COUNSELLOR QUARTERLY 1PRESIDENT’S MESSAGEThe past quarter has seen continued positive returns and large flows of investmentsinto equity markets in the developed world, in spite of mixed economic signals.In the U.S., the fiscal cliff is still not fully resolved, however, the risk has been diminished. In addition,with the U.S. housing crisis fading and employment improving, we have left our forecast for the U.S.unchanged. In Canada, lower commodity prices, a strong dollar and a weakening housing market haveresulted in a continued downward trend in the economy.In Europe, while the intensity of the crisis has been reduced, the region remains weak and we havereduced our outlook here. China and Japan, on the other hand, are showing some positive signs. Chinahas managed a soft landing for its economy, and Japan, after many years of negative growth, is showingpositive signs for growth in 2013 and 2014.With the muted economic outlook, we expect inflation to remain subdued and, therefore, interest ratesin the short term should also remain stable. The caution here is that yields are at historically low levelsand we expect central banks may begin raising short-term rates in 2014. I encourage you to read a morein-depth analysis from RBC Global Asset Management (RBC GAM) Chief Investment Officer DanChornous and Chief Economist Eric Lascelles.However the markets may behave, sound investment management is timeless. With this in mind,I am pleased to introduce a new investment manager. Following a rigorous investment managersearch process conducted by the RBC Global Asset Management manager research team, I am pleasedto announce that Guardian Capital LP (Guardian) has been appointed sub-advisor for our CanadianGrowth Equity mandate. Based on the portfolio manager’s depth of knowledge and experience inCanadian stocks, and the mandate’s sound investment process, strong historical performance and abilityto outperform in different market cycles, we believe that Guardian will be a complementary addition toour existing Canadian equity offering.In recognition of our approach to investment management, our award-winning fund families wereonce again recognized at the 2013 Lipper Fund Awards. Combined, Phillips, Hager & North InvestmentManagement and RBC GAM have been recognized as Best Funds Group overall for six of the past sevenyears and Best Bond Funds Group for the past seven years.The greatest acknowledgment we can receive for our work, however, comes not from our peers but from ourclients. In May you will receive our bi-annual client survey conducted by independent survey firm CorporateInsights. These surveys are essential in helping us to understand and exceed your expectations, and we lookforward to your feedback.Your personal information and responses will remain strictly confidential.I’d like to thank you for your continued trust and loyalty. If you have any questions when you receive yourclient survey, or any concerns about your relationship with RBC PH&N Investment Counsel, yourInvestment Counsellor will be pleased to speak with you.Sincerely,VIJAY PARMAR, CAPRESIDENT
2 RBC PH&N INVESTMENT COUNSELCONTINUING PROGRESS TOWARD SUSTAINED RECOVERYThe global economy continues to heal and riskappetite around the world appears to be reviving.Global PMIs have swung higher and leadingindicators point to decent economic prospectsin the coming months. The U.S. housing crisisis now behind and employment is improving,albeit slowly.While economic momentum has flattened out in recent weeksand the post-fiscal-cliff rebound in consumer and businessconfidence has been more subdued than we had hoped,investors appear to be looking past the immediate threats andfocusing on the many positive developments that haveoccurred since the financial crisis, laying a base for sustained,balanced growth in the future. Headwinds remain and thereare still many hurdles to overcome before the global economyis fully stabilized, but significant progress has been made.HEALING CONTINUESOur basic economic thesis remains unaltered. The globaleconomy is still destined for slower-than-normal growth, butbeneath the surface, the beginning of an upward trend maybe starting to form. The largest downside risks have arguablyshrunk over the past year: the intensity of Europe’s crisis haseased, China has engineered a soft landing and U.S. politicaldysfunction has diminished somewhat. We have adjusted oureconomic forecasts for 2013. The Eurozone and U.K. outlookshave again shifted lower, reflecting the enduring nature of theweakness in these regions. The U.S., Canadian and emerging-markets basket of forecasts have held firm. Consensusexpectations have moved in a broadly similar fashion to our own.The theme of healing is of central importance around the world,but this is particularly true in Europe. Current-account deficitsare shrinking, signalling greater self-sufficiency in Europe’speriphery. Many countries have made significant progress inreducing their budget deficits. However, public support for theseinitiatives has always been fragile, and the inconclusive Italianelection demonstrates what can happen when austerity becomestoo painful. These events have triggered a renewed sense ofuncertainty in Europe. Still, while only in the early stages ofrehabilitation, Europe has made measurable progress towarda sustained recovery.The words “Japan” and “exciting” have not often gone togetherover the past two decades, despite the country’s status as theworld’s third-largest economy. That could be about to changewith the newly elected government leaders making sweepingcommitments to spur Japanese growth. These actions shouldmaterially boost Japanese economic growth in 2013 and 2014.We have pushed our Japanese outlook significantly higher toreflect this new stimulus.INFLATION REMAINS TAMEIn a period of slow economic growth, few wage pressuresand steady commodity prices, global inflation is unlikelyto rise particularly quickly. Economic theory suggests thatinflation should begin to edge up over time as economicslack is absorbed. However, we don’t think this will havean overwhelming effect in the near-term and inflationwill remain subdued over the forecast horizon.PUBLIC DEBT NOW IN FOCUSIn stark contrast to diminishing global risks and healingeconomies, global public-debt loads continue to rise in thedeveloped world. Fortunately, policymakers are now turningtheir attention to serious debt reduction. Governments arebeginning to take decisive steps to reduce their debts andthis bodes well for long-term economic growth prospects.That said, debt loads will take many years to decline tomore reasonable levels, and this makes nations vulnerableto economic shocks along the way.BY DANIEL E. CHORNOUS, CFACHIEF INVESTMENT OFFICERRBC GLOBAL ASSET MANAGEMENTMARKET COMMENT
