As 2011 winds down, we have seen something that has been quite rare of late. 2011 marks just the second time in the past 10 years that the S&P 500 (US markets) will have outperformed the TSX (Toronto markets) in Canadian dollars. We believe that this is a significant shift for Canadian investors. Quite frankly, after many poor years, the US market is today, simply better valued than Canada, and as a result, there represents greater opportunities to find ‘cheap’ companies in the United States. This doesn’t mean a wholesale shift in investments, but simply a meaningful return to the largest investment market in the world. Of key importance, this is not driven by any great belief in the American economy, but rather a focus on large, global companies that generate sizable revenues from Asia and emerging markets. We believe that many of these US based global companies have not seen appropriate valuations of late, in large part because of a negative view on the United States.
The next big theme is Europe. The only questions about Europe is “How bad will it be?”. The range of options go from a worst case scenario of significant bank failures and a freeze in global credit, to a best case scenario, with no bank failures but a period of recession and high unemployment and rising taxes. Neither sounds like much fun. While this will continue to put pressure on markets around the world, a ‘best case scenario’ will actually help North American markets in two ways. The first is that the market is pricing in very bad news from Europe, and only bad news is a positive. The second is that capital must flow somewhere. As money leaves Europe, some of it will support stock markets closer to home.
The other focus for 2012 is the search for income. In a world of GICs and government bonds paying 1% to 2%, the search for income, especially among retirees will only grow. 2012 looks like another year of very low interest rates. The good news is that dividend yields on stocks have improved over the past year as corporate earnings have been strong, and as some stock prices have declined. Corporate bonds and preferred shares continue to pay reasonable income in the 3% to 5% range for good quality companies. An added income opportunity that we will be using more in 2012, is covered call options. This strategy allows for added income that is treated as capital gains for tax purposes. In times of market volatility but low market growth, covered call options along with bond interest and dividends can provide for portfolio returns of 5%+ even when there is no growth in stock prices.
Overall, 2012 looks like a year that will start with continuing volatility and risk stemming from Europe, but we believe that it will also represent some exceptional entry points for great quality companies with growing dividends. These companies can form the foundation of portfolios for many years to come. We look forward to taking advantage of these entry points – in particular with Canadian bank stocks, US tech stocks and US health care stocks.
