Wednesday, January 28, 2015

Volatility Watch

  • The measure of volatility on the S&P 500 (VIX) hit multi-year lows back in June of 2014 just above 10.
  • In October 2014, at the height of the Ebola scare, it rose to above 30.
  • Earlier this month, the drop in oil prices and global economic certainty pushed the vix into the low 20's.
  • The ECB helped to counter this with last week's QE measures.
  • US corporate earnings surprises (to the downside) are pushing it back up.

Remember my theme: Central Banks do not like volatility because it  reduces confidence:

  • Yesterday the Conference Board announced that the (US) Consumer Confidence Index reached 102.9 (the highest level since 2007).
  • I would suspect that with today's post FOMC meeting statement, the FED does not want to undo the current level of confidence with any significant change in policy.
  • Sometimes boring is good. In fact when it comes to investing, we like boring!!
  • However, volatility levels have been rising to higher levels since last June and investors must not be complacent about this trend.
  • Balance and diversification are the best protection to get reasonable growth and minimize the impact of volatility.
  • How is your asset allocation?

Tuesday, January 27, 2015

Waiting for the FED

While we (and financial markets) wait on the results of the US Federal Reserve's Open Market Committee (FOMC) meeting which begins today and will culminate in the release of a statement at 2:15 pm (EST) tomorrow...

It is important to understand the key roles that central banks have played in trying to guide monetary policy since the financial crisis began in 2008.

  • The FED's key role is to safeguard the stability of the US financial system:
  • This mandate includes:
  1. promoting maximum employment
  2. promoting stable prices
  3. promoting moderate long-term interest rates
Historically, in relatively normal circumstances, monetary policy was achieved with the raising and lowering of interest rates (in the US, the FED would determine the base rate).

However the extraordinary circumstances that were created by the "Great Recession" called for extraordinary monetary measures now commonly referred to as QE (Quantitative Easing).

This is where the FED made bond purchases for it's balance sheet from the bond market and in turn added significant liquidity (cash) to the economy to maintain the stability of the system.

Critics claim that this monetary stimulus did not all make its way back into the system (some institutions were hoarding cash for safety reasons) and was not as effective as a result, however strong equity markets and improved economic growth over the last couple of years have shown that it has been effective.

Economic growth is a function of psychological confidence held by the households and businesses which participate in the economy.

When households feel confident in the future they will consume at a higher level. When businesses feel confident, they will invest in future growth.

What the FED and other central banks around the world have been trying to do is instill confidence in consumers (they will have jobs in the future) and businesses (consumers will return) in an effort to change the psychology from the lack of confidence created by the financial crisis and the ensuing recession.

Fortunately the FED was proactive and realized early on that extraordinary measures were necessary.

Other central banks have followed their example.

For those that want instant gratification, they may be disappointed. The positive results will take time to achieve. It is no simple matter to change the negative psychology that has been built up.

Patience is required.

I am a cautious optimist. I can see the benefits of the central banks' efforts and know that in time they will prevail and that their methods will prove successful. It is why we must focus on the long-term. There will be short-term difficulties, but given time, we will all be better off.

Monday, January 26, 2015

Monday Morning Recap:

What is important?

  1. Greek elections: not unexpected results, however there is some uncertainty going forward as to how Euro area and the Troika will deal with the new "anti-austerity" government.
  2. Corporate Earnings: S&P500 Q4 results will continue to be announced. Q4 earning expectations have been lowered, but early on it appears that companies are beating these lowered expectations. The underlying fundamental for equity prices are corporate earnings. Strong earnings should be positive for equity prices, if earnings are above analyst expectations. Financial market participants focus on results each quarter. This is rather a short-term approach for our liking, but important for short-term volatility if expectations are missed.
  3. $US: with many countries now trying to lower the value of their currencies to increase export demand and revive their respective economies (Euro area, Japan, Canada), the $US is significantly stronger. This may have negative earnings impact in the longer term for US based global companies and should be considered as a rational for closer scrutiny of US equity weighting allocations.
  4. Oil Prices: all the experts, talking heads and wannabe's are trying to call "the bottom", however that is of little consequence. There is structural change happening to the global economy and there will be countries that benefit and those that don't. Remember that if you buy an ETF that is "country" specific, you own a basket of companies that reside in that country. In a global economy, many of those companies will depend on broader markets that range well beyond the borders in which that country is domiciled. Research is important.
  5. Bond Prices (and Yields): in May of 2013 all the "experts" predicted US 10 year bond yields were headed to 4% (or thereabouts) and bond market volatility shot up. Investors in fixed income securities ( considered the "safe haven") were shocked by the change in value of their portfolios (to the negative). Bond markets and interest rate sensitive REIT's have been driving fixed income performance significantly so far this year. However, with yet again, record low interest rates with all the central bank stimulus over the last week, volatility in bond markets may be set to rise.

Friday, January 23, 2015

ECB Does Not Dissapoint

Over 1 Trillion Euros of QE
(only 550 million was expected).

  • As I have been suggesting, Central Banks do not like volatility because it erodes confidence in investors.
  • Yesterday, The European Central Bank surprised financial markets with a larger than expected dose of monetary stimulus.
  • Equity markets rose significantly on this news.
  • Volatility dropped.

