October 31, 2011

Equity Markets

This summer has been the worst downturn since the downturn of 2008 of the Asset Backed Commercial paper (ABCP) crisis. The three main causes of uncertainty globally and declines in equity markets have been in order of occurrence: 1.) Arab Spring 2.) Fear of an economic slowdown in China, Europe and US. 3.) The European credit crisis with Greece, Italy and Spain presenting the greatest risks. Even though the Arab Spring and the slowdown fears have had some impact the main cause of the recent decline was the European credit crisis. Peak to trough the TSX had lost most of the major indices, down 24.3% (Fig. 1) and even the Dow Jones Industrial Average (Fig. 2) that lost the least still was down 19.2% from peak to trough, the S&P 500 lost 21.6% (Fig.2) and the NASDAQ 20.4% from top to bottom.

 Fig 1. – TSX

The European debt crisis has had as much impact on equity markets this year as the ABCP crisis several years ago. The major difference however is that the European debt crisis has not had much impact on North American income statements and balance sheets whereas the ABCP crisis had ruined banks globally. In fact North American earnings, despite the debt crisis in Europe, have continued to do well. This has brought earnings multiples to bargain levels recently. Equity markets have since recovered somewhat with optimism about a resolution to Europe’s problems emerging after Europe has indicated that a deal has been reached with bond holders of Greek bonds taking a 50% haircut. Although a deal has been reached in principal, details will still have to be worked out and delays could still cause some havoc for equity markets and the deal does not mean that austerity measures are not needed anymore. Generally equity markets are still cheap compared to their long term averages.

I have compiled a comparison of P/E ratios for the major North American equity indices below.

Table 1 Oct 31, 2011

The best indication of overall equity valuations is the S&P 500 index as it is the broadest index. The S&P 500 index has traded as high as 44 times earnings and has had a long term average since 1880 of 16.4. This would indicate that the S&P still trades at almost a 20% discount to its long term average. Even without the extreme outliers the median P/E ratio for the S&P 500 is 15.6 where the current level still represents a 15% discount. (Table 2 below). The P/E ratio for Dow Jones Industrial Average has been as low as 10 and as high as 28 since 1929.

Table 2 

Third quarter earnings have grown 14.3% “adjusted” and 20% “as reported” over a year ago levels and 70.4% of companies have outpaced expectations as of October 28th whereas only 19.8% have fallen short of expectations. Continued growth in corporate earnings will stimulate employment.

Fig.2 – Dow Jones Industrial Average

The Economy, Inflation, the Canadian dollar and Crude Oil.

Inflation has crept up over the past year with the most recent readings at 3.2% in Canada and 3.9% in the United States due to higher energy and food prices. Although there are signs of inflation and improving fundamentals the Federal Reserve in the US is still taking a very cautious approach to increases in interest rates as unemployment is still stubbornly high at 9.1% compared to an average of 5.7% since 1948 in the US.

Even though Canadian unemployment levels are significantly better with its latest unemployment rate at 7.1% compared to an 8.5% average since 1976 the Bank of Canada is unlikely to take a much more aggressive approach to the US to avoid a rise in the Canadian dollar. (A comparative increase of interest rates in one country over another will cause its currency to rise as money will flow to the country with the increasing interest rate).

Central banks mostly control short term interest rates to control inflation with a few exceptions such as “Operation Twist” recently. Longer term bonds have levelled out and the bond bull market may be coming to an end at some point now. Softness of prices of Long term bonds are often the initial indicator of increasing interest rates. (Prices of bonds are inversely related to bond yields – softness in bond prices indicates an increase in bond yields and long term interest rates).
The Canadian dollar, in the absence of diverging central bank policies, will continue to be highly correlated to oil prices. Although resources prices have shown significant weakness over the past year, improvements in equity markets will most likely slow down its decline in the short term and will also offer some support or strength to the Canadian dollar. With conflicts in oil producing countries declining and the reduced fear of supply constraints in the oil market, oil prices will likely soften more over the long term. In perspective by 1998 oil prices declined to about $12 per barrel from a high of about $30 and a brief spike to $40 per barrel in the early 90’s during Iraq’s invasion of Kuwait. Since then oil prices sky rocketed to over $140 per barrel in 2008. Subsequently oil prices collapsed to a low below $40 per barrel. Over the past two years oil prices stabilized and are now fluctuating between $75 and $95 per barrel, with a short rally over $110 early this year.

