- The Empire Club of Canada Addresses (Toronto, Canada), 11 Jan 2001, p. 203-218
- Waldman, Jeffrey; Sterling, William; Joseph, Ian, Speaker
- Media Type
- Item Type
- Jeffrey Waldman:
The fixed income market. A recap of some fixed-income highlights from last year. Our current level of interest rates in historical perspective. Two themes that will dominate bond markets over the coming years. An outlook for this year. A potential movie sequel to watch for in the year 2001.
Some personal background of the speaker. Looking at the declines as cathartic, and how that is so. Some salubrious effects to this correction, with illustrative examples. A brief examination of the more secure conditions that have formed the basis for the long expansion and whether or not they have been exhausted. What lies ahead for the Canadian market. A bumpy year ahead with anticipated volatility. The speaker's portfolio of choice. A final remark about Nortel.
An introduction from the speaker as a recovering economist. A message of cautious optimism. The signs. Financial-sector indicators. A look at the real economy side. Some historical perspective. What we have now. The ultimate success of the Fed. Good news for investors looking offshore from the US. A final piece of wisdom.
- Date of Original
- 11 Jan 2001
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- Full Text
- Jeffrey Waldman
Vice-President, Fixed Income, TAL Global Asset Management Inc.
Chief Investment Officer, C.I. Global Advisors LLC and C.I. Mutual Funds Inc.
Vice-President and Portfolio Manager, Canadian Equities, Altamira Management Ltd.
ANNUAL FINANCIAL FORUM
Chairman: Catherine Steele
President, The Empire Club of Canada
Head Table Guests
Margaret M. Samuel, CFA, Equity Analyst, Royal Bank Investment Management Inc. and Director, The Empire Club of Canada; Eric Tripp, Executive Managing Director, Equity Division, BMO Nesbitt Burns Inc.; Joe Oliver, President and CEO, Investment Dealers Association; Robbie Pryde, CFA, Vice-President and Director, TD Newcrest; Chuck Powis, CFA, Managing Director, Institutional Bond Sales, RBC Dominion Securities Inc.; The Hon. Tom Hockin, PC, President and CEO, Investment Funds Institute of Canada and Director, The Empire Club of Canada; Grant Kerr, Associate Minister, St. Paul's United Church, Brampton; Blake C. Goldring, CFA, President and CEO, AGF Management Limited and Director, The Empire Club of Canada; J. Adam Conyers, CA, Senior Vice-President, Equity Markets, The Toronto Stock Exchange; Francois Du Plessis, CEO, HSBC Securities Canada Inc.; Andre Brosseau, Director, Institutional Equity Sales, CIBC World Markets Inc.; and Gerald C. Throop, Executive Vice-President and Managing Director, Equity Markets Group, Merrill Lynch Canada Inc.
Introduction by Catherine Steele
It is my privilege to welcome our guest speakers, Jeffrey Waldman, Ian Joseph, and William Sterling.
To borrow a phrase from a song made famous by the Beatles, ""The best things in life are free, but you can keep them for the birds and bees. I want money.""
Given everything that is currently happening with the markets, the economy and predictions on the economy, today's Empire Club financial forum couldn't be more timely. Our financial forum has become an annual tradition having noted financial experts share their insights and help us make some sense of what is happening in the markets.
Today, we have three eminent speakers who will share their views with us in succession. Each speaker will have a maximum of 12 minutes.
Our first speaker is Jeffrey Waldman, Vice-President, Fixed Income, TAL Global Asset Management Inc. Mr. Waldman joined TAL in 1998 and not only contributes to overall strategy but is responsible for strategy implementation and trading.
Our second speaker, Ian Joseph, is Vice-President and Portfolio Manager, Canadian Equities at Altamira Management Ltd. He is the Lead Manager of the Altamira Capital Growth Fund and the Altamira Dividend Fund.
Our third speaker, Bill Sterling, Chief Investment Officer, CI Global Advisors, founded CI Global Advisors and is the co-author of Boomernomics, a book advising how to integrate demographics and investing.
Ladies and gentlemen, please welcome our first speaker, Jeffrey Waldman to The Empire Club of Canada.
