JMRD Market Observer for January 23rd, 2015: JMRD Diversifed Income & Growth Basket (DIG) Update‏

January 23, 2015

**January 23rd Issue of The JMRD Market Observer**

 

In This Week’s Market Observer

  • Bank of Canada Rate Cut: Why now, and what it could mean for investors
  • JMRD Diversified Income & Growth Basket Update
  • 2015 Tax Reminders
  • Retirement Corner
  • Week at a Glance
  • Reads of the week
  • Economic Calendar
  • Earnings Reports

 

Bank of Canada Rate Cut: Why now, and what it could mean for investors

In light of Wednesday’s surprise interest rate decision, we have been reading a lot of observations about the actions taken by Canada’s Central Bank and the potential outcomes that may follow.  Below you will find a very interesting commentary from Dynamic Mutual Fund’s Chief Economist, Todd Mattina.

 The Bank of Canada surprised the market yesterday by cutting its key short-term interest rate to 0.75%, a 0.25% decrease. The cut was prompted by growing concerns that falling oil prices could slow economic growth in Canada.

“The drop in oil prices is unambiguously negative for the Canadian economy,” Bank of Canada governor Stephen Poloz said at a news conference. “Canada’s income from oil exports will be reduced, and investment and employment in the energy sector are already being cut.”

The Bank of Canada’s key rate had been sitting at 1.00% since September 2010. Yesterday’s cut sent the Canadian dollar tumbling below the 81-cent U.S., marking its biggest one-day drop since November 2011. It is now at its lowest level against the U.S. dollar since April 2009.

Why the decision surprised the market

  • All 22 contributing economists in the Bloomberg survey predicted that the Bank of Canada would maintain its policy rate at 1.00%
  • This rate cut came as a surprise to many economists because monetary policy decisions are typically based on longer-term considerations given “long and variable lags” between changes in interest rates and economic outcomes
  • The cut was also unexpected at this meeting because the impact of the large drop in oil prices remains uncertain; lower business investment and layoffs in the oil patch could be offset by higher consumer spending and non-energy exports
  • Also, the decline in longer-term inflation expectations implied by inflation-linked bonds (the 10-year breakeven is about 1.56%) has remained within the Bank of Canada’s target band, so the risk that expectations become unhinged from policy targets seems manageable despite the collapse in energy prices
  •  Another risk is that lower interest rates may increase financial instability if Canadian house prices begin rising at a faster clip
  • The Bank of Canada’s rationale for cutting the rate may stem from its more pessimistic growth forecast for 2015 compared to the consensus outlook. It reduced its growth forecast to 1.5% in first half of 2015 compared to a 2.5% pace in October
  • By way of comparison, the latest Bloomberg consensus forecast is for growth of about 2.5% in 2015
  • The rate cut will deliver short-term support to the economy; specifically, the weaker Canadian dollar will accelerate rebalancing of the Canadian economy towards non-energy exports and related business investment
  • The pass through of the depreciation into headline inflation will also help to offset downward pressures from the collapse in energy prices
  • The main risk for the Bank of Canada is that it could find itself in the awkward position of raising rates later in the year if Canadian growth turns out to be closer to the consensus forecast
  • The resulting policy uncertainty could also boost the volatility of the Canadian dollar and interest rates in the coming months

Global context

Various central banks around the world have been surprising global markets recently with unexpected rate changes.

  • Norges Bank in Norway lowered its key policy rate by 0.25% to 1.25% in December for the first time in almost three years
  • The Swiss National Bank last week cut its rate on sight deposits and reduced the target range for its key rate (the three-month Libor) to between –1.25% and −0.25%
  • The Bank of Japan has increased asset purchases and intends to continue quantitative and qualitative easing measures until the country hits its 2% inflation target
  • Bank of England policymakers voted to keep interest rates on hold this month after falling oil prices caused inflation in Britain to decline more than expected.
  •  The European Central Bank is expected to announce a program of large-scale government bond purchases (quantitative easing) designed to stimulate growth in the faltering eurozone

All of these central bank actions point to the U.S. Federal Reserve delaying its first interest rate hike, probably until late this year.

 

The Diversified Income & Growth (DIG) Basket: Q4 Update

 The DIG Basket closed out 2014 with a gain of 4.66%.  A rather disappointing result considering the Basket was up double digits for much of the calendar year but the late year selloff hit all sectors regardless of dividend quality.

 

Another year of positive returns is our main take-away and we do feel the DIG Basket is positioned extremely well for the year ahead.  

