How did the markets perform?
The second quarter of 2013 was very mixed across the globe.
- The Toronto indices were all negative for the quarter, the TSX was down 4.1% and the TSX Small Cap was down 8%.
- The Canadian Bond Universe was down about 2.4%
- The U.S. stock markets continued to perform well. The S&P 500 was up 2.9% in local terms and 6.5% in Canadian currency as the Canadian dollar was weak during the quarter.
- Global stocks were generally down in local terms but still positive when factoring in the weaker Canadian dollar. The EAFE Index (Europe, Australa, Far East) was down almost 1% in local currency and up 2.8% when priced in Canadian dollars.
- The MSCI Emerging markets index was down 8% and down 4.7% with currency.
So the message for the quarter:
Many markets were down and the Canadian markets were in the middle of the pack.
How did TriDelta perform?
Overall, the second quarter was fairly flat for TriDelta clients – but very positive in comparison to the Canadian market for stocks and bonds.
Virtually all clients outperformed the Canadian Stock and bond markets during the quarter with a range of returns from 1.0% to -2.5%.
The range of performance was primarily determined by model selection and asset mix. The Core (Growth) bond and equities portfolios outperformed the Pension equivalent and portfolios. Those with higher stock allocations outperformed portfolios holding more bonds.
The rationale for Pension underperforming Core during the quarter relates to some of the more defensive and stable dividend paying sectors like Utilities and Telecom which were two of the three worst performing sectors down 5.5% and 9.4% respectively. The worst performing sector for the quarter was Materials which includes mining stocks, was down 23%.
Once again all of our portfolios performed reasonably well under poor stock market conditions.
The key reasons for our decent performance would include:
- Meaningful stock exposure to the U.S. Market. At some point this may decline if we feel that the US market valuations are getting ahead of themselves, but we do not believe that is the case today. In addition, the US market gives us strong global exposure to several sectors that Canada lacks.
- Very low exposure to Materials stocks, especially precious metals. We never say never when it comes to sectors of the market. There may come a time when we begin to build more in these sectors.
- Growth outperformed Value. In general stocks with strong earnings growth profiles performed much better than stocks with very cheap valuations as investors looked for more certainty during the volatile quarter.
What are we doing about rising interest rates?
This seems to be the big question of the day. Clearly one of the big challenges in the quarter was the significant increase in long term interest rates.
This increase that reached a full percentage point for 10 year government bonds was the largest short term increase since 1994.
The immediate impact was for bond prices to fall. Longer term bonds fell more than short term, and corporates fell a little more than government bonds.
In addition, stocks that are deemed interest rate sensitive such as utilities and telecom stocks also fell with the rise in interest rates.
The first thing to know is that we believe that the interest rate moves were overdone, and expect bonds to actually perform quite well over the next quarter. We do believe that interest rates will ultimately rise, but it will happen over time and not in major jumps. As a result, we expect the major jump in yields that we just experienced to slowly move lower over the coming months, before it moves ahead further.
We did make a move in late April to shorten the term of our bond holdings, and that helped our performance. We are now moving again to lengthen the term of bond holdings. This is not necessarily a long term move, but one that we believe will bring outperformance through the rest of the year.
In terms of stocks, we continue to believe in dividend growers, strong balance sheets, and consistent earnings, but we are also looking at some sector shifts within these parameters. From a historical perspective, certain sectors do tend to outperform during mid stages of a market recovery and in rising interest rate scenarios. We will continue to be looking for some opportunities in sectors like technology and energy. This is a slow shift that we believe will position portfolios better for growth in 2014.
For those who believe that it is time to sell all bonds and go into stocks, keep in mind the purpose of bonds is both for income and stability of the overall portfolio. Bonds can go down in value as they did last quarter, but in the last 61 years, the very worst period was from June 1980 to July 1981. During this unique time of soaring interest rates and high inflation, the prime rate surpassed 20%.
