This week, Bay Street veteran David Baskin paid a visit to another money manager in New York. The manager wanted to sell him on a strategy for a fixed-income fund, to be used by a pension plan that Mr. Baskin is involved with as a director.
It was quite a sales pitch. “He said his objective this year is not to lose too much money,” Mr. Baskin said. “That’s the best you can do. This is a poor schmuck with $50-billion worth of bonds.”
A slow economic recovery, vanishing inflation and central banks that have been flooding the world in money have conspired to keep interest rates at ultra-low levels for years. Government bonds look unattractive. The yields remain low – 10-year U.S. Treasuries pay just 2.7 per cent – and for those who can’t hold to maturity, there is the prospect of significant capital losses in the years ahead if growth, and inflation, heat up. (Bond prices move in the opposite direction of yields.) Many corporate bonds also look expensive.
“So what are you going to do with your money?” Mr. Baskin asks. For many investors, the only answer is stocks, baby. Since the great rotation has spun money out of bonds and into equities, the stock market has become the best game in town. U.S. equities in particular have staged a huge rally: The Standard & Poor’s 500 is up 24 per cent on the year, on course for its best year in a decade, and has now risen 162 per cent since hitting bottom in early 2009. All 10 major sectors are on course for double-digit gains this year, a feat matched only once before, in 1995.
But the stock renaissance has been a global phenomenon, if not quite a universal one. While investors soured on some emerging markets this year, European and Japanese benchmarks have soared. Despite weak commodity prices, the Canadian market has also made respectable gains, with the S&P/TSX composite index up 7.6 per cent so far in 2012.
If not for its heavy concentration of mining stocks, the TSX would be doing far better. Big companies such as Magna International Inc., CGI Group Inc. and Manulife Financial Corp. have soared. Bank shares are near record highs. Royal Bank of Canada recently broke through $100-billion in market capitalization – the first Canadian company to do so since Nortel Networks Corp. got caught in the great tech bubble.
The flip side of any great market rally, of course, is that it will inevitably end. The S&P 500 has now gone for more than two years without a correction of at least 10 per cent. “We know we’re going to have a ten-per-center. We have to,” Mr. Baskin said. Market watchers everywhere worry increasingly of asset bubbles and inflated valuations.
So does this bull market still have legs?
The breakout of U.S. stock averages to new record highs is due in large part to the unprecedented market influence of the U.S. Federal Reserve, which has forced money into equities by making fixed-income securities less attractive. That’s one of the effects of quantitative easing (QE) – the name for the bond-buying program the Fed uses to create new money to stimulate economic activity.
“This has been a central-bank-driven market,” said Lorne Steinberg, president and portfolio manager at Lorne Steinberg Wealth Management in Montreal. “It’s been all about forward guidance, making investors feel as comfortable as possible that rates will stay low for a very long time, so they’ll keep on taking risk.”
Quantitative easing is bringing about the reversal of some time-worn investing truisms in the process.
Traditionally, stocks would draw strength from improvements in the real economy. But the U.S. market is now in a counterintuitive situation: Stock prices rely, in part, on economic weakness to ensure the continuation of more Fed stimulus, said Don Coxe, chairman of Coxe Advisors LLP.
“For the first time in history … the last thing anybody wants is really big economic numbers, because the stock market couldn’t withstand it,” he said.
Ironically, he said, “for a bear market to come, what we need is for the economy to get strong enough that the Fed is forced to change its policies. As soon as we do that, we’re going to have a big selloff.”