I can see clearly now

“I can see clearly now”. Well that’s how the words of the song go. These days it’s very hard to see a clear path through this financial mess. There is so much information flying around from many sources. What to believe and what to disregard—that is the question. We have spent many hours digging for answers and looking for a road map to guide us out successfully. When we are being bombarded with opinions from well meaning and sometimes self-serving organizations, or individuals, it serves us well to look to the fundamentals of the situation. Here is what the facts tell us—

• There is no longer any doubt that the U.S. and global financial system is under significant strain, with painful economic implications. But it is neither the end of the world or the U.S. economy, nor is it unprecedented. The International monetary Fund recently released a paper on 124 banking crises in the past 27 years. There are some good lessons from Japan in the 1990s and the rest of Asia in 1997-98. Simply put, excessive lending results in bad loans that imperil financial institutions. As the weaker players fail, the stability of the financial system comes into question and the normal interaction between financial players and the economy grinds to a halt, further aggravating the situation. Ultimately, government must step in and recapitalize the banking system by removing the bad loans and providing the capital to restart the credit creation process, in order to grow the economy out of the economic slow-down. No one other than the government has the muscle needed to accomplish this task.

• Understandably, there is massive public outrage at the need for taxpayers’ dollars to solve the mess that the perceived fat-cat bankers created in the first place. However, the longer debt markets remain closed, the more innocent victims the credit crunch will claim. This is the reason for the urgency in policymaking by the U.S. Government. It’s important to remember that the U.S. created this problem; they must take the lead in fixing it and they are. Canada will benefit from this intervention…the U.S. taxpayers will foot the bill.

• Before this crisis is resolved there will be more U.S. bank failures (particularly small and mid-sized institutions) and likely more government action to inject capital into the system to ensure stability.

What do these events mean for Canadians? We’re in surprisingly good shape, all things considered. Concerns about the prospects for our commodities, such as oil and gas, are the main reason for the recent declines on the Toronto benchmark S&P/TSX index. We had a “commodity price bubble”, which has now burst. Yet the wider economy is doing well:

• Unemployment figures for Canada are near 30 year lows at 6.1%, with employment stable or growing in most sectors (with the exception of export-oriented manufacturing and forestry).
• After eight years of rising prices, the Canadian housing market is in the midst of a “soft landing”, very different from the 30%+ drops experienced in the U.S. market.
• The Canadian banking sector is sound, having, for the most part, resisted the U.S. sub prime loans offered to them. Canada’s banks must follow stricter rules and have a high level of regulatory scrutiny. While U.S. bank stocks are nose-diving, Canadian banks, while modestly down, have held their own and are rumoured to be considering purchasing ailing American financial institutions.
• Companies in Canada have relatively strong balance sheets; they have not over-borrowed to finance expansion.
• Canada is the only G-8 nation with successive federal budget surpluses over the past decade and is much better equipped to weather this financial storm.

We feel that it’s important to share with you what we’re doing. First, we believe that some of the best portfolio managers in the world are on our team. With that said, we continue to believe that when this crisis is behind us, that our “steady as she goes” approach will have been the correct choice. Therefore we’re staying invested in our properly diversified portfolios and continuing to “buy low”. We should not deviate from our investment philosophy which has been tested over time. In the face of all this bad news, it can be difficult to “stay the course”. History shows us that markets tend to recover before economies. When markets turn around, the recovery tends to happen very quickly.

As always, we are available to answer any questions.