The total return for the bond market during that period was minus 11%. This is certainly a poor return, but keep in mind how different the inflation scenario is that we see today. In most years, bonds provide steady single digit returns. Stocks have been much more volatile. This basic fact leads to a fundamental investment belief.
The right mix of stocks and bonds for an individual can see some shifting based on markets, but in general, if you are risk averse, and holding 30% in stocks, we do not believe you should make a radical shift. The market will do its thing regardless of everyone’s beliefs, and you need to maintain your appropriate asset allocation and risk profile. To make major changes (often after the fact) is usually one of the biggest investment mistakes people can make.
More thoughts on Bonds
- The latest bond sell-off was due to a combination of news that the US Fed sees “diminished downside risks to the outlook” and Bernanke’s comments that the Fed may trim its $85 billion bond buying initiative. The timing suggested it could start this year and end around mid-2014 if the economy grows in line with their forecast. This was not new news. This news has been in the market place as early as the turn of 2013. However, it certainly triggered a flight from bonds.
- Fast money, ETF trading, and new pricing levels were the catalyst for the extreme ranges traded in such a short period. Get me out – now – mentality prevailed, and once that trade has passed, more rational trading ensued.
- Tame inflation expectations and mixed economic releases argue for a new trading range with 10-yr yields between 2.00% and 2.50%, but not for the higher yields doomsayers are suggesting. If the recovery continues, ending of Quantitative Easing is still not tightening of US monetary policy. It’s a move to neutrality, and if history is a guide, central banks could be neutral for quite a while.
- As active managers, and with an extremely liquid portfolio of holdings, we have positioned our portfolios to take advantage of the volatility that will be the norm until the markets enter the next interest rate cycle.
Why less Quantitative Easing is Just a Shell Game
We believe that a reduction in Quantitative Easing purchases will potentially overlap with reduced borrowing requirements of the US government. How ironic would this be if the pay down of debt matches the gradual reduction to Quantitative Easing? At some point, the disappearance of Quantitative Easing will overshadow the reduction of supply; however, by then, market participants will be focused on the next big issue.
What about the rest of the year?
For the rest of 2013 we expect the markets to move around in the ranges already established during the first half of the year. In other words we see limited upside and a couple of short term corrections that will provide some decent buying opportunities.
The risks and news items that may cause a correction are many and are well know to the market as they have been climbing these walls of worry since late 2012 and include the following:
- The U.S. Fed slowing quantitative easing
- Sequestration in the U.S. continues and is a drag on economic growth
- Portugal, Italy and Greece continue to struggle
- Growth in China slows
- Continued political turmoil in many Emerging Market economies
Overall we continue to see the positive side winning out in the longer term:
- Earnings growth continues to be positive
- The U.S. jobs and economic data continue to improve
- Stocks are still attractively priced
- Few alternatives for investment dollars since GIC and cash rates are still very low
- Global support from central banks to stimulate the economy continues to be in place
We have been raising cash in all portfolios recently and are continuing to looking for opportunities to sell call options for some clients on a number of holdings to help generate excess return and income if the markets pull back.
Many of our holdings continued to increase their dividends during the second quarter. The following nine companies increased dividends and none of our holdings decreased their dividend paid over the last three months.
|Company Name||% Dividend Increase|
|Johnson & Johnson||8.20%|
|Canadian Imperial Bank||2.10%|
Investment management is never easy, and the rush to get out of bonds is a great example of emotional decision making. It can be very hard to act against the emotional pull to sell something when everyone seems to be bailing.
When we step back and look at the world in July 2013, we see reasonable market valuations. Keep in mind that from deep recessions come long recoveries. We believe we remain solidly in this recovery phase. It won’t rise in a straight line, and we may very well see more volatility this summer, but the general trend remains positive for stock markets, with room for decent bond returns on an actively managed basis.
|TriDelta Investment Management Committee|
VP, Fixed Income
President and CEO