The World Doesnt End Every Day November 2012 We dont think its so - PowerPoint PPT Presentation

The World Doesn’t End Every Day November 2012

 We don’t think it’s so bad  We’ll tell you why 1

A GENDA 1. A Tumultuous Period 2. Seeking Safety 3. Long Live Equities 2

A T UMULTUOUS P ERIOD Investor psychology has been damaged by a series of negative events since 2000  Investors have suffered through a dismal period  Poor equity returns and high volatility  Economic outlook remains anemic  Major economic/political downside ‘event’ risks remain 3

A T UMULTUOUS P ERIOD Investors have suffered through a dismal period S&P 500 Total Return Index (1) 130 Housing Bubble Bursts Credit 110 Crisis  US$ total return of 1.7% per year since Sep 11, 2001 90 the Millenium  Translates into a 1.3% loss per year in 70 C$ Tech Bubble 50 1999 2001 2003 2005 2007 2009 2011 . 4 Source: Bloomberg. (1) Represents the US dollar total return, indexed to 100 at December 31, 1999.

A T UMULTUOUS P ERIOD Economic recovery has been a major disappointment U.S. Real GDP Across Economic Cycles (1) This Recovery  Mediocre growth  Chronic unemployment  Staggering deficits  Political gridlock 5 Source: Bank of Canada. (1) The horizontal axis numbers refer to the number of years before and after the onset of the recession. The “Big Five modern financial crises” indicates the average economic path for the following crises: Spain (1977), Norway (1987), Finland (1991), Sweden (1991) and Japan (1992).

A T UMULTUOUS P ERIOD Major geo-political and economic risks persist  European economic and political break-up  Middle East unrest  Territorial friction between China and Japan  U.S. ‘fiscal cliff’ 6

S EEKING S AFETY Investors have sought safety, and these responses, while natural, have flaws  Investors are avoiding risk by fleeing to apparently ‘safe’ assets  No ‘silver bullet’ – typical responses present new risks themselves  Recent experience – good or bad – often overwhelms investors’ emotions  Leads to a ‘bandwagon effect’ 7

S EEKING S AFETY Many investors have sought ‘safe havens’ It’s not always easy to stick The traditional safe havens to the plan… are back in fashion  Fixed income  Gold  High-yielding equities 8

S EEKING S AFETY Fixed Income Good bond returns have prompted investors to take refuge in Bond Funds Canadian Mutual Fund Flows (2) Canadian Bond Returns and Yield (1) (March, 2009 – August, 2012) $700 14% $42bn Value of $100 Invested (LHS) $621 10-year Canada Yield (RHS) $600 12% Bond Return $500 10% CAGR 8.1% $400 8% Equity Funds $300 6% Bond Funds $200 4% $100 2% 1.8% ($28bn) $0 0% 1989 1994 1999 2004 2009 . . (1) Total return from DEX Universe Bond Index since June 30, 1989. The 10-year Canada yield is the forward 10 year yield-to maturity at each date. 9 (2) Data from Investment Funds Institute of Canada.

S EEKING S AFETY Gold Gold has found new lustre in these uncertain times Gold Price Market Capitalization of SPDR Gold ETF US$2,000 $80bn SPDR Gold $70bn Gold Price CAGR ETF US$1,600 since Gold ETF launched $60bn 12-Nov-04 launch = 18.7% $50bn US$1,200 $40bn US$800 $30bn $20bn US$400 $10bn US$0 $0bn 2003 2005 2007 2009 2011 2013 2005 2006 2007 2008 2009 2010 2011 2012 2013 . .  Gold ETF explosion – cause or effect? 10 Source: Bloomberg.

S EEKING S AFETY High-Yielding Equities High-yielding equities have also been a crowd favourite S&P 500 vs. Utilities Total Return (1) 250 S&P 500 Utilities 200  Other high-yield 150 alternatives exist 100 50 2002 2004 2006 2008 2010 2012 . 11 Source: Bloomberg. (1) Represents the total US dollar return from the overall S&P 500 and the Utility sector of the S&P 500, both indexed to 100 at November 1, 2002.