It is my pleasure to be here today to speak about the fixed income market, particularly in light of the fact that bonds were the best-performing asset class in the year 2000, exceeding the returns on stock markets in Canada, the U.S. and all other major international exchanges.
I'll begin with a quick recap of some fixed-income highlights from last year, then I'll put our current level of interest rates in historical perspective. Next I'll point out two themes, which will dominate bond markets over the coming years, and present our outlook for this year. I will conclude with a potential movie sequel to watch for in the year 2001.
While the year 2000 was satisfying from the standpoint of bond market returns, market conditions were anything but straightforward and ordinary. We had to contend with all these events over the past year. The U.S. Treasury announced in January that it would be buying back $30 billion of outstanding bonds and issuing fewer 30-year bonds in the year 2000. During the year, the yield curve inverted, then normalised again; the 10-year bond overtook the 30-year bond for benchmark status; the market priced in significant rate hikes by the Federal Reserve and Bank of Canada, then significant rate cuts; and finally, corporate bonds got hit from economic concerns and event risk. And that brings us to where we are today, with 10year Government of Canada bonds yielding 5.25 per cent.
Interestingly, when one compares the 5.25-per-cent yield today to government bond yields over the past 200 years in North America, we find that 85 per cent of the time yields stayed within a range of 3 per cent to 7 per cent. There have only been a couple of instances when yields fell below 3 per cent or rose above 7 per cent for an extended period of time. So today, we are practically right in the middle of that very popular range.
Our own city of Toronto issued its first bond back in 1874. It came with a yield of 6 per cent. Here we are 127 years later and City of Toronto bonds are still yielding just under 6 per cent!
Over the coming decade, there are two dominant themes, which will bring secular interest rates down--down to the lower half of that long-established 3-per-cent to 7-per-cent range.
First, inflation will become less of a factor in determining bond yields, as investors get accustomed to lower inflation volatility. Remember that prior to 1970, inflation was practically irrelevant in determining the levels of bond yields, even though there were periodic outbreaks of double-digit inflation over the past 200 years. North America has not experienced anywhere near double-digit inflation for 20 years. When the market begins to recognise that the inflation volatility from 1974 to 1982 was indeed an anomaly, bond yields will move lower.
The second theme that will help drive secular interest rates lower in the coming decade is supply and demand. Official recognition of the need for fiscal responsibility will continue to reduce the supply of government bonds. In the past 200 years of U.S. experience, a reduction in government supply has always been accompanied by lower interest rates.
Compounding this effect will be a demographic shift, which will increase the demand for bonds. As individuals get older, their tolerance for risk declines and they tend to seek out lower risk assets such as bonds. As the collective population ages, the liability profile of pension funds will get shorter. Equities are considered more of a long-term asset than bonds. So to maintain the match between the new shorter pension fund liabilities and the assets funding those liabilities, pension funds will gradually shift a portion of their portfolios away from equities towards bonds.
But those are the secular themes that will dominate in the decade ahead. What about the cyclical outlook for the bond market in 2001? Well let's begin with a quote and see if you recognise which American politician said this and when. ""We're in a slowdown economically in this country, if not recession.""
Although it sounds like President-elect George W Bush in January 2001, it was actually President George Bush in January 1991! Little did President Bush know that just two months later the U.S. economy would begin the longest period of uninterrupted economic growth in its history.
By law, the Federal Reserve is responsible for maintaining what is referred to as ""sustainable economic growth"" and stable prices. To accomplish this, we expect to see in the order of 100-150 basis points of easing this year from the Federal Reserve and 50-100 basis points of easing from the Bank of Canada. This should be sufficient to maintain a growth level in the economy that is sustainable, even if it isn't as spectacular as we have witnessed in the past few years. This slow-growth scenario is our highest-probability outcome for 2001.
Based on this scenario, 10-year bond yields should bottom out in the area of 5 per cent to 5.25 per cent. Over the course of the year, the 10-year yield should trade in the range of 5 per cent to 6 per cent.
