Many investors assume that stock returns follow the business cycle. According to this view, the stock market offers a higher expected return premium in a strong economy and a lower premium in a weak economy. (The market premium refers to the return of stocks over T-bills.)
In reality, the market premium tends to run counter to the business cycle, as illustrated in this conceptual graph. The premium is a function of how investors perceive their risk exposure in equities relative to cash, or T-bills. During recessions, as company earnings fall and investors become more risk averse, stock prices adjust downward, which raises expected returns. The possibility of earning higher returns compensates investors for choosing stocks over cash. Conversely, investors will accept a lower expected return when they regard stocks as less risky relative to cash (i.e., a lower market risk premium). This typically occurs when the economy is expanding and the outlook for company earnings is strong. As more investors choose to hold stocks, market competition drives up stock prices relative to company performance, which reduces expected returns.
Investors should not attempt to time the business cycle. Economic performance is only known after the fact, while stock prices reflect the market's view of future business performance. As new information becomes public, stock prices adjust to provide equity investors an expected return that matches perceived risk.
Investors are best served by diversifying across many stocks, maintaining a long-term perspective, and applying discipline throughout the business cycle.
Canadians are slowly waking up to the fact that putting the brakes on spending is not enough to battle household debt.
According to the latest debt report from the Certified General Accountants Association of Canada (CGA-Canada), Canadian families are faced with household debt that’s reached a record high.
“The debt of a typical household is rising,” says Rock Lefebvre, CGA-Canada’s vice-president of research and standards and co-author of the report. “And the financial situation of certain groups of households is much worse than average and continues to deteriorate. This is concealed if you focus only on the national or aggregate picture.”
The report illustrates that while consumer spending may be down in the first quarter of 2011, many Canadians continue to struggle with household debt that has reached a new all-time high of $1.5 trillion. The situation has hit those already feeling the pinch of lower or stagnant incomes, or personal circumstances, even harder.
The survey-based report reveals several alarming trends, as single-parent families, retired Canadians, and those with annual household income of less than $50,000 face a bleak financial situation.
“The report confirms that more than half of indebted Canadians are borrowing just to afford day-to-day living expenses like food, housing and transportation,” adds Anthony Ariganello, president and CEO of CGA-Canada “For these individuals, there is little hope for improved financial condition.”
Some of the key findings of the report show more Canadians are carrying debt into retirement, with one-third of retired households carrying an average debt of $60,000 and 17% carrying $100,000 or more. More than half of indebted respondents (57%) singled out daily living expenses as the main cause for their increasing debt. The single-parent family is the only category where debt increases with age.
If household debt was spread evenly across all Canadians, a family with two children would owe an estimated $176, 461.
Lefebvre says that a number of measures taken by the government to address some identified shortcomings have not helped improve household balance sheets.
“It’s important that the dynamics of household indebtedness remain high on the radar of policy-makers,” said Lefebvre, “particularly when it comes to policies and incentives that encourage Canadians to improve their finances.”
With the Bank of Canada likely to delay rate hikes, an effective deterrent to debt can be discounted. At a time when household debt has reached a record high, low interest rates could prove somewhat counterproductive as they may tempt more Canadians to take on debt.
Canadians can expect borrowing costs to remain near record lows for the rest of the year, according to the quarterly economic forecast issued today by TD Economics.
“That’s because the pace of the economic recovery is expected to slow sharply in Canada, the United States and much of the world,” said the report, credited to Craig Alexander, chief economist, TD Economics.
As a result, the Bank of Canada will likely refrain from raising its key interest rates until 2012. This will make it easier for Canadians to continue borrowing, burying themselves deeper in hock which will take years to clear.
Debt is partly contributing to a slowdown in Canadian growth as households are too overstretched to further stimulate the economy, thus creating something of a vicious cycle that many global economies are struggling to break.
Filed by Vikram Barhat, editor@Advisor.ca Originally published on Advisor.ca