In this week’s issue: 1. Market closes for Friday, January 30, 2009 2. Maybe it's a "reset" but it's not a depression 3. Budget 2009: Tax cuts aimed at middle class 4. Bankruptcies on the rise 5. History suggests a bright future: O'Shaughnessy 6. Canadian GDP worse than expected 7. TD backs down on "inactivity fee" 1. Market closes for Friday, January 30, 2009: Close Change YTD Dow Jones 8,000.86 -148.15 or -1.82% -8.84% S&P 500 825.88 -19.26 or -2.28% -8.57% NASDAQ 1,476.42 -31.42 or -2.08% -6.38% TSX COMP 8,694.90 -67.86 or -0.77% -3.26% Close Change YTD BoC Open Today Previous Nikkei 7,994.05 Canadian $ -257.19 or -3.12% -9.77% 0.8153 0.8175 Hang US $ 1.2265 1.2233 13,278.21 +123.78 or +0.94% -7.71% Seng SENSEX 9,424.24 +187.96 or 2.04% Euro -2.31% Spot Rate Today Previous FTSE 100 4,149.64 -40.47 or -0.97% Cdn -6.42% 0.6367 0.6306 CAC 40 2,973.92 -35.83 or -1.19% Euro -7.58% 1.5705 1.5857 DAX 4,338.35 -89.76 or -2.03% -9.81% Bonds $Current $Previous Gold %Yield AM Previous Cdn. 10-year bond 109.86 109.71 3.03 PM Cdn. 30-year bond 121.85 121.05 London Gold Fix 3.74 $918.50 $919.50 U.S. 10-year bond 107.64 107.47 ($US) 2.85 U.S. 30-year bond 116.17 115.78 3.60 WTI Crude $41.64 +$0.20 or Future($US) +0.48% 2. Maybe it's a "reset" but it's not a depression (January 26, 2009) Today's economic environment is difficult, but it's not the start of a depression, according to two of Invesco Trimark's senior portfolio managers, who say while there's no way to sugarcoat the severity of this downturn, it's nonetheless rife with opportunity for shrewd stock pickers. Dana Love, vice-president at Invesco Trimark and the lead manager of the firm's flagship Trimark Fund, says many managers are now referring to the 2008 downturn as a reset. Speaking to the Invesco Trimark's Portfolio Manager Forum in Toronto, Love was adamant he has no idea what's going to happen in the near term, and he strongly suggested that nobody at this point can accurately forecast what is going to happen with certainty. "You can gather enough data in this market to make whatever argument you want," he says. "There is no one single entity in the world right now that can solve the problems on their own." Instead, Love says a global restructuring of the financial system is taking place. Much of the run-up in the markets has been due to the leverage and debt that inflated asset prices. As the world de-leverages itself from this debt, it is, in a very real way, structurally resetting itself. "The structure of the global financial system is changing as we speak," he says. "Within the last 25 years, we've had this broad trend of a rising market, increasing productivity, relatively low inflation rates, stable monetary policy rates, increased risk taking and all these things have led to uniform increases in asset prices across all asset classes. If you look at the 25 years, you view this as a hiccup; you buy on the dips — because over the last 25 years buying on the dips was a strategy that worked." Love says there's a growing view that the last 25 years was an aberration in stock market performance, fueled in part by the massive amount of leverage in the markets. "If you look at a much longer period of time, such as 80, 100 or even 200 years of financial history, you can see that the last 25 years have been the outlier," he says. "If what we are doing is resetting, as some people are suggesting — which are some very bright business leaders — then we all need to reset our expectations. If we are resetting to a lower level, and have to re-grow from that lower level, we may have to reset our expectations for the next quarter century." Love emphasizes that for long-term investors this is actually a positive development. The Trimark investment discipline is focused on bottom-up selection, buying individual businesses at discounted values. The present market is offering historical opportunities for this stock selection process, he argues. "Different doesn't mean worse. It just means we think a little bit differently and frame things a little bit differently," Love says. "This isn't something that is measured in months or quarters; it's likely to be measured in years." He says the economy may have to start to improve for people to even gain a sense of confidence before they return to the market. "Right now is the best time to buy some of the very best businesses ever created, as long as you're not too picky about what happens in the short term," he says. "We've been mostly focused on upgrading the quality of the companies in the portfolio. That means making some hard decisions, so portfolio turnover is probably higher than you're used to seeing with the Trimark discipline. Usually we have to be very selective, because there are only a few