Second Quarter 2015

Market Review Quarter 2, 2015


Second Quarter

Equity Markets                                                                                                       % Change (in Cdn$)

S&P/TSX Composite                                                                                                           -2.8%

S&P 500                                                                                                                             -1.7%

MSCI/Europe                                                                                                                      -1.8%

MSCI/Far East                                                                                                                    -2.3%

TSX Energy                                                                                                                        -5.7%

TSX Financials                                                                                                                   -1.1%


Interest Rates                                June 2015                               March 2015

Cdn 91 day T-Bills                                 0.58%                                        0.53%

U.S. 91 day T-Bills                                0.02%                                        0.02%

Cdn 10 year Bond                                  1.69%                                        1.37%

U.S. 10 year Bond                                 2.35%                                        1.92%


Commodities (in U.S.$)                June 2015                                March 2015

Oil                                                            59.09                                     47.64

Natural Gas                                                2.82                                        2.64

Gold                                                     1172.10                                   1183.30



Portfolio Management Strategy


What Worked                                                                          What Didn’t

– Small Cap Stocks                                                                    – Utilities

– Crude Oil                                                                                – Bonds

– Euro                                                                                       – Preferred Shares


Spend, Spend, Spend NL

Canadian investors had difficulty making money in the second quarter.  The S&P/TSX Composite declined during the quarter, as did the S&P 500, MSCI/Europe, and MSCI/Far East all in Canadian dollars.  Bond and Preferred share investors didn’t do much better as their yields spiked, sending down the prices of fixed income investments.  Oil and gas investors thought that they, at least, should have made money as their underlying commodities rallied off their March lows, but the takeover premium in energy stocks we discussed in last quarter’s Commentary began to disappear and energy shares declined.  None of this came to us as a surprise, hence the higher amounts of cash than normal that we are holding in our clients’ accounts.

We like the prospects for most of the world’s economies.  Though growth is slower than hoped for in most countries, it remains positive, fueled largely by continued ultra-low interest rates.  The big guessing game in our industry is when will the Federal Reserve Board (Fed) in the U.S. finally begin to raise administered interest rates? There is by no means any consensus on this issue and being investment professionals has given us no better insight, as there is a fair amount of gamesmanship involved between the various regional Federal Reserve Banks, voting Fed governors (not all governors have votes) and its chairperson, Janet Yellen.  We are of the view that the U.S economy is strong enough to withstand higher rates and the bond market seems to agree.  We hope that history is not repeated (as it has in similar situations many times) and the Fed overstays its welcome, fearing to raise interest rates when it should, with higher than expected inflation the inevitable and predictable result.  Current economic conditions in the U.S. don’t warrant significantly higher interest rates.  However, they also do not warrant them at only 0.25%, as is currently the case.

Canada is a different issue entirely.  While our economy is highly dependent on the U.S. economy, it is also far less diverse, with commodities playing a much larger role, despite our wishes that it be otherwise.  Despite the fall in the value of the Canadian dollar giving us some cushion from lower commodity prices (as commodities are priced in $US), those lower prices and much reduced demand for commodities has put a severe crimp in Canada’s economy at this time.  While our neighbor to the south contemplates when they should be increasing their interest rates, we in Canada just experienced the Bank of Canada lowering ours again.  To my way of thinking, lower rates are like pushing on a string as commodity demand and prices are not influenced by Canada’s interest rates, so nothing will be accomplished except further fueling the real estate frenzy that is present in some of Canada’s largest metropolitan markets.  Also, for the second time this year, the banks in Canada only passed on some of the cut in rates.  Good for their bottom line but not so much for the Canadian economy.

For those of you who use Twitter, I am finally tweeting and you may follow me at @levinepmc.  You may not agree with everything I post (just as you may not agree with everything I write each quarter in these pages), but I hope what I post will be stimulating, interesting, and informative.  One topic that has been recurring in these pages, and now in my Twitter account, is what I believe to be out-of-control growth in provincial government debt in Canada. In the past week, both Manitoba and Ontario have seen their credit ratings lowered and Alberta’s new government has stated that it wishes to greatly increase its debt load.  With record low interest rates, borrowing is both cheap and easy and governments are hard at work spending that money with very little of economic substance to show for it, as wages and benefits for an ever increasing public sector eat up much of those funds.  Spend, spend, spend.  As governments rarely, if ever, actually pay down their debts, when the inevitable rise in interest rates arrive, the cost of carrying this fast growing debt will soar, as bond issues mature and are replaced at whatever current interest rates are at that time.  For most provincial politicians, it will be someone else’s problem down the road.  But it will be their legacy.


