monetary Fund and the European Central Bank a “line of credit” was established called the European Financial Stability Facility. As long as countries introduce measures to address the public debt problems than this facility is available to them. Greece, Ireland and Portugal have already accessed this facility. What it does is allow these countries refinance their debt in controlled, transparent way. To put things in context, the PIIGS countries (Portugal, Ireland, Italy, Greece and Spain) represent only 4% of world GDP (International Monetary Fund Estimate 2010 and CIA Fact Book 2010) and so long as Germany and France remain strong economic powers (as they are today), the threat of one or more of these countries defaulting and pulling the world into a global recession is remote. The other positive point is that the EU has taken ownership over the issue and convened various meetings and summits (one this week) to ensure there is a clear consensus among all policy makers. European leaders negotiated a Greek aid package yesterday during an emergency summit in Brussels. Banks will voluntarily agree to write down the value of their Greek securities by 21% as part of a bond buyback and exchange program. Europe’s 90 biggest banks hold about 98 billion Euros of Greek debt. This package will require the banks to contribute 54 billion Euros. (Bloomberg)
The most recent source of market volatility was the passing of austerity measures in Greece to ensure they would receive funding from the IMF and European Union. While these measures were met with public protests and political brinksmanship, they were passed in the end. While this is the first on many measures, I am sure there will be protests again at a later date. A summary of the Greek austerity measures include:
Tax Increases
· Solidarity Levy – applied to all citizens – amount dependent on income
· Lower Income Tax Free Threshold
· Sales Tax – VAT increased from 13% to 23%
· Wealth Taxes – yachts, pools, property
Spending Cuts
· Public Sector Wages decreased by 15%
· Public Sector Wage Bill – cut 150,000 public sector jobs
· Social Benefits Reforms – raise retirement age to 65
· Spending Cuts
· Social Contribution – cut down on evasion
· Public Investment – decrease spending on infrastructure
Privatization of Government Companies
They say that the biggest issues contributing to Greece’s debt problems is corruption resulting in poor tax enforcement (it was estimated that around 25% taxes are not being paid in Greece), corruption does not go along with transparency. What is important to keep in mind that with both the situation in Europe and the US, is that all the information is known and priced into the markets. It is the unknown or unforeseen events that trigger short term market volatility. It is important to ensure your portfolio continues to remain well diversified and actively managed. As well, maintaining an asset mix that matches your time horizon, risk tolerance and stage of life.
Cheers,
Chris
Friday, July 22, 2011
Tuesday, March 15, 2011
Commentary on the Situation in Japan
The recent earthquake and subsequent tsunami in Japan has naturally caught the world’s attention. Our thoughts are with the people of Japan during this time of great human suffering.
One of our management teams, Signature Global Advisors, has provided me with their view on how this natural disaster will impact the Japanese economy. Below is a brief commentary from Drummond Brodeur, Portfolio Manager from our Signature team who specializes in Asian securities. Drummond also discusses their funds’ exposure to Japanese securities.
At this time, many uncertainties remain and the key risks of further aftershocks and nuclear accidents are impossible to quantify.
In terms of our portfolio exposure, all of our funds were significantly underweight in Japan compared to their respective benchmarks. Beyond our global and international funds, no fund has a direct exposure greater than 1%.
We do expect there to be several short-term implications as markets asses the scale of damage and policy responses. From a macro perspective, there will clearly be a near-term hit to Japan’s fledging economic recovery, as many factories and facilities close for varying lengths of time to asses and repair any damage. In the medium-term, there will be an offset as significant disaster recovery and infrastructure rebuilding commences. The earthquake and tsunami hit to the north of Tokyo while the core of Japan’s industrial heartland is to the south. Overall, most of Japan’s key global industries and international trade infrastructure remains operational. The region covered by the disaster is estimated to account for about 6% of Japan’s GDP.