companies at any given time that meet our portfolio selection criteria." He adds, "Nobody knows when things are going to improve. The good news is that if you're a buyer of good businesses and you're not doing any sort of tactical or strategic allocation between sectors, you can make money. Given the abundance of opportunities across all sectors, we're actually able to cherry-pick the best businesses wherever we find them across different industries." A thesis being thrown out by the pessimistic is that another Great Depression is imminent; a doomsday scenario for stock investing that would make buying now a very bad idea. Rob Mikalachki, vice-president and portfolio manager for Trimark's small cap mandates, such as the Trimark Canadian Small Companies Fund, says that if an advisor can take the emotion out of what's happening, most clients will realize circumstances are nowhere near where they were during the Great Depression. Unemployment during the Depression was 25%; today it's 7.2% and rising, but there are no indicators to suggest one in four adult Canadians is going to be officially unemployed. It should be noted that data for employment statistics gathering has changed in the last 70 years. Other indicators do not suggest anything resembling the 1930s. For example, GDP fell 30% during the Depression, while the Bank of Canada is calling for a decline of a little more than 1% next year. Mikalachki also notes there were more than 9,000 bank failures globally in the Depression; in the current crisis, that tally stands at 23. Also, Depression- era depositors did not have deposit insurance we have today. Mikalachki says, "2008 was the second-worst year on record in 183 years. When the market bottomed last November, on a ten-year basis, this was the worst market we have ever endured in almost 200 years of recorded years. The market was given a decent punch and we've absorbed it." Mikalachki places much of the culture of fear surrounding the markets squarely at the feet of financial pundits who have been trying to outdo each other with predictions of financial devastation. "These economists, these prognosticators, are showmen, in a sense. That's how they earn their income. They are not going to earn an income by being the guy that says what everyone else is saying. It's very easy to take a single data point and look at it out of context to support some of the crazy arguments out there." 3. Budget 2009: Tax cuts aimed at middle class (January 27, 2009) Markets are in the toilet which means most clients with invested assets are feeling the pinch in some way — especially if they are retired and obligated, under federal government rules, to liquidate their assets to comply with mandatory registered income fund withdrawals. If the budget passes, they may just get a break in this respect. Seniors might also benefit, marginally, from an increase in the age credit amount to $6,408, but the big news for seniors appears to be a direct response to current market conditions: For one time only, for the 2008 tax year, the government will reduce the amount seniors are required to withdraw from their RRIFs by 25%. The measure was first tabled in Parliament in November 2008. A newer measure relates to RRSP or RRIF payments after death. Where the fair market value of investments held in a registered plan are generally included as income when clients die, the budget points out that "there is no existing income tax provision to recognize a decrease in the value of RRSP or RRIF investments that occurs after the annuitant's death and before they are distributed to beneficiaries. Budget 2009 proposes to allow, upon the final distribution of property from a deceased annuitant's RRSP or RRIF, the amount of post-death decreases in value of the RRSP or RRIF to be carried back and deducted against the year-of-death RRSP/RRIF income inclusion." Notably absent from Finance Minister Jim Flaherty's announcement today is any hint that the government might eliminate or reduce capital gains taxes. Infrastructure spending is a cornerstone of this budget announcement as well, but the government seems to be keen to go it alone: Although many will likely benefit — including those employed in the building and forestry sectors, supply chain managers, commuters, other travellers and those using outdated university and research facilities (Flaherty says most new funding for infrastructure projects will only be available for only the next two years while the country's need for stimulus is greatest) — there is no mention that public–private partnerships or other investment opportunities might be part of the equation. That said, there are a number of new measures that will affect clients and business owners. Tax bracket changes Changes