Changeable, Mercurial, Tending to Fluctuate Sharply and Regularly

July 13, 2015

This time is no different than any other; uncertainty over world economic factors and political worries have abounded; accompanied by a raft of unusual concerns that have added to the current nervousness.

1.  Greece voting against austerity and the fear of contagion.

2.  Chinese stock market falling after the government imposed trading restrictions attempting to prevent further weakness (this never works).

Each of these concerns are driven by the fear of uncertainty; contagion in Europe if Greek exit occurs, the Chinese market rout and the potential effects on world economies, especially closer to home – our North American economy, and the price of oil. Let’s take a closer look:

1. Greece:

A credible plan for Eurozone Leaders must be presented by this Sunday in order to avoid bankruptcy. Sundays gathering may represent the climax of the five year effort to contain Greece’s debts, which exceed 170% of GDP. European sentiments for a deal don’t hold out much hope – although Germany has now conceded that Greece needs ‎some debt relief. The Greek economy comprises 1-2% of Eurozone GDP and 0.3% of world GDP. Agriculture, food, and of course tourism are the primary drivers.

The debt burden is thought to be un-manageable according to the International Monetary Fund. As we see this play out, our view is that Greece must undertake further painful restructuring and austerity (which the people voted against), or leave the Eurozone currency block and revert to the Drachma. The Eurozone is in a significantly better position to weather the storm vs. 2010 when the initial Greek bailout occurred. In 2012 the Eurozone Banking Authority was formed to bring regulation to the zone; of note is that most of Greek’s debt is owned by the IMF, the ECB, Germany and France. Very little is held by the banking sector. Italy, Portugal, Spain and Ireland have undertaken austerity and on a relative basis are performing better than they were. We see the risk of contagion as fairly low; the ECB will do whatever necessary to contain the Greek crisis; after all, they’ve had lots of time to consider Plan B.

These decisions will no doubt be difficult, creating potentially more short term volatility; A Greek exit will hurt confidence in the Euro currency. However longer term, we believe this concern to be minimal to no effect to your investment performance.

2. China:

The slide in Chinese equities has been one of the most spectacular market routs since the financial crisis of 2007-08. Chinese stocks have plummeted nearly 30% since their mid-June highs and a series of measures by the countries securities regulators have failed to slow the decline thus far. The crash comes after the Shanghai Composite soared nearly 60% since January 1st, while the Shenzhen Composite surged by 120%, easily making them the world’s best performing markets. Much of the rise has been attributed to the fact that Chinese state media have been promoting the benefits of investing to the Chinese people. The investing frenzy became so pitched that many ordinary people engaged in high risk investing which amounts to speculation; including borrowing money to buy stocks (buying on margin).

China has approved roughly 100 initial public offerings (IPOs) this year alone, allowing companies to offer their shares to investors for the first time. (courtesy: Bloomberg, July 8 2015)‎. All new IPOS have been delayed by regulators. Does this sound familiar in any way? Like many of history’s great bubbles, this one was built on borrowed money. Total margin lending is estimated by Analysts to add up to as much as 4 trillion yuan, accounting for a significant portion of China’s 7 trillion yuan stock market. Currently Beijing is adopting aggressive measures to stem the tide, including cutting interest rates, pumping liquidity into the banking sector and relaxing margin lending rules. Growth had already begun slowing for the past few years; this current market weakness will further complicate the fiscal and monetary policy that aims to guide the Chinese economy into slower growth. In every country’s growth trajectory, peaks and valleys have occurred; no market can outlast positive sentiment and China has learned their own tough lesson of “irrational exuberance” which the US learned in 2000. The State will do what it must to calm investors. The fundamental law of the markets is the Reversion to the Mean … this is happening as we write this blog.

The Impact:

Turbulence in Greece and China will undoubtedly further strengthen the USD ‎(safe haven status), which in turn will potentially dampen demand for US exports and keep inflation in check. June reports show improvements in consumer spending and housing; however consumer price gains have stubbornly lingered below the Federal Reserve’s 2% goal for three years now. Expect a hold on interest rate hikes by the Fed, or at minimum a small upward tick in rates.

At home here in Canada, expect a weaker CAD (some analysts point to a 0.70 Lonnie. This is a positive for the manufacturing sector but not so good for those with the travel bug! The price of oil will likely remain weak given the current geo-political factors at work. Market corrections unfortunately happen. However, they’re healthy and have occurred throughout history on a regular basis, creating opportunities when investors react irrationally; driven entirely by their fears. Interestingly, over 11 decades (since the 1900’s) the S&P 500 US Benchmark Index has given a 9.1% compound, annual rate of return. 4.5% of this return is courtesy of the dividend income, 4.3% originates from the enterprise growth (capital gains), with only a tiny 0.3% being attributed to “speculative growth” (which encapsulates the psychology of the markets which is the volatility of what investors are willing to pay at any given time for the earnings of companies). As you can readily see, the speculative return over the very long term is virtually meaningless. (courtesy: John C. Bogle, The Lessons of History, September 12,2011)

You’ve given us the mandate to invest your hard earned savings. In the face of difficult market conditions we make calm, unemotional decisions in an effort to protect your wealth‎, creating sustainable income and growth. As we’ve done in the past, we’ll continue to do our best to create the circumstances for success through the application of our disciplined investment approach.

We continue to focus on managing your wealth with measured confidence and value your trust in us.

Warmest Regards,

The Wooding Group