The Japanese government will be required to fund significant rebuild programs and given their massive debt and deficit, how these get funded is unclear. Certainly, some will come from various reserves designed for such purposes, but it will also likely require additional borrowing, which could potentially be funded through further easing by the Bank of Japan (BOJ) or quantitative easing as the U.S. calls it. I have argued for many years that with structural deflation and a strong Yen, the BOJ should be printing more money regardless and such a tragedy may be a catalyst for more aggressive policy. While the Japanese government may have a massive debt, we cannot forget that Japan as a nation has massive net savings and continues to run a current account surplus, so policy options do exist. As for the currency, initial strength is expected as funds are repatriated by companies and financial institutions. Think of insurance companies facing significant claims needing to sell and repatriate some of their overseas holdings. By later in the year, I would expect any Yen strength to reverse as weaker economic numbers and low rates weigh on the currency, particularly if the U.S. recovery continues to gain traction. The ultimate pace and direction for the currency will be dependent on Japan’s policy decisions over the coming months, which we will continue to monitor.
One area of particular concern is the damage to nuclear facilities. While the extent of damage and radiation leakage remains unclear, at the very least, one and possibly two plants have been rendered permanently inoperable while several more have been shut down to asses any potential damage and will be offline for months. In the near-term, Japan will have to rely on a significant increase in gas, oil and coal fired power generation, thereby increasing demand for oil, gas and coal imports. One likely consequence of the unfolding nuclear plant accidents will also be an increased aversion globally to expanding nuclear power generation, particularly in the West.
Several refineries have also been closed, so we can expect a decline in crude imports and an increase in refined product demand, leading to an overall tightening in these markets. For the electronic components and auto industries, there will be some specific disruptions in supply chains, but for the most part, these industries are globally diversified and supply will be sourced from alternative sources and existing inventories, thereby also tightening up several of these markets as well.
We were lucky to have a very limited exposure to the areas directly impacted by this disaster. All of our portfolio managers and analysts continue to look into the potential implications in their sectors and holdings, and will interpret information as it becomes available. In short, the unpredictable nature of such events only underscores the need for well diversified portfolios, across regions, sectors and asset classes, where appropriate, such as those managed by the Signature Team.
Drummond Brodeur, Signature Global Advisors
One of our management teams, Signature Global Advisors, has provided me with their view on how this natural disaster will impact the Japanese economy. Below is a brief commentary from Drummond Brodeur, Portfolio Manager from our Signature team who specializes in Asian securities. Drummond also discusses their funds’ exposure to Japanese securities.
At this time, many uncertainties remain and the key risks of further aftershocks and nuclear accidents are impossible to quantify.
In terms of our portfolio exposure, all of our funds were significantly underweight in Japan compared to their respective benchmarks. Beyond our global and international funds, no fund has a direct exposure greater than 1%.
We do expect there to be several short-term implications as markets asses the scale of damage and policy responses. From a macro perspective, there will clearly be a near-term hit to Japan’s fledging economic recovery, as many factories and facilities close for varying lengths of time to asses and repair any damage. In the medium-term, there will be an offset as significant disaster recovery and infrastructure rebuilding commences. The earthquake and tsunami hit to the north of Tokyo while the core of Japan’s industrial heartland is to the south. Overall, most of Japan’s key global industries and international trade infrastructure remains operational. The region covered by the disaster is estimated to account for about 6% of Japan’s GDP.
The Japanese government will be required to fund significant rebuild programs and given their massive debt and deficit, how these get funded is unclear. Certainly, some will come from various reserves designed for such purposes, but it will also likely require additional borrowing, which could potentially be funded through further easing by the Bank of Japan (BOJ) or quantitative easing as the U.S. calls it. I have argued for many years that with structural deflation and a strong Yen, the BOJ should be printing more money regardless and such a tragedy may be a catalyst for more aggressive policy. While the Japanese government may have a massive debt, we cannot forget that Japan as a nation has massive net savings and continues to run a current account surplus, so policy options do exist. As for the currency, initial strength is expected as funds are repatriated by companies and financial institutions. Think of insurance companies facing significant claims needing to sell and repatriate some of their overseas holdings. By later in the year, I would expect any Yen strength to reverse as weaker economic numbers and low rates weigh on the currency, particularly if the U.S. recovery continues to gain traction. The ultimate pace and direction for the currency will be dependent on Japan’s policy decisions over the coming months, which we will continue to monitor.
One area of particular concern is the damage to nuclear facilities. While the extent of damage and radiation leakage remains unclear, at the very least, one and possibly two plants have been rendered permanently inoperable while several more have been shut down to asses any potential damage and will be offline for months. In the near-term, Japan will have to rely on a significant increase in gas, oil and coal fired power generation, thereby increasing demand for oil, gas and coal imports. One likely consequence of the unfolding nuclear plant accidents will also be an increased aversion globally to expanding nuclear power generation, particularly in the West.
