Our Library

The world economy is stuck in between a recession that is over and a sustained recovery that has yet to arrive. September 7th, 2010 By Kim Mailey, CFP

Send to a Friend Back to Our Library

September Market Commentary

The world economy is stuck in between a recession that is over and a sustained recovery that has yet to arrive. This naturally leads to frustration and worries about whether progress is truly being made. This also helps to explain why the markets have moved a lot this year, but have gone nowhere! The first quarter saw the TSX go up 2.5%, followed by a 6.2% decline in the second quarter, but yet another reversal resulting in a gain so far in the third quarter of nearly 7%.

While I am the first to agree that past performance does not guarantee future results, I do believe that history can help us understand what is "normal". The 2008/2009 financial melt down was not part of a normal economic cycle or "traditional recession". I will use the term that the International Monetary Fund (IMF) used in its 2009 report – "a deep, widespread financial crisis - a synchronous financial crisis (SFC)".

The table below shows the IMF’s comparison of previous SFCs to the 2008/2009 crisis:

	Average of previous SFC downturns	2008 / 2009 crisis
Length of GDP contraction	7 quarters	6 quarters
Peak-to-trough decline in real GDP	4.8% contraction	4.1% contraction
Increase in GDP in first year of recovery	2.8% increase	2.8% increase
Length of time for GDP to return to Pre-recession levels	7 quarters	? (see below)

The US economy is currently in its 5th quarter of the recovery cycle and GDP is 1.3% below the peak level. To match the historical experience, the economy will need to experience an average annualized growth rate of 1.5% - which is thought to be quite achievable.

The US is currently tracking the traditional post SFC experience. None of the countries in the IMF study experienced deflation or a double dip recession, nor is it expected this time.

A recession (defined as two or more consecutive quarters of a declining GDP) can’t be entirely ruled out given the fragility of the world economy. Speculation about double dips and deflation can become a self-fulfilling prophecy if it becomes too intense.

US data released last week pointed to some improvement in private sector employment, manufacturing, retail sales, and existing home sales. The bond market is also telling an interesting story in that the difference between short term and longer-term bond yields has increased. A "steepening" of the yield curve is generally a sign that the economy will improve.

As I have mentioned in previous commentaries, many corporate balance sheets are flush with cash and just need the confidence to start spending to grow their businesses instead of defensively hoarding their cash. President Obama’s recent announcement to allow corporations to write off all new investments in plant and equipment through 2011 may provide the impetus to loosen the purse strings and spark economic growth.

I continue to expect lower than historical returns for all asset classes over the next year or two, with expected returns for equities of 5% to 7% and bond returns of 3% to 5%. Within the equity component of taxable accounts, exposure to companies with sustainable (and growing) dividends and strong balance sheets is recommended. A hub and spoke strategy where the growth portion of the portfolio is primarily invested in a globally diversified and actively managed pension portfolio, such as Pinnacle and Russell, but a portion of the portfolio is invested in individual securities with attractive dividends (and the accompanying dividend tax credit) can be considered.

Examples of high quality Canadian equities with attractive dividend yields that could be considered for the "spoke" in this strategy are:

	Sector	Target 1 Yr. Rate of Return	Current Dividend Yield
National Bank	Financials	26.6%	3.95%
TD Bank	Financials	24.3%	3.28%
Crescent Point Energy	Energy	37.1%	7.31%
Fortis Inc.	Utilities	10.2%	3.67%
Husky Energy	Energy	22.2%	4.64%
Rogers Communications	Telecommunications	9.2%	3.38%
TransCanada Corporation	Energy	27.1%	4.18%
Thomson Reuters	Consumer Discretionary	21.5%	3.18%

One must remember risk and reward are correlated. Before implementing portfolio changes, a thorough discussion should take place aligning your risk tolerance with the investments attributes. A full list of Canadian companies that increased their dividends in 2008 and 2009 is available upon request.