Flattening Yield Curve: Good For Stocks But Bad For Banks

As the concerns about the economy have lessen, the Bank of Canada has moved to a more neutral monetary policy resulting in a gradual rise in short term interest rates. At the same time, long term rates have dropped reflecting  a re-emergence of deflationary fears in the U.S. This has caused a flattening in the yield curve as the spread or the difference between short and long term rates has narrowed.

Government of Canada Interest Rates

	91 Day Tbill	10 Year Bond	Difference
April 28,2010	0.39%	3.66%	3.27%
October 13,2010	0.90%	2.73%	1.83%

The change has been significant. The current difference between long and short rates is 1.83% compared to 3.27% less than 6 months earlier. This phenomena has been happening the U.S. as well.

In a recent article Is the Flattening Yield Curve Good For Stocks?,  Liz Ann Sonders, Chief Investment Strategist for Charles Schwab & Co., Inc., discussed the implication for the stock market when the yield curve flattens. Her conclusion was: “Historically, a narrowing of the yield curve has been tied to stocks performing reasonably well.” In the 10 periods they studied when there has been a sharp decline in the yield  curve, the S&P was up on average 5.21% 3 months later,  and 17.97% 12 months later.

Although a flat yield curve might be good for stocks, it is generally considered  to be negative for bank stocks -  certainly compared to the rest of the market. Banks will typically borrow money at the short end and lend out money at the long end of the yield curve. The profit margin will shrink as the spread between long and short term rates narrows.

In the chart below, the S&P/TSX Composite is higher than it was  6 months ago yet the Financial sector is still below. The Financial sector has underperformed the overall market by 10% in the last 6 months. This under performance is similar in the U.S. and EAFE countries.

iShares S&P/TSX Composite (XIC) versus S&P/TSX Financial Sector Index (TTFS)

Bottom Line
As of October 14, 2010, the Financial Sector is the largest Industrial sector in the S&P/TSX Composite with a 29.1% weight. Most Canadian investors will have significant portion of their Canadian equity portfolio in Financials. It is important to  check  the sector weight in your portfolio and if it represents  more than 30%, then reducing the exposure could mean better performance and lower risk for your portfolio over the next 6 to 12 months.

Are You Rich, Uber Wealthy or Just Affluent?

Ferrari Enzo

In marketing a product or service it is important for a business to define their target market and then define a strategy to sell to that specific market segment. As an example Ferraris are marketed differently than Kias, It is no different in the Investment Management and Advisory business.

As a marketing man would say, a well defined target is the first principle to a successful marketing strategy. In the investment business the most common way of defining the market is based on the amount of investible assets an individual or family owns. There is no precise definition as it will vary depending on the financial institution.  Wealthy  and affluent investors  will have assets of between $100,000 and $1,000,000; high net worth individual have between $1,000,000 and $5,000,000; a very high net worth client  is defined as  between $5,000,000 and  $30,000,000 and ultra high net worth  investors have greater than $30,000,000.

In the The Merrill Lynch – Capgemini World’s Wealth Report  of 2009  it is estimated to that in  2008 there were 8.6 million High Net Worth Individuals (HNWI) worldwide representing total wealth of US$32.8 trillion, and that by  2013 HNWI wealth will be valued at $48.5 trillion. In Canada, according to the financial research firm Investor Economics,  there were 544,000 high-net-worth households in Canada. By estimates of BMO’s market research estimates there are about 27,000 homes in Canada with investment asset of greater than of $10-million.

Bottom Line

As an investor, the investment opportunities, advice and service offered to you is based to a large degree on your wealth. As the level of wealth rises, so does the quality of advice and service. It is important therefore to assure that you have the quality of investment advice you deserve.

Please Allow Me To Introduce Myself

Ken Hawkins is the founder of Ohow Investor Consultants, a private investment office, set up to help high net worth investors effectively manage their investment portfolios. Ohow is the Cree Indian word for “Owl” and the Owl has become to symbolize, wisdom, prophecy and prosperity.

As a seasoned investment professional Ken has gained considerable knowledge in the many facets of investment management including portfolio management, investment consulting, quantitative research, investment strategies and the unique challenges of working with high net worth private investors.

Prior to founding Ohow Investor Consultants, Ken was  the Chief Investment Strategist at Weigh House Investor Services, a Portfolio manager with Ontario Teachers’ Pension Plan,  A Quantitative Analyst/ Strategist with Scotia Capital and Deutsche Morgan Grenfell and as an Investment Advisor with ScotiaMcleod and BMO Nesbitt Burns.

The objective of this blog is to provide information, insights, about the implementation of investment stratifies and the process of managing the investment assets specifically for the high net worth investor. This blog will also discuss the unique characteristics of the high net worth investors and those who provide the service, products and advice to them.

Our philosophy for the investment management is as follows:

        

• The optimal approach to investment management, involves a mix of both passive and active investment strategies utilizing the strengths of both approaches and minimizing their weakness.

• Costs and fees are an inevitable part of managing investment assets. Minimizing cost is important, but more important is assuring you get the best value out of the fees that are paid.

• A simple, eloquent, easily understood, but well diversified portfolio is always preferred to a complex, overly diversified portfolio.

• Developing and following the correct investment policy and asset mix, understanding and managing risk, and the proper rebalancing of asset classes and investment managers are most important factors for investment success.

• Investors should think of themselves as the CEO of their investment portfolio, like being a CEO of an operating company.