Several refineries have also been closed, so we can expect a decline in crude imports and an increase in refined product demand, leading to an overall tightening in these markets. For the electronic components and auto industries, there will be some specific disruptions in supply chains, but for the most part, these industries are globally diversified and supply will be sourced from alternative sources and existing inventories, thereby also tightening up several of these markets as well.
We were lucky to have a very limited exposure to the areas directly impacted by this disaster. All of our portfolio managers and analysts continue to look into the potential implications in their sectors and holdings, and will interpret information as it becomes available. In short, the unpredictable nature of such events only underscores the need for well diversified portfolios, across regions, sectors and asset classes, where appropriate, such as those managed by the Signature Team.
Drummond Brodeur, Signature Global Advisors
Thursday, March 3, 2011
A Glass Half Full
Please see below some excerpts from a commentary on the situation in Europe by Richard J Wylie, Vice President Investment Strategy for Assante Wealth Management. In his comments he highlights the reforms that have taken place by the European Union to help Greece, Ireland, Portugal and Spain restructure their debt in an orderly manner.
Recent European history seems to be full of financial crises. In the fall of 2008, Iceland’s three major commercial banks collapsed, and that was followed by more turmoil on the continent. However, even though Europe has seen plenty of shocks, signs of improvement have appeared. As with most industrialized nations, the major European economies have found that global growth, driven by the developing world, has translated into stronger exports. In addition, the region-leading German economy has seen considerable improvement since the end of the recession.
Debt and deficit
Most of the headline-grabbing news in Europe has been with respect to what is now being called the “sovereign debt crisis.” As the original creation of the Eurozone raised the interconnectivity of those countries that use the euro, so too did it increase the risk of contagion spreading if financial problems were to emerge. Greece’s borrowing problems became a headline issue in early 2010. Worries quickly spread to include nations that would eventually be branded the “PIIGS” – Portugal, Ireland, Italy, Greece and Spain. After the introduction of the euro in Greece in 2001, the country was able to borrow at lower interest rates than had previously been possible under the nation’s former currency, the drachma. However, new
borrowing at lower interest rates was not used to retire higher interest rate debt: Greece’s overallindebtedness continued to climb, along with heavy social spending.
Debts and deficits among the so-called PIIGS were significant economic issues in 2010. The global financial crisis that began in 2008 and the subsequent widespread recession had a particularly large effect on Greece. Real gross domestic product (GDP) declined by 2.0% in 2009 and the International Monetary Fund expects the Greek economy will have contracted by an additional 4.0% during 2010. Eventually, government austerity measures and a European Union loan arrangement helped to restore some stability to the Greek government’s finances. Similarly, Ireland was on the receiving end of a €67.5 billion bailout later in 2010. As worries over the plight of Portugal arose in the wake of the Irish crisis, a framework for assisting member nations emerged. To shore up longer-term confidence in the euro, European Union finance ministers also agreed on a permanent mechanism that from 2013 onward would allow a country to restructure its debts once it has been deemed insolvent.
Currency implications
Interestingly, if the PIIGS were applying today to enter the Eurozone and use the euro as their common currency, they would not meet the Maastricht criteria, which are the requirements for membership:
1. The ratio of government deficit to GDP must not exceed 3% and the ratio of government debt to GDP must not exceed 60%.
2. There must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination, which does not exceed by more than one and a half percentage points that of the three best performing member states in terms of price stability.
3. There must be a long-term nominal interest rate which does not exceed by more than two percentage points that of the three best performing member states in terms of price stability.
4. The normal fluctuation margins provided for by the exchange-rate mechanism must be respected without severe tensions for at least the last two years before the examination.
Source: European Central Bank
However, today’s practical realities of maintaining the Eurozone have allowed for flexibility. Debt and deficit targets as opposed to unbending requirements have become part of the bailout packages. As well, because these nations are members of the Eurozone, they cannot unilaterally stimulate their respective economies with monetary policy. They are not free to independently pursue policies like lowering interest rates or using quantitative easing if they desire – options that are available to nations like Canada and the U.S., for example, which do not have linked currencies. Eurozone countries face the catch-22 of wanting to stimulate their economies but having to adopt austerity measures to qualify for the bailout packages.
