• David Cockfield

Keeping Cool in the Summer


We have stated in previous issues of The Artisan that volatile financial markets should be expected. Well here we are. The TSX closed lower as of June 30, 2015 than it was a full year ago. Newspaper headlines and articles make the possible exit of Greece from the Euro a death knell for the European Union itself. Falling oil prices are seen as pushing Canada as a whole into recession. China is seen as slowing, putting further downward pressure on commodity prices. When you throw into the mix the unresolved conflict in Ukraine and the war raging in Syria and Iraq, it is hard not to become pessimistic.

However, when one stands back and looks at these issues of concern it becomes apparent that much of the fear factor is focused on what could happen, not on what is actually happening. Greece is a good example. Greece is some 2% of the Eurozone GDP – a tiny portion. The concern centers on the precedent established of Greece staying or exiting from the European Union. If concessions are made and more Euro funds are provided to keep the Greek economy afloat, other European countries such as Portugal, Spain and Italy could cry foul rather than suffer under austerity program snow in place. Why not elect a government that will dispense with those programs and renege on any debt owed? This risk has been well appreciated by the European politicians involved. Why assume that they will open this door to a collapse of the Eurozone?Germany particularly has gained great advantage from the low Euro currency. If and when Greece exits the Eurozone, it will likely be a painful experience that few countries would like to emulate.

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There is evidence however that the Chinese economy as a whole is struggling to reach the 7% growth rate objective set by the Chinese government. We think this is a valid concern and see future commodity prices continuing under pressure. However a 5 to 6% growth rate in China is likely, and combined with better growth in the U.S. and Eurozone it should bring better balance to commodity market. It must be remembered that China is a managed economy that can mandate growth rates by directing investment into any sector it chooses. Politically, it is essential for the ruling party that growth occurs.

The potential for Canada being in technical recession is hardly surprising. Alberta, normally a major source of growth, is contending with a significant decline in oil prices and being sensible and cutting back. The rest of Canada is doing okay and beginning to experience the benefits of lower energy prices and a lower Canadian dollar. So far there has been no surge in unemployment and the corporate sector is still showing growth in earnings. Interest rates continue to remain very low which helps support the housing sector. Inflation also remains a non-issue. So Canada is hardly suffering, recession or not.

A major element in our relatively upbeat outlook is the revival of the U.S. economy. When the U.S. went into recession, Canada has followed. The opposite is also true. Canada benefits when the U.S. experiences strong growth. The U.S. leading indicators are signaling a broad based recovery Lower energy costs are a major plus for consumers. Housing starts are also rising, as are house prices. For some years now the U.S. has seen housing demand levels lag behind the growth in family formation. This has created a potential shortage, as with new jobs and improving incomes, young newly married couples become potential home buyers. Surveys have shown that with present low mortgage rates it is cheaper to own a house in the U.S. than to rent. Strong housing demand provides a source of stimulus as new homes requires lumber, cement, roofing, appliances, heating and cooling – which benefits a number of industries.

With investor psychology leading to volatile equity markets, investors should focus on equities that pay safe dividends and display lower than average volatility, combined where appropriate, with alternative investments such as private real estate, private equity and carefully chosen hedge funds in order to better diversify a portfolio. Economic fundamentals are still okay, as are future corporate earnings prospects.

Fixed income markets continue to anticipate future interest rate increases in the U.S. Investment returns recently have been negative, a trend we see continuing. Investors should keep fixed income terms short and avoid the long-term market as it is more susceptible to losses when rates rise. Areas such as private mortgage pools and select hedge funds which specialize in credit may provide a better alternative to the volatile public debt markets.

#DavidCockfield

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