This month I’d like to present a letter from John Rovansek of Great-West Life:

Over the past few weeks, I sent out correspondence on a couple of themes. The first theme focused on building a case for considering, or re-considering, US investments and the second theme built a case for consideration in adding global fixed income exposure to client portfolios. Based on recent financial data, articles & interviews, I thought I would ponder the question – are we headed for another recession?

Since the end of May a number of headlines have made their way to the front pages of financial publications. One prominent headline on May 30 featured Mark Mobius, executive chairman of Templeton Asset Management’s emerging markets group. Mr. Mobius postulated that another financial crisis is inevitable because the causes of the previous one haven’t been resolved. His thesis focused on the derivatives market, and specifically, the effect the volume of derivative “bets”, in different directions, will have on volatility in the equity markets. He also cautioned that the largest US banks have grown larger since the financial crisis as has the number of “too big to fail”. If his prediction proves correct, the US taxpayer will once again be forced to protect those deemed “too big to fail”.

A second headline was the hawkish tone that Mark Carney, governor of the Bank of Canada, signaled when he delivered his May 31 speech to hold the line on interest rates. Mr. Carney pointed to continuing global threats & the dampening effect of the strong Canadian dollar on exports for keeping rates steady. He also indicated he is worried about a slowdown in spending by US consumers but also acknowledged inflation is hotter than was anticipated in Canada, and this could be interpreted as a sign the central bank will raise rates before the end of the year.

Do these headlines indicate we are headed for another global recession? I suggest we look to yield curves for guidance. Yield curves are leading indicators. Let’s examine the US yield curve to get sense if a return to recession is on the horizon in the US. Why? For several reasons. One, the US is the largest economy on the planet. Two, economic expansion has been increasing, albeit at a morbid pace. Three, the Federal Reserve has been steadfastly accommodating on its monetary policy.

With the Federal Reserve’s benchmark rate at zero to 0.25% & the 10-year Treasury note yielding approx. 3.06%, the spread between the two interest rates is among the widest in history. It’s when we see an inverted yield curve – short rates above long rates, that recession takes hold. The spread derives it predictive ability from the simple fact that one rate is artificially pegged by the central bank while the other is determined by the market. When the yield curve is steep, as it is now, it induces banks to expand their balance sheets – borrow short, lend long & increase the money supply. That US bank credit isn’t growing is more a reflection of the lessons learned during the period of excess leverage & in part to the new lending standards imposed by banks.

The time to worry about recession is when the Fed raises the funds rate to the point where the yield curve inverts. The yield curve is one of 10 components of the US Index of Leading Economic Indicators. Historically, the yield curve has been the first of the leading indicators to signal a turn in the business cycle. With the spread currently about 300 basis points & the Fed in no hurry to raise short-term rates, recession doesn’t appear to be on the horizon any time soon. In the recession that we just completed, the fed funds rate rose above the 10-year Treasury yield in June 2006. The US recession started on or about December 2007. Over the past seven expansions, they lasted, on average, 71 months. The current one is not quite 24 months old, and by some metrics, it has yet to get going. The US $15 trillion economy won’t, & doesn’t turn on a dime. While the possibility for a recession may still exits, the probability remains small. Things don’t change that quickly.

For the time being, being contrarian and looking at the aforementioned themes of US & global opportunities may prove to be correct after all.

If you would like to talk about John’s comments and how they might affect your investments, please give our office a call and make an appointment to speak with one of our financial advisors.

Hello,

I came across an interesting article (see link below) recently that discussed having “the talk” with aging parents. “The talk” refers to discussions with aging parents regarding health and financial matters facing them. For the older generation, this may be a difficult discussion for them to have, but with our population aging and the first “boomers” turning 65 this year, it may a discussion best had sooner, rather than later.

The author suggests 5 pointers that may help make these types of discussion a little less difficult. I won’t go into the details of each point since they are in the article, however a summary of the points discussed are:

1. Start early – use a 40/70 rule – when kids are approximately age 40 and parents age 70.
2. Be respectful – ask more probing questions to seek parents wishes & desires.
3. Ask for their feedback – update or amend your own will and ask your parents for their advice. Parents are natural advice givers and it may get the discussion going regarding their circumstances.
4. Keep having conversations – the more open ended and probing questions asked, the better the opportunity to find solutions.
5. Take the time – learn as much as possible, listen to what they want to have happen when they no longer can express their wishes.