Conclusion

I expect:
• Strength in equity markets with some volatility in the short term
• Higher inflation rates
• Weakening long term bond prices (increased bond yields)
• Stabilizing to weaker oil prices over the long term
• Longer term weakening of Canadian Dollar
• Improving economics and unemployment rates

Should you wish to discuss the thoughts above further please contact me at (416) 572-2265 or e-mail me at aweller@schwaben.ca Albrecht Weller

This article can also be view at http://SchwabenCapital.wordpress.com

To my valued clients and friends,

Since my last newsletter the US debt ceiling impasse has been resolve however S&P downgraded the US creditworthiness. The current equity market volatility and panic is more driven by a lack of volatility and the absence of many institutional investors over the summer months. Pension funds are long-term investors and have long term asset allocation targets that they require to maintain. As such the tactical asset allocation of pension funds is not impacted by short-term events however is more driven by relative valuations of various asset classes and not by short-term fears or panics. The past several weeks have significantly re-adjusted the relative valuations and should sooner or later revert to their normal norm. I am making significant reference in my analysis to the US and less to Canada as the current market conditions are driven to a very large extend on the events in the US. Equities in the US were not over valued even before the recent correction at 14 to 15 times for the Dow Jones Industrial index and the Standard and Poor index before the recent decline. At a P/E ratio currently of 11.6 for the Dow and 12.3 for the Standard and Poor index equities have become very cheap in the US. This does not mean that in the short term a further decline may not be possible however it is an indication that with current earning fundamentals and valuations in corporate America are very sound. Canadian equities are valued above these levels however are now at 15.9 and not considered expensive either. Equities should recover significantly over the next 6 to 12 months. In 1987 the Dow Jones Industrial Index had recovered all its losses from the decline of leading up to and including Black Monday within 6 months. This was almost a 40% decline from top to bottom. The Dow Jones in August of 1987 was above 2,700 at its height and at the bottom had reached 1,700 the year that I started in the investment business. I have a more in detailed and in-depth analysis of the recovery of the 2008 decline in the February of this year in the Schwaben Blog at http://SchwabenCapital.wordpress.com . Over the past P/E ratios for the Dow Jones and the Standard and Poor’s index have reached levels between 20 to 25 with less corporate earnings growth than this year. This reflects that although investors are nervous due to all the geopolitical events that occurred this year, corporate fundamentals are still very strong with very reasonable valuations.

Equity market volumes were significantly lower in July due to the summer season. Only in the first week of August did volume spike due to individual investor panic both on a direct investment basis and due to Mutual Fund redemptions that have forced Fund Manager to liquidate a significant amount of holdings into a market that does not have rationality. Institutional investor, especially pension funds are generally less active over the summer months as such volatility has naturally been higher than normal especially with various geopolitical factors playing a more intense role. Pension fund have so far not significantly stepped in as they are waiting for “the dust to settle”. Since our last newsletter congress has passed the bill to raise the debt limit however not until the very last minute and not without politically and economically “speculative games” in favor of attempting to obtain the upper hand in the next election. Unfortunately this has now come at the expense of the general public, retirees and many other investors. Up to this point the US economy was on the road to recovery although not as strong as expected however earnings have increased and employment numbers last week were revised upwards and employment numbers were better than expected. However since the impasse only Moody’s and Fitch had reaffirmed the “AAA” credit rating for the US. Standard and Poor’s still had not re-affirmed the “AAA” credit rating causing significant nervousness by investors. A re-affirmation would have resulted in a relieve rally in equities.

Although the US finances have significantly deteriorated during the last administration caused by the US credit crisis and military spending, The US financial position has not deteriorated to the point where it should have received a lower credit rating however the US impasse and political wrangling over the debt ceiling has exposed the risk of a dysfunctional congress in the US. The mere fact that some politicians were willing to gamble on the potential default of the US government on its debt has caused many investors to reassess the political and sovereign risk of the US. Both, Moody’s and Fitch obviously focused primarily on the financial stability and dominance on the US. Standard & Poor’s on the other hand had allocated significantly more weight to the current political instability. Given that credit rating agencies were severely criticized after the credit crisis in 2008, Standard and Poor may have reacted too soon rather than too late. While the credit downgrade by Standard and Poor’s downgrade has limited impact on investment funds at this point, the potential ramification of what would happened if a second rating down grade by either Fitch or Moody. Furthermore and the fact that the US has never had anything less than a “AAA” and the fact that Standard and Poor was aware of the political backlash it would receive after the downgrade speaks volumes about Standard and Poor’s decision. Japan had lost its “AAA” credit rating in 1991 and did not regain it until 1999. Most funds that are mandated to only invest in “AAA” require that at least 2 out of the 3 credit rating agencies must have a “AAA” credit rating on the investments. Furthermore the US debt represents 75% of the total debt globally as such the two largest creditors, China being number 1 and Japan being as number 2, have limited options to invest in other major liquid bond markets. Although S&P had downgraded the US to “AA+”, the second highest credit rating, Japan had re-affirmed that it considered US bonds as the safest investment, while China on the other hand had handed out significant criticism on the US’s handling of their finances.

