The Canadian stock market (S&P/TSX Composite Index) and the U.S. stock market (S&P 500 Index) each had weak results in the first quarter in local currency terms with returns, according to Morningstar.com, in the 1-2% range. However, when factoring in the decline in the value of the Canadian dollar, the S&P500 index provided Canadian investors with a gain of about 10%. Therefore the above average portfolio gains our clients experienced this past quarter were attributed to a weak Canadian dollar as well as strong stock market performance outside of North America, in both Europe and Asia.
Most of our clients hold a balanced portfolio with a blend of geographically-diversified stocks and bonds, typically with a 60/40 allocation favouring stocks. The U.S. stock allocation benefitted from the significant devaluation of the Canadian dollar. Currency gains are transient and cannot be expected to be a continual source of performance in the future, although we do expect the possibility of further weakness in the Canadian dollar as oil prices remain weak.
According to the Bank of Canada, the Canadian dollar gained modestly relative to the EURO which acted to dampen the performance of the European holdings. However, in spite of this performance mitigator, the European market experienced double-digit returns in the first quarter.
During the first quarter, and over the last few years, price volatility has been below average for the stock market and by extension for our client accounts. We measure volatility using the mathematical metric - ‘Standard Deviation’. We also track the Sharpe Ratio, which combines performance, standard deviation and the risk-free alternative return available to investors, in order to determine risk-adjusted returns. Any number greater than zero for the Sharpe Ratio indicates investors are being paid for the risk they are taking.
GETTING BACK TO 'NORMAL'
Generally, the normal range of results for the Sharpe Ratio, are between 0 and 1. The closer to 1, the better your risk-adjusted return. During the last quarter and over the last couple of years, many of our clients have had ratios exceeding ‘1’. However, over longer time frames like 3 to 5 years, we expect the Sharpe Ratio to gravitate to the normal range. In other words, the recent, above average Sharpe results are transitory in nature and are unlikely to remain that way.
The continued diligence of the IPC Portfolio Services team in assembling the components of our clients’ portfolios, have contributed greatly to their successful results. The IPC Portfolio Services team also monitors and changes component investment specialists when required, and rebalances on a regular basis. In addition, the customized asset allocation structure we create in consideration of each client’s objectives, time horizon and risk tolerance, provides further enhancement of results.
FUTURE EXPECTATIONS
The expected long-term average annual performance of a 60/40 asset mixture is in the mid-single digits. Portfolio exposure to the Canadian marketplace has been a disadvantage this past year due to the unexpected collapse in oil prices. I expect oil prices to be either neutral or a net contributor to performance the Canadian component of your portfolio for the upcoming year. North American corporate earnings have been flat to modestly higher so far this year so the market requires time to digest these results. In the meantime the balanced approach we take to portfolio construction provides an excellent array of geographic diversity so that results in one geographic region can be balanced by results in another.
Our typical balanced portfolio has about 40% in fixed income securities (bonds and similar instruments), with a portion invested in 'high-yielding corporate bonds'. These bonds typically pay a much higher rate of interest than that offered by most government bonds. Another attractive quality of high yield bonds is that they act as a stock 'proxy'. This means that they have historically captured the majority of the stock market's long term gains, with much less volatility, thus providing a superior risk-reward trade-off relative to stocks. To be clear, when fear periodically finds its way into the capital markets, high yield bonds will also experience some downside volatility, but their above average cash-flow will mitigate that risk.
MARKET OUTLOOK
As mentioned, North American markets were essentially flat for the first quarter as investors await economic statistics on how the U.S. economy is expected to perform for the balance of the year. In the U.S., there is an expectation of the possibility of higher interest rates in the late summer or early fall which is keeping investors hesitant. Rising interest rates from such low levels however, should not undermine economic activity and in fact are an indicator of a strengthening economy. As such, a pause in performance in the U.S. stock market would not be unusual for the next 6 months or so, with a return to more dynamic performance in the fourth quarter.
A slowdown in the growth rate of the Chinese economy as well as significant economic slack in Europe, as noted by very low inflation levels there, are also acting as an anchor on stock market performance overall.
In January of this year, Canada lowered its' benchmark central bank rate by 0.25%, bringing it to 0.75%, with the possibility of an additional interest rate cut later this year. Oil prices are cyclical and at some point there will be a resurgence in prices, which will benefit Canada's energy companies.
At present, greater opportunity seems to lie in European markets which had been beaten down over the last couple of years and has introduced aggressive monetary stimulus. Additionally, Asia provides some opportunity for stock market gains in the coming quarters. Your portfolio is geographically diversified so that regardless of what is occurring in Canada, you likely have exposure to some better performing market elsewhere.
Sincerely,
John Soutsos, CIM®, EPC, B. Econ.
Investment Advisor,
IPC Securities Corporation
Private Client
Wealth Management Services
jsoutsos@ipcmississauga.com
Disclaimer: The comments expressed here are the opinions of the Advisor and may not represent the views of IPC Securities Corporation.
15 April, 2015 Financial Planning Investment Services Special Reports and Newsletters