Key Market Facts

May 14, 2004

Level YTD Indices     S&P 500 1095.70 -1.46% DJIA 10012.87 -4.22% S&P/TSX 8188.08 -0.40% Currencies / Commodities CAD / US 1.3885 7.20% US / EURO 1.1877 -5.23% Gold $US 377.80 -9.34% Crude Oil $US 41.38 27.24% Natural Gas $US 6.40 3.34% Interest Rates Canadian Bank Rate 2.25% -25.00% Canadian Prime Rate 3.75% -16.67% Fed Funds Rate 1.00% 0.00% Us Prime Rate 4.00% 0.00%

As a result of all the discussion in the press, I have recently received a number of questions relating to the impending rise in short term US interest rates. Specifically, how will the increase affect your portfolio?

With US economic expansion moving onto a more self-sustainable footing, the Federal Reserve’s ‘easy money’ policy is coming to an end. We will most likely see the Federal Reserve increase short-term rates before the end of this year.

Equity markets have been weak over the past six weeks caused in part by the continued unrest in the middle east and the levels of oil and gas prices but primarily due to concerns on how the Federal Reserve is going to act in light of the recent strong US economic numbers, especially in employment.

Currently, the market is trading based on economic data releases and not company fundamentals. Once there is more certainty around when rates are going to increase and by how much, the market will begin to focus back on fundamentals, such as earnings growth.

Historically, bond yields start moving higher about six months ahead of the first Federal Reserve rate hike. We saw the beginning of higher bond yields in early April after US non-farm payroll employment increased by 337,000 for the month of March. The nervousness continued when earlier this month the number again increased by 288,000 for the month of April.

Employment and consumer confidence are considered lagging economic indicators. This means that once they start to turn around the new economic cycle that you are going into is already strongly in place. When the economy is turning downwards and moving into a recession, labour is always the last area that employers are willing to cut. The same is true when the economy starts improving. Additional labour is not hired until employers are certain that the increase in demand for their products is sustainable enough to support the increased number of employees.

What does this mean for your investment portfolio? If you currently own any long term bonds in your portfolio you should be selling them and replacing them with a laddered bond portfolio with an end maturity date no longer than three to five years. For clients whose focus is preservation of capital or to reduce overall portfolio volatility, bonds make up an important portion of their portfolio. By reducing the term of your existing bond positions, you will significantly reduce the negative impact that higher interest rates will have on your accounts.

Within the equity component of your portfolios, you should be reducing or eliminating the interest rate sensitive stocks.

These include equities in the following sectors; utilities, pipelines, REITS, telecommunications, bank financials and income trusts.

In most cases this does not mean that you will want to eliminate all of these positions but you must be aware of their sensitivity to a rising interest rate environment so that if you are currently overweight in these sectors you may consider reducing your exposure.

The areas that I would recommend you be overweight in right now are industrials, materials and energy.

Non-bank financials and consumer stocks should maintain a market weighting.

For specific recommendations or if you are uncertain as to what your overall exposure is, please contact me directly at 604 257-7055.

Impact of Interest Rates on Income Trusts

I frequently have something to discuss with respect to income trusts in this newsletter. There are a number of reasons for this. In general, income trusts seem to be the least understood amongst retail investors compared with all other classes of securities. Their lower trading volumes and therefore high price sensitivity to news makes them a higher risk equity for your portfolio relative to many other income generating stocks. It is for this reason that I have recommended that a client not invest more than 15% of their overall portfolio in income trusts.

Over the past four years the rewards of owning the recommended trusts have significantly outweighed the risks however with interest rates threatening to move higher it is important to understand the sensitivity this group will have to higher rates. When interest rates rise and the difference between interest rates and yields on income trusts narrows, individuals are less likely to take on the risk of owning equities versus a cash investment.

If you invested in the sector for the sole purpose of generating additional cash flow for your portfolio then I will likely recommend that you hold your positions. Again the actual income fund or individual income trusts that you own may need to be reviewed as some are positioned better for increasing interest rates than others. If it will bother you to see your unrealized capital gains erode and you are less focused on the actual cash flow then you should consider selling or reducing your position in this asset class.

Please call me directly if you are not sure what would be the best option for you at 604 257-7055.

Did You Know?

The incidence of disability compared to death is significantly higher than many people think. At age 37 the ratio is 8:1 and at age 47 it is 5:1. Many people do not think twice about protecting their families earning potential by purchasing life insurance however many do not consider disability insurance. The following notes the statistics in any given year of popular insurable events:

For more information contact me at 604 257-7055.

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