Investment Commentary – September 2011

US Debt Ceiling 

In our view, the 2011 debt limit increase was a non-event, primarily fueled by warring political factions in Washington scrambling for votes in the next election. In fact, this was the 11th debt ceiling increase in the last 10 years. However, never before was the debt ceiling increase specifically linked to debt reduction as a condition and we do view the $2.4 trillion reduction over the next 10 years as a first step in the direction of sustainability. As well, although unwarranted, the S&P downgrade served as a wake-up call to US politicians who will hopefully start working together on reducing deficits as well as the debt.

As a result of the sovereign debt crises in Europe, confidence plunged the most since December 2008, which roiled markets and clouded growth prospects across the 17-nation Euro region. Combined with fears of a US led global recession, investors shifted considerable sums of money out of equities and into safe haven assets, such as Treasuries, gold, and the Swiss franc. Meanwhile, benchmark equity indices around the world accumulated losses of up to 20 percent or more from recent peaks.

Canada’s economy shrank in the second quarter for the first time since the recession ended two years ago.

Where to from here?

As a result of corrections in the stock market over the past few months, equities are at much lower valuations, not far above where they were in the market troughs seen in early 2009. The stock market has priced itself for a recession that has not yet occurred and many feel will not come to pass…..rather we have experienced slowing in economic growth that is typical of many past recoveries. Combine that with 80% of corporations in the S&P 500 reporting higher than expected earnings in the second quarter as well as having record levels of cash on their balance sheets. Also, bond rates are at or close to record lows and there is little to no inflation in the developed world. Therefore, we do not see a lot of downside to stocks, although volatility is likely to continue. Despite fears over US and European government debt levels, we are nowhere near a financial crisis like that experienced in 2008. If anything, prior financial crises and their subsequent resolutions lead us to believe that European and US governments will now be forced to balance their books over time in order to avert future crises.