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Markets
This Week |
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Investment
Idea
Quiz
Our Portfolio
Market Highlights
Economic and Valuation Indicators
Behavioral Finance Indicators
Our Model Portfolios
Answer to the Quiz
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Question: What is the fastest growing investment segment?
Answer: Private equity - as many institutional investors are
gradually diversifying away from the traditional asset classes
(i.e. stocks, bonds and cash) and moving to alternative assets.
What
is private equity?
Private equity, unlike public equity, is
held privately and not traded on the public stock exchanges.
In comparison with public equity, private equity is less liquid,
subject to much less scrutiny by authorities, and offers about
a 3 – 7% higher return per year. Currently, the growth
of private equity, especially in emerging markets, is nothing
short of phenomenal. For instance, in 2005 private equity firms
raised an unprecedented US$21 billion in emerging markets, which
is 3.5 times the US$6.1 billion raised in 2004.
N.B. The alternative asset class is comprised of the following
4 segments: hedge funds, real estate, commodities and private
equity.
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Since inception, in terms of return,
the S&P 500 has outperformed our passive and conservative
60/40 portfolio. Last week, both the S&P 500 index and our
portfolio were largely unchanged.
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- This week, the US market had a change of heart. At first
it moved up strongly then it took a big dive last Friday
(Charts 2 - 3). Friday's employment data was a bit stronger
than expected with 211,000 new jobs however the previous month
number was revised down. Thus, the combined result was in
line with expectations.
 
Charts courtesy of StockCharts.com
- The US equity market has been stuck in a trading channel since January 2004. We believe there is an increased probability that, in the near term, the market will decline towards the lower band of the channel (Chart 4).
Please see our discussion in the Behavioral Finance Indicators section.
Chart courtesy of StockCharts.com
- The Canadian markets finished the week marginally up due to higher resource prices and strong macroeconomic fundamentals (Charts 5 & 6). The Canadian employment data was very strong with 51,000 new jobs added, and a corresponding unemployment rate of 6.3% (the lowest since 1974). The Canadian dollar has gained over 50 basis points on this news.
 
Charts courtesy of StockCharts.com
- Bond yields continue to go up (while bond prices decline) as increases in crude oil and other commodity prices add to inflation worries.
- It appears that economic recovery in Japan is gaining solid traction. The Bank of Japan's Tanken survey of business confidence shows significant improvements. In addition, the Nikkei index continues to set new highs.
- Americans are very optimistic by nature. More than 4 in 10 are somewhat confident they will have enough money to retire comfortably.
Sadly, more than half of Americans have less than $50,000 in their nest egg (excluding the value of primary residences estimated at $160,000).
Considering the insufficient safety net after retirement, many experts suggest having about 20 times the annual pre-retirement income set aside
to enjoy a comfortable retirement. The line-ups for lottery tickets are already forming.
- Despite not having even one mile of expressway 18 years ago, China now has the second most extensive highway network in the world, behind only the United States. The current Chinese industrialization is quite comparable with the situation in Western Europe after WWII. As a result of the Marshall Plan, Western Europe got a head start towards solid economic progress combined with a comfortable standard of living. We believe China is on its way to repeat the example set by Western Europe.
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The US economy continues its steady
course, albeit at a slower rate than that seen a couple of years
ago (Chart 7). The inflation rate is steadily rising but it is
still moderate by historical standards.
The ISM index is one of the best leading
indicators of US economic activity and is viewed as a swing factor
proceeding economic upturns and downturns (Chart 8). New orders
provide the forward read on production and employment. Currently,
the ISM index and new orders signal a continuation of economic
expansion.
The shape of the yield curve is often
a leading indicator of both economic activity and the stock
market. The current upward slope indicates the continuation
of economic growth.
View yield curve
The most common valuation measure for
equities is known as the P/E (price to earnings) ratio. Presently,
the S&P 500 is somewhat overpriced, but not too overpriced
at its current level of 18.12 (Chart 9). The current low inflation
rate environment is more supportive of higher valuations because
earnings are not reflecting a high inflationary component.
N.B. Our analysis focuses mostly on
the US economy, given its size and importance. Comparable Canadian
data can be found in the Statistics Canada and Bank of Canada
databases.
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(see
explanation)
It looks like the equity market may
be ready for a downturn in the short-term. The advancing/declining
line signals a divergence between prices and fundamentals, while
the majority of unsophisticated investors are showing a rising
degree of confidence. For an historical comparison, please look
at August 2005 on Charts 10, 11 and 12.
Please consider the following factors:
- Chart 10 - the divergence between prices (black line) and
the advancing/declining line (red line)
- Chart 11 - the confidence of small investors (as represented
by AAII, i.e., the ratio of bulls/bears is low) is rising
- Chart 12 - the declining put/call ratio indicates that
small investors are showing confidence that the market will
advance (red line)
Charts courtesy of StockCharts.com
and DecisionPoint.com
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Conclusions based on Charts 13 - 15.
Since inception,
the EFA (Morgan Stanley Index for Europe and Asia) has been
the best investment on a risk adjusted basis. Our High Risk
(80/20) portfolio has managed to surpass the almighty S&P
500 index. It is quite an achievement given that 84% of mutual
fund managers cannot outperform an index.
Note: The names/symbols
of securities are provided at the bottom of this section.
Conclusions based on Charts 16 -
18.
Since inception, the TSX has been
the best investment on a risk adjusted basis. It has surpassed
our three portfolios, which continue to deliver respectable
gains combined with a lower volatility.
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D is correct.
Private equity is rather illiquid since it cannot be quickly sold
on the stock market. In some forms of private equity
(e.g., venture capital) investors have to wait for more than seven
years before being able to liquidate the position.
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This Week.
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