to the personal income tax brackets are among the more notable developments announced in Budget 2009. As of January 1, 2009, the two lowest income tax brackets will be raised 7.5% above 2008 limits to $40,726 and $81,452 respectively. The basic personal amount will also be increased to $10,320 in 2009, up from $9,600 in 2008. This change to the lowest tax bracket could also affect those collecting income–tested benefits like the National Child Benefit Supplement and the Canada Child Tax Benefit — the budget proposes to apply the new upper limit of the 15% tax bracket for income testing both, allowing lower income families to earn more before clawbacks begin — a move that Flaherty says, "will help low and middle income Canadians and it will stimulate consumer spending." Additional Support to Low-and Middle-Income Families with Children Example-Single Parent with Two Children-July 2009 to June 2010 Existing Additional Benefits Benefits New Family Income Total NCBs CCTB NCBs CCTB $20,000 $3,913 $2,680 $0 $0 $6,593 $25,000 $3,181 $2,680 $436 $0 $6,296 $30,000 $2,031 $2,680 $436 $0 $5,146 $35,000 $881 $2,680 $436 $0 $3,996 $40,000 $0 $2,633 $166 $47 $2,846 $45,000 $0 $2,433 $0 $76 $2,509 $50,000 $0 $2,233 $0 $76 $2,309 Note: Totals may not add due to rounding. TD vice-president and deputy chief economist, Craig Alexander said, "as you go up the income scale, the amount you tend to consume out of every dollar you earn diminishes. People who earn a lot of money only spend a fraction of what they earn and they have significant savings. At the low end of the income scale, people who have very modest income spend almost everything that they earn. If you want to boost spending, reduce the impact of how much goes to savings, the people you should target are people with the most modest income." Also, he says, those at the low end of the income scale have huge effective tax rates because of their reduced access to government programs. "Your effective tax rate is enormous for those individuals. That's really unfair and it also tends to diminish their willingness to participate in the labour market. So for a number of reasons, both economic and social, I think the government should target tax cuts for low- income Canadians as opposed to mid-income Canadians." Business owners Businesses and small business owners also have a few reasons to be cheery. Small business owners will benefit from an increase in the amount of small business income eligible for the reduced federal tax rate of 11% — changes announced raise the current limit of $400,000 to $500,000 as of January 1. Those planning business investments will also be helped by plans to extend temporary measures that allow companies to write off investments in machinery and equipment. According to budget documents, the capital cost allowance (CCA) system determines how much of any capital asset costs can be deducted each year for tax purposes. "The government's approach has generally been to set CCA rates so that the deduction for capital costs is spread over the useful life of the asset," say the budget's authors. Budget 2009 proposes temporary increases in CCA rates for computers and machinery and equipment used in manufacturing or processing, to provide "economic stimulus and assist Canadian businesses during this challenging economic period." The measures include a move to create a temporary 100% capital cost allowance rate for computer hardware and systems software acquired after January 27, 2009 and before February 1, 2011. For manufacturers, the budget proposes to extend measures announced in the 2007 and 2008 budgets that gave business in manufacturing and processing sectors a 50% straight-line accelerated rate for eligible assets acquired during a certain period of time. Budget 2009 proposes to extend the rate to investment in machinery and equipment made in 2010 and 2011 as well. "Canadian business must be free to reinvest. In our last two budgets our government temporarily accelerated the capital cost allowance treatment of investments in machinery and equipment," Flaherty says. "We will extend the 50% straight-line accelerated capital cost allowance rate by two years." Other proposed initiatives that affect business owners include: Reduced Employment Insurance premium rates to $1.73 per $100 of insurable earnings, their lowest level since 1982. A repeal of section 18.2 of the Income Tax Act. This section is scheduled to come into force in 2012 and will affect businesses by constraining the deductibility of interest in certain situations in which a Canadian corporation uses borrowed funds to finance a foreign affiliate. "Early action is being taken in relation to the panel's recommendation concerning section 18.2 because of the conclusions