COUNSELLOR QUARTERLY 3DOLLAR BOTTOM IS BROADENINGThe cycle of U.S. dollar strength is unfolding as we expected.What started as safe-haven flows into the dollar due to theEuropean crisis a couple of years ago has evolved into supportfor the U.S. dollar based on an economic recovery and relativemonetary policies. There is tentative evidence of a gradualshift towards a positive equity/dollar correlation and it lookslike the dollar base is broadening against more currencies.That’s the nature of broad currency trends – the bouncingalong the bottom for the index happens as individual troughsare established. We continue to work with the base assumptionthat the rocky bottom will eventually resolve into a meaningfuluptrend, and our 12-month forecasts reflect this.RISE IN YIELDS LIKELY TO BE GRADUALCentral banks are probably far from tightening, and in somecases even have more stimulus to deliver. The short end ofthe bond market should thus remain anchored by stimulativecentral banks. The long end of the yield curve is always moredifficult to predict. Yields remain at unsustainably low levels,and as risk appetite increases bond yields should beginto rise. However, there are distinct limits to how high bondyields can rise in the near term. In addition to the obviousconstraints of sluggish growth, moderate inflation and lowcentral-bank rates, we must not forget that a key reasonfor the global recovery is the very existence of ultra-lowborrowing costs. Just as rates were managed lower by centralbanks, we expect they will be managed higher as well.STABLE EARNINGS GROWTH, REASONABLE VALUATIONSEquities have continued to rally in the first quarter of 2013and we have seen large equity inflows for the first time inmany quarters. It appears that the market has begun to lookpast the various macroeconomic headwinds and is nowfocusing on an economic recovery that is gaining traction.Investors are recognizing the stability of the U.S. economyand are no longer reacting solely based on concerns relatedto other regions. Corporate profit growth has been the maindriver of index gains, as companies have proven themselvescapable of stretching profit margins ever wider, even in atough operating environment. But in an era of sluggisheconomic growth, further stock-market gains are now morelikely to come from shifting investor behaviour than surgingearnings. As the economy continues to heal, we expectvaluations to gradually move higher, pulling the equitymarket up with it.In Japan, the world’s third-largest economy, newly elected leaders are making sweeping commitments to boost Japaneseeconomic growth in 2013-14.
4 RBC PH&N INVESTMENT COUNSELAROUND THE WORLD IN 80 SECONDSA = Actual, E = Estimate, F = ForecastSources: RBC Global Asset Management Inc., RBC Dominion Securities Inc., RBC Economics.ECONOMIC & CAPITAL MARKETS FORECASTSCHIHCHINAAH NAReal GDP 2012A 7.80% | 2013E 8.00%ea 2 2GDPReReal GDP 20112A 7.80% |ea 2 7 %80%CANADAReal GDP 2012A 2.00% | 2013E13013E 1.75%1.75%3E 1.S&P/TSX Composite February 2013 12822 | February 2014F 1301301ruaruaruruary 2013 1282822 | February 20 3000020rua2 | F3 12ry 2 Feb01USD–CAD February 2013 1.03 | February 2014F 1.00014a201 F 1.0013 1.03 | Febrbruary 2014F 1.066.06014ruar| F3 1.201 .0Fe13Overnight rate February 2013 1.00% | February 2014F 1.25%1.2ebruu 1.25%ruuary 2013 1.0000% | February 202014F 1.25%1200%013ary 4F 10%y10-year bond February 2013 1.84% | February 2014F 2.50%F 2ebru ebuuary 2013 1.8.84% | February 2y 2014F 2.50%%y 2Fe.8401ary Fe2UNITED KINGDOMMKINIUNITED KReal GDP 2012A 0.00% | 2013E 1.00%0%20A 0DPR DP 2012ARRe l GDP 201 AARFTSE 100 February 2013 6361 | February 2014F 6475br 116ua10 uary 2013 6361 | February 4F 6475GBP–USD February 2013 1.52 | February 2014F 1.47b 013bru–UBase rate February 2013 0.50% | February 2014F 0.50%eb 013rue rBase %%10-year gilt February 2013 1.97% | February 2014F 2.50%| F| F 2 0%01Feyear gilt Febr 0%0UNITED STATESTDE TEE TATATATReal GDP 2012A 2.20% | 2013E 2.25%%130A12 20132A 0% | 2013E 2.210 013S&P 500 Index February 2013 1515 | February 2014F 160002FuFx 1515 |Feb y 20133 1511 15USD–CAD February 2013 1.03 | February 2014F 1.064Fruy 2uru ruary 201ry 2ru 2013 1.033 | F| ebruru1.Fed funds rate February 2013 0.25% | February 2014F 0.25%25yuaebFe ary 2014F 0.25%eb ary 2013 0.225% | Fe%1ry 2010-year bond February 2013 1.87% | February 2014F 2.50%0%yryrubrruary 2013 1.87%% | Februar|313 1.87DOW HITS RECORDCOCORD HIGH AMIDDHDD HIGUNDERLYING MOMENNOMMMMEEENTUMMN MAlthough the growth rate was the slowest since the ﬁrst quartere shee slowest since the ﬁrst quaquarterue twe the ﬁrst quartsloof 2011, consumer spending expanded at 2.1%, suggesting thatndannded at 2.1%, suggesting tgsatnd d at 2.momentum in the economy continues to build. In early March,Maesses to build. In early MaMIno be ld. In early Mues tothe Dow Jones Industrial Average surpassed its previous recordco dedsed its previevd ited its peeedhigh set before the ﬁnancial crisis in October 2007, and closededan20 7, and close200700at a new all-time high of 14,253 – well ahead of the standardndtandardrecovery period of 78 months.FOR ITALY, IT’S LA DOLCE FAR NIENTEConfronted by the worst recession in their country since the 1930s, almost25% of the Italian electorate skipped the February 2013 general elections – apost-war record.BANK OF CANADA CAUTIOUS CANADIANSEconomic growth stagnated in the fourth quarter as GDP grewat a mere 0.6% annualized pace, with companies scaling backinventories and a decline in economic output led by manufacturersand retailers.The Bank of Canada (BoC) kept