As of this morning overseas equity markets have erased losses and US index futures over night have gone through drastic volatility from the Dow futures were down over 300 and later on rallied to 350 points into positive territory. This represents more than a 6% swing of the index. As of 7:23 this morning S&P index futures are up 2.3% – recovering a significant portion of yesterday’s losses.

This newsletter will also be posted on our Blog at:

http://SchwabenCapital.wordpress.com

Please also visit our website at

http://www.Schwaben.ca

Should you have any questions or would like to discuss this further please call us at (416) 572-2265 or e-mail us at info@schwaben.ca.

Thank you for your interest and your business.

Kind regards,

Albrecht Weller

To my dear clients and friends,                                                                            July 28, 2011

Equity markets have experienced significant volatility over the past several weeks. US equities are now off 4.3% for the year. The main causes for the volatility were primarily:

1.)  Arab spring and political uncertainty surrounding the consequences

2.)  Fears of slow down in the Chinese economy

3.)  Uncertain earnings seasons

4.)  Fear of the US slipping back into a recession

5.)  European debt crisis

6.)  Lastly but certainly not least the impasse in the US debt ceiling negotiations.

All these reasons are very valid reasons for concern that have stunned the appreciation of stock prices however have only had a short term impact on the fundamentals.

North American equity earnings have grown significantly in 2011. More than 70% of companies reporting have outpaced expectations in the US and more than 50% in Canada. The Dow Jones industrials Index and the S&P500 index are off 4.3% and 4.7% respectively for the year and the TSX is down 2.8% since January 1, 2011. This implies significantly lower valuation levels. The lower valuation level is caused by what is referred to a higher equity risk premium, which anticipates a lower growth rate for the economy and earnings. The above factors can certainly have an impact in the economic future of North America however in my opinion the equity risk premium at this stage is unjustified. I am listing the above uncertainties and the outcomes or consequences to this point in order to show how much less the factors have impacted economic growth and activity and North American earnings for stocks.

Analysis

After reviewing the two proposals I feel that a solution by next week could be very likely. I think it would be quite conceivable that if a deal is reached before next Tuesday and US treasury bonds will not be downgraded that both the TSX and the Dow could appreciate by 500 to 1,000 points within a few days if not quicker. According to this illustration both sides are close on their fundamental bases. S&P has made it quite clear that even with a two stage deal US Treasury bonds would most likely be downgraded. Both cases,  1.) no deal gets done or 2.) a two stage debt ceiling increase would likely cause a downgrade of the US and would in my opinion be political suicide for the republicans after a downgrade. I believe that the options for republican negotiations have now become limited without the blame of the consequent turmoil being carried by the republicans.

We have not increased any of our equity exposure since the impasse become more prominent however I feel exiting equities at this point could have very regrettable consequences if and when a deal gets done. Failure of the debt ceiling being raised would definitely have a negative impact on equities and US interest rates however I do not believe in a catastrophic proportion.  It would created a creates disruption the US bond market as it could have sever implication on funds that only can hold AAA bonds.

The CBO verdict

How the Congressional Budget Office scored the two deficit-reduction plans by House Speaker John Boehner and Senate Majority Leader Harry Reid

* – Revised plan

February 23, 2011

To our dear friends and clients,

We had recently published our first article on Inflation as I felt this would be or become topic that would impact both lives of investors and also their portfolios. Given the price increased in commodities I felt that there would be underlying inflationary pressures that would impact our lives. This has so far not occurred to a great extend. I subsequently analysed what is called the Produced Price Index. The Producer Price Index is a wholesale price index, the cost that producers pay for their goods and services. The Producer Price Index is sub-categorized in various groups, Industrial, Raw Material and Services.  Some of these show a different story which will lead into our next article and offer a further insight why inflation is a threat we will have to deal with in the near future. In this article Bernd, my partner, has been able to connect Economics 101 to the real world in this article in a very congruent and understandable manner in examining the Consumer Price Index, the price index that affects our daily lives.

