April 4th, 2012 by Dan Richards, ClientInsights.ca

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Each quar­ter since 2008, I have posted a tem­plate for a let­ter to serve as a start­ing point for advi­sors look­ing to send clients a sum­mary of what’s hap­pened in the past 90 days; and the out­look for the period ahead.

Advi­sors have told me that they’ve got a great response to these quar­terly let­ters and the tem­plates rank among my most pop­u­lar arti­cles. This let­ter goes into more depth on global growth fore­casts than past tem­plates. If this is more detail than you think your clients will be inter­ested in you can eas­ily delete this section.

Just a reminder that if you’re going to use this let­ter, take the time to cus­tomize it and put it into your own words, so that it truly does rep­re­sent your point of view.

An overview of Q1 2012 mar­kets: Bernanke, Buf­fett and Siegel on the prospects ahead:

The first quar­ter of 2012 rep­re­sented the strongest start for the U.S. stock mar­ket since 1998; with Japan turn­ing in its best first quar­ter gains in 24 years. This was largely dri­ven by a reduc­tion of fears about an extremely neg­a­tive out­come in Europe, as well as stronger eco­nomic data in the U.S.

Of course, there are some for­mi­da­ble issues still to be addressed. This let­ter pro­vides per­spec­tive on some of these issues, and out­lines some thoughts on what we can expect for the bal­ance of 2012 and beyond. As part of that, I have tapped into recent com­ments from Ben Bernanke and War­ren Buf­fett, as well as Chris­tine Lagarde; man­ag­ing direc­tor of the Inter­na­tional Mon­e­tary Fund and the Whar­ton School’s Jeremy Siegel, today’s lead­ing mar­ket historian.

Before get­ting into their views, here’s a sum­mary of mar­ket per­for­mance in the first quar­ter, all in local cur­rency so as to exclude cur­rency fluc­tu­a­tions. Even with strong first quar­ter returns, most mar­kets with the excep­tion of the United States are under­wa­ter over the past 12 months. Its resource expo­sure has meant that Canada has been a par­tic­u­lar lag­gard over the past year.

					Emerg­ing	Global
	Canada	US	Europe	Japan	Mar­kets	Returns
Jan­u­ary	5%	5%	4%	4%	7%	5%
Feb­ru­ary	2%	4%	5%	11%	5%	5%
March	–2%	3%	0%	3%	–1%	2%
Q1 2012	5%	13%	9%	19%	11%	12%
Last 12 months	–11%	7%	–4%	1%	–4%	1%

The IMF’s view: A reduced fore­cast for global growth:

The sin­gle fac­tor that more than any other will drive stock mar­kets over the mid-term is the path of global eco­nomic growth; Europe in par­tic­u­lar remains a ques­tion mark. In early Jan­u­ary, the Inter­na­tional Mon­e­tary Fund reduced its fore­cast for global growth, and pre­dicted that con­ti­nen­tal Europe would see a mild reces­sion in 2012. Here are excerpts from the IMF’s Jan­u­ary fore­cast for eco­nomic growth:

Eco­nomic Growth:

	Actual		Projections		Changes from Sept 2011 forecast
	2010	2011	2012	2013	2012	2013
World out­put	5.20%	3.80%	3.30%	3.90%	–0.70%	–0.60%
Advanced economies	3.20%	1.60%	1.20%	1.90%	–0.70%	–0.50%
Emerg­ing economies	7.30%	6.20%	5.40%	5.90%	–0.70%	–0.60%
Canada	3.20%	2.30%	1.70%	2.00%	–0.20%	–0.50%
United States	3.00%	1.80%	1.80%	2.20%	0.00%	–0.30%
Euro area	1.90%	1.60%	–0.50%	0.80%	–1.60%	–0.70%
China	10.40%	9.20%	8.20%	8.80%	–0.80%	–0.70%

Bernanke & Lagarde: Sign of improve­ment … but efforts must continue:

Since this fore­cast was released in Jan­u­ary, actions by global gov­ern­ments have changed the Euro­pean out­look for the bet­ter. Indeed, it was greater opti­mism about a res­o­lu­tion to Europe’s issues that fueled the first quarter’s strong mar­ket performance.

There is still much work to do, how­ever. March 20^th fea­tured a press con­fer­ence by Chris­tine Lagarde, Man­ag­ing Direc­tor of the Inter­na­tional Mon­e­tary Fund and, for­merly Finance Min­is­ter in France. She painted a more pos­i­tive but still cau­tious pic­ture. Here’s how her remarks began:

“In terms of global eco­nomic out­look, we are cer­tainly not, and I do say not in as bad a sit­u­a­tion as we were only three months ago; and there have clearly been some sig­nif­i­cant improvements.”

