July 12 Weekly Summary

Not a great week for investors, as Correction 2008 continues on North American markets...the TSX lost its title as the only major market in positive territory, riding Friday's volatile selloff to a level about 1% below the beginning of the year.
US markets fared little better, with the Dow dropping below 11000 for the first time in 2 years.

Global numbers are pretty startling...for 2008, the TSX is off 0.90%, finishing at 13709, but compare that to the Dow, finishing Friday at 11000, down over 16%, the Nasdaq, down to 2239, of 15.5%, the S&P, at 1239, off 15.5%...the TSX is still a star.

The rest of the global story is worse...of the major European markets, only the FTSE is less than 20% in the hole year to date...and it ended the week off 18% year to date. The Dax is off 23%, the CAC 40 is off 27%, and the Euro Stoxx is off 27% as well.

Looking to the Far East, China is off nearly 50%, the Nikkei is down 14%, the Australian ASX and Hang Seng are both off about 21%

The global equity sell off really has been a worldwide phenomenon...even Brazil and Mexico have faded, down 5 and 6% respectively.

The flight to safety really has been a flight to cash, as bonds have not rallied significantly...although higher yielding commercial paper, especially in the US, has rallied from its almost illiquid state earlier in the year.

Late week, investors were truly troubled by the possibility that the two major US Government Sponsored entities, Fannie Mae and Freddie Mac, might collapse

I thought this article by MarketWatch captured the state of the market well.

"Is that glass half-full or half-empty?

Those with a half-empty point of view will point out that this week, because of rumor, innuendo and a few worrying facts, shares of Fannie Mae and Freddie Mac tumbled to unthinkable lows. Unthinkable because the two companies were supposed to be the housing market's Rock of Gibraltar. After all, they provide the billions of dollars the financial system needs to keep the dream of homeownership within reach for millions of Americans. Owning a home, we all know, is a key to economic success in this country, and e! conomic success is what we're all about.

These companies, which for decades were unflappable institutions beloved by borrowers, lenders and the political class, were this week beset by worries that the trillions of dollars of mortgage debt they own or are responsible for might be worth a lot less than previously believed. There was talk the government might have to take them over, or that taxpayers might have to bail them out. Letting Fannie and Freddie fail, it was universally agreed, was not an option.

Even if complete failure was not on the cards, equity investors didn't like the look of things, particularly since, under at least one scenario floated in the press, they would see the value of their holdings re! duced to zero. By the end of Friday, Fannie shares were showing a monthly decline of 48%, while Freddie was off 53%."

Although a great deal of shareholder equity disappeared, just on Friday, investors are hoping Fannie and Freddie's funding needs for the immediate future could be put to rest if Federal Reserve chairman Ben Bernanke allows both companies to borrow directly from the so-called discount window, like commercial banks do. That would mean they wouldn't need to go to the public debt markets to raise money to keep operating.

It may be very important to see what happens to Freddy and Fannie over the next few days.

On the commodities side, this week saw yet another new record for oil, reaching over $147 US per barrel, although it saw a midweek drop into the low 130s before spiking again on geopolitical tensions.

Gold jumped over 20 dollars just on Friday, as traders fled the greenback, once again.

Canadian homeowners got a bit of a surprise when the CMHC rules for maximum mortgage terms were reduced, and the minimum downpayment was increased back to 5 percent. in an upcoming show, i will host one of Scotiabank's Mortgage managers, to get his take on the impact this may have on home affordability, and eventually house prices.

If you have been tuning in over the last few weeks, I have been discussing the value of playing defense with your money in these volatile markets...and i still believe that protecting capital should be a part of the investment program of all but the most aggressive investors...and this does not mean being out of the market, or fleeing entirely to GICs. Over recent shows, i have covered a number of ways to conserve capital...and I believe the time will soon come where many of the downtrodden segments of the market will present great opportunity. An investor with a long time horizon may be comfortable wading into the current market, recognizing that many great companies will be far more valuable 15 or twenty years from now.

The current selloff has presented some really remarkable opportunities...Canadian financials, both their common and preferred shares, are paying phenomenal dividend yields. Energy companies, especially Canadian oil and gas companies, are down significantly, even though oil is at a record high. Real estate income trusts are paying fabulous yields, although these yield payers could all be hurt if central banks change decide to increase rates to curb inflation. I believe the impact of energy prices will be similar to a tax increase...and will slow economic growth without the need for significant interest rate intervention.

What if you are not able to be patient? Some investors, especially those nearing or entering retirement, may need some guarantees to sleep at night. I have a video that I recommend highly to investors in their last five years of working, or their first five years of retirement...it is produced by Manulife investments, and it does a great job of summarizing the risks to retirees, in what they refer to as the Retirement Red Zone...they key to the whole presentation is this...during your accumulation years, the sequence of returns from year to year really does not matter...all that matters is the rate of return you average...but if you use their sequence of returns calculator (and listeners can find this by coming to my blog on AM 980's web site, you can find the link in today's show content, which should be posted on Monday...the calculator is fantastic, as it shows the dramatic impact of lousy returns in the first or second year of retirement withdrawal. In the example on the video, a bad first year shortens a retirees income payments by about 7 years...pretty dramatic.