Inflation: What causes it?

Last time we examined the calculation of the Consumer Price Index (CPI) and how it applies to the average Canadian household, but not necessarily to you. Now, we want to look more in detail what can cause it and how do the economic relationships work. You will say it is easy to determine what causes inflation, e.g. higher commodity prices, higher import prices, higher wages.

Yes, these are obvious items that have an effect and we will get back to it later. From a monetary economic point of view an important variable is money supply and how it is connected to other aggregate economic numbers. The quantity theory of money provides such a frame work, it looks at the relationship between the velocity (V), the money supply (M), the price level (P), and the output (Y). This is represented by the equation M * V = P * Y. The right part of the formula represents the nominal GDP (P * Y).

How does this help me in estimating inflation? Assuming that the velocity and output are constant a 3% increase in money supply would result in a 3% price increase. Is it really that easy? No, let’s take the US as an example. The money supply measured by the money aggregate M2 increased from end of 2007 to 2010 by 18.66%.

However, up to this moment this has not yet translated into higher prices as prescribed by the theory, as the price level increased only by 4.35% in the same time and the output was constant. Why, the velocity of money went down by 11.36%, as every solvent bank was sitting pretty, hoarding cash, cutting credit lines and therefore not increasing the circulation of money. In addition the consumer was suddenly concerned with their debt levels and started saving and paying down debt. Velocity can also be considered as an indicator of business activity, if consumers and businesses buy goods – money changes hands. The more active the economy, the more often money changes hand or is created through use of credit. This is why central banks across the world, especially the FED, have stepped in and pumped money into the economy and become true lender of last resort. This was good news during the recession, but what if the economic activity increases and the velocity starts to rise again. If the central banks cannot reduce the money supply this will end in higher inflation.

An additional point of view is to not only consider the monetary policy of a country but also at the fiscal policy. In recent years the fiscal theory of the price level, a new economic theory is quoted more frequently. It states that government fiscal policy can affect the current price level, by connecting the present value of future government tax and spending plans to today’s outstanding government liabilities through the inflation rate. For example, if it is expected that the government is spending more money in the future, than a higher inflation rate is necessary to off set this and create the same present value of all future spending plans. (Note: A higher inflation rate results in a lower present value of future cash flows.)

This causality has been shown in the past, however the effect on the inflation rate is not always as direct as expected and is highly dependent on the expectations if future governments can produce a balanced budget or even a surplus. Otherwise, we would be in deep trouble, given the current fiscal deficits in the developed world and future obligations due to an aging population.

We looked at the monetary and fiscal policy influence on inflation and its danger. What are other factors that impact inflation such as higher commodity prices? These factors will eventually be passed on to the consumer, if they are perceived to be permanent by the producer. Bad weather for example that affects the harvest in one region might not result in a direct overall price increase. But an increased demand or decreased supply due to permanently altered patterns will lead to higher prices. The recent uproars in the Middle East are partly attributed to higher food prices.

At the same time developed countries phase the danger of imported inflation because several emerging countries like Brazil, India, Indonesia or even China experience higher inflation due to the fact that their economies have expanded at a higher rate than they increased their capacity. As these countries manufacture many parts for industrialized countries, price increases are passed on; for example import prices in Germany increased by 12% in the last year.

From a Canadian perspective we are somewhat sheltered from this effect up to this point as the Canadian Dollar has appreciated against most other currencies and this absorbed some of the price increases; on the other hand it reduces our competitiveness as our goods become either more expensive for foreigners to buy or our companies earn less money on it.

Another big influencing factor on inflation are increases in wage levels. In recent years wages in developed countries have been stable or have even declined. As the economy will pick up, we will see that people will ask for higher salaries. Currently, the main argument against this is that the unemployment rate is too high and therefore employees and unions don’t have the negotiation power to demand higher wages. This argument might have some validity for unskilled work, but in professions where skilled labour is needed and cannot be replaced by a random unemployed person, employees will start to push for higher wages. These factors are already apparent in the Producer Price Index.

