Weekly Capital Strategy – July 22, 2016

July 22, 2016

The World Might Not Be Richer Than You Think
(Andrew Pyle, Senior Advisor and Portfolio Manager)

News is sold on the basis of the headline, whether we are talking about politics or business. When talk of two-hundred point moves in a stock index fail to grab attention, the media resorts to bigger numbers.  Like trillions.  With the continued advance in global equities since the UK Brexit fallout, the total value of world stocks has risen to $65 trillion.  Headlines therefore have been playing up the near $5 trillion rebound since Brexit.

To put the recent improvement in perspective, global equity market capitalization had fallen to around $55 trillion back in February when investors appeared to have thrown in the towel on the world economy and oil prices. Just three months prior the value of stocks stood at almost $66 trillion. In other words, we have now essentially recovered all of that lost ground.  Roughly this time last year the value of global stocks had reached a record high in the neighbourhood of $73 trillion, marking a 6-year recovery from the post-crash low of $25 trillion set in March 2009.


World market cap Jul 2016


There has been plenty of discussion recently about how the rally in US stocks is now the second longest in history at just over 7 years.  The longest stretch for the S&P500 was just under 10 years (from October 1990 to March 2000).  Bulls will argue that there is still a long way for this recovery to run before it hits a wall and investors may be tempted to follow that prescription in the belief that we will be at this until March 2019.

If we go back to the issue of global market capitalization, however, it looks as though the recovery is already over and has been since last summer.  In fact, you can say that global investors are about $8 trillion less rich than this time last year. The disconnect between a second-longest US equity rally and the fact that global markets are $8 trillion cheaper can be attributed to the weakness in Europe and Asia, where the Euro Stoxx index and Japanese Nikkei are down close to 20% from this time last year. Not that the gains in the US have been remarkable (S&P up 2.6%), but without this minor uptick the deterioration in global equity value would have been even worse.  Let’s examine the arguments in favour of and against a continued stretch in US stocks.

On the positive side, corporate earnings have done better this past season than what was expected.  Roughly 80% of the companies that have reported have delivered earnings above consensus, while just under 60% have come in ahead of estimates on revenues. A weaker US dollar from February to May certainly helped, but domestic economic conditions were also supportive. The other argument is that interest rates will likely remain low for a considerable period, keeping a lid on corporate borrowing costs.  And low rates will induce investors into taking on risk (i.e., buy stocks) rather than accept paltry yields on bonds.


US 10yr bond long term Jul 2016


The counter-arguments are as pervasive if not more so. Global economic conditions are not great and certainly no where close to what was seen during the 1990s. Rates may be low today and may indeed stay that way, but continued low rates are not the same driver for increased stock multiples as declining rates. From October 1990 to October 1998 the 10yr US bond yield fell from 9% to below 5%.  Unless we think that yield will fall to minus 2.5% the economy and market is not going to get the same amount of stimulus as then. The other problem, and it is related to the interest rate reality, is that the US economy looks tired. Canada as well faces economic fatigue as it deals with record-high debt burdens. Then there is Trump factor. With the candidacy confirmed we now have to face the very real risk that a Trump administration emerges post-November and that global trade frictions show up. This would be happening at the same time that the Brexit fallout through Europe intensifies. Betting on another 3 years of stock market gains is risky against this backdrop. Trillions at stake.



Gold Shedding One of Its Disadvantages
(Andrew Pyle, Senior Wealth Advisor and Portfolio Manager)

Last month I commented that the surge in gold prices which has been a key feature of global capital market developments in the first half was going to fade as the US dollar began its recovery. This past week we saw gold head lower towards $1300/oz after reaching intra-day highs near $1375 in the first week of July. Given the more than $300 gain since December, this retracement is modest and gold bulls remain convinced that the journey back to the 2011 highs above $1800 will continue. The reasoning is that global economic and market uncertainty is only going to increase as Europe tries to find itself and the US approaches a potential dramatic shift in policy after the election.


Gold Jul 22 2016


There is another supporting factor put forward that doesn’t normally get a lot of air time. As we know, gold offers a number of benefits from being a store of wealth to being a hedge against inflation. It is also a precautionary alternative investment that can provide an anchor in times of ‘chaos’. What it does not do is pay us any income. True, holding gold stocks in your account can deliver dividend income, but even that tends to be minimal. The TSX gold sub-group has an overall dividend yield of 0.5% or less than what we can earn on a high interest savings account.  Unless you charge your friends and neighbours an entrance fee to come view your physical gold holdings in the basement, you won’t receive any income. The difference between the zero yield on gold and nominal interest rates on bonds represents the opportunity cost of holding it.