S EEKING S AFETY In the search for safety, investors have overlooked other risks Asset Class Concern  Potential capital loss Fixed Income  Erosion of real value  No intrinsic value Gold  Cost to carry  Poor long-term return  Investors may be High-yielding equities overpaying 12

S EEKING S AFETY Fixed Income – Short Run Risk of capital loss is significant if interest rates normalize quickly 10-Year Canada Bond Projected Holding Period Total Returns (1) If yield changes to … Holding Period 1.0% 4.0% 6.0%  Historical “normal” 1 yr 8.1% -13.8% -25.6% range for interest rates is 4% to 6% 2 yrs 9.2% -10.6% -21.5%  Rates are certain to normalize, but we 3 yrs 10.2% -7.3% -17.2% expect it to be gradual 4 yrs 11.1% -4.0% -12.7% (1) Total period return (not annualized). This assumes an investor buys a 10-year Government of Canada bond yielding 1.79% and sells it after the indicated holding 13 period, during which period the yield on the bond increases or decreases in equal increments to the yield indicated under ‘If yield changes to…’.

S EEKING S AFETY Fixed Income – Long Run The real return from Canada Bonds over … it has happened before the next 10 years will be negative… Prospective 10-Year Canada Bond Return Historic Real Return on Long Bonds (annualized) (1) (annualized) 1900 - 1919 -6.6% Pre-tax (20 years) 1.79% Return 1920 - 1939 7.4% (20 years) Tax -0.82% Payable 1940 - 1979 -1.1% (40 years) Assumed Future -2.00% Inflation 1980 - 2011 7.3% (32 years) Value of $100 After-tax in 10 years' Real time is -1.03% 2012 - 2021 ? Return $90.13 (10 years) . . 14 Source: Triumph of the Optimists, TD Newcrest. (1) Assumes a 10-Year Canada bond was purchased on October 31, 2012, is held to maturity, and the marginal tax rate is 46%.

S EEKING S AFETY Gold It is difficult to make money investing in gold Long-Term Real Returns Challenges Holding Gold (1900 to 2011 annualized) Cdn T-Bills 1.6%  No intrinsic value  Value depends on human emotion Cdn Bonds 2.1%  Earns no income  Costly to store Cdn Equities 6.1% (1) Gold (US$) 0.9% . 15 Source: Triumph of the Optimists, Timothy Green’s Historical Gold Table. (1) This is US$ real return, assuming no storage or insurance costs for gold. Over the full 112 years, inflation rates in Canada and the U.S. have been similar (3.0% and 3.1% per year, respectively).

S EEKING S AFETY High-Yielding Equities As of October 31, 2012 Investing only in dividend stocks presents concentration and valuation risks Top 40 Canadian Dividend Stocks Sector Allocation (1) Forward Price/Earnings Multiple (2) Other, 7% 25.6x 16.0x Telecom, 18% 13.7x 12.6x Financials, 45% Energy, 30% Top 40 TSX Index U.S. S&P 500 S&P 500 Cdn Dividend Dividend Index Stocks Aristocrats . . Source: TD Newcrest, Bloomberg. 16 (1) Top 40 Canadian Dividend Stocks are based on the highest dividend-paying stocks with market capitalizations of at least $1 billion. Market cap. weighted. (2) The two dividend portfolios are equally weighted and the two indices are market cap. weighted

S EEKING S AFETY The Madness of Crowds Investor behaviour is flawed, but predictable  It feels best to be part of the crowd  Recent experience almost always extrapolated  Fear or greed dominates 17

S EEKING S AFETY The Madness of Crowds The current environment is reminiscent of 1979 Concerns in 1979  Stock returns poor for a decade  Inflation out of control  Iran hostage crisis  Soviet invasion of Afghanistan “Only the elderly who have not understood the changes in the nation’s financial markets, or who are unable to adjust to them, are sticking with stocks” BusinessWeek , August 13, 1979 18

L ONG L IVE E QUITIES Equities have strong prospects for the long term – if part of an appropriate investment plan and strategy  Equities may well surprise to the upside – as demonstrated by market history  Pre-conditions for economic and equity outperformance are in place  An appropriate investment plan and strategy is necessary  Fit with investor’s circumstances – the role for fixed income remains  Limit real risk  Nexus’s controlled-risk investment approach is proven 19

L ONG L IVE E QUITIES Equities overcome challenges Dow Jones Industrial Average 100000 Blank 4-Year Price Return After Event (1) 10000 Asian Financial Crisis +36% Savings & Loan Crisis +105% 1000 Watergate & Oil Embargo +1% Cuban Missile Crisis +41% 100 Pearl Harbour +67% FDR Closes Banks +258% 10 1910 1930 1950 1970 1990 2010 . (1) Selected from 20 negative events since 1930. For all of these events, the total equity return for the following 4-year period was positive. 20

L ONG L IVE E QUITIES Economic Reversion to Trend Economic growth has always reverted to trend Actual U.S. GDP vs. Trend 1950 1960 1970 1980 1990 2000 2010 21 Source: Businessweek.com “The Business Cycle Doesn’t Care Who’s President”, October 11, 2012.