All these factors raise concern, so watch out for inflation, but don’t expect that it will materialize in one big jump. However why worry about inflation other than more expensive goods. It will also impact interest rates and therefore mortgage rates. Several recent articles have already stated that the average consumer debt level is higher than ever before since it has been measured at more than 145% of income.  Can all the consumers that have purchased expensive homes continue to afford their mortgages if mortgage rates increase by 2%. This would represent almost a 50% increase on a 5 year mortgage. What will happen when these come up for renewal ?

As always, should you wish to discuss this further or would like us to review your portfolio please call us at 416.572.2265 or email us.

Bernd Henseler                                               Albrecht Weller

bhenseler@schwaben.ca …………………………… aweller@schwaben.ca

February 3, 2011

To our dear friends and clients,

We have now completed our first year of operation and have started a track record of our Canadian stock model portfolio. Our model portfolio is a portfolio that has been set up with a quote vendor that track positions when we purchase or sell these in the model portfolio. The actual purchase and sale in our clients portfolios may differ from when we purchase and sell securities in the model portfolio due to risk and other portfolio restrains. The model portfolio however offers a good representation of what a portfolio would look like if we had invested the funds starting January 4, 2010 and it had no restraints. A model portfolio is not eligible for an official performance track record thought, based on the CFA Institute guidelines or as it is official referred to the “Global Investment Performance Standards” or other regulatory organizations as it cannot be audited and does not meet some of the rules and guidelines that are required when calculating investment returns for official performance guidelines. It offers a good indication though how well all of our selections have performed.

The return on our Canadian dollar model portfolio including dividend and distributions was 25.5%.  Our portfolio was fully invested for almost the entire year.  The only sale we made was our position in Western Coal on November 18, 2010. We purchased Western Coal at $3.86 at the beginning of the year and sold it on November 18 for $10.75, with a 178% gain, after a takeover bid from Walter Energy pushed the stock as high as $11.00. The stock has since appreciated to over $12.00 however we were happy with the return that we achieved as we did not want to be exposed to a potential decline should the takeover bid have fallen through. We put Enbridge on our watch list, were we will not add the position to any portfolios as we feel it may be a bit expensive and we want to review the position to determine to what extend and how much more upside there may be in Enbridge.

Last year we also established some selected positions in the US to offer some of our clients where appropriate some exposure to the US. This year we established an entire model portfolio that will allow us to track our US performance. One of the positions that we established last year in the US was Apple. We have sold Apple earlier this year at U$342.00, for a 36.8% gain, after Steve Jobs indicated a medical leave of absence. It was our concern and opinion that a complete absence of Steve Jobs would have a sever impact on Apple. Steve Jobs has had two major medical complications since he has taken the helm at Apple. Initially he was a survivor of on of the least lethal forms of pancreatic cancer in 2003 and he recovered in 2009 from a liver transplant operation. While we hope that Mr. Jobs recovers from his current medical ordeal we feel that we do not want to risk the potential price volatility that may occur if he does not. The Chief Operating Officer Tim Cook is not a very well known personality and in the total absence of Steve Jobs would likely not attract the instant confidence of many investors. A further point is that growth expectations for Apple have increased significantly and with the increased competition in the smartphone and tablet area, we feel that Apple could miss the market expectations.

While we feel that equities have appreciated significantly over the past 6 months, in fact since the bottom of last August at just above 11,000 on the TSX and just above 9500 on the Dow and just above 1,000 for the S&P every Index has marched straight North to levels not seen since 2008. In the last two quarters equities in all sectors across the board have surprised investors as well as Analysts with stunning results. This has resulted in an almost 30% appreciation in the S&P 500, a 25% appreciation in the Dow Jones Industrial Average and an almost 23% capital appreciation since then. You may ask yourself why your portfolio did not achieve such spectacular results.

1.)  Your investment period was most likely longer than July 2010. January 2010 equities levels were higher than the low point in July of last year. Returns from December 31, 2009 to December 31, 2010 on equities were significantly less, in fact 12 months 12 months return have only been 14.1% for the Dow Jones and 15.1% for the S&P 500. Please see the statistics below for further insight,

2.)  Our equity selection is skewed away from cyclical equities such as resource based stock. Resource based stocks have done extremely well over the past 6 months with metals and Oil appreciating significantly since then. We do not believe in specific market timing, resource based and cyclical stocks generally can add significant volatility to portfolios. Our focus is to achieve solid returns with smaller troughs and peaks. We prefer that our clients sleep well at night. We think there are still enough reasons to have ups and downs that we don’t need to add volatility created by commodity speculation.

