Commentary Archive - 2008

2008 IN REVIEW

During 2008 the Toronto Stock Exchange depreciated in value 35%. The S&P 500 (top 500 companies in the United States) was down 38%, and the MSCI (World Index) was down 45%. Obviously, 2008 was a very, very challenging year in all regards for equity returns around the world. In fact many world stock exchanges fell by much more than Canada’s.

The bear market started in the U.S.A. in late 2007, but in Canada actually started in July of 2008. The reason is that the price of oil stayed up until the summer, therefore Canada, being primarily a resource-based economy, had its index levels (as well as our currency) remain at more buoyant levels as opposed to world markets. In fact, the TSX recorded an all-time high in mid-June of 2008. From its peak, the TSX declined by 49% to its late November bottom. This sudden devastating drop was certainly very, very painful for everybody. Fixed income investors were not immune – the values of bonds and debentures and preferred shares, regardless of credit rating, also dropped drastically due to the credit crisis.

The following chart provides an even longer view of how 2008 fits into history. The 2008 performance for the TSX (pictured here) was the worst since 1937, and in fact the Dow Jones Industrial Average return of a negative 34% was their third-worst ever (since 1895).

The fallout from the U.S. housing downturn, the global credit crisis, the lack of liquidity, panic in capital markets, and heightened systemic fear all led to massive government intervention, drastically lower central bank interest rates, and injection of public money into major companies, all of which continued in early 2009. The government action has been critical to help “heal the patient”. Fears shifted dramatically from inflation (remember the record price of oil of US$147.00 per barrel in the summer), to deflation. By the end of 2008, for example, crude oil dropped to $37.00 per barrel, surrendering four years’ worth of gains in just four months. That in and of itself was a major blow to Canadian markets.

The world economy had begun to soften in 2007. In 2008 the economy was weaker and signs of cracks were appearing. The world economy will continue to be very, very challenging in 2009 as the recession deepens. Retail sales, house prices, and many industries will suffer. Personal bankruptcies will escalate. Corporate bankruptcies will be announced, one example being Nortel, the darling of the dot.com craze just nine years ago.

What is Next?

The valuations of the TSX and the S&P 500 are at historic lows based on most valuation measurements. Scotia Capital’s Portfolio Strategist, Vincent Delisle (who presented a most valuable seminar to our clients in November 2008) believes that we are nearing the end of this bear market. He remarked that investors have only seen such an attractive, oversold, long-term entry point two other times in the past 80 years. His 2009 targets for the TSX and the S&P 500 represent one-year potential rates of return of 17% and 28% respectively. “We will look back at today’s valuations with nostalgia” Mr. Delisle says.

Has it been painful to watch the performance over the past year? Absolutely. Looking at generational lows of the markets, and price/earnings multiples now hovering below ten times (historically they are closer to fifteen times), the Kelland Group believes that the best way, currently, to invest in this market is to “Buy the Index”. Rob Kelland discussed this recommendation in more depth in his January 2009 Conference Call. Looking forward, we are convinced that the market is on sale. The environment is very, very challenging, but at the same time, as counter-intuitive as it may seem, we think it is a very good time to be investing, it is as simple as that.

As alluded to in our 2008 market commentary, the long-term stock market rates of return are still the best thing going. If you invested in the markets January 1, 1970, and just left your money alone, for 39 years until January 1, 2009, you would have averaged a rate of return of 9%. But, you would have had to endure seven down periods (in varying lengths of time) where your capital would have eroded, on average, 30% each time. Over an even longer period of time, since January 1, 1950, Canadian stocks averaged – to June 2008 - an annual return, through thick and thin, of 10.8%. During that period, inflation averaged 3.9%. So Canadian stocks, over 58 years, provided a “real” rate of return of almost 7%, higher than any other asset class.

The key lesson, as hard to learn as it is, emotionally, is that “it is time in the market, not market-timing” that matters the most. Rob expands on this thesis in his Conference Call. After every downturn, markets have rebounded to new highs. We believe that will continue.

We want to assure all our readers that we care. Our team cares. We feel your pain, and we understand it. We are committed to helping you meet your financial goals and objectives over the long term.

Sources: Scotia Capital, Fidelity Investments

Third Quarter 2008

The status of the Toronto Stock Exchange (TSX) as one of the few markets in the world with a positive performance in 2008 not only was forfeited during the summer months – it was shattered. With the downturn of global economies, the sharp decline in commodity prices and – most notably – the historic collapse of major financial institutions in the United States and Europe, the TSX – like other world markets – suffered a freefall from its heady 15,000 level in the spring to a depressing 9,000 in early October. The TSX Energy sector is down 55% from its peak. Bond markets were also devastated by the worldwide credit crisis resulting from the toxic mortgage-related assets and the massive de-leveraging of corporate balance sheets. In simplest terms, the world's banking systems are not functioning properly.