its key overnightlending rate at 1%, warning that high household debt levels are thes are thees are thtvels aevels arelargest risk facing the country’s economy.EUROPEAN UNIEEURUROPEEAN UUEU N UNIONNIONN NNReal GDP 2012A (0.50%) | 2013E (0.75%)RReall GDDP 2012A 0.50%Real A 0.50 ) | 2013E (0.75%0 50 | 2013E (0.775%00 0.7MSCI Europe February 2013 1483 | February 2014F 1650MSCI uro e Fe ruar 2ope F rEurope February 2012013 1483 | Februur 2013 1483 Feeb13 Fe ruEuro–USD February 2013 1.31 | February 2014F 1.20uro US Feb uary 01uro–USDUS February 2013 1.3131 | February 20U 13 311 | bruu ry 2US 3 1 u 20Eurozone policy rate February 2013 0.75% | February 2014F 0.50%E oz e p icy FFebcy rate February 202013 0.75% | Fecy e F uary 013 75% | FFeb 0 |Germany 10-year bund February 2013 1.45% | February 2014F 2.00%G ma 10- Fyearr bub nd February 202013 1.45% | Fr b d Fe ary 13 45% | Far bun 20 %JAPANJAPANReal GDP 2012A 1.90% | 2012E 1.75%a 01 0%0% 20012A 1.90 201% | 20120Nikkei February 2013 11529 | February 2014F 12250ik ru 01Nikkei Feb 13 11USD–JPY February 2013 92.53 | February 2014F 95.00US F uarP FFeebruruOvernight call rate February 2013 0.10% | February 2014F 0.10%O ghOvern ght ca10-year bond February 2013 0.66% | February 2014F 1.25%100.YEAR OF THE SNAKE STARTS OFF SLUGGISHYEAR OF TTHE SNAKE STTARTS OFF SSLUGGISHAR S ST OF U SHKE STAR UGGShanghai fell 1.0% ahead of key economic data releases. Factory growthS s FFs. Fhanghai fell 1l 1.0% ahead of keeyy economic ddaata releasesfe e e c el sghai fell 1.0% ahea dataslowed to multi-month lows as sluggish domestic demand was added tos manl maowed toto multi-month lowss aas sluggish domomestic demm th slu o cish do mman already depressed foreign demand. The Nikkei closed up 0.3% aftera seseedednn alalready depressed foreigeign demand. Thhe Nikkei clod fo m e idemand i cloparing gains in reaction to the Bank of Japan’s decision not to pursuep c onec naring gains in reactionn to the Bank of JaJapan’s decisionns on an a ceactionon to th s dec nnfurthefffurthrther easing at thiiss point.in pother easing t
COUNSELLOR QUARTERLY 5GLOBAL ECONOMYREVIVING RISK APPETITEIn contrast to the economic improvementscelebrated in the previous edition of CounsellorQuarterly, the past quarter was more mixed.Economic momentum has flattened out, andit is inescapable that output in the world’s majordeveloped nations declined in the final quarterof 2012. The post-fiscal-cliff rebound in U.S.consumer and business confidence is proceeding,but more gingerly than hoped given higher taxes,rising gasoline prices and several remainingpolicy hurdles.To be sure, there is still much that is going right. Japan isimplementing bold policy remedies that might just awaken itfrom two decades of economic slumber. The decline in existentialrisks is spurring a revival of risk appetite, and the much-fearedU.S. fiscal cliff was mostly deflected at year-end. Leadingindicators point to decent economic prospects for the comingmonths, and the stock market has given its clear approval.As a result, our basic thesis remains unaltered. The globaleconomy is still destined for slower-than-normal growth,mainly because fiscal authorities are trying to disentangle theircountries from large deficits. But beneath this, the beginningof an upward trend may be starting to form. The U.S. economyis healing and is now capable of generating additional growth.Europe, while only in the early stages of rehabilitation, hasmade measurable progress. Risk appetite is reviving, withpositive consequences for growth and markets.BY ERIC LASCELLESCHIEF ECONOMISTRBC GLOBAL ASSET MANAGEMENTRECONCILING CONTRADICTIONSThe first order of business is to reconcile the apparentcontradiction between leading indicators that point to decenteconomic growth with fourth-quarter GDP that shrank in theEurozone, the U.K., Japan and – most surprisingly – left U.S.output basically flat.Normally we would be inclined to take GDP as the better arbiterof economic health, but in this case leading indicators appearmore trustworthy. Certainly, the Eurozone is in recession, and itseconomic figures are a fair reflection of that. But the U.K. andJapan – for all of their flirtations with recession – are probably ona trajectory of slow growth once the quarterly wiggles have beensmoothed out (and as prophesied by leading indicators).The fourth-quarter U.S. GDP figure was the big surprise.However, it is likely an outlier. Revisions have turned what wasinitially a slight negative into a slight positive. Moreover, muchof the remaining weakness was temporary. Inventories exerted adrag, likely because of the dampening effect of Hurricane Sandyon production. This should shortly turn into a tailwind as thoseeffects reverse. Military procurement was exceptionally weak,and while some part of that may persist as the U.S. winds downits overseas military commitments, the extent of the drop wasunusually sharp. The U.S. economy is almost certain to reboundwhen the next quarterly figure is published.DIMINISHED SEASONALITY TO COME?Seasonal trends have played an unusually large role in economicstatistics over the past three years, with economic data strongerin the winter and weaker in the summer. Explanations for thisinclude distortions to the seasonal adjustment factors arisingfrom the economic collapse of 2008-2009 and/or a subsequentpattern of warm winters and sweltering summers that tiltedconstruction toward the winter months.We anticipate a diminished seasonal trend this year for fourreasons. First, these patterns are simply not supposed to existand could vanish just as mysteriously as they appeared. Second
