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.

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.

SURPRISE!!

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

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!

IMF Lowers Global Growth Projection

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

More here: http://www.imf.org/external/pubs/ft/survey/so/2015/NEW012015A.htm

“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.

Interestingly:

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.

And:

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.

All Eyes On The ECB!

Deflationary Pressures continue to plague the European economic situation:

• Financial market prices are determined by the expectations of its participants: traders and investors.
• What is built in to current prices (equity market prices and fixed income market prices) is a considerable move toward substantial Quantitative Easing (QE) by the European Central Bank (ECB) led by President Mario Draghi.
• This new round of QE is anticipated to be announced on January 22 and is expected to include bond purchases totaling 550 Billion euro's.
• All of this is intended to add further stimulus to the European economy which continues to exhibit broad deflationary pressures.

Risks:

• certainly one of the major "risks" at the moment is that the ECB will not be able to offer as broad a QE as is anticipated.
• this would certainly be a negative for financial markets that have been waiting for some time for this to happen.
• there are opponents to QE in the European community and most of that opposition comes from Germany.
• as well, the ECB's powers differ from other central banks like the US Federal Reserve, where its 3 efforts at QE were successful in getting the US economy up on its feet over the last few years.
• Also any QE will have to pass the scrutiny of the European Court of Justice.
• Further complicating issues are the technical aspects of how the ECB will purchase the various European government bonds that have different credit ratings.

The implications for the Global Economy are far reaching:

• more recently the US economy has been "carrying" the global economy.
• however, it is unlikely that this is sustainable without considerable improvement in Europe.
• QE in Europe needs to happen and it needs to be successful for the long-term health of the Global economy.
• These are big risks with long-term implications and volatility levels on Thursday could soar.
• Are you protected?

What is going on in Switzerland?

In a nutshell:

• back in 2011, when there was a significant flight out of the Euro, the Swiss Natonal Bank (central bank, SNB), "pegged" the value of the Swiss Franc (CHF) at 1.20 Euro's in order to stem the rise in it's value and ward off the economic problems inherent with a rising currency value: tighter monetary policy in a declining economic growth environment.
• Yesterday, without warning and as a major surprise to financial markets, they ended the "peg".
• Remember that the CHF is considered a "safe haven" currency because of the perceived stability of the Swiss banking system.
• Crucial is the fact that any borrowers of Swiss Francs will have to pay almost 15% more to purchase them and pay down their loan. That is a huge new "penalty" and will have a significant impact on the already receding European Economy.

Throw in another batch of uncertainty

• into the already high and rising levels of volatility and as traders and emotional investors do: move out of riskier assets into safe assets.
• Bond prices up, equity prices down.

Bond Yields are back to record lows:

http://www.bloomberg.com/markets/rates-bonds/

(10 Year Government Bond yields):

US = 1.72%

Canada = 1.47%

Germany: 0.46%

UK = 1.47%

Spain = 1.58%

Italy = 1.74%

What does this tell us?

• Interest rates will rise when bond markets are concerned about inflation in the future.
• If target inflation for a central bank is 2% (at the low end)...
• to purchase a 10 year bond and hold it to maturity, a bond investor in Canada would get a negative real return (actual return- inflation) of approx. .5%, if inflation was at the 2% level.
• At the moment: either bonds are extremely expensive or deflationary forces are building significantly.
• for those expecting/counting on higher interest rates? 
• bond markets are sending you a message!