An Overdue Correction and a Yawn – DS

What an interesting year so far as in the last 9 months we have seen four crises or so the media would have us believe.  First, there was the fallout from Russia’s incursion into Ukraine.  Depending on which side of the fence you sit there are pros and cons and each faction holds views diametrically opposed to the other’s.  Anglo Saxon press from across the globe led by the Wall Street Journal, Bloomberg, and the Financial Times re-visited their Cold War mantels so we had months of front page headlines espousing Russia as the evil predator with Ukraine cast as the victim.  All things Russian eventually sold off but not because of the widely publicized U.S. sanctions, as U.S. – Russian trade is minuscule, but rather due to the fall in the price of oil.  The markets panicked and foolishly believed the biggest oil exporter aside from Saudi Arabia with the fifth biggest foreign reserves was not going to continue plodding along.  Now, with 20-20 hindsight it appears the share prices of most multinationals with sizable Russian exposure are back to or above pre-Ukraine crisis levels.  Did we have a Russian financial crisis?  No not really but we did have a media driven political circus that fueled a large destruction in wealth.

Now to oil prices, which I personally find very misleading.  I filled my car two days ago and wasn’t surprised to see gas was 10 cents cheaper than it was prior to the late 2014 oil price decline.  Global press are again screaming “blue murder” over the price of a U.S. dollar denominated commodity.  Here in Canada the rise of the U.S. dollar (50% in two years in Canadian dollar terms) has effectively raised the Canadian dollar price of oil.  For companies in the oil patch that have Canadian dollar costs and U.S. dollar revenues this is excellent news and at the very least somewhat cathartic.  Perhaps the take away is we should read less U.S. financial press while the U.S. dollar is high, more Canadian press and perhaps be more judicious in how we think about commodity prices here in Canada.

Now to Greece and all its drama.  I was in Greece for the two weeks prior to the recent No Vote.  What struck me as odd was how little the Greeks actually manufacture.  A visit to any supermarket illustrated quite clearly the failing of the current and previous regimes as there is virtually nothing of Greek origin aside from olive oil related products on the shelves.  The list of countries producing competing olive oil products is large so Greece’s ability to tie its wagon to the olive oil industry in a substantial way is problematic.  In essence, what else can they currently harness apart from tourism to power their economy?  Also troubling is how can a mere 11 million people with a GDP of only US$12,000/person cause so much angst for European equity markets?  The Greek financial crisis has been a slow train wreck for at least five years.  Unless Eurozone regulators and banking officials, which effectively manage the 380 million person regional economy, are completely incompetent and or lack any forward looking vision the likelihood of a full blown financial crisis in the Eurozone whether Greece defaults, stays in the Euro or returns to the Drachma is low. The media, however, would have us believe otherwise.

Now to China, which perhaps provides my biggest chuckle.  China has the world’s largest sovereign reserves by a wide margin and has the fastest growing economy of any significance in the world.  The country, however, is still firmly stuck between first and third world economic realities if its current stage of development is fully considered. Educational quality, standard of living, air and water quality, food security and even access and provision of healthcare all remain poor by developed world standards.  Is it any real surprise that, following nascent efforts to opening up its domestic economy, challenges would arise?  The big rise and fall of Chinese securities recorded on the Hong Kong exchange this month were generated almost exclusively by a surge in prices of the top 300 Chinese companies listed on the Shanghai Index that were recently cross listed on the Hong Kong exchange.  The greed with which Chinese and foreign investors pursued these newly cross-listed securities ultimately drove share prices to dangerously unsustainable levels.  A correction was badly needed.  In the fallout of the correction, sanity is re-emerging so the share prices of the quality, blue chip names are returning to reasonable valuation levels while the weak, hyper growth (think boom bust) stories have come back to earth dramatically.  On reflection, why is the correction front page headlines? Surely others saw the correction coming?

Looking full circle, as frequent readers of our Commentary will recall, we have been calling for a correction for some time now as share prices across the globe have in most cases become extremely expensive.  The U.S. market is touted as fair value by many pundits.  However, to anyone other than Amercians using U.S. dollars, U.S. securities are very expensive.  The U.S. dollar appreciated substantially in Canadian dollar terms (see above) and valuation multiples are approaching or are at all-time highs.  A similar story could be made for companies listed in France, Germany, Hong Kong, the Scandinavian region, Switzerland, the United Kingdom and a range of other developed economies.  On reflection, perhaps the media has played its part in selling the crises but the underlying facts are that the markets are struggling to sustain high share prices in the face of modest earnings growth.  Perhaps these closely timed media driven corrections ultimately reflect the markets’ need for a real correction.  Time will tell.