of the panel on the potential effects of the provision on foreign investment by Canadian multinational firms, particularly in the context of the current global financial environment. Accordingly, it is proposed that section 18.2 be repealed." Increasing access to credit for small business through proposed amendments to the Canada Small Business Financing Program and the Business Development Bank of Canada. Home-buying and home ownership First-time home-buyers who are eyeing the market, and those interested in making renovations in the next year or two, are also on the government's thoughts this year. To encourage home ownership and home construction, the finance minister proposes to increase the amount first-time homebuyers can withdraw from their RRSPs to purchase or build a home — from $20,000 to $25,000. It also proposes to establish a first-time homebuyer's tax credit which could amount to $750 worth of savings on closing costs. The second "limited-time offer" being offered up in this budget is a temporary home renovation tax credit. Until January 31, 2010, this proposed measure will provide tax relief for home renovation costs. Once calculated on a client's 2009 tax return, the savings could work out to $1,350 for each family. Flaherty says the home renovation credit is available for any project. "Everything from a new furnace to energy-efficient windows to a new deck" at the house or cottage is eligible. The credit can also be claimed in addition to support from existing government energy retrofit programs and the medical expense tax credit. Other measures Finally, additional measures announced today include but are not limited to, a new extension to mineral exploration tax credits, the establishment of a new Clean Energy Fund to support research, development and demonstration projects, possibly in areas of interest to green investors, protection for workers when employers go bankrupt and changes to employment insurance provisions. Flow through shares could get an extra boost by way of a one-year extension in the existing 15% mineral exploration tax credit (the shares allow companies to renounce or "flow through" any tax expenses associated with Canadian exploration activities to investors, who deduct the expenses when calculating their own taxable income). The mineral credit, first introduced in 2000, is currently scheduled to expire at the end of March 2009. "In light of global financial conditions and the important role of the mining sector in Canada, Budget 2009 proposes to extend eligibility for the mineral exploration tax credit for one year, to flow-through share agreements entered into on or before March 31, 2010. Under the existing 'look-back' rule, funds raised in one calendar year with the benefit of the credit can be spent on eligible exploration up to the end of the following calendar year. Therefore, funds raised with the credit during the first three months of 2010 can support eligible exploration until the end of 2011." Bankrupt employers can cause significant financial strain for many when their underfunded pension plans are left behind as well. To address this possibility, plans announced will extend the Wage Earner Protection Program to cover severance and termination pay. The program currently provides guaranteed and timely payment of wages and vacation pay owed to eligible workers if employers fail to pay after declaring bankruptcy. Currently this assistance is worth $3,254 per person. Maternity and parental benefits for the self-employed are also likely to be examined in the future as a result of this budget announcement. According to documents, the Minister of Human Resources and Skills Development will be asked to establish an expert panel that will consult Canadians on how to best provide self-employed Canadians with access to EI maternity and parental benefits. "These benefits could help self-employed parents to better balance work and family responsibilities and give them the opportunity to spend more time with their newly born or adopted children." 4. Bankruptcies on the rise (January 29, 2009) The slowing economy has led to increased bankruptcies in Canada, according to consumer credit rating agency Equifax Canada. The number of bankruptcies has increased by 9% year-over-year, to 109,068 at the end of November 2008. "Unfortunately, our latest data illustrates that the weaker economy coupled with high personal debt levels has led to an increasing number of consumers declaring bankruptcy," said Nadim Abdo, vice-president of Equifax Consulting Solutions. Not only are more consumers declaring bankruptcy, but the average loss resulting from the filing has increased to $33,000 (excluding mortgage debt) for October and November. In January 2008, the average loss was $31,000. While all parts of the country are seeing an increase, some are holding up better than others. In the west, the number of bankruptcies increased 4.2% in the first 11 months of 2008. In Ontario, the increase was 10.5%. 