Germany generates robust growth
While much recent market attention has been focused on the travails of the PIIGS, significant improvements have been seen in Europe, particularly in Germany. By the close of 2010, Germany recorded a new 18-year low in unemployment, declining to 6.8% – and itsemployment level exceeded the pre-recession peak. In line with the employment gains, wages and salaries rose 3.8% during 2010. However, consumption edged up only 0.5% over the year.
Despite the relatively soft growth in Germany's domestic spending, the economy recovered surprisingly quickly from the economic crisis, revealing some disparity between it and other European nations. German gross domestic product (GDP) advanced at roughly twice the pace of the Eurozone economy as a whole for 2010. In fact, Germany's overall economy grew at its strongest rate since the country's reunification in 1990. Significantly, trade was key to the nation’s improving circumstances. Exports in 2010 surged 14.2% in inflation-adjusted terms, while imports rose 13.0%. This followed on the heels of declines of 14.3% and 9.4%, respectively, in 2009. Not surprisingly, developing nations where economic growth has been strongest were providing growing demand for German exports. In particular, well-recognized luxury brands experienced strong export growth. Chinese demand for luxury autos has been especially robust. According to marketing research firm J.D. Power and Associates, China’s
luxury car segment expanded by more than 40% in 2010 and nine of the top-selling luxury models in China are German, led by Audi.
Elsewhere
While China is not the only destination for European exports, it does stand out as one of the fastest growing. Global management consulting firm Bain & Company estimated that the Chinese luxury market grew by more than 23% in 2010. As this suggests, one of the paradoxes of this communist country is that luxury exports from Europe are in very high demand. Italy’s Ferrari announced its 999th Chinese customer in January 2010, something that would have been impossible before China began its economic reformation. Also, retail outlets for other well-known European luxury goods providers, from clothing to jewelry, are becoming more commonplace within the country. The United Kingdom, France and the other nations that
export these goods will derive increasing benefit from this trend. Avoiding protectionism and fostering improved trade ties should eventually benefit all of Europe.
Conclusions
• The European sovereign debt issue will continue to take time to play out. Additional bailout funds and austerity measures may yet be required, but in the end the fiscal and monetary lessons learned will provide a firmer base for the region’s economic expansion.
• Germany stands as an example of how good economic and financial market news can be drowned out by other events within the region. Good prospects for continued expansion in trade will further bolster overall economic growth for Europe.
• Looking beyond the headlines for investment opportunities can bear fruit.
• Investors can capture opportunities if they use a disciplined approach, professional advice and welldiversified portfolios.
Recent European history seems to be full of financial crises. In the fall of 2008, Iceland’s three major commercial banks collapsed, and that was followed by more turmoil on the continent. However, even though Europe has seen plenty of shocks, signs of improvement have appeared. As with most industrialized nations, the major European economies have found that global growth, driven by the developing world, has translated into stronger exports. In addition, the region-leading German economy has seen considerable improvement since the end of the recession.
Debt and deficit
Most of the headline-grabbing news in Europe has been with respect to what is now being called the “sovereign debt crisis.” As the original creation of the Eurozone raised the interconnectivity of those countries that use the euro, so too did it increase the risk of contagion spreading if financial problems were to emerge. Greece’s borrowing problems became a headline issue in early 2010. Worries quickly spread to include nations that would eventually be branded the “PIIGS” – Portugal, Ireland, Italy, Greece and Spain. After the introduction of the euro in Greece in 2001, the country was able to borrow at lower interest rates than had previously been possible under the nation’s former currency, the drachma. However, new
borrowing at lower interest rates was not used to retire higher interest rate debt: Greece’s overallindebtedness continued to climb, along with heavy social spending.
