In the 1920s, international flows of speculative financial capital increased, leading to extremes in balance of payments situations in various European countries and the U.S.  In the 1930s, world markets never broke through the haphazardly constructed, nationally motivated and imposed barriers and restrictions on international trade and investment volume.  These deficiencies turned the recession into a global depression as countries raced to devalue currencies to improve their trade positions.  Global central bankers attempted to manage the situation by meeting with each other, but their understanding of the situation as well as difficulties in communicating internationally hindered their abilities.  In order to do this there had to be stable currencies.  Following these currency wars of the Great Depression and the end of World War II, the consensus of global leaders was that it was in everyone’s interest to increase global trade.  The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world’s major industrial states.  It was the first example of a fully negotiated monetary order intended to govern monetary relations among independent nation-states.  The chief features of the Bretton Woods system were an obligation for each country to adopt a monetary policy that maintained the exchange rate by tying its currency to gold and the ability of the IMF to bridge temporary imbalances of payments.  Also, there was a need to address the lack of cooperation among other countries and to prevent competitive devaluation of the currencies as well.  We appear to have gone full circle again following the Financial Crisis of 2008 (a less destructive stock market downturn than the Stock Market Crash of 1929, thanks to the quick action of central bankers and governments) which lead to a global recession (again not as severe as the 1930’s).  But the central banks have pushed these policies too far and we are seeing major devaluations of global currencies such as the Euro and the Yen.  Quantitative Easing has only served to inflate the value of financial assets, as opposed to leading to a stronger global recovery.  The simple lesson has always been that a country cannot ‘devalue its way to prosperity.’

We continue to be concerned about the short-term outlook for stocks, given that we feel the aggressive combined action of central bankers across the globe has lead to the creation of a ‘bubble’ in the value of financial assets, including both stocks and bonds.  Our stock weights remain near the low end of the allowable range for now and we have overweight positions in preferred shares, REITs, Telecom and other high yield stocks and are underweight cyclical sectors of the stock market including consumer stocks, technology, basic materials, industrials and energy.  Having said that, we still feel that we are in a secular bull market that started in 2009, but which has not experienced a significant correction in over three years, much longer than the typical time between corrections.  With valuations near record levels and little room for further monetary stimulus (i.e. interest rates can’t really go any lower as they are already near zero in most countries), we think that a stock market correction is imminent.  We would most likely start adding to stock positions on any pullback in the 10-15% range.  Energy stocks in particular are starting to look interesting as we still see the global cost of production being in the US$60 range, suggesting that oil prices will ultimately head higher.  Shorter-term excesses in inventories and production may yet push oil prices lower but, for investors with longer-time horizons, we are starting to see some exceptional value in the energy service names (Secure Energy, Trinidad Drilling), the high-yield producers (Whitecap Exploration, Crescent Point Energy) and even some of the oil sands developers that have strong balance sheets (Athabaska Oil).

We have also moved to a slight overweight in the gold sector as we feel that the aggressive currency depreciations will ultimately drive investment funds into the gold market.  Mid-sized producers in safer jurisdictions top our buy list, including Detour Gold, B2Gold and Kirkland Lake.  We also see value in the Telecom stocks (Rogers, Telus) despite increased competition in the sector.  Other stocks where we see decent valuation and some earnings growth going forward include Loblaws (new growth from Shoppers acquisition), Blackberry (hardware sales to turn higher and software value is not recognized), Martinrea International (benefit from low Canadian dollar, European exposure and aluminum content growth) and Torstar (ridiculously low valuation and an 8%, fully funded, dividend yield).

While we do have a cautious short-term outlook, we do recognize that stocks still remain one of the strongest investments for the long term.  The chart below shows the returns for the U.S. stock market for the last 140 years.  While there will always be volatility, there has never been a 15-year period where stocks have generated a negative return, not even during the Great Depression or the two severe bear markets seen already in this century.

U.S. Stock Market Returns for Past 140 Years

That is definitely a ‘glass half full’ view of the world.  But we still see considerable short-term risks, not unlike what we saw in 2000 and again in 2007.  Until the market corrects or the economic data starts to look better, we will continue to hold a conservative investment stance.

1 2 3