Investment Trends

Today's message contains a review of excerpts from the latest newsletter of Canada's largest private investment management firm Nigel Stephen's Counsel. Learn from this information four ways to improve your investment portfolio now.

Historically economic and financial markets have repeatedly moved through 30 year growth and consolidation patterns. These periods can be divided into strong growth trends lasting about 20 years. 1945 to 1968 was one such growth period. 1980 to 1999 another. These growth trends are then followed by a consolidation pattern with slower growth lasting about ten years. Markets fluctuate during these consolidation terms but end the ten year period relatively unchanged. An example is between 1968 and 1978."

This suggests that the current consolidation that began in 2000 will last until 2010. Periods like this are very influenced by the economic cycle and annual growth rates may be as much as 4% to 6% in periods but there may be large swings in the stock market.

Right now we are at the low point in this decade of consolidation. During this time a number of former large companies will mature, merge or even fail. At the same time a number of incubator companies are growing. These companies, which are still relatively small, will fuel the next strong twenty-year cycle. Two major influences on today's markets are the short tem interest rate and price of oil. The U.S. reduced U.S. dollar interest rates significantly in light of the slow economy and the events of September 2001. Normally the impact of the interest rate drop would restimulate financial markets within six to nine months. Providing that there is no change in the price of oil. Unfortunately the possibility of war has caused oil prices to rise significantly and has inhibited global recovery as it is oil that enables the world to run its factories and bring products to market.

Once the price of oil drops to $20 per barrel we should expect a positive impact on market within six to nine months. However if oil prices remain higher through the decade we can expect a decade of slower growth.

There is a third factor to consider in this ten-year consolidation periods. There is the likelihood of large currency exchange rate shifts. The dollar enjoyed a long period of strong growth over the past 20 years. During this new period of consolidation in the US and Western Europe other markets will grow rapidly and become economic powerhouses by the end of this decade. China's economy for example is growing at 10% per annum.

Such dramatic shifts may lead to volatility in exchange rates in these and other growth areas such as Eastern Europe. There are four ways to improve your portfolio during this time of slow growth with strategies that Nigel Stephens follows:

#1: Greater exposure to currencies outside the Canadian and U.S. dollar.#2: Increase the weighting of shares of companies with intrinsic value.#3: Hold more dividend paying stocks.#4: Increase the number of good quality bonds with staggered maturities over ten years.

Since the year 2000, the Morgan Stanley World Stock Index has fallen 40%. Yields on ten-year bonds have fallen. Yet real estate has risen 40% in Britain, 20% in Canada and the U.S.

It appears that many investors now believe that real estate is the desired risk free investment. They have forgotten that real estate values can decline as they did 1982 to 2000. This latest series of price rises has been fueled by low interest rates and not inflation as in 1960 to 11980.

Individuals have borrowed heavily. Growth in mortgage debt is at record levels in relation to income.

Home equity withdrawal is running at record levels in North America and Britain. Are investors who are burnt out from the plunge in the stock market now over investing in real estate? The truth is that house prices, like equities, cannot outpace the growth of nominal incomes for long. Investing in real estate is not risk free. In Japan real estate prices have remained depressed for ten years. With interest rates remaining low it is likely that real estate prices will level off.

Consumer spending accounts for nearly 70% of both the U.S. and Canadian GDP and is critically important to future growth. During the economic slowdown of the past two years, consumer spending has continued to be reasonably strong. Corporate spending weakened in response to overbuilding of technology infrastructure and a need for many corporations to reduce their high debt levels. Now by judging the tightening of spreads, corporate credit levels appear to be easing.

However there could be a second credit squeeze based around consumers. Credit card debt in the U.S. is high by historical standards and has risen the past year to 1.7 trillion. Studies suggest that expansion of credit has been accompanied by a very real lowering of the credit standard. About 37% of credit card debt now consists of sub prime loans. Default levels have been rising and now are at 7% which is nearly double last year. There is some evidence that the default level is peaking and that the worst offenders have already been cut off. Total debt including mortgage debt has been rising in the past few years and total debt service is now at a level of 12% or 4 points higher than in 1989.

There is a question about how much additional debt that consumers are willing to take on to fuel further consumer discretionary spending.

The worst scenario would be rising interest rates. This would have a double negative impact of triggering higher mortgage rates and the same time that house payments would peak or fall. In this scenario consumers would be pressed to spend on non-discretionary goods since interest costs would be reducing disposable income at the same time that the family net worth would likely be falling.

With tremendous amounts of excess manufacturing capacity, low unemployment strong housing prices and real income growth of 25 to 35 per annum, we are not of the view that a decline in consumer spending or a significant drop in the housing market is likely.

I found these excerpts to be a grim reminder that investing in this decade will be tough. This does not mean that there is no opportunity. We just have to work harder for our profits. You can learn more about how to invest globally with Nigel Stephens website

Until next message may all your investing be good!


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