Areas of the bond market that should outperform this year are corporate bonds which are currently priced for a recessionary environment and not the 2001 economy we expect. In particular, the balance sheets of many issuers in the banking and financial sectors are in much better shape than they were a decade ago. Long bonds have the most room to outperform this year. That's because the market will again be notified by the U.S. Treasury that the amount of 30-year bonds issued in 2001 will be lower than last year, and more outstanding bonds will be repurchased. The supply of bonds will diminish this year even if a package of tax cuts is implemented in the U.S.
Areas which could lag this year include corporate bonds in the telecommunications and real estate sectors. The former because the sector is undergoing a metamorphosis and the latter because of where we are in the real estate cycle. Real return bonds could also lag after performing very well over the past couple of years. They have become expensive recently due to some short-term excess demand. The yield curve may steepen a little bit more in the two-year to 10-year area as the Bank of Canada embarks on a programme of easing interest rates. But most of the steepening has already taken place.
I will now conclude with a movie sequel to watch for in 2001. In Cast Away Again, the sequel to Cast Away, Tom Hanks makes a new start with UPS and gets back together with Helen Hunt. With the Nasdaq trading at 5000 in March of 2000, Tom invests his entire retirement savings plan in a Nasdaq index fund then heads out on a business trip to fix a problem half way around the world. Well, as bad luck would have it, he meets misfortune and is stranded in the outback of Australia. After surviving on his own for four years, he is finally rescued in 2004. Returned to the U.S. he is devastated to discover, not that Helen left him for another man, but that the Nasdaq is still below 5000, and the average bond fund is up 35 per cent during the time poor Tom was away. The movie ends with Tom looking lost and wondering why he didn't invest some of his retirement savings in a bond fund.
Thank you for your attention, and may you have a prosperous 2001.
Good afternoon Madam President, ladies and gentlemen. It has been my standard practice when asked to foretell events in the equity market, to predict a return of 12 per cent for the year ahead and leave it at that. This type of forecast is mercifully brief and conveniently close to the long-term average return on stocks. Significant deviations in any year therefore give rise to much congratulatory back slapping or remorseful hand-wringing-neither conducive to recalling forecasts. Clearly, this tactic will not fly today. I now have nine of my allocated minutes left and if the first days of January are to be the barometer for the rest of the year, 12 per cent up or down could be the average weekly or even daily return.
I think it only fair to run up my colours immediately. I am by nature an optimist; I am an immigrant to Canada, who, 30 years on, is still filled with awe as to the seemingly inexhaustible energy and potential of this continent. Lastly, and most germane to this declaration, I am by profession a mutual fund manager who, along with my colleagues, is long a lot of stocks on behalf of our unit holders. Market catastrophe therefore is not part of my lexicon today, nor do I believe all the gloomy prognostications of the ink-stained wretches and finger-wagging `I told you so-ers,' who along with the short sellers have ruled this bleak winter so far. Make no mistake, the events of the last quarter have been bruising for many investors, especially those who share my penchant for growth stocks. But I see the declines as cathartic, as something of a 'market-cleansing.' So sanguine a view will not be universal, especially amongst those with large undiversified holdings in positions down 75 per cent or so.
But there are some salubrious effects to this correction besides the obvious one that some fine companies can be acquired at less than half the price at which they were offered six months ago. For instance, do you recall those cocktail party bores who would corner you to provide intimate detail-of their portfolios; the wizards who had bought gobs of technology stocks while you were busy grocery shopping? They won't be bothering you for a while.
And the obnoxious kid from down the street--the one who repeatedly dented your car with his bicycle. There's no need to worry that he will be announced on the front page of the newspaper as the latest instant dot-com billionaire.
And finally you can stop feigning familiarity with all those annoying acronyms like CDMA and ESMR and not feel social pressure to litter your conversation with references to `space,' `bandwidth' and `switched multi megabit data services.'
Most market commentaries today suggest that what we are living through is the end of the cycle. Some even suggest that it is the end of an era. Winston Churchill referring to a crisis of considerably more gravity once said: ""This is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.""
So it is with this dramatic, even revolutionary period in the development of the global economy. We are experiencing a cyclical contraction, engineered in part, by a U.S. Federal Reserve whose record at this monolithic task has been admirable.
