Canadian Corporate Balance Sheets Solid As A Rock

Highlights

• If we compare the current standing of corporate balance sheets in the first half of 2012 to what they looked like some 20 years ago, the picture has brightened significantly.

• Financial ratios have improved markedly over the last two decades, including a decline in debt-to-equity and improved liquidity.

• Improvements have been driven by solid growth in assets, led by strong profitability. In addition, over the past twenty years, non-financial corporations have elected to finance investments more through internally generated cash and issuing stocks than has historically been the case.

• Over the last 20 years there has been a growing preference of businesses to build financial assets. In particular, cash was the fasted growing asset during that time. This trend has accelerated since the 2007-2008 financial crisis, as Canadian companies focus on risk management.

• Going forward, a softer profit environment will likely keep asset growth more modest. We are likely to continue to see a heightened preference for cash over the next 6-9 months. However, over the medium-to-longer term we anticipate that non-financial corporations will start to invest less in cash and more in fixed capital. Debt will grow as a more important source of funding those investments.

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Performance of Pension Managers' Pooled Funds For The 3rd Quarter of 2012

 

According to the report, in the third quarter of 2012, diversified pooled fund managers posted a median return of 3.4% before management fees. The median year-to-date return obtained was 6.7%.

"After a difficult second quarter, pension funds are benefitting from the recent rally of the stock markets to post profits that surpassed the expected returns for an entire year in accordance with the actuarial return assumptions commonly used by pension funds. The median return of 6.7% obtained in the first nine months of the year exceeds, after fees, the actuarial return assumption of 5.5% to 6.0% per year for the average pension fund."

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An Economic Perspective On Long-term Financial Returns

• Our assessment of financial returns based on economic fundamentals suggests that diversified portfolios will likely deliver an average annual return between 4.00% and 6.00% over the next decade.

• Cash will likely provide an average annual return of 2.00%. Meanwhile, bonds are likely to return less than their coupon on a total return basis due to capital losses on longer-term bonds created by rising interest rates. The DEX Universe Bond index is projected to return roughly 3.00% on an average annual basis.

• Equity markets among major developed economies will likely return 7.00% annually, on average. However, this assumption does not include any allowance for higher price-to-earnings multiples. Moreover, exposure to emerging markets could boost equity returns; however, we must caution that these investments do carry materially greater risks.

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Quarterly statistics commentary Q3 2012

Most central banks currently view their country’s economic state as unacceptable and have acted to accelerate the economic recovery. However, there are many obstacles facing developed countries that will force central banks to continue their unconventional monetary policies. In the US, the Fed is motivated by the ailing labour and housing markets and would like unemployment and inflation to be closer to normalised levels. The market expects partial normalisation to begin around mid to late 2014, though if Japan were to be used as a guide, a prolonged period of subpar performance may lie in store. BoJ’s policies have set a precedent in unconventional monetary policy duration as they are now in their 12th year. The ECB is caught between regional recession coupled with fiscal austerity and a prolonged period of intervention before growth and price stability are restored to a consistent path.

The backdrop of negative real yields, a slow recovery and a likely continuation of expansionary monetary policies – with all the risks these present – provides further support to the long-term strategic investment case for gold.

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Fixed Income Investing In A New Yield Environment

The attributes which make bonds an attractive long-term holding have not changed, i.e., providing income and diversification. While achieving 10% annualized returns for the next 30 years from fixed income seems elusive at best, fixed income remains a core component to counter equity market volatility, which is the main contributor to portfolio volatility. For example, as highlighted in Figure 2, taking a balanced portfolio with 60% allocation to Canadian and global equities and 40% allocation to fixed income, we find more than 90% of the volatility that the portfolio experienced was attributable to equities.

Equities, by far, remain the largest contributor to risk in one’s portfolio, and fixed income will continue to be a viable source to counter that volatility. Therefore, a dramatic asset allocation shift in response to current low yields should take into consideration the implication on total portfolio risk.

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Market Indices, Asset & Risk Management Numbers: September 30, 2012

This is a great summary of the markets' recent performance - Stock and Bond Markets, Benchmark Portfolios - Month-To-Date, Quarter-To-Date, Year-To-Date and 1-Year returns.

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Past Returns Are Not A Reliable Guide To The Past

The annualized return for the S&P 500 index for the 20 years ending December, 2010, was 9.10% per annum (pa). What annualized return did the average equity mutual fund holder achieve?

The answer is potentially surprising. We will assume the reader also knows to deduct average mutual fund costs of around 2.0%, so a reasonable guess would be a return of 7.1% pa for the 20-year period. The actual answer is the average mutual fund investor earned a return of 3.80% pa, which was only 1.20% pa above inflation. This answer ought to shock us. It is an almost incredible, needless destruction of value. It turns out that retail investors in mutual funds aren't very good at 'Buy and Hold' and instead chase higher returns with tragic results. The story is essentially the same for institutional investors, although the scale of value destruction is smaller.

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Macro Malpractice

The wrong medicine is being applied to America’s economy. Having misdiagnosed the ailment, policymakers have prescribed untested experimental medicine with potentially grave side effects.

The patient is the American consumer – the world’s biggest by far, but now in the throes of the worst funk since the Great Depression. Recent data on consumer spending in the United States have been terrible. Growth in inflation-adjusted US personal consumption expenditures has just been revised down to 1.5% in the second quarter of 2012, and appears to be on track for a similarly anemic increase in the third quarter.

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