Last week finished with a much-anticipated sell-off in global equity markets. Nothing too major, but stocks closed down about 1% leaving investors wondering how much more there is to come. Tough to say, but it has been our view that equities are over-valued and have been for some time. Globally, economic growth appears to be entrenched in a period of malaise, in spite of considerable efforts by Central banks and governments to stimulate growth. Given that debt levels are already high and interest rates low, there is little room for maneuver on either front. This leaves the fate of the world economy to the invisible hand of capitalism, which has historically weathered anything and everything over the centuries. There will be a return to long term historical averages in terms of growth, though it likely will be slower then politicians looking to get re-elected would like. The rest of us too are getting anxious, given the unprecedented efforts to re-inflate the world economy.
So what has to happen for this to occur? For one, the ‘lower-for-longer’ interest rate environment has to come to a close. Zero yields were thought to be the cure for economic stagnation, but they have become part of the problem. Owners of money are being punished, while borrowers are being rewarded, regardless of the economic merits of accumulating ever-more amounts of debt.
Second, the developed world has to reset it’s expectations of government, and stop asking them to deliver more than the tax base can provide. Governments of all stripes borrow the difference and the mountain of debt gets bigger. A return to sensible, balanced budgets and bringing the private sector in to fund infrastructure rather than have governments try to do it themselves in also part of the solution.
Third, pension reform has to occur, including extending the ages where citizens can start collecting Canada Pension and Old Age Security (which at $6,500 per year does anything other than provide security). This requires a national conversation that has yet to begin. But it must, and soon. The clock is ticking and debt is increasing.
So where do we go from here? Well, portfolio wise we stay the course, with significant allocations to government and corporate bonds. This lowers overall portfolio risk, while emphasizing yield over capital gains; the latter expected to be in short supply going forward. As far as the global economy is concerned, as mentioned we expect things to get better, though at a glacial pace. Too slow in fact to be perceptible at times and far too long for the short term exigencies of 21st century capitalism.
We may be looking at a generational time frame, where the amortization of debt over a couple of decades is what is required before we see a return to normal growth. Time will tell, but being patient and circumspect is important to weathering the markets for the balance of the year. Our portfolios are well diversified and conservatively positioned for solid risk-adjusted returns going forward.
So as events unfold, know that you are protected from the elements. Water-resistant, not water proof, but sufficient protection from the elements of market volatility and market downside.
Look forward to speaking with you in Q4, the last fiscal quarter of 2016.