6 RBC PH&N INVESTMENT COUNSEL(and relatedly), lingering seasonal trends are absorbed by themodel over time, eventually snuffing out any visible pattern.Third, this winter has not been as warm as last year’s. Fourth,initial readings for 2013 have already adhered less closely tothe usual seasonal trend.To be clear, we still suspect that this spring and summer willexhibit weaker activity than the winter, and this could inducea temporary dip in confidence and perhaps even markets.Economic momentum has already flattened out. But thesubsequent softening may be less obvious than in past years,and it is important to keep in mind that growth has alwayssubsequently returned (Exhibit 1).MIXED BAG OF FORECASTSIn response to these developments, we have adjusted oureconomic forecasts for 2013 (Exhibit 2). The Eurozone andU.K. outlooks have again shifted lower, reflecting the enduringnature of the weakness in these regions. The U.S., Canadian andemerging-market basket of forecasts have held firm. Meanwhile,we have pushed the Japanese outlook significantly higher toreflect new stimulus.Consensus expectations have moved in a broadly similar fashionto our own. Relative to the consensus, we nonetheless look for astronger U.S. and Japan, and relative weakness in the Eurozoneand emerging markets.This report marks the introduction of our 2014 forecasts.Most estimates are informed by our knowledge of long-termsustainable growth rates, overlaid with the expectation thatgrowth will begin to rebound given ongoing healing and theeventual abating of fiscal drag. Supporting this narrative ofmoderate improvement, financial conditions have becomefavourable, and excess liquidity signals further growth.EXISTENTIAL RISKS HAVE SHRUNKThe identification of tail risks is no less important than thegeneration of base-case economic forecasts. The largestdownside risks have arguably shrunk over the past year: theintensity of Europe’s debt crisis has eased; China has engineereda soft landing; and U.S. political dysfunction has diminishedsomewhat. Each is being bled of its venom while simultaneouslybecoming less likely to bite.Of course, there are always new risks. A steady drip of electionsover 2013 brings an element of uncertainty, especially in abeleaguered Europe where the need for political consistencyis greatest. Unfortunately, the deadlocked Italian election hastriggered a renewed sense of uncertainty in Europe. Socialunrest is significant across Europe, the Middle East and NorthAfrica. Separatist movements are on the march in Catalonia andScotland. Geopolitical risk percolates in Syria and Egypt, andelevated frictions exist between Iran and the West, Israelis andPalestinians, and China and Japan. A nuclear test in North Koreaand accusations of Chinese cyber-sleuthing add to the clamour.Natural disasters constitute a perpetual unknown. These sortsof developments rarely exert a tangible presence on the globaleconomy or markets, but they could.Exhibit 1: 2013 U.S. Quarterly ProfileSource: RBC GAMPOLICYUNCERTAINTYSANDYREBOUNDSEASONALITY Q1 Q2 Q3 Q4REBOUNDFROMQ4 GDPExhibit 2: RBC GAM GDP Forecast for Developed MarketsSource: RBC GAM2.25%1.75% 1.75%1.0%-0.75%2.75%2.0%1.25%1.5%0.5%-1.0-0.50.00.51.01.52.02.53.0U.S. Canada Japan U.K. EurozoneAnnualGDPGrowth(%)2013 2014
COUNSELLOR QUARTERLY 7REVIVING RISK APPETITERisk appetite appears to be reviving around the world givendeclining perceptions of risk. This can be seen in narrowingcredit spreads and lower expected volatility in financial markets.It also shows up in declining correlations across asset classesand between individual stocks.The revival of risk appetite is an important development.In an era of sluggish economic growth, stock-market gains(and bond-market losses) are more likely to come from shiftinginvestor behaviour than surging earnings. Already, investorsare beginning to show a greater thirst for equities. Continuedimprovement in risk appetites will be critical in determiningthe performance of financial markets over the coming year.HEALING CONTINUESThe theme of healing remains of central importance. In anera when sluggish economic growth casts a sickly pallor, itis important to acknowledge the mending of bones occurringbeneath the surface.The U.S. housing market continues to surge, and appears tohave additional upside left in it. Credit is flowing again, andeven hiring has pushed higher in workmanlike fashion. Thesethree variables are particularly important: the first was the rootof the financial crisis, and pullbacks in the latter two had themost devastating consequences.Europe, too, can now begin to claim some healing afterpolicymakers took a scalpel to the gangrenous debt that afflictsthe continent’s periphery. The restorative effects are bestdemonstrated by the remarkable decline in Spanish bond yields.Competitiveness is rebounding, albeit with some distance to go.Current-account deficits are shrinking, signalling greater self-sufficiency in Europe’s periphery. Many countries have madesignificant progress in shrinking their budget deficits (Exhibit 3).Even the run on Greek and Spanish banks seems to have faded.However, public support for these initiatives has always beenfragile, and the February 25 Italian election demonstrates thegridlock that can result when austerity becomes too painful.The Cypriot election reassures that pro-Europe candidatesstill have at least a chance at the polls, though it also remindsus that the era of bailouts is not quite over.EUROZONE RECESSION PERSISTSOne must distinguish between the progression of the Eurozone’sdebt crisis and the erosion of the region’s economy. Whereas thedebt crisis has ebbed, the economy is still shrinking. In fact, therate of GDP decline in the fourth quarter of 2012 was the worstsince 2009 (Exhibit 4).This gulf can be reconciled in two ways. First and mostimportantly, the economy has tended to lag developmentsin the sovereign-debt crisis. For instance, it took a year for theEurozone to descend into recession after the debt crisis struck.Exhibit 3: Significant Fiscal Tightening Done, but More to GoNote: Numbers shown are reductions in budget deficits during the time periods.Structural balances from 2012 to 2017 are IMF forecasts. Source: International Monetary Fund, Haver Analytics, RBC GAM3.014.15.24.184.108.40.206.02.34.03.13.2ItalyGreecePortugalIrelandSpainFranceChange in Government Structural Balance as % of GDP2009-2012 2012-2017
