Monthly Archives: July 2011

Anthony Sabti

U.S. Debt Ceiling Update

The Republican-led House of Representatives and Democratic-led Senate went ahead Friday with separate measures to avoid a U.S. default on August 3rd.  The two parties are currently involved in a political standoff on how to resolve the U.S. debt situation. 

John Boehner, the top Republican in the House of Representatives, reworked his proposal to cut spending and raise the government’s borrowing authority after opposition from his party’s conservative members forced him to postpone votes twice in two previous days.  The conservatives wanted a balanced-budget amendment to the Constitution, and it was added to Mr. Boehner’s bill.

Mr. Boehner’s bill calls for a $900-billion increase in borrowing authority, which is required for the U.S. to keep paying all its bills after next Tuesday, and $917-billion in spending cuts.

At the same time, Democratic Senate Majority Leader Harry Reid worked on an alternative bill to cut spending by $2.2-trillion and raise the debt limit by $2.7-trillion. That would be enough to meet President Obama’s terms that it tides the Treasury over until 2013.

Boehner planned to try for another vote late Friday. Even if it passes, it likely won’t pass in the Senate. Reid signaled he would push ahead with his own plan, but that has little chance of passing in the House.  However, the bills could provide the grounds for behind-the-scenes talks by congressional leaders which hopefully lead to a compromise that could win approval in both chambers before Tuesday’s deadline.

President Obama cited the potential effects on the economy as he urged lawmakers to find a way out of gridlock.  He said that for all the partisanship, the two sides were not that far apart. Both parties agree on initial spending cuts to take effect in exchange for an increase in the debt limit, he said, as well as on a way to consider additional reductions in government benefit programs in the coming months.

According to the U.S. Treasury, the American government will run out of money on August 3rd and will then have to cut government spending, sell government assets, or default (miss coupon payments on U.S. Treasuries).  The possible outcomes to the U.S. debt situation are: the debt ceiling is extended immediately, the debt ceiling is not extended immediately, or a U.S. default. Most analysts are saying that a default is the worst case scenario and that a deal to increase the debt ceiling will be struck, likely at the eleventh hour.

Please read Odette’s brief below for more information regarding this story and it’s possible impact to your portfolios. 

Market Wrap-up (July 29, 2011)

The TSX closed at 12946, down -4.07% over the past week.
The DOW closed at 12143, down -4.24% over the past week.
The S&P closed at 1292, down -3.94% over the past week.
The Nasdaq closed at 2756, down -3.60% over the past week.
Gold closed at 1625, up 1.37% over the past week.
Oil closed at 95.92, down -3.80% over the past week.
The CAD/USD closed at 1.0464, down -0.83% over the past week.

Odette Morin

Will the US default on their debt? and How will this affect my investments?

“I just received my statement. What is happening with my investments Odette? I thought we were on the path to recovery?”
This is a typical question I get these days.  So I thought I would brief you again on the recent developments. 

The President and the U.S. Congress are working to reach a deal to raise the U.S. debt limit by August 2nd. The government budget is made up of spending and revenues, and if revenues fall short of spending we have a deficit. The national debt is the total of past deficits.  Normally, the debt ceiling is raised as a matter of course.  During the past administration congress voted for debt ceiling increases totaling more than $5.3 trillion.   Today, there is a political battle; that’s politics.

Let’s assume that the U.S. did default on its debt; what then?  (But we strongly believe that an agreement will be reached before this outcome). A worst-case scenario would have U.S. Treasury yields rising (the U.S. would have to pay more to borrow) significantly, bringing interest rates up alongside, representing a tightening of financial conditions in less-than-perfect economic times. The U.S. dollar would likely drop, as would stocks.    

But there is also a lesser held view that markets may not move as dramatically as many are assuming. In fact, it’s supported by the so-far benign moves by both stocks and Treasury bonds as we’ve approached the deadline. The deadline is approaching but there is no sense of panic.  Demand for U.S. Treasury securities has remained strong throughout the debt-ceiling debate and stocks have been volatile, but not excessively weak. This suggests investors don’t believe there will be a default and/or that Treasury prices are already reflecting the global concern.  A default (particularly if it was short-lived) could cause the stock market to fall to the lower end of the trading range it’s been in for more than a year, but may also provide some support for stocks if it triggers more meaningful negotiations and ultimately a bigger deal on debt/deficit reduction.