5. History suggests a bright future: O'Shaughnessy (January 30, 2009) If investors truly believe that "this time it's different," they need to understand that they are betting against almost 200 years of market performance, says Jim O'Shaughnessy, the Connecticut-based star fund manager renowned for his quantitative investment philosophy. O'Shaughnessy, chairman and CEO of O'Shaughnessy Asset Management, who manages a number of popular mandates for RBC Asset Management, lets the numbers dictate his investment strategy. He points out that, in more than 100 years of U.S. market data, long- term stock market returns always come back to their mean, an annualized compounded 7% real rate of return. If historical numbers are a reliable guide, as things have gotten worse, market prospects have drastically improved. "The challenge we have as investors is to take the behavioural aspect of people into consideration. Everyone I've talked to — and I talk to a lot people — is terrified; they have the inability to unstick themselves from what has recently happened, and have the inability to recognize that a) this has happened in the past and b) we are not unique in our situation," O'Shaughnessy says. "Human beings buy securities. Things move in and out of fashion. There is a business cycle, and you cannot repeal that business cycle." O'Shaughnessy says recent research into the 19th century shows the same pattern: regardless of global economic circumstances, business cycles and therefore stock returns drive back toward the same mean. As cycles go, the early part of this one has been the worst in history, he says, meaning the prospects for the next 11 years of investing seem very appealing. Even if the stock market were to have a healthy compounding real rate of return of 6%, this rolling 20-year period of stock returns would still finish off as the worst in history. "What I found is if the stock market beginning this year starts to compound at 6% real rate of return through December of 2019, the 20-year annualized real rate of return would be 1.9%, ten basis points lower than the lowest 20-year period ever recorded, which ended in 1949," he says. "I do not believe the current economic circumstances warrant that type of conclusion." He adds, "If you look back to the early 1930s, the United States had 25% unemployment, GDP declined by 33%, and land values were cut in half. The Federal Reserve contracted the money supply by 80%. Clearly, none of those are present. Yes, GDP will slip, unemployment may get to 10%, but the Fed, far from contracting, is expanding and is serving as the lender of last resort." As a man who will let only math dictate his investment decisions, deduction then suggests that a 6% return is the baseline prediction for the next 11 years of stock returns. Given that economic conditions don't seem as dire as they were in the Great Depression, he says it wouldn't be unreasonable to expect double-digit returns. Few investors share this unbridled optimism right now — it feels different for them — but O'Shaughnessy has maintained for years that they were spoiled over the last 20-year rolling cycle of returns that ended in 2000, which were the best in history. "In March of 2000, there was nary a negative story on the market anywhere. Everyone felt like an heir to a glittering throne. The U.S. had a surplus; it had destroyed the USSR, the biggest superpower in the world. Everyone thought their birthrights were returns of 15% to 20%," he says. "There are 200 years of data suggesting that in fact what happened is that the market reverted down to its mean. If you invested a dollar in the S&P 500 in 2000, when you strip inflation away, it is worth 50 cents today." At the turn of the millennium, O'Shaughnessy was ridiculed in some corners for predicting 3% to 4% annualized returns for the coming years. Ironically, this prediction ended up being overly optimistic. O'Shaughnessy concedes that even he didn't anticipate the eventual carnage of this decade, but this only strengthens his conviction that things will get better. "Back at the turn of the century, we were forecasting 3% to 4% annualized returns and everyone thought we were barking mad because they were expecting 15%," he says. "Well, if you compounded at a 12% real rate of return from now until the end of 2019, you'd still only turn in a real rate of return of 3.3%. From our perspective, because of the damage happening so early in the game, we expect the market will certainly deliver 6% and 12%. Even more