“Cou­pled with an uptick com­ing out of the United States of Amer­ica, it gives an over­all pic­ture (for Europe) that is slightly more pos­i­tive than it was three months ago; not to say that all the dif­fi­cul­ties have been cleared. If I have one mes­sage, it’s that the reforms and the efforts under­way in advanced economies have to con­tinue and that the same vig­or­ous rigor has to be applied by Gov­ern­ments in the pro­grams and the efforts that they have undertaken.”

The very next day, Ben Bernanke spoke to the House Com­mit­tee on Over­sight and Gov­ern­ment Reform about the Fed­eral Reserve Board’s views on Europe. He pointed to improve­ment in Europe and focused on three pos­i­tive steps on the con­ti­nent to increase sta­bil­ity. He also dis­cussed favourable results of stress tests of banks in the event of a severe pull­back in the U.S. economy.

But his clos­ing com­ments echoed Chris­tine Lagarde’s note of cau­tion about the need for fur­ther action to address Europe’s struc­tural issues:

“The recent reduc­tion in finan­cial stress in Europe is wel­come given our impor­tant trade link­ages. The sit­u­a­tion how­ever remains dif­fi­cult and it’s crit­i­cal that Euro­pean pol­icy lead­ers fol­low through on their com­mit­ment to achieve a last­ing sta­bi­liza­tion. I believe our Euro­pean coun­ter­parts under­stand the chal­lenges they face and they’re com­mit­ted to take the nec­es­sary steps to address those issues.”

Should you be inter­ested in watch­ing them, here are links to the com­ments from Ben Bernanke (CLICK HERE) and Chris­tine Lagarde (CLICK HERE).

Also, you can CLICK HERE to go to the IMF’s most recent global growth forecast.

From my own point of view, it’s worth not­ing that given Euro­pean issues and a slow­down in China, there is broad con­sen­sus that the next five years will see “2, 6 and 4” growth; an aver­age of 2% in devel­oped coun­tries, and 6% in emerg­ing economies, lead­ing to 4% global growth over­all. It’s this diver­gence in growth between devel­oped and emerg­ing coun­tries that is dri­ving increased focus by multi nation­als on faster grow­ing emerg­ing economies.

War­ren Buf­fett: “America’s best days lie ahead:”

In the face of chal­lenges for devel­oped economies, there is a per­sis­tent view of Amer­ica as an “empire in decline.” This was rein­forced by last year’s down­grade of US debt and by the stale­mate in Con­gress over deal­ing with America’s deficit and debt challenges.

As I look at for­mu­lat­ing rec­om­men­da­tions for my clients, I don’t sub­scribe to the view of a declin­ing Amer­ica. With­out dis­miss­ing its issues, the biggest com­pet­i­tive advan­tage for United States is its vital­ity and capac­ity for change and inno­va­tion. It con­tin­ues to dom­i­nate in high tech, and remains a mag­net for the best and bright­est tal­ent from around the world.

I’m not alone in this view. Here’s an excerpt from War­ren Buffett’s annual let­ter to investors released in Feb­ru­ary:

“In 2011, we will set a new record for cap­i­tal spend­ing, $8 bil­lion and spend all of the $2 bil­lion increase in the United States. Money will always flow toward oppor­tu­nity, and there is an abun­dance of that in Amer­ica. Com­men­ta­tors today often talk of “great uncer­tainty.” But think back, for exam­ple, to Decem­ber 6, 1941, Octo­ber 18, 1987 and Sep­tem­ber 10, 2001. No mat­ter how serene today may be, tomor­row is always uncertain.”

“The prophets of doom have over­looked the all-important fac­tor that is cer­tain: Human poten­tial is far from exhausted, and the Amer­i­can sys­tem for unleash­ing that poten­tial, a sys­tem that has worked won­ders for over two cen­turies; despite fre­quent inter­rup­tions for reces­sions and even Civil War remains alive and effec­tive. We are not natively smarter than we were when our coun­try was founded, nor do we work harder. But look around you and see a world beyond the dreams of any colo­nial cit­i­zen. Now, as in 1776, 1861, 1932 and 1941, America’s best days lie ahead.”

You can read War­ren Buffett’s full let­ter to investors HERE.