What does history tell us about defaults?  We don’t really have much history to go on to gauge market reaction except for other countries that have lost AAA ratings. S&P downgraded several European countries (Belgium, Ireland, Italy, Portugal and Spain) from AAA in May 1998. Then, a week later, 10-year bond yields for those countries were only slightly higher; a month later they were actually slightly lower; and a year later they were nearly 1% lower. Japan lost its AAA rating in February 2001. A week later its 10-year bond yield was flat; more than 0.3% lower a month later and only slightly higher after a year. The most recent US government shutdown was from December 13, 1995 to January 6, 1996. The Dow Jones Industrial Average actually rose about 2% during that period.

What to do?  We’ve heard a lot of questions about what investors should do in their portfolios to account for the risk of a default. We continue to preach the benefits of diversification among and within asset classes, both domestic and international.  Even if you did put all your cash under your mattress,  you would have problems if inflation accelerated, not to mention the lost opportunity cost in the event of a substantial relief rally in stocks and bonds. Finally, another reason for hope beyond the debt-ceiling debate comes from corporate earnings. We’re still early in the reporting season for second-quarter earnings, but so far about 75% of companies have beaten expectations, which is historically high. The positive reports have been across a broad range of industries and sectors and earnings are on track to surpass their 2007 peak. 

I know, it’s frustrating to see your account go down. We can make any changes you want but that would be a mistake to react. Our  best advice is to stay put, collect the dividends and interest coupon  you earn on your portfolio and ride the psychology driven markets up and down. In the end, the companies’  ability to grow revenue is what matters and eventually , market valuation  will pick up again. 


Odette Morin

Mid-cycle slowdown or double dip recession

The Global economy is currently experiencing a slowdown caused by a number of factors. There is a lot of doom and gloom talk out there, fear and uncertainties. We believe that this downturn is temporary and the recovery will pick up again in the later part of this year.  Here are a few reasons we stay optimistic in the midst of so much negative talk.
The current economic environment looks a lot more like a mid-cycle slowdown than a pre double dip recession.  Typical indicators preceding recessions are not currently showing. 
Here are 4 great predicators of recessions.  These leading indicators accurately predicted past recessions.
  1. Yield curve: This is the ratio between the 10 year versus 3 month treasury bond rate.  It is currently at 2.9%. The average is 1.45% and 6 months before a recession it is inverted or negative at about -.8%.  So, this leading indicator is not pointing to a recession at all.
  2. Real Rate:  This is the ratio between the 3 month saving rate versus Inflation (CPI) which shows whether the saving rate is greater than inflation.  Currently it is at -1.3%.  The average is +1.3% and 6 month before a recession it is at +2.5%.  Therefore, this indicator too does not point to an approaching recession.
  3. Excess inventory: Currently, inventory level are very low at -14%.  The average is zero and 6 month prior to a recession it is at about +3%. So, this indicator would actually point to a bullish scenario.
  4. US composite leading indicator is currently at +3.5%.  The average is at about 1.3% and 6 months prior a recession at -1.2%.
Of course, these can change but it is fair to state that we do  not have evidence of a near recession at all.  These indicators point to a recovery. Having said that, it appears that we are currently in a mid-cycle slowdown.  It actually looks a lot like in the late 70s and 80s immediately preceding the incredible market recovery from 85 to 1991.
Please bear in mind that:
  • the average recovery lasts 32 quarters or about 8 years.  We are only 6 quarters in this recovery.
  • it is the price multiple growth rate of a stock that is the best indicator of its value not its P/E ratio.  The multiple growth currently is very attractive.
  • the valuations are incredibly cheap now after the past 2 months pull back.
  • Typically, equity move sideways from May to September.
Having said this, we can’t ignore the following facts:
  • the Sovereign debt crisis is an issue in Europe over the mid-term
  • China’s high inflation and rise in interest rates to control it is a smart move but will temper demand, especially for commodities which will affect Canada greatly in the short-term
  • the US economy, heavily dependant on consumer spending, will continue to experience slower growth due to a shift from spending to saving until home equity is restored which will take time.
  • this major events will affect markets in the short-term to the mid-term.  Long-term trends point to growth from the expansion of Emerging Markets. 
This is why, portfolio management is so important.  Picking managers who can successfully manage defensively and preserve capital through turbulent times as well as position the portfolio to capture growth trends is key.  Please keep in mind also that to benefit and hedge your profits you can take advantage of these types of low point we are going this summer and periodically, by making an investment if you can. 
“The most common cause of low prices is pessimism – some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.” ~ Warren Buffet
Never hesitate to contact Terry, Anthony or myself if any questions or concerns about your portfolio or your plan.