The Fed initiated this process with a series of interest rate hikes two years ago, reasoning that the engine of global growth-the U.S. economy-was growing too fast for long-term stability.
The rate of the economy's deceleration has scared the markets and provided the doomsday prophets with a ready platform, but it may prove useful to remember that the equity market has not been anything like a finely calibrated instrument for predicting the timing, duration or depth of a recession. In fact, some say the market has predicted eight of the last three recessions.
And what of the more secure conditions that have formed the basis for this long expansion? Have they been exhausted? Let us examine some of them.
1. Open markets and free trade have encouraged expansion by multinationals that have tapped efficient pools of labour and developed new markets. 2. Investment in technology has been widespread and based on economic rather than nationalistic objectives. The result has been a dramatic boost in global productivity. 3. We have an unprecedented degree of co-operation between central banks and world governments, which has served us well through the Asian, Russian and Brazilian crises in averting global disaster. 4. Never before in history have we been so able to export excess capital for investment without depending on armies and navies to defend it. 5. Risk hedges are more efficient than ever. 6. Finally, the potential for armed global conflict has been largely diminished. This last point bears some vigilance given the structure of Mr. Bush's retro-cabinet, but I think you will agree that rarely or never have global investors had conditions so hospitable. These favourable conditions, which have led to a decade of spectacular investment returns, are still largely in place.
And what lies ahead for the Canadian market? This much is certain. Life will be `interesting' in the sense of the Chinese curse-varied and tumultuous.
I said aloud on the first day of the year that the TSE looked to be in need of divine intervention, to which one of the many wags in my office replied, ""You will have to go higher than that; this market needs Greenspan.""
And so it will be that at least for the next two quarters the TSE will follow the vagaries of the U.S. market, which in turn will be in thrall to every action of the Fed. This relationship will likely be even closer than in previous cycles, reflecting the changes in the composition of the TSE over the last five years favouring industrials and financials over natural resources.
History clearly instructs us that it does not pay to bet against the Fed. History also suggests that the markets 12 months from now will have recovered with contributions from most sectors. Now, if you are saying to yourself ""that sounds too easy,"" you are right, because, markets may be repetitive under similar conditions, but always with a twist.
Through the course of this year, returns will be more broadly based, with more sectors participating than in recent experience. Companies with predictable and accelerating growth will command premium multiples and earnings revisions will abound. In other words, it looks like a year that will favour the nimble opportunist.
I anticipate a dramatic rally over the next two months, spurred by the Nasdaq, but expect that selectivity in the Canadian market will be critical.
The trend in research and allocation of funds between smaller markets has been towards a `borderless' approach based on sector preference rather than country preference. This trend will continue in Canada with strong companies in strong sectors growing even stronger as prospects for cyclical recovery take hold.
I also foresee orphan status for more Canadian stocks as investors exercise their option to shift an additional 5 per cent overseas, consolidating what has become a more ""continental"" approach to portfolio construction.
If this just elicited a twitch of patriotic concern in anyone, I simply suggest that global competitiveness is the overriding criterion. I also suggest that as long as Florida remains the favourite choice for Canadian vacations, and The New Yorker publishes more stories by Alice Munro than anyone else we have a de facto continental union.
The united currency debate I will leave to Mr. Black and his antagonists, but if this were a forecast for the upcoming century, I would add that to the list of the inevitable.
I am strapping myself in for what promises to be a bumpy year. I anticipate volatility, I expect uncertainty and I am prepared to change my mind often. In this
'Perfect Storm' I am sure to seek safe harbour occasionally, but I will not abandon ship. My portfolio of choice will be well-capitalised, liquid and reflect a bias towards future growth. Here is a miniaturised version:
• Beginning with a bank, the CIBC because it is the cheapest of the majors, all of which should outperform as interest rates decline. • In technology, Celestica for strong global revenue growth and for those of you with strong hearts, Research in Motion for dominance in the consumer wireless data market. • For an underrated play on the Internet, the Thomson Corporation and for a strong oil and gas company with global assets, Talisman. • Finally, for a dash of the `continental' portfolio; Micron Technology and Lucent.