THESE ARE NOT NORMAL MARKETS. Investor confidence is at 1973 levels. Investors have built up cash reserves never seen before. While governments install various remedial plans to deal with the credit crisis, it will take time for confidence to be restored in the world's financial systems. This global financial crisis will not be fixed overnight. The economic downturn will not be reversed until 2009 at the earliest.

A broad review of our clients' accounts reveals two things: YES, we are ALL significantly affected by the market downturn; but NO, our accounts are NOT lower by the 40% drop in the TSX. The current environment is not pleasant for anyone. When confidence is restored, and investable cash begins to move again, the financial markets will lead - not follow - the economic news of recovery.

A VERY MEANINGFUL PERSPECTIVE

We are not speculators. We are long-term, patient and service-oriented advisors. We do not chase the hot stock or the most popular sector. We strongly believe that investments in high quality companies will reward our clients who stick with it in the longer term picture. It is absolutely true that we have to endure the bad times in order to experience the good times, with our philosophy.

In this regard, we want to ask a question of all our readers. If you are investing for long-term results (including interest and dividends along the way) WOULD YOU BE SATISFIED IF ONE DOLLAR that you invested in year one GREW TO $38 DOLLARS in year 38? Such performance is exactly the total return provided by the Toronto Stock Exchange from January 1970 to September 2008 (an annualized rate of return of 9.9%).

In order to achieve this exceptionally strong rate of return you would have had to STICK WITH the market through bad times as well as good. In those 38 years the TSX experienced seven periods with negative returns worse than 20% (this includes the present downturn in 2008). Some of these downturns were short in duration, some were longer. Some were suddenly negative, others developed over a number of months.

The previous six downturns lasted an AVERAGE OF TEN MONTHS with an AVERAGE NEGATIVE RETURN in those periods of negative 31% - a loss (on paper) of almost ONE-THIRD the market value invested. Would you be willing to stomach such wrenching downturns in order to accomplish a very strong long-term rate of return? In a nutshell, that is the question we are all asking ourselves at the present time. This historical analysis represents, in a broad sense, the SHORT TERM PAIN FOR THE LONG-TERM GAIN that we all must deal with if we invest for long-term growth using stock investments as a significant component of that growth.

ARE WE AT THE BOTTOM? We do not know. In reality we will never know this except with the benefit of hindsight. Wherever we are in these gut-wrenching times, all of us at the Kelland Group are here to help you through this very tough time and all of us are working very hard with the welfare of each of our clients in mind, every day.

Sources: Scotia Capital, Fidelity Investments

Second Quarter 2008

As the proverb says, just when you think you may be escaping the jaws of a lunging lion, you run into the arms of a pursuing bear! Just when the markets breathed a little easier in April and May, uneasiness and anxiousness and instability returned in June. The World Markets Index (MSCI) recorded its worst start to a year since 1982, a –12% (Cdn. $) negative return. The combination of both fear of inflation (triggered primarily by the high price of fuel) and prolonged weakness in the United States and global economies prompted renewed market concerns.

Inflation is rising in much of the world – at much higher rates than in Canada. Record crude oil prices have more than doubled in the past twelve months. The ripple effect of the damage already done by both fuel costs and the U.S. housing crisis will translate into economic shakiness for the balance of 2008 and potentially into 2009.

For the first half of 2008, the TSX is one of the very few major stock markets in the world with a positive return. It is important, however, not to become complacent or misled by the overall TSX index. The United States housing crisis is still with us. American and global markets are still very weak – the major U.S. and global indexes are down 14%-15% in the past twelve months. American markets experienced their worst month of June since 1930. Furthermore, the TSX index is dominated by a handful of stocks, mostly in the energy sector. On closer examination, Canadian investors are still impacted by market weakness as 75% of the TSX listed stocks have declined by 10% or more in the past twelve months. Ten stocks account for ALL of the 2008 gain to date. 140 of 260 stocks declined in the first six months of 2008.

All of this is to reiterate to our clients that it has been, and will continue to be, a very tough year for all investors. We do not manage accounts “to swing for the fences” - had we, for example, allocated substantial dollars to the hot Chinese and Asian markets at the end of 2007, clients would have seen this aggression fall flat on its face. Asian markets had the worst first-half performance in 16 years. We are finding some excellent value “Buys” in this market. Time, diversification and patience are your strongest assets. Stick to your plan in these very difficult markets.