  • Volatility, as measured by the VIX moved to 16.4 from its recent highs above 23.
  • The Euro/USD fell to lows not seen since 2003.

What Happens Next?

  • As the Bank of Canada did on Wednesday, The ECB has used surprise to stimulate markets. This has been a positive in the short-run.
  • However, the long-run impact is still to be determined.
  • What is hoped for is a move to higher levels of inflation at 2%.
  • This will be created on the back of stronger economic growth, but will likely take until 2016 to achieve, given the current global economic weakness.
  • In the interim, interest rates will remain low for a longer than expected period, especially in Canada, the Euro area and Japan.
  • An "unspoken" currency war has begun with all countries trying to lower the value of their respective currencies vs. the $US to enhance export growth.
  • In turn this will likely have a mildly restrictive impact on the US economy and impact US corporate earnings negatively (especially for companies that have a global sales reach).
  • It may, as a result impact the timing of any US Federal Reserve interest rate increases.
  • All in, it should be positive for global growth, but it will take time and in the interim many questions will be asked.
  • For now, volatility is down, but in the short-term as market participants lose patience (and we know that many focus on a far too short time horizon for results) volatility will return and challenge the Central Banks once again.
  • Stay balanced, stay diversified.
  • my 60/40 model is up more than 2% on the year, being led by Emerging Markets (especially India) and Canadian REIT's. Interestingly, US equity markets have been flat.

Thursday, January 22, 2015


BOC drops the Bank Rate to 0.75%

This is why we want to have diversification and balance in a portfolio!

  • All of a sudden, some of the assets in my models (that were least expected to perform) are out-performing!
  • Many of these are fixed income assets and some are Canadian Equity assets.
  • this is why trying to "pick" investing themes or "time" specific asset trades does not work over the long run.
  • Central Banks do not like financial market volatility because it erodes confidence so they will take actions to ensure that investors do not lose confidence: the BOC is no exception, they are staying "ahead of the curve" to try and offset the negative influence of lower oil and commodity prices.

The Theme for my Blog for 2015 
(go back to Jan 2):

"Expect The Unexpected"

  • Now it is the ECB's turn to instill confidence

Wednesday, January 21, 2015

Bank of Canada Takes The Stage Today

Bank of Canada governor Stephen Poloz will release the bank's Quarterly Monetary Policy Report at 10am today.

  • It is widely anticipated that he will cut Canada's 2015 GDP growth forecast to 2.0% (from 2.4%)
  • While it is also widely anticipated that he will leave the Bank Rate at 1%, it is thought that he may pave the way to a cut in the Bank Rate down the road.
  • and hence, the rationale for yesterdays $C tumble:

  • Last week, BOC deputy governor Timothy Lane spoke about the impact of lower oil prices on the Canadian economy (blog of Jan,14: "Oil and Canada") and stated that the repercussions would be a net negative.
  • However, there is more at play than just oil prices:
  • Copper, a "bellweather" for the direction of the global economy continues its slide as well:
  • currently at prices not see since 2009.
  • Deflationary pressures are strong across the commodity indexes.
  • Certainly the BOC is monitoring this as well, given that Canada is a major exporter of commodities.
The upside of a weaker C$: Canadian things are cheaper for those who desire to purchase them.

  • Next on Center Stage: Tomorrow the European Central Bank:
  • Will they live up to market expectations or will they disappoint? 
  • stay tuned...........and hold on!

Tuesday, January 20, 2015

IMF Lowers Global Growth Projection

For 2015, Global GDP Growth Has been revised down to 3.5% (from 3.8%)

“At the country level, the cross currents make for a complicated picture,” says Olivier Blanchard, IMF Economic Counsellor and Director of Research. “It means good news for oil importers, bad news for oil exporters. Good news for commodity importers, bad news for exporters. Continuing struggles for the countries which show scars of the crisis, and not so for others. Good news for countries more linked to the euro and the yen, bad news for those more linked to the dollar.”

In a nutshell:

This should favour US, Japan and Euro are economies.
Likely not good for Canada (see Jan.14 blog)
Definitely not good for Russia.


the growth forecast for China, where investment growth has slowed and is expected to moderate further, has been marked down to below 7 percent. The authorities are now expected to put greater weight on reducing vulnerabilities from recent rapid credit and investment growth and hence the forecast assumes less of a policy response to the underlying moderation. This lower growth, however, is affecting the rest of Asia.


Risks to recovery
The distribution of risks to global growth is more balanced than in October, notes the WEO Update. On the upside, lower oil prices could provide a greater boost than assumed. Other risks that could adversely affect the outlook involve the possible shifts in sentiment and volatility in global financial markets, especially in emerging market economies. The exposure to these risks, however, has shifted among emerging market economies with the sharp fall in oil prices. It has risen in oil exporters, where external and balance sheet vulnerabilities have increased, while it has declined in oil importers, for whom the windfall has provided increased buffers.

For 2015, my 60-40 and 40-60 models have been adjusted: adding Euro area and Japanese equities and lowering Canadian Small Cap and Emerging Markets exposure.