8 RBC PH&N INVESTMENT COUNSELSimilarly, the debt crisis has abated in part because banksare recapitalizing nicely and governments have cut spending.These very actions mean less economic growth in the short run.The big question for the Eurozone is whether the economy willfinally begin rebounding in 2013. We suspect the answer isunfortunately “no.” Whereas Eurozone GDP shrank by around0.5% in 2012, we forecast an even larger decline of 0.75% in2013. Happily, growth is expected to return in 2014, when weforecast a 0.5% expansion, and the outlook may soon beginimproving if leading indicators are to be believed (Exhibit 5).With the recession well underway, we are now in a position toevaluate the severity of the Eurozone’s downturn. Officially, ithas been a shallow recession. However, it has often felt muchworse than that. Why? One reason is that some countries havesuffered greatly, while others have sailed through (Exhibit 6).The situation also depends on which aspect of the economy isbeing discussed. Exports have held up fairly well, leaving theimpression that the economic decline was much milder thanin 2009. But to domestic households and businesses, the hithas been nearly as bad as 2009 – pretty brutal stuff.Eurozone inflation has been unusually high for a number ofyears as sales-tax hikes took effect. With the tax hikes now mostlycompleted and falling out of the equation, inflation should runat a more subdued 1.75% in 2013 and 1.25% in 2014. Facedwith this, the European Central Bank (ECB) may be forced toreconsider its stubborn policy stance, potentially delivering afurther rate cut to trigger a softer euro. Quantitative easing wouldbe good medicine, but seems unlikely given current attitudes.Some countries fared better than others during theEurozone downturn. Estonia’s experience was notablybetter than in economies like Greece, Portugal or Cyprus.Exhibit 4: Eurozone in Enduring RecessionSource: Haver Analytics, RBC GAM220.127.116.11 18.104.22.168.4-1.4-0.1-0.7-0.3-2.3-3-2-1012345GDPGrowth(QoQ%Annualized)Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12
COUNSELLOR QUARTERLY 9U.S. PRIVATE DELEVERAGING OVERThe U.S. economy appears to be outperforming most of itsdeveloped peers for two reasons. First, it enjoys a higher GDPspeed limit than other nations due to a combination of superiordemographics, a culture of innovation and entrepreneurship,and better competitiveness.Second, the U.S. was more forthright in acknowledging lossesafter the global financial crisis, which permitted more rapiddeleveraging. Our calculations suggest the U.S. private sector isin fact now fully deleveraged. Illustrating this, household debthas now declined by more than the value of household assets.All the same, there remains one last cinch on U.S. growth.Fiscal tightening is set to subtract between 1.5% and 2.0% fromGDP growth in 2013. There is still some uncertainty aroundthe precise drag owing to several decisions that remain in thehands of American politicians. Most prominently, the sequester’sMarch 1 deadline has now passed, meaning that $85 billionof spending cuts scheduled for 2013 are commencing. But thereare still opportunities for politicians to halt the cuts, includingtoward the end of March when a budget deal must be struck,or as the debt ceiling is hit over this summer.In this context, it is frankly remarkable that the U.S. is still ontrack for something near 2.25% growth this year. As fiscalausterity subsides later in the year and risk appetite continues torevive, we look for growth to accelerate to 2.75% in 2014. Inflationlooks set for slightly below 2% in 2013, and around 2% in 2014.The U.S. Federal Reserve (Fed) was very busy over the final fewmonths of 2012, first instituting a new round of quantitativeeasing in September, and then expanding it in December. Recentcomments from Fed members reveal a schism on the committeeregarding when these asset purchases should end. A number ofmembers favoured an early conclusion while several others –presumably including Chairman Bernanke – preferred to continuepressing ahead. If we have learned anything over the past severalyears, it is that policymakers are likely to deliver more stimulus,not less. Despite this, the U.S. dollar may find itself wafting higheras other countries get in on the currency-depreciation game.CANADA SPUTTERSThe Canadian economy sputtered through the second halfof 2012 and ended the year with a face full of soot. There areseveral reasons for this. The Canadian dollar is still arguablystronger than it should be. Western Canadian oil producers arebeing forced to accept deeply discounted prices due to pipeline-capacity problems, while consumers in the rest of the countryare paying a premium for imported crude. The gap betweenthe two is problematic. Lastly, and perhaps most importantly,the Canadian housing market is cooling.Despite all of this, we still expect the Canadian economy tomuddle through. The Bank of Canada’s Business Outlook Surveystill shows that companies plan to continue with hiring andcapital investments (Exhibit 7). Canada is ramming throughless fiscal austerity than most of its peers. Even if the housingmarket does correct substantially, some offset would comefrom a weaker Canadian dollar, and perhaps from fiscal ormonetary stimulus, where policymakers have some leeway.Most importantly, it is far from clear how much or how quicklyhousing activity and prices will actually decline.Exhibit 5: Eurozone Economy Shrinking Less QuicklyNote: PMI refers to Puchasing Managers Index, a measure of economic activities.Source: Markit, Haver Analytics, RBC GAM30354045505560652006 2007 2008 2009 2010 2011 2012 2013ManufacturingPMIExpansionContractionExhibit 6: Varying Economic Experiences in EuropeSource: Haver Analytics, RBC GAM-8 -6 -4 -2 0 2 4EstoniaSlovakiaAustriaGermanyFranceBelgiumEurozoneNetherlandsFinlandSpainItalyCyprusPortugalGreeceQ4 2012 GDP YoY % ChangeNotably worseNotably betterAverage