And what of Nortel, the stock that became a national obsession? Will things indeed ""Come Together"" as the advertisement urges or will John Roth become the ""Nowhere Man""? I add Nortel to the portfolio because it will epitomise two of the years themes in the Canadian market: the first, earlier mentioned, that the strong will grow stronger and the second, that out of the current turmoil will emerge the greatest opportunity.
Madam President, ladies and gentlemen, good afternoon. I would like to thank you for the invitation to speak to you today.
I would like to introduce myself first and foremost as a recovering economist. I took a 12-step programme many years ago to re-orient my career into a more socially useful direction. But I learned where an investment strategist, which is my current career, fits in the pecking order of life when I was at a large Wall Street firm and was introduced by one of their senior executives. He started with a story about Albert Einstein because apparently Einstein when he went to heaven landed in a special section where they would put your IQ number under your cloud. He had 200 under his cloud and was floating around proudly when he bumped into a fellow with 175 on his cloud. He got pretty excited and said: ""How do you do? I'm Albert Einstein. I look forward to talking to you about relativity theory and especially my unified field theorem."" Well that was fine. He then bumped into another fellow with 150 on his cloud. Again he was pretty excited and thought that here was somebody he could speak to. He introduced himself and said: ""I look forward to talking to you about prospects for world peace and justice."" They had an erudite conversation about that topic. Well finally he must have drifted over into Forrest Gump's section of heaven and he bumped into a fellow with 75 on his cloud. He really didn't know what to say. He scratched his head for a minute and said: ""What do you think the stock market is going to do this year?"" That's my job. So I hope I picked my profession correctly.
What I'd like to do today is deliver what I think is a message of cautious optimism. The caution is for some obvious reasons and I'll focus on the outlook from the United States, which is where I'm from. I think the U.S. is fairly obviously flirting with recession, while the optimism part of the message will come from the fact that Alan Greenspan is on the case and certainly has indicated a willingness to cut rates very quickly to deal with this. The reality is it may take many months, six or 12 months, before rate cuts that we've had recently actually deliver a rebound from the valley. So the questions are: ""How deep is the valley?"" ""How long is the valley?"" And I think it's fair to say nobody knows.
Let me talk first about the signs. That nasty ""r"" word has been used among the economists who, as was pointed out, have correctly anticipated nine of the last four recessions or something along those lines. But I like to look at both financial indicators and real economy indicators and when they are all pointing in the same direction you know something is up or down as the case may be.
If we look at financial-sector indicators, the most important leading indicator of the U.S. economy (and this has been confirmed by a great deal of academic research) seems to be the shape of the yield curve in the United States-the gap between short-term interest rates and long-term interest rates. When long-term interest rates fall sharply relative to short-term interest rates (the yield curve is inverted), that has often been a sign of a recession on the horizon.
We had a situation over the last four weeks where the average spread between three-month treasuries and 10year government bonds was about 70 basis points, 0.7 per cent. The Fed itself in its New York branch had done research in the past and that research suggested that much of an inversion of the yield curve would be associated with 40 to 50 per cent probability of recession. So Greenspan was getting a pretty strong signal of danger ahead for the economy, not to mention the fact that when stocks are also down more than 20 per cent from the peak that too is a warning signal.
If you look at the real economy side, we saw a number of indicators which clearly have in the last few months slid into recession territory. One is the National Association of Purchasing Managers survey which hit 43.7 per cent and typically any reading under 45 per cent in the past has been associated with recessions. We also have unemployment data with initial unemployment claims in the United States up roughly 23 per cent from a year ago. If you look historically that type of sharp jump in initial unemployment claims has usually been associated with the beginning of a recession.
With that, I'm going to conclude, but I was just want to end with one bit of wisdom I learned from having spent five years in the Far East in the early part of my career. Man who make living with crystal ball sometimes eat crushed glass. Thank you.
The appreciation of the meeting was expressed by Blake C. Goldring, CFA, President and CEO, AGF Management Limited and Director, The Empire Club of Canada.