A long term per­spec­tive on valuations:

While eco­nomic growth enables long term increases in cor­po­rate prof­its as a whole, in the short and mid-term we have to pay a fair value for the com­pa­nies we buy. Any­one who invested at the peak of the U.S. mar­ket val­u­a­tions in 2000 learned a hard les­son about the per­ils of los­ing focus on what we pay for a dol­lar of earnings.

There are few more hotly debated issues on Wall Street than whether today’s mar­ket is over­val­ued, under­val­ued or priced just right. In look­ing at all the avail­able data, my own con­clu­sion is that the mar­ket is roughly fairly valued.

That’s not to say it doesn’t face some speed bumps in the period ahead. But I was inter­ested to see a March 29 inter­view with Jeremy Siegel of the Whar­ton School. Author of Stocks for the Long Run, which exam­ined almost 200 years of mar­ket data, in this inter­view Siegel looks at his­tor­i­cal prece­dent; and sees sig­nif­i­cant upside poten­tial at today’s stock val­u­a­tions. To see his inter­view, CLICK HERE.

What this means for your portfolio:

While all port­fo­lios are cus­tomized to clients’ spe­cific needs, there are three guid­ing prin­ci­ples to the advice that I offer.

1. The first relates to the allo­ca­tion between stocks and bonds, and comes from Ben­jamin Gra­ham; the Colum­bia pro­fes­sor who was War­ren Buffett’s teacher, and who is con­sid­ered the father of value invest­ing. In a recently dis­cov­ered 1963 talk, Gra­ham had this to say on asset allocation:

“In my nearly fifty years of expe­ri­ence on Wall Street, I’ve found that I know less and less about what the stock mar­ket is going to do but I know more and more about what investors ought to do. My sug­ges­tion is that the min­i­mum amount (of the investor’s) port­fo­lio held in com­mon stocks should be 25% and the max­i­mum should be 75%. Con­se­quently the max­i­mum amount held in bonds would be 75% and the min­i­mum 25%; any vari­a­tions should be clearly based on value considerations.”

2. The sec­ond prin­ci­ple relates to, bar­ring a sig­nif­i­cant change in cir­cum­stances, stick­ing within the invest­ment frame­work that we’re decided upon.

Some of you may recall my advice in early 2009, as we faced what appeared to be an end of the world sce­nario and some stocks hit lows they hadn’t seen in 20 years. At that time, I urged clients to main­tain a core level of equity expo­sure. Recently, I have had ques­tions from clients about increas­ing equity weight in port­fo­lios, given low inter­est rate and strong stock per­for­mance in the first quarter.

While I am always happy to dis­cuss this on a case by case basis, given the level of uncer­tainty that still exists, I gen­er­ally advise against increas­ing equity allo­ca­tion from the level that we had going into 2012.

3. The final prin­ci­ple relates to the role of cash flow from invest­ments. In an uncer­tain envi­ron­ment for eco­nomic growth and equity returns, we con­tinue to place pri­or­ity on the cash yield from invest­ments. In my view, the returns on some REITs, cor­po­rate bonds and div­i­dend stocks in selec­tive sec­tors con­tinue to make these attrac­tive rel­a­tive to the avail­able alternatives.

Should you have any ques­tions on any­thing I’ve cov­ered in this note or on any other issue, please feel free to con­tact myself or one of the mem­bers of my team directly. And as always, thank you for the oppor­tu­nity to serve as your finan­cial advisor.

About ClientInsights.ca A breakthrough in client communication Not long ago, clients read what you sent them. Today that's changed. In the You Tube world we live in, many investors would prefer to hear from a portfolio manager directly. And instead of reading an article on tax saving or estate planning strategies, more and more Canadians would rather watch an expert discuss the topic. Clientinsights.ca was developed in response to these changes - to deliver information in the form that investors want to receive it. It provides over 150 short video interviews, each about 4 to 6 minutes - you can email them or watch a video along with clients to start a meeting. No matter how you use it, Clientinsights.ca is designed to help you take client communication to a higher level. Dan Richards Founder and CEO, Clientinsights.ca Read more from the author/contributor here.

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Tags: 24 Years, Ben Bernanke, Christine Lagarde, Currency Fluctuations, Economic Data, First Quarter, Global Growth, Growth Forecasts, Historian, International Monetary Fund, Jeremy Siegel, Leading Market, Managing Director, Market Performance, Negative Outcome, Outlines, Quarterly Letters, U S Stock Market, Warren Buffett, Wharton School
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