10 RBC PH&N INVESTMENT COUNSELWhile residential construction represents an unusually highshare of GDP, the sector’s share actually looks quite pedestrianin inflation-adjusted terms. And while tighter mortgage rulesintroduced in July 2012 have indeed cooled the Canadianmarket, their effect usually wanes after two to three quarters –around now. Affordability is still fairly good given currentinterest rates, though this will deteriorate when interest ratesdo eventually rise. We look for the Bank of Canada to tightenpolicy at the beginning of 2014 at the earliest.The latest national statistics show a clear slowdown in housingstarts and building permits. Growth in household credit isslowing and home prices are also stalling. Our analysis suggestssome further moderate drag is likely from housing, mainlybecause of the overbuilding evident in certain regions andsegments of the market. This points to a leaner year or two forthe Canadian economy and marks one of the few times sincethe financial crisis that Canada’s economy has underperformedExhibit 7: Canadian Businesses Expect to Increase Investmentand HiringSource: Haver Analytics, Bank of Canada, RBC GAM-25-15-55152535451998 2000 2002 2004 2006 2008 2010 2012BusinessOutlookSurvey(%Balance)Future Investment and EmploymentDespite slowing growth in household credit and a cooling housing market, the Canadian economy is still expected to muddlethrough. The Bank of Canada may tighten policy in early 2014.
COUNSELLOR QUARTERLY 11the U.S. But the timing is highly imprecise, systemic risks arelow, the banking sector is fairly well insulated and the largestrisks confronting Canada are still global in origin.PUBLIC DEBT’S LONG JOURNEYIn stark contrast to diminishing global risks and healingeconomies, global public-debt loads continue to rise in thedeveloped world. This is normal in the sense that public debtusually declines with a lag, ceding priority to the private sectorto unwind its excesses first.Fortunately, policymakers are now turning their attention toserious debt reduction and they have many options availableto them. The most likely fix is a combination of budget surplusesand repressed interest rates, combined with a smidgen ofadditional inflation and economic growth. However, even withall of these contributors pulling in the same direction, public-debt reduction efforts will take an excruciatingly long time.By our calculations, many countries will be locked in debt-reduction mode for decades if they wish to return to normaldebt levels. (Exhibit 8).Governments are beginning to take decisive steps to reducetheir debts, and this bodes well for long-term economic growthprospects. The economic pain associated with falling debt loadsis very much front-loaded (Exhibit 9). However, the very fact thatdebt loads will take many years to decline to more reasonablelevels makes nations vulnerable to economic shocks.EMERGING MARKETS STABILIZEWith few exceptions, emerging markets do not suffer from thesame public debt problems as the developed world. Theylearned their lesson during a series of financial crises in the1990s (Asian financial crisis, Mexico’s “Tequila” crisis), andsubsequently constructed a protective shell of low debt loads,current-account surpluses and large foreign-exchange reservesto ward off the risk of recurrence.Emerging-market economies have lately rebounded nicely afterswooning in mid-2012. We suspect the rebound itself is peaking,and most emerging economies are unlikely to fully return tothe growth rates achieved over the prior several years. But thecurrent rate of growth can probably be maintained, allowing oursix-nation basket of emerging markets to achieve solid growthof around 6.0% in both 2013 and 2014, while inflation holds inthe 4.5% range. As usual, China looks set to outperform the rest,as its economy expands 8.0% in 2013 and 7.5% in 2014.INFLATION REMAINS TAMEIn a period of slow economic growth, few wage pressures andsteady commodity prices, global inflation is unlikely to riseparticularly quickly, as confirmed by current copacetic levels.There are certainly national exceptions to this prognosis – theU.K. is clearly one, while Japan is (hopefully) another – butmost are well in line with these levels.Exhibit 8: Target Achievement of Public Debt GoalNote: “Public Debt Goal” defined as easier of 60% debt-to-GDP ratio or pre-crisis (2007) debt-to-GDP ratio. Source: IMF, RBC GAMYear Necessary Debt Reduction (ppt)Netherlands 2016 8Germany 2017 18Canada 2018 21France 2021 26Italy 2021 23U.K. 2025 29Spain 2027 31U.S. 2028 40Japan 2035 54Portugal 2036 51Ireland 2037 58Greece >2050 63
12 RBC PH&N INVESTMENT COUNSELChina’s economy expanded over 15% from 2013-2014s, and it looks set to outperform the rest of the emerging-marketeconomies in the months ahead.YIELDS TO RISE SLOWLYWe have already discussed each major central bank separately.Together, the common theme is that central banks are probablyfar from tightening, and in some cases even have more stimulusto deliver. This is an easy call for Japan, but may also prove truefor the Bank of England, the ECB and even the Fed. The shortend of the bond market should thus remain anchored bystimulative central banks.The long end of the yield curve is always more difficult topredict. Our models suggest that yields are unsustainably low,as they have for many months. Yields have primarily been helddown by two drivers: risk aversion and central-bank stimulus.Together these forces have pushed real yields far belowequilibrium, and to the point where investors are seeingnegative returns after the effects of inflation. Risk appetite isnow beginning to pick up, which should allow yields to drifthigher. More of a risk to bond holders is central bank policy.As the economy continues to leave the burden of the financialcrisis behind and unorthodox monetary policies that arecurrently suppressing yields become less desirable, real rateswill begin to move back toward historic norms draggingnominal yields with them.Exhibit 9: Pain Is Front-LoadedSource: RBC GAMBudgetBalanceas %of GDP+_RisingdeficitSteady deficitShrinkingdeficitRisingsurplusSteady surplusGROWTHDEBTBoosts growth Growth neutralRising debtHurts growthStabilizing debtGrowth neutralFalling debtRising debtCurrent Phase Next PhaseEconomic theory suggests that inflation should begin to edgeup over time as economic slack is absorbed. There is even thechance of a bit more inflation than usual – several years downthe line – given the way that central banks have shifted theirfocus toward economic growth, and given fears of prematuretightening and temptations to inflate away government debt.But this is highly speculative, and unlikely to have anoverwhelming effect through the forecast horizon.
