The following report includes data and summarized forecasts prepared by TD Economics and RBC Global Asset Management. While based on real economic indicators, forecasts are opinions and of course, cannot be guaranteed. Please also find attached to this email a copy of the Redwood Capital Investment Policy. The attached policy reflects recommended asset allocations for summer 2010.
Economic Overview
Recent credit events in Europe and worries about growth in China have surfaced as significant headwinds against global economic growth. The period of sharp recovery is indeed over. Governments’ decision to focus on deficit reduction and reduce stimulus spending will slow economies, which in some regions, are showing signs of strong market growth. Also disrupting market prices is erratic investor behaviour. After a deep recession, it is easy for investors to focus on things that can derail a recovery. The experience of the credit crisis has conditioned some to head for the exits at the first sign of trouble and ask questions later. This behaviour will continue to be a factor and we should expect continued volatility in capital markets.
Despite the many questions surrounding the global economy, general economic consensus suggests the odds of a double dip recession are low and that we are in a period of sustainable, although subdued, growth. Continued low interest rates, low energy prices, strong profit growth and low stock prices have led us to continue to be slightly overweight in equities compared to historical benchmarks (see attached investment policy). I will outline some of the factors that led to this decision below.
Strong profits
o Many companies in North America and abroad responded to what they believed to be the next great depression with deep cost cuts (evident in decreases in full time employees for example). Small increases in revenues have led to larger than expected profits because of lingering effects of the cost cuts.
Low asset prices
o Across major economies, equities are priced at some of the most conservative levels in the post war era. For example, despite large gains in 2009 and early 2010 the S&P500 index is priced at 36% below the 1 year forward fair value estimate. In Canada, the TSX is much more fairly valued yet still historically a good buy.
Regional Summary
The suggested allocation split between Canadian and Foreign equities has not changed significantly from the last quarter. Our regional investment policy is that effective diversification within each region and across regions should prove to reduce country specific risk. For example, the meltdown of the Greek economy and subsequent devaluation of the Euro has buoyed Germany’s export weighted economy and increased value in German Companies. All of our equity portfolios are, however, overweight in Canadian Equities so special mention needs to be given to the state of the Canadian market.
The Canadian economy has been among one of the strongest performers in the world over the last 3 quarters. Domestic spending has helped this growth and unfortunately it has come at the cost of increased household debt. While our neighbours to the south have been reducing average household debt, Canadians, over the last 6 months have been spending. Many believe households have been both taking advantage of low interest rates and trying to beat the July 1 HST for large ticket items. As rates very slowly increase and HST passes in, Canadians will begin saving again and domestic spending will decrease. Canadian stocks, although expensive compared to foreign equivalents are below the midpoint of fair value estimates. Current fair value range estimates for the TSX Composite are from 10789-16085.
Summary
Global markets lie in a period of subdued growth that will be potholed by dips caused by nervous investors.
Suggested asset allocations have been modified to reflect current economic position and forecasts.
As always, our best tool and our strength at Redwood is to work with clients to ensure they understand all of the risks they will face as investors and to appropriately judge their risk tolerance, and capacity. Given that, we will choose an investment asset allocation that is properly adjusted for economic conditions and create a diversified portfolio.
Summer 2010 Semi-annual Economic report and forecast
Economic Overview
Recent credit events in Europe and worries about growth in China have surfaced as significant headwinds against global economic growth. The period of sharp recovery is indeed over. Governments’ decision to focus on deficit reduction and reduce stimulus spending will slow economies, which in some regions, are showing signs of strong market growth. Also disrupting market prices is erratic investor behaviour. After a deep recession, it is easy for investors to focus on things that can derail a recovery. The experience of the credit crisis has conditioned some to head for the exits at the first sign of trouble and ask questions later. This behaviour will continue to be a factor and we should expect continued volatility in capital markets.
Despite the many questions surrounding the global economy, general economic consensus suggests the odds of a double dip recession are low and that we are in a period of sustainable, although subdued, growth. Continued low interest rates, low energy prices, strong profit growth and low stock prices have led us to continue to be slightly overweight in equities compared to historical benchmarks (see attached investment policy). I will outline some of the factors that led to this decision below.
o Many companies in North America and abroad responded to what they believed to be the next great depression with deep cost cuts (evident in decreases in full time employees for example). Small increases in revenues have led to larger than expected profits because of lingering effects of the cost cuts.
o Across major economies, equities are priced at some of the most conservative levels in the post war era. For example, despite large gains in 2009 and early 2010 the S&P500 index is priced at 36% below the 1 year forward fair value estimate. In Canada, the TSX is much more fairly valued yet still historically a good buy.
Regional Summary
The suggested allocation split between Canadian and Foreign equities has not changed significantly from the last quarter. Our regional investment policy is that effective diversification within each region and across regions should prove to reduce country specific risk. For example, the meltdown of the Greek economy and subsequent devaluation of the Euro has buoyed Germany’s export weighted economy and increased value in German Companies. All of our equity portfolios are, however, overweight in Canadian Equities so special mention needs to be given to the state of the Canadian market.
The Canadian economy has been among one of the strongest performers in the world over the last 3 quarters. Domestic spending has helped this growth and unfortunately it has come at the cost of increased household debt. While our neighbours to the south have been reducing average household debt, Canadians, over the last 6 months have been spending. Many believe households have been both taking advantage of low interest rates and trying to beat the July 1 HST for large ticket items. As rates very slowly increase and HST passes in, Canadians will begin saving again and domestic spending will decrease. Canadian stocks, although expensive compared to foreign equivalents are below the midpoint of fair value estimates. Current fair value range estimates for the TSX Composite are from 10789-16085.
Summary