Bits and Pieces  FB

Over the past few years I’ve been fielding an ever increasing number of requests from clients to have their investment portfolios made joint with their children where possible.  The rationale is to save on probate fees in the future and while the joint ownership strategy certainly accomplishes that it also comes with some potential negatives.  After attempting, and likely failing to explain the potential pitfalls I realized I was doing my clients a dis-service in that I was lacking expertise.  To cure that problem I’ve asked a friend of our firm who does have the necessary expertise if he would write a short article(s) explaining the possible dangers as well as the benefits.

Reg Watson is a partner in the firm of Carswell & Watson and has extensive knowledge of Estates and Trusts.  I trust his judgement and recommend that anyone considering entering into a joint ownership arrangement with their child(ren) should read his article carefully.


Guest Contributor – RW

A Few Thoughts on Joint Ownership (with a right of survivorship)

One of the advantages of aging is an understanding that nothing is perfect.  This reality applies to joint ownership of assets (with a right of survivorship), which is a popular estate planning tool.


Have you ever heard anyone suggest:  “You should put your house (or any other asset) in joint tenancy with your two children (or some other family member) to avoid the probate fee on your death”?   You might have thought to yourself:

– my two children will get the house anyway in my Will;

– my house is worth a million dollars;

– the probate fee is about $15,000 (approximately 1.5% of the house value);

– I would rather have that $15,000 go to my two children than the Provincial Government.

If so, you are not alone.  It is a popular suggestion which is often implemented.  Clearly, there are good reasons to consider this option; however, there are powerful disadvantages, which must also be considered before a final decision is reached.  I will discuss two disadvantages: potential loss of the asset and loss of control of the asset; however, there are other disadvantages, including the potential for adverse tax consequences.


Disadvantages of Joint Ownership: Potential Loss of the Asset; Loss of Control

The first disadvantage I will discuss is the potential to lose the asset.  What, you say! Lose my asset?  How could that ever happen when I am just adding my child to the title of my asset?

Let’s stay with our example of a house (however, this applies to any asset, including your portfolio).  In order to avoid the $15,000 probate fee on your million dollar house, you decide to put your two children on title with you as joint owners of your house.  This means that when you die (assuming you die first) the house will be owned by your two children (the surviving joint owners) and your estate doesn’t pay the probate fee.

So you put your two children on title and they also become owners of what was formerly your house alone.  So what?  As owners, the house becomes one of their assets.  Thus, if they incur a large personal or business liability which they cannot satisfy with their other assets, their new house asset (formerly the house you owned by yourself) may be sold to satisfy their debts.

This “forced sale” scenario could arise in many circumstances, including if one of your two children is subject to:

– a large matrimonial debt on the breakup of their marriage;

– a hefty tax obligation; or

– a significant legal judgment (e.g.  ordered against them if they are involved in a car accident where someone is badly injured).

In any of these situations (and many others), what was formerly your asset could be sold to satisfy the liabilities of the people who now own the asset with you.

The second disadvantage is that once another person is on title with you, you lose control of the asset.  When you are the sole owner of the house, you can do what you wish with your asset.  You can sell, mortgage, rent – whatever you wish to do with your asset, since you are the only owner.  However, once you put another person on title with you, you must obtain their consent for any decision which affects the asset owned by everyone on title.

Many people will say that their children would always grant consent.  Let’s assume that is true. However, what about others?  For example, what happens if one of your children can’t give consent (e.g. is hit by a car and in a coma, etc).  Are you certain their spouse (your “in-law”, who is their Attorney under a Power of Attorney) would consent?  Could a potential conflict of interest arise?

This is a complex area, with important decisions rendered by the Supreme Court of Canada (Pecore v. Pecore (2007 SCC 17); Madsen Estate v. Saylor (2007 SCC 18)).  Our discussion in this article scratches the surface.  In the next quarterly report, I will discuss the implications of these two decisions, especially the presumptions mandated by the Supreme Court; the importance of the intentions of the parties (and how that is documented) and where the onus of proof lies.

Joint ownership of assets (with or without a right of survivorship) is a reasonable choice for many people.  However, before you come to a decision, consider the disadvantages, as well as the advantages, and seek professional advice.  Nothing is perfect.


Administration  FB

When I joined Portfolio Management in August of 1990 the firm consisted of Bob McInnes and the administration was handled by Barb Chambers.  That was then and we’ve grown a fair bit in the interim.  Even allowing for improved productivity through the use of computer software the thought of having everything done by one administration person now is ridiculous.  We’ve been operating with three administrators for some time but as the firm has continued to grow we‘ve recently made the decision to expand our admin staff by 33% (sounds more impressive than saying we’ve added one person).  As of June 1st Kathy Tevlin is now part of our client service team.  Kathy comes to us after a long stretch with Weight Watchers Canada but as she has a Bachelor of Commerce degree from Queen’s University she is unlikely to be intimidated by the vagaries of the financial world.  When you are next in our office I encourage you to introduce yourself to Kathy as it’s always nice to put a face to a name.



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