Some of you may have already faced similar situations in regards to the health and financial well being of aging parents and as a result have already been in such discussions, while others may not. Some of you may have also had this same discussion with your own children regarding your future circumstances. Whatever the case, you can help guide and coach them on how to manage such a discussion.

Read the full article on Morningstar here.

Please take time to review the article and take the appropriate action as you see it fit your situation.

I do hope all is well and look forward to our next meeting.

Harvey

Photo credit: <<Hey, wait dad!>> by Tambako the Jaguar on Flickr

GLC Asset Management Group recently offered some comments on the Japanese earthquake and current market conditions. I’ve included some highlights below:

What We’ve Seen

As with most large scale natural disasters or major geopolitical shocks, capital markets are responding with a move to more defensive positions, selling off riskier assets. So far we have seen:

• A sharp sell-off in the Japanese stock market (Nikkei decline of over 15 per cent over past two days)
• A moderate pullback in global stock markets
• A shift toward “safe haven” assets
  • U.S. Treasury bond yields down (bond prices up)
  • Gold price up
• Commodity prices down
  • Oil off approximately $4 per barrel (but remains up so far this year)
• Stocks linked to property and casualty insurers, the Japanese capital markets and the nuclear industry (e.g. GE, uranium stocks) have been particularly hard hit as would be expected under the circumstances.

What We Expect – Economy

The Japanese economy will take a hit this year due to severe disruptions in supply and infrastructure, but is expected to rebound quickly as rebuilding activity and support by the Bank of Japan provide a boost to economic growth.

We expect the impact on the global economy will be modest. Japan represents approximately 8.7 per cent of global gross domestic product (GDP) as of 2010 (according to the International Monetary Fund (IMF)). While production and supply disruptions are likely to be felt globally, much of that production could be sourced elsewhere, especially due to excess capacity in North America. For example, even if the impact of the earthquake knocked 1.5 per cent off Japanese GDP (a significant amount), the effect on the global economy would be less than 0.2 per cent.

The key economic impact will likely be felt within specific sectors and industries, rather than at the global economic level. As with other times in which economies experience turmoil, this will hurt certain industries, while creating opportunities for others.

What We Expect – Capital Markets

If it’s one thing investors hate, it is uncertainty. As following almost all natural disasters, the effect on capital markets is usually short-lived. In this case, the disaster is still playing out, while investors were already feeling a bit unsettled by the situation in the Middle East and the emerging global economic recovery. Negative sentiment and investor concern might take a bit longer to ease.

In general, we expect to see the following:

• Commodities prices: While the demand for oil might be lower over the short term, potential supply risks in the Middle East have the opposite affect on oil prices. As reconstruction gets underway, we would expect an increase in demand for a wide range of raw materials.
• Stock markets: Much of the sell-off so far has been sentiment based, as opposed to reflecting the actual fundamental impact on the actual companies. As the unknowns reveal themselves investor sentiment will become more positive and we expect stock markets to regain strength. The Canadian stock market in particular should fare well, as it is not highly linked to the Japanese economy and we may see investors rotating out of their Japanese equity investment in favour of other jurisdictions, such as Canada and the U.S.
• Bond market: The bond market has been a beneficiary of the flight-to-safety trade so far. We expect yields to remain dampened from their pre-earthquake levels as there is likely to be some residual investor nervousness and expectations for a slight reduction in economic growth.

What Should I Do?

As long-term investors, your best bet is to stick with your long-term investment plan. No one knows how the situation in Japan will play out; however, situations like these are always a reminder to stay focused on your longterm investment goals. They also remind us of the importance of diversification. A well-diversified portfolio is unlikely to be heavily weighted in one or two industries and, therefore, diversification can provide the added benefit of softening the effects of short-term volatility and sharp market pull-backs. While the headlines are scary, the net impact on a well-diversified portfolio has been modest and within a couple of weeks, may even be long-erased as the markets turn their attention back to the broader global economic outlook.

For up-to-date information and resources related to the 2011 Japan Crisis, as well as donation options, Google has set up a page here: http://www.google.com/crisisresponse/japanquake2011.html