COUNSELLOR QUARTERLY 13traction. According to our fair-value models, equity markets inmost regions remain undervalued, indicating the potential forfurther gains.THE GREAT ROTATIONSince the beginning of 2013, the media has been focused on thetheme of “The Great Rotation.” This refers to the point at whichinvestors decisively move their assets from bonds and other safehavens into the stock market. Since the first week of January, wehave seen large equity inflows. In the past two months, $21 billionof assets has flowed into equities, close to the amount that hasflowed to equities in the past two years combined! That said,bond inflows have been strong as well, indicating that investorsare simply moving cash into both the equity and bond markets.Although a “great rotation” isn’t evident in the flow data – atleast not yet – the new attention to equities may be a positivesign for near-term performance. Since equity outflowstroughed in December 2012, the market has increased 11% andoutflows are currently around $1.5 billion. Continued healingin the global economy and increasing investor risk appetitemay eventually push equity mutual-fund flows into positiveterritory, providing fuel for stocks to move even higher.The global economy continues to heal. Risks remain, but themarket appears to be looking past immediate hurdles andfocusing on positive developments taking place.We are already beginning to see yields tentatively rise. Reflectingall of this, our forecast for the next 12 months is for an increase in10-year yields across the developed world on the order of 50 to 70basis points. Aside from the U.K., most countries over the forecastperiod are likely to see negative total returns to sovereign debt.Looking out further, based on a return to equilibrium, totalreturns could be low or negative for an extended period.However, there are distinct limits to how much bond yieldscan rise in the near term. In addition to the obvious constraintsof sluggish growth, moderate inflation and low central-bankrates, we must not forget that a key reason for the globalrecovery is the very existence of ultra-low borrowing costs.For policymakers to allow a significant increase in rates wouldbe to betray the very recovery on which the low bond yields havebeen based. Just as rates were managed lower by central banks,we expect they will be managed higher as well, moving graduallytowards our forecasts and, ultimately, equilibrium.STOCK MARKETS CONTINUE TO PUSH HIGHERStock markets got off to a quick start in 2013 with globalequities, as measured by the MSCI World Index, up almost 5%year-to-date. While the U.S. fiscal debate is on-going and thecrisis in Europe continues to evolve, it appears that investorshave begun to look past the macroeconomic headwinds andare now focusing on an economic recovery that is gaining
14 RBC PH&N INVESTMENT COUNSELPLANNING STRATEGIES FOR COUPLESCouples in a long-term relationship orconsidering one now need to be more aware thanever of the financial and legal ramifications of alove that lasts and, equally, where it may not.Whether due to the increasing tendency to marry at an olderage, live longer or the increased prevalence of divorce,Canadian marriages are now facing increasing financialresponsibilities, likely not considered in generations past.On top of this, there may be even more mouths to feed atthe Canadian couple’s financial table – whether with theincrease in “blended families” (children from previousmarriages) or those in the “sandwich generation” (couplescaring for aging parents in addition to children). Exploringthe following issues can contribute to the likelihood of aloving and stable relationship well suited to meet life’schallenges over time.Whether you have been married for 50 years or consideringmarriage, the following are the key areas of tax, estate, andfinancial planning consideration for couples (includingcommon-law partners).1. CREATE A FINANCIAL PLANDeciding together how to best allocate and prioritize expenseswill not only save headaches, but build valuable habits andsave money. A financial plan may also identify a number of taxplanning strategies for couples (for example, “incomesplitting”). One example of income splitting for couples is tohave the higher-earning spouse pay living expenses for thefamily as well as the family’s tax liabilities, so the lower incomespouse can invest their own income which will be taxed at thelower-income spouse’s tax rate.Another effective income splitting strategy is a spousal RRSP,which is an RRSP to which one spouse makes contributionsWEALTH MANAGEMENTCouples need to be more aware than ever of financial and legal planning considerations – whether they have been marriedfor 50 years or are considering marriage.