interesting are the short-term prospects for the markets, O'Shaughnessy notes, because historically the returns on stocks have realized phenomenal gains not too long after a devastating correction. In examining the 12 worst periods of ten-year returns, O'Shaughnessy says they were always followed by years with positive returns. On average, the year after one of those worst-12 periods, returns were 25.8% for that year. After three years, returns compounded annually at 11.46%, five years later they compounded at 13.49% and finally ten years later they compounded at 10.75%," he says. "We have beta back to 1900 on U.S. stocks, on an annual basis. When you look back to 1900, there were only three decades that provided negative returns to investors. The first decade was 1910 through 1919, the second decade was 1970 to 1979 and, barring a miraculous 100% to 200% rally this year, the [third is the] decade of 2000 to 2009." Of course, each of those preceding two periods were followed by historically strong bull markets: the Roaring Twenties and the 1980s. Not surprisingly, O'Shaughnessy is loading up on equities. "I don't often say this, but this is buy-everything time," he says. "We do think the prospects for a couple of strategies are superior. One area is large cap growth stocks, since they have been down 70% in the last nine years. Another area is small cap value. We think that, given the hit that small cap value took in the last quarter in 2008. Small cap value has been the best asset class bar none and our expectation is you'll see that coming back strongly." He remains very upbeat on quality dividend stocks. "These dividend stocks are a godsend to conservative investors. We are buying stocks on their dividend yields, making certain they are market-leading companies. We define a market-leading company as having a market cap, shares outstanding and cash flow all greater than average. In addition, these companies have sales or revenues greater than 50% [more] than average. If you apply that criteria to companies in a universe that holds about 8000 names, that gets you down to about 340 names." 6. Canadian GDP worse than expected (January 30, 2009) The Canadian economy contracted 0.7% in November, according to the latest data from StatsCan. That's almost double the rate of contraction expected by economists, with a consensus estimate of 0.4%. In October, the decline had been just 0.1%. "The combination of the fall's intense financial market volatility and the deepening global downturn caught up with Canada big-time in November," wrote BMO Nesbitt Burns deputy chief economist Douglas Porter. "After largely skating above the fray for a spell, the economy clearly reached a breaking point late last year." Porter said that when December's data is released, he expects Canadian real GDP will be roughly in line with that of the U.S. for the fourth quarter. "By the same token, Canada will have to look south for the first inklings of recovery, and that awaits the second half of this year...if everything goes right," he wrote. So far, things don't look so good south of the border, where real GDP contracted by 3.8% on an annualized basis in the fourth quarter. There is some good news, however: That beat consensus estimates of a 5.5% decline for the month of December alone. "Despite the better-than-expected print on U.S. economic activity, the fact remains that the U.S. economic recession intensified in a fairly dramatic fashion in Q4," wrote TD Securities economics strategist Millan Mulraine. "And with the financial sector turmoil and labour market woes likely to continue for some time, we continue to believe that a recovery in economic activity remains some way off, with the recession expected to drag well into this year." 7. TD backs down on "inactivity fee" (January 30, 2009) The customer has spoken and the bank has listened. TD Canada Trust has announced that it will not charge its customers an inactivity fee for unsecured lines of credit. The new fee was slated to kick in at the end of April and would have seen clients tapped for $35 simply for the privilege of having the line of credit. The negative feedback was so overwhelming that the bank has committed to introduce no new fees or fee increases on personal and small business banking products, through to the end of 2009. "We've been listening to the concerns our customers and employees have been expressing, and we believe that this commitment is the right response in the current environment," said Tim Hockey, president and CEO, TD Canada Trust. "We recognize that times are challenging for many people right now. Holding the line on fees is one tangible way of helping." Have a nice and fruitful week!
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