March 2012
While economic growth faces headwinds, corporate debt
a 'preferable place to be'
Countries and consumers in the West have been piling up debt for years. As they begin to pay it down, it will have a dampening effect on the economy for months to come. Consumers won't have as much to spend, and countries, in an attempt reduce their debts, may cut entitlement programs, forcing individuals to save even more. Steve Locke, Team Lead of Mackenzie Sentinel Funds, discusses the economic environment and what investors can expect in the months ahead.
Deleveraging: The accumulation of debt was a multi-decade phenomenon. And now, we are unwinding that debt. Deleveraging has to occur in the global economy and in most western countries. The chart below is from a US economic perspective but Canada's situation is relatively similar. Growth in US household income (grey line) and US household credit (blue line) are shown over a period of several decades. The amount of debt held by US households has outstripped income growth. As we unwind that debt burden, it means that yields need to stay low for some time. The moment yields start to rise, debt becomes too costly for households to bear on what has been fairly anaemic income growth in recent years.
Austerity: Previously, when we've come out of recession, US households reduced their savings rate, and propelled economic growth higher. What's changed today is that savings rates for US households are likely to remain elevated in the future. There's likely to be much more austerity at the household level and reduced expenditures as people see a need to help provide for their own future. We've seen a lot of benefit cuts starting to be discussed. That's the type of austerity that's going to require households to think about saving for their own future.
Unemployment: In the US, unemployment has come down to about 8.5%, but it's unlikely to trend dramatically lower over 2012. Any positive news on the labour front is likely to be met with more people re-entering the labour market and that will keep the balance tilted toward higher unemployment. So the 7% unemployment rate of a few years ago is really a bit of a distant memory and unlikely to be seen again over the coming years.
Inflation: The implied inflation rate for Canada for the next 30 years is about 2% annually. This is what the market is telling us. That's right around where it has been for much of the last decade, minus the deflationary environment in the 2008-09 credit crisis. We've been in around 2% to 2.5% in general, and that's likely going to be the sustained inflation rate over the next few years.
Based on the low growth rate and limited inflation, you're likely to see lower potential investment returns across most asset categories. We expect bond yields to be in a low range, similar to where they've been over the past year.
The good news for investors
The good news for investors is that there are some definite improvements that we've seen over the past few years, including corporate fundamentals. We see less debt on the balance sheet, and we see more cash being held. I think cash is likely to remain at a higher level, as companies don't want to relive the crisis in financing that hit them in 2008.
In addition, banking systems are being improved. The Canadian banking system has been very robust through this period. But globally, banks are being required to hold more capital and have better liquidity on their balance sheet going forward. These are positives from a bondholder perspective, and definitely make portfolios slanted toward corporate debt a preferable place to be.