Source: Scotia Capital

First Quarter 2008

The first quarter of 2008 further intensified the downturn of global markets experienced last year. 2007 turned out to be a very difficult year for investors globally. The first half of 2007 was positive, followed by some dark clouds in the summer, and poor markets, which remained throughout the end of 2007. Although the Toronto Stock Exchange (S&P/TSX) showed a modest 7% rise for the year, this positive return was very misleading. Three-quarters of this return could be attributed to just three stocks. A very weak U.S. dollar, rising commodity prices, an economic slowdown and very soft real estate markets in the United States, and the fallout from the sub-prime mortgage defaults that severely damaged liquidity in financial markets around the world, shook confidence in all markets over the last half of 2007 and into 2008.

The 2007 financial markets exhibited the highest level of volatility in recent years. Please refer to our January 2008 Investment News for more detailed analysis of last year’s turbulent markets, which brought into focus our concern, voiced early in 2007, as to whether the longest Bull Run in 50 years could be sustained (see below). This volatility was even more gut-wrenching in early 2008.

The Kelland Group’s view, looking further into 2008, continues to be one of caution. One of the lingering problems is the massive personal and government debt in the U.S., magnified by the sub-prime mortgage and credit liquidity issues. We do not have to understand the “nuts and bolts” of these problems to appreciate that Canada would be hard pressed not to feel the pain of a significant economic slowdown in the U.S., our largest trading partner. Other global economies are likely to feel the pain as well – we do not subscribe to the “decoupling theme” that maintains that emerging world economies can escape the consequences of a U.S. slowdown. Remember that economic data measures the past. The markets look to the present, and more so, to the future.

Equity and bond markets are “leading indicators” of the economy, and that is why our view is not more negative. We feel that some of the negative news is already priced into the markets. With a tired American consumer (which normally “drives” the U.S. economy and indeed represents 18% of the world’s economic output), it remains our advice to invest in only high quality securities, and in a diversified manner, and in keeping with clients’ individual comfort zones for risk.

Even the slightest bit of bad news can rock the markets on a daily basis. The market doldrums are not likely to subside until we see some relief from the global “credit crunch” issues. Although financial stocks have felt the impact of the credit crisis most severely, the Canadian market heading into the second quarter has seen some relief in the overall Toronto index with the strong performance of commodity-related stocks, as the industrialized and developing world continues to require the raw materials that Canada produces, and the weak U.S. dollar has contributed pricing power for these commodities worldwide.

We believe the long-term investment climate ultimately will turn around. However, it will take time (perhaps up to 18 months) to work through these turbulent issues. It is our job as investment advisors to look through today’s dismal weather to the longer-term outlook. As we progress through 2008, our view is cautious, but pragmatically optimistic. We will invest in good companies we deem undervalued as compared with long-term expectations. Market prices today are, for the most part, reasonable. We can buy good companies at attractive prices for good potential long-term growth. But patience and persistence is required. As recommended to all our clients in January 2008: Stay the course - stick with your long-term plan.

Commentary Archive - 2007

Current Bull Run - The Longest in Half a Century! But, Is It Over?

October 31, 2007

Subsequent to the events of September 11, 2001 and the mild economic recession in 2002, global equity markets in general, and the Toronto Stock Exchange in particular, have enjoyed a phenomenal "Bull Run". As pictured in the chart below, the rising TSX bull market of the past 60 months is approaching a duration almost twice that of the average bull of 32 months. The peak, at the 57 month mark, was reached in July. This cycle is now the longest running bull since the mid-1950's. The rise of the index of about 150% was the second strongest in fifty years, and approached the strongest bull run made 30 years ago in the late 1970s. [Note: To open a new window with a larger version of the chart, click here.]

What does this tell us? As advisors who attempt to manage risk as well as performance, we are cautious. Yes, interest rates are still low. Yes, the Canadian economy is still strong. Yes, there is still considerable interest in Canadian stocks. (In fact, takeover spikes have accounted for about 40% of the rise of the TSX so far in 2007. Canadian corporate takeover announcements in the first half of 2007 represented 10% of global takeover offers in that time period).

The summer of 2007, however, is a strong reminder that bulls do not run forever and that strong markets inevitably suffer setbacks. The recent volatility is indication the bull may be on its last legs.

We are not "market timers". We cannot predict highs and lows any better than anyone else. Simply stated, history is the best teacher. Setbacks do and will occur. We have experienced them in the past, and will do so again. Our patient and value-based approach has served our clients well in both strong and weak market environments. Both hands are on the wheel.

Source: Scotia Capital