If you would like a copy of Manulife's video on the subject, let me know, and i will send one to you personally...i can be reached at , or via phone at (519) 660-3260

Although it is not the only solution, using a segregated fund is certainly a novel and relatively simple way to protect and ensure income for life. i really think that they make sense for retirement allowances and RRIFs, especially if an investor wants the security of an annuity or pension, while retaining control of their capital.

The biggest reason i like the idea of using a segregated fund or deferred annuity program, like Manulife's GIF, is that it eliminates one of the five key risks to retirement, identified in the landmark research done by Fidelity Investments, and that is asset allocation. I believe Fidelity's research on the five risks to retirement security will some day be recognized for it's brilliance. One of the key themes of the research was that investors frequently panic, and seek absolute guarantees of return in retirement...but the reality of the eight, ten, or twelve percent returns of Canada savings Bonds or GICs in the eighties is likely history. The more current, four percent or so, average return of GICs, comes nowhere close to covering the rate of inflation, especially in this world of spiralling energy costs. Many investors might hear that the risk of asset allocation means they should immediately move to entirely secure investments, but unless a person living on an average income accumulates millions, they are unlikely to generate sufficient, inflation protected income using only GICs. The real risk is in becoming too conservative...a balanced portfolio will almost always outperform a secure portfolio...and therefore, the secure portfolio is likely to run out first. An investor using a deferred annuity still invests in the market, but is less likely to bail out in risky or volatile times...because they have a guaranteed income stream. This is not an all or nothing solution. In fact, i frequently use this type of product for a significant part of the equity in an investor nearing retirement's portfolio...while still buying individual stocks or bonds...for example, they might put their RRIF money in a deferred annuity, while buying individual stocks and bonds with their non registered investments.

I made reference to the five key risks to retirement planning...in this segment, I am going to review those five key risks, and offer ideas of how to construct your portfolio, considering the risks.

The source of the research is Fidelity Investments Canada Limited...and it should change the way you think when you’re making your financial plans

Longevity is the first risk. Canadians are living longer and longer, and this presents a significant risk when investing for retirement. Many retirees shoot for freedom at 55...but this could require 40 or more years of need for retirement income. In fact, a couple retiring at 65 has about a one in two chance of one member living to 90, and one in four of them reaching 94. Pensions were a creation of kaiser Wilhelm back in the 19th century, and 65 was chosen as the time to put old bureaucrats off on pension...with the assumption that they could no longer work effectively, and would not live much longer, anyways. Both assumptions are completely wrong today, with life expectancies growing rapidly. On a percentage basis, the age group of population growing the fastest is those over age 100, and the second category is over 85. many of these aging canadians are dynamic and active, able to golf, garden, walk, and even parachute, into their 90s and beyond.

Many public pensions are in serious trouble due longevity, and fewer and fewer employers choose defined benefit pensions, as they are costly to provide, given the combination of longevity and low interest rates.

This makes it very attractive for investors to consider deferred annuities, like I discussed before the break...or even annuities, which offer guaranteed income, and great tax efficiency for the right investors. Neither strategy should be taken lightly, or done without the guiding hand of an advisor.

Longevity leads right to the second risk...health care. We are living longer, but are we living better? Sometimes I wonder. About 45% of 65 year olds will require nursing home care before they die...with an average duration exceeding two years. The impact on a household where the other spouse is still alive is dramatic...essentially, you end up running two homes. This risk is rarely covered in plans I see...yet imagine the impact of having to run two homes for five years...the costs may be huge. I believe the solution to this exists...but is rarely used. Insurance companies have built exceptionally well priced programs of long term care insurance, which provide cash for care, either in the home, or in long term care facilities. I believe this strategy will gain popularity as people see the impact on their parents' savings.

Inflation is the third risk, and one of the great offenders in the inflation category is health care cost...but there are many other culprits...rising fuel, insurance, heat, and food costs directly impact the aging population. The retiree facing thirty years of retirement had better account for the fact that a mere three percent inflation rate may increase her food costs by 250% or so. Sadly, many pensions are only partially indexed, or tied to the rather artificial CPI calculation...which nets out many of the most inflationary categories...who, exactly can live "net of food and energy?" This lead right back to my contention that investors need to stay in equities, to grow their assets against the risk of inflation. Two solutions are the deferred annuities discussed prior, and a simple basket of consistent, dividend growing stocks...a well designed portfolio of suck historical dividend growers as banks, utilities, and energy companies, along with a Reit or two, give you a pretty good hedge against inflation, if you stay the course.

Withdrawal, especially early withdrawal, is a huge risk. Taking out too much, too soon, is a sure fire route to poverty in later stages...but it happens. it could be argued that your needs are greater for disposable income early in retirement...but in later years, investors cutting it close may want to consider the guarantee of an annuity.

As i discussed earlier, asset allocation is the final, great risk to retirement security. the first, obvious issue, is being too concentrated in any asset class, even the value of your principal residence. More importantly, bailing out in volatile markets may just be the worst possible risk, as selling low is the one way to lock in investment losses. Yet again, the deferred annuity is very attractive, since the guarantee may keep you in your portfolio in choppy markets.

Regardless of which risk may challenge you in retirement, there are strategies to cope, and the key is to work with an advisor to select the best defense.

If you have any questions, please feel free to contact me, ScotiaMcLeod Wealth Advisor jeff wareham, at (519) 660 3260, or at www.jeffwareham.ca.