Today, that opportunity cost is on the decline as US bond yields have reached generational lows.  The same holds true for peripheral European bonds, while gold technically yields more than German and Japanese bonds where yields are negative. To some extent this narrowed differential has led more investors into gold, though I would argue that the precautionary motive has been stronger. It’s important to remember, however, that gold is a higher risk investment than a government bond so investors are cautioned against moving into gold just because bonds offer less in income.


CRM2 Introduces Dollar-Weighted Returns
(Natalie Warren, Investment Associate)

The Client Relationship Model (CRM) is a regulatory initiative with the intention to improve the ideals wealth managers must meet. Over the past few years as part of CRM 1, clients have seen many changes like relationship disclosures, conflict of interest disclosures, enhanced suitability to ensure investments are suited to each investor’s objectives and time horizon. Following CRM 1 is CRM 2 which came into effect on July 15, 2016.  These improvements cover account cost and performance reporting.  Part of this reporting refers to the use of dollar weighted returns (DWRR) instead of time weighted returns (TWRR).

TWRR measure the historical performance of an investment portfolio compensating for external flows. To compensate for external flows, the overall time interval (e.g. a one year time period) is divided into adjoining sub-periods at each point in time within the overall time period whenever there is an external flow. In general, these sub-periods will be of unequal lengths. The returns over the sub-periods between external flows are compounded together by multiplying the together the growth factors in all sub-periods. This measure is appropriate for comparing manager/fund performance as the timing of the cash flows does not impact the manager’s performance. Portfolio advisors use time weighted returns calculations as they follow Global Investment Performance Standards (GIPS) issued by the CFA Institute.

DWRR or money rated returns or Internal Rate of Return (IRR) have been described as measuring the performance of the portfolio as experienced by the investor.  The return is based on how well the investment has done as well as the amount and timing of cash flows in and out of the portfolio. The formula places a greater weight on the performance in periods when the account size is highest. This is a limitation when evaluating managers.

While it is best left to the computer programs to calculate returns, to illustrate how they differ, I will borrow a simple example from a Scotia Wealth piece entitled “Explaining Dollar Weighted and Time Weighted Returns”.

  Year 1 Year 2
Cash Flows Initial Deposit $1000 Deposit $8000
Fund Performance 100% -20%
Annual Gain/Loss $1000 -$2000
Book Value $1000 $9000
Portfolio Value at Year End $2000 $8000


Time Weighted Calculation ((1+100%)x(1+(-20%))1/2 -1 = 26.5%

Dollar Weighted Calculation ((8000/9000)-1) x100 =-11.1%

The article suggests that DWRR are not useful for evaluating your advisor’s performance or comparison to a benchmark or another advisor’s returns. To make these comparisons, it may be best to use TWRR. On the other hand, DWRR are useful for evaluating your progress towards your investment objectives such as the return that you use in your financial plan.

A DailyVest article makes the suggestion that “Financial institutions should use DWRR if they want to measure how well the investor did at the timing and amount of the inflow or outflow. They should use TWRR if they want to measure how well the investor did at growing their assets over time.”


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This publication has been prepared by an advisor of ScotiaMcLeod, a division of Scotia Capital Inc. (SCI). This publication is intended as a general source of information and should not be considered as personal investment or tax advice. We are not tax advisors and we recommend that individuals consult with their professional tax advisor before taking any action based upon the information found in this publication. Opinions, estimates, and projections contained herein are our own as of the date hereof and are subject to change without notice. The information and opinions contained herein have been compiled or arrived at from sources believed reliable but no representation or warranty, express or implied, is made as to their accuracy or completeness. Neither SCI nor its affiliates accepts liability whatsoever for any loss arising from any use of this publication or its contents. This publication is not, and is not to be construed as, an offer to sell or solicitation of an offer to buy any securities and/or commodity futures contracts. SCI, its affiliates and/or their respective officers, directors, or employees may from time to time acquire, hold, or sell securities and/or commodities and/or commodity futures contracts mentioned herein as principal or agent. All performance data represents past performance and is not indicative of future performance. SCI and/or its affiliates may have acted as financial advisor and/or underwriter for certain of the corporations mentioned herein and may have received and may receive remuneration for same. All insurance products are sold through Scotia Wealth Insurance Services Inc., the insurance subsidiary of Scotia Capital Inc., a member of the Scotiabank group of companies. When discussing life insurance products, ScotiaMcLeod advisors are acting as Insurance Advisors (Financial Security Advisors in Quebec) representing Scotia Wealth Insurance Services Inc. This publication and all the information, opinions, and conclusions contained in it are protected by copyright. This report may not be reproduced in whole or in part, or referred to in any manner whatsoever, nor may the information, opinions, and conclusions contained in it be referred to without in each case the prior express consent of SCI. © 2016 The Pyle Group – Scotia Wealth Management Peterborough.