Debts and deficits among the so-called PIIGS were significant economic issues in 2010. The global financial crisis that began in 2008 and the subsequent widespread recession had a particularly large effect on Greece. Real gross domestic product (GDP) declined by 2.0% in 2009 and the International Monetary Fund expects the Greek economy will have contracted by an additional 4.0% during 2010. Eventually, government austerity measures and a European Union loan arrangement helped to restore some stability to the Greek government’s finances. Similarly, Ireland was on the receiving end of a €67.5 billion bailout later in 2010. As worries over the plight of Portugal arose in the wake of the Irish crisis, a framework for assisting member nations emerged. To shore up longer-term confidence in the euro, European Union finance ministers also agreed on a permanent mechanism that from 2013 onward would allow a country to restructure its debts once it has been deemed insolvent.
Currency implications
Interestingly, if the PIIGS were applying today to enter the Eurozone and use the euro as their common currency, they would not meet the Maastricht criteria, which are the requirements for membership:
1. The ratio of government deficit to GDP must not exceed 3% and the ratio of government debt to GDP must not exceed 60%.
2. There must be a sustainable degree of price stability and an average inflation rate, observed over a period of one year before the examination, which does not exceed by more than one and a half percentage points that of the three best performing member states in terms of price stability.
3. There must be a long-term nominal interest rate which does not exceed by more than two percentage points that of the three best performing member states in terms of price stability.
4. The normal fluctuation margins provided for by the exchange-rate mechanism must be respected without severe tensions for at least the last two years before the examination.
Source: European Central Bank
However, today’s practical realities of maintaining the Eurozone have allowed for flexibility. Debt and deficit targets as opposed to unbending requirements have become part of the bailout packages. As well, because these nations are members of the Eurozone, they cannot unilaterally stimulate their respective economies with monetary policy. They are not free to independently pursue policies like lowering interest rates or using quantitative easing if they desire – options that are available to nations like Canada and the U.S., for example, which do not have linked currencies. Eurozone countries face the catch-22 of wanting to stimulate their economies but having to adopt austerity measures to qualify for the bailout packages.
Germany generates robust growth
While much recent market attention has been focused on the travails of the PIIGS, significant improvements have been seen in Europe, particularly in Germany. By the close of 2010, Germany recorded a new 18-year low in unemployment, declining to 6.8% – and itsemployment level exceeded the pre-recession peak. In line with the employment gains, wages and salaries rose 3.8% during 2010. However, consumption edged up only 0.5% over the year.
Despite the relatively soft growth in Germany's domestic spending, the economy recovered surprisingly quickly from the economic crisis, revealing some disparity between it and other European nations. German gross domestic product (GDP) advanced at roughly twice the pace of the Eurozone economy as a whole for 2010. In fact, Germany's overall economy grew at its strongest rate since the country's reunification in 1990. Significantly, trade was key to the nation’s improving circumstances. Exports in 2010 surged 14.2% in inflation-adjusted terms, while imports rose 13.0%. This followed on the heels of declines of 14.3% and 9.4%, respectively, in 2009. Not surprisingly, developing nations where economic growth has been strongest were providing growing demand for German exports. In particular, well-recognized luxury brands experienced strong export growth. Chinese demand for luxury autos has been especially robust. According to marketing research firm J.D. Power and Associates, China’s
luxury car segment expanded by more than 40% in 2010 and nine of the top-selling luxury models in China are German, led by Audi.
Elsewhere
While China is not the only destination for European exports, it does stand out as one of the fastest growing. Global management consulting firm Bain & Company estimated that the Chinese luxury market grew by more than 23% in 2010. As this suggests, one of the paradoxes of this communist country is that luxury exports from Europe are in very high demand. Italy’s Ferrari announced its 999th Chinese customer in January 2010, something that would have been impossible before China began its economic reformation. Also, retail outlets for other well-known European luxury goods providers, from clothing to jewelry, are becoming more commonplace within the country. The United Kingdom, France and the other nations that
export these goods will derive increasing benefit from this trend. Avoiding protectionism and fostering improved trade ties should eventually benefit all of Europe.
Conclusions
• The European sovereign debt issue will continue to take time to play out. Additional bailout funds and austerity measures may yet be required, but in the end the fiscal and monetary lessons learned will provide a firmer base for the region’s economic expansion.
• Germany stands as an example of how good economic and financial market news can be drowned out by other events within the region. Good prospects for continued expansion in trade will further bolster overall economic growth for Europe.
• Looking beyond the headlines for investment opportunities can bear fruit.
• Investors can capture opportunities if they use a disciplined approach, professional advice and welldiversified portfolios.
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