 For new clients and for those not familiar with DIG Basket, we provide some historical returns:

  • 2009 return of 41.51% versus the TSX Total Return of 35.05%.
  • 2010 return of 17.27% versus the TSX Total Return of 17.61%.
  • 2011 return of 6.35% versus the TSX Total Return of -8.71%.
  • 2012 return of 8.61% versus the TSX Total Return of 7.19%.
  • 2013 return of 16.33% versus TSX Total Return of 12.99%.
  • 2014 return of 4.66% versus the TSX Total Return of 10.55%

 

Compound returns have been very good.  Below are results as of the end of December 31, 2014:

•           3  year compounded average return of 9.76%, versus the TSX Total Return of 10.22%

•           4  year compounded average return of 8.90%, versus the TSX Total Return of 5.15%

•           5  year compounded average return of 10.52%, versus the TSX Total Return of 7.53%

 

We also wanted to highlight the risk-adjusted returns of the DIG Basket versus the TSX Total Return Index and the S&P 500 since January 2009.  Risk adjusted return is an important concept that refines an investment’s return by measuring how much risk is involved in achieving that return.  An ideal situation is when an investment has a lower standard deviation (volatility) but a higher return than what it is being compared to.  As you can see from the attachment, the DIG Basket achieved a higher rate of return than both indices with a lower standard deviation versus the TSX Total Return Index (its true benchmark) and a similar standard deviation to the S&P 500. 

 

Below is a snapshot of the current holdings.  The current annual cash flow is $507 for a yield of 3.25%.   

  image005.png@01D0371C.22944A20

 

We consider the DIG Basket a top pick for clients seeking income and growth and feel it is very appropriate for a portion of a client’s equity weighting.  The current value of one DIG Basket is approximately $15,600 making the minimum initial position approximately $31,200, which is two Baskets.  This amount will continuously change as the prices of the DIG Basket components do fluctuate.  Subsequent purchases can be made in one Basket increments.

 

2015Tax Reminders

  • 2015 TFSA contributions – contribution limit $5,500.00 can be made in cash or securities.
  • 2014 RSP contribution deadline – Monday March 2, 2015. The 2014 maximum RRSP contribution limit is 18% of “earned income” in 2013, to an annual maximum $24,270. The 2015 contribution limit is a maximum of $24,930.

 

Good news!  Tax slips are here!

Through our Online Documents Service, you can now elect to receive your 2014 tax slips electronically, as soon as they are issued! Enjoy easy, secure access to all of your account documents – trade confirmations, prospectuses, portfolio statements and tax slips – in one place!

How to adjust your delivery preferences:

  • Sign into our Online Services website by clicking on the “Client Access” button and select the Accounts tab, then the Electronic Documents option. It’s that simple!

Haven’t signed up for Online Services yet?

  • 1. Go to nbfwm.ca
  • 2. Click on the “Client Access” button
  • 3. Click on the “Sign up for Online Services” link at the top of the page
  • 4. Follow the instructions and submit

 

Retirement Corner

1)     “Should You Give TFSA Money to your Adult Children?” (Financial Post) 

2)     “ Why Some People Keep Working at 65” (Financial Post)

 

 Week at a Glance

 (See attached Week at a Glance report

 Week At A Glance 

Reads of the Week

  •   NBF Hot Charts  Canada: Record CAD depreciation offers hope for earnings (See attached report) The Canadian dollar is already hovering near a multi-year low of 80 cents U.S. and many investors continue to call for continued weakness. While a small depreciation might still be possible – we see the Bank of Canada cutting the overnight rate by another 25 basis points this spring – we think that most of the drop is behind us. Keep in mind that the CAD has already depreciated by more than 20% in the past 24 months. As today’s Hot Charts show, a move of this magnitude is unprecedented. If oil prices stabilize and/or if the Federal Reserve was to delay the start of its tightening campaign (it wouldn’t be the first time that a central bank surprises markets in 2015), there is scope for some firming in the Canadian dollar. In the meantime, we note that the significant depreciation of the Canadian dollar over the past two years is starting to catch the attention of equity analysts. As shown, profit expectations for the S&P/TSX have become a lot less negative with the one-month change in earnings expectations showing the first sign of stabilization since the summer of 2014. (See attachment below for further information) 
  • Hot Charts

 

Economic Reports

 Monday January 26th  – None

Tuesday January 27th – U.S. Durable Goods Orders, U.S. New Home Sales, U.S. Consumer Confidence Index

Wednesday January 28th – FOMC Rate Decision

Thursday January 29th – U.S. Pending Home Sales, U.S. Initial Jobless Claims

Friday January 30th – Canadian GDP, U.S. GDP, U.S. Personal Consumption, U. of Michigan Sentiment

 

Earnings Reports

 Monday January 26th  – Microsoft, Texas Instruments

Tuesday January 27th – 3M Co, Amgen, Apple Inc, Caterpillar, Canadian National Railway, Lockheed Margin Corp, Metro, Open Text

Wednesday January 28th – CGI Group, Facebook, Methanex Corp

Thursday January 29th – Amazon.com, Canadian Oil Sands, Celgene Corp, ConocoPhillips, Potash Corp of Saskatchewan, Rogers Communications and Visa

Friday January 30th – Chevron, MasterCard

 

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