COUNSELLOR QUARTERLY 15(the contributor), but is opened in the name of the otherspouse, who is the annuitant (or owner) of the RRSP. SpousalRRSPs provide a simple way to split retirement incomebetween spouses in an effort to equalize the retirement incomeand minimize the couple’s income taxes.2. USE YOUR PRINCIPAL RESIDENCE EXEMPTION WISELYWHEN OWNING TWO HOMESAn exemption on the capital gain only applies to your principalresidence, and now that you are a couple, only one exemption isavailable per family unit per year (for each year prior to 1982,each member of the family unit may designate a separate homeas their principal residence). This means if you and your partnerboth own a house (or a house and a cottage), only one exemptionis available for the years that you are considered common-law ormarried. Be sure to consult your tax professional to determine thebest use of the exemption where there is more than one home.3. DETERMINE THE BEST OWNERSHIP OF ASSETS FORYOU AND YOUR PARTNER AND THE ACHIEVEMENT OFYOUR GOALSDo you wish to own them jointly or in your own names? Ensurethat you understand the advantages, but most importantly, thelegal and tax results and how they will be distributed if you die(or break up). You should obtain independent legal advice froma qualified family law lawyer as every province has its ownunique rules.4. FOR THOSE WHO HAVE BEEN MARRIED BEFOREConsider obligations you may have with a former spouse,children or elder parents. You will need to consider how yourassets are going to be shared both during your lifetime andlater, through your estate plan.5. MAKE A PRACTICE OF REVIEWING AND UPDATINGBENEFICIARY DESIGNATIONS ON YOUR REGISTERED PLANSAND LIFE INSURANCE TO ENSURE THAT THEY ALIGN WITHYOUR CURRENT WISHESThis is particularly important if you now have a RRIF(beneficiary designations are not automatically carried overfrom your RRSP) or have remarried.6. CONSIDER YOUR WILL SOONER RATHER THAN LATERBe sure it is up to date, and if recently married or re-married,whether it has been automatically revoked on marriage. Thiswill depend on the provincial laws where you reside. You willalso need to decide how your partner/spouse will benefitunder your Will.7. UPDATE YOUR POWERS OF ATTORNEYSo that if you are unable to make health care or financialdecisions, the right people have the authority to make themfor you.8. SOMETHING TO THINK ABOUT FOR THOSECONTEMPLATING MARRIAGE OR LIVING TOGETHERConsider a marriage or cohabitation agreement that sets outyour financial expectations concerning the relationship tohelp avoid conflicts later (including legal hassles) should therelationship end. In most jurisdictions in Canada, legislationis encouraging use of these agreements by giving certaintythat they will be upheld except where they are found to beunreasonable. You can also agree on certain matters relating tothe children, including their educational or religious upbringingand custody and access issues (however, in many jurisdictionsthese provisions may be disregarded by a Court if it is felt tobe in the best interests of the children). However, do not leavethe marriage contract to the last minute. It is probably wise toconsult your respective lawyers well in advance of the proposednuptial date or even the “Save the Date” cards being sent toallow for adequate consideration and negotiation. Theimplementation of a marriage or cohabitation agreement willgenerally require that you make full financial disclosure to yourpartner. Full financial disclosure may include providing detailsof your assets, income, debts and liabilities to your futurecommon law partner/spouse. As part of this process, you mayneed to obtain professional valuations for various assets,including business and real estate interests.Now may be a good time to review your planning. Formore information on planning strategies for couples, pleaseconsult with your RBC advisor and your tax or legal advisor,as applicable.Together with our RBC Partners, we can assist with any of thefollowing recommendations, in conjunction with your tax orlegal advisors.You should obtain professional advice from aqualified tax advisor before acting on any of the information inthis article. This will ensure that your own circumstances havebeen considered properly and that action is taken on the latestinformation available.
16 RBC PH&N INVESTMENT COUNSELThree years ago, I wrote to you about bringingtogether the two firms of PH&N InvestmentManagement (PH&N) and RBC Phillips, Hager& North Investment Counsel (RBC PH&N IC),making a significant investment in technologyand continuing to build on our investmentsolutions. Much has happened since that time,and I wanted to update you on our progress.At the outset, we were determined to continue to exceed yourexpectations of us. In fact, we wanted our highly valued clientsto benefit from the integration of both firms. Some of thesebenefits are already in place, and some will come to fruitionover the next few months, including:First, we have expanded our award-winning investmentoffering to provide you with even more choices for fixed-income, equity and alternative investments. With theacquisition of BlueBay Investment Management we cannow extend more fixed-income choices, and we have alsoexpanded our equity offering with new dividend-orientedinvestments, hedge funds and private equity options.To make it easier for you and your Investment Counsellorteam to stay in touch, and to provide additional functionality,we are investing in our business technology to provide morecomprehensive reporting and communications. Over thenext six months, we will be implementing new portfoliomanagement and contact management systems, culminatingwith the transfer of all RBC GAM (former PH&N) clientaccounts on to this platform.Amid ongoing global economic change, we wanted solutionsto be available for you to protect the wealth you’ve earned,minimize the taxes you pay and prepare your estate totransition to the next generation. To do so, and based onclient feedback, we have expanded our resources in theareas of tax, financial, insurance and estate planning. Wehave also grown our team of specialists and brought onexperts in business succession to help manage, protect andtransition the wealth in your business.We will be communicating regularly with you over the comingyear on the progress of these changes. By always remainingcommitted to you, our clients, we can continue to provide theindustry-leading investment solutions, wealth management,service and reporting that, we hope, will continue to exceedyour expectations.VIJAY PARMAR, CAPRESIDENTINVESTING IN OUR BUSINESS, AND OUR CLIENTSTHE LAST WORD