3.)  The asset allocation to equities and fixed income including preferred shares in your portfolio most likely resulted in less than 100% exposure to equities. In many cases we have used high yielding, high quality preferred shares to obtain income in lieu of actual bond. We feel that the yield premium and the preferential tax treatment of dividends more than make up for the extra interest rate risk or credit risk that high quality preferred shares may have.

In spite of all these facts our twelve months return December 2009 to December 2010 on our model portfolio, of which our clients portfolios are partially made up, was 25.5%.

Although the last six months have had very significant capital appreciation we feel that many equities are still not overvalued and that with proper stock selection this may be a time when active stock selection can still be of significant value.

In spite of many political and economic hurdles, equities seem to continue to march higher both in Canada and the US. There may be some volatility over the next few months however we believe that since equity markets have broken new highs and established new support levels the downside should be limited at this point in time.

Performance of North American indices and

Schwaben Canadian $ Model Portfolio

in 2010

* There is no price return performance measured for the Schwaben Model Portfolio because of purchases and sales of securities.

To our dear friends and clients,

Over the past several years I have often wondered what the true inflation rate is in Canada and the US. The US has had some significant compression in hard assets due to the compression of housing prices over the last number of years however Canada has had no or very little decline in housing prices except in Alberta. Many raw material prices however have increased very drastically starting with oil from $10 to $12 per barrel 10 or 12 years ago to food agricultural commodities, services, real estate and the list continues. An increase in inflation results in higher bond yields and could have an impact on your bond portfolio or your preferred shares. A recent article on Marketwatch has confirmed my suspicion even in the US. Please read it on Marketwatch directly at:

http://www.marketwatch.com/story/why-you-cant-trust-the-inflation-numbers-2011-01-26-1137490

or as the attachment to our e-mail (please ignore the advertisement on top – we believe it should be the Schwaben Banner and not Putnam – a bit of humor).

Several economists have increased their long term bond yield forecasts today which is an indication that higher inflation is on the horizon.

My partner, Bernd Henseler, has done a more extensive review of this phenomenon and has come up with the following preliminary conclusion:

Inflation: Do you live in an average Canadian household?

If yes, then the latest Consumer Price Index (CPI) data might be relevant to you. If not, you might feel that the latest annual increase in the CPI of 2.4% is does not reflect your cost of goods and will likely indicate a lower increase than what you may be experiencing.

Firstly, what is the CPI? The CPI measures the price development of a representative shopping basket of 600 goods and services that the average household consumes. The basket is adjusted throughout time to reflect changing consumer behaviour.

But secondly, what is an average Canadian household? The average household has a total annual income of around $71,277 and after taxes and pension savings it has expenditures of $50,734. Expenditures are spent on:

Source: Statistics Canada 2009

Not surprisingly the CPI basket that is used has a similar breakdown and weighting.

And, do you feel represented by this breakdown? Where are the soaring energy cost, what about the latest increases in tuitions, nobody noticed the rising food or commodity prices? HST?

Maybe, the simple answer is you are not an average Canadian household, but you are an average household in Ontario. Households in Ontario earn more than the national average and have general higher costs for housing and transportation. The CPI figure for Ontario is 3.3% and therefore 37.5% higher than the Canadian CPI figure of 2.4% (see Table 2). If you are living in Ontario, that lets you definitely feel a bit more pinched for your money.

Table 2: Annual CPI for Canada and Ontario, Source: Statistics Canada

Another reason might be that your shopping basket is not equivalent to the average Canadian and therefore you feel that prices have increased. For example your households owns two cars instead of one, then you will be more aware of changes in energy prices. In Canada energy prices increased by 10.5% and in Ontario by 15.6% over the past year. In Ontario, energy prices added a full percentage point to the CPI. Without increases in energy the CPI would have been only 2.3% instead of 3.3%.

What about substitution of goods that you have purchased in the past, but now change to new more expensive items? For example, haven’t we used in past simple cell phones just to call people. Now, we have the latest I Phone or smart phone including data plan and many other expensive add ons.

What about the other big news items that food and commodity prices increased, e.g. vegetable products increased by 21.9% and animal products increased by 5.1% in the last year. But the CPI for food increased only by 1.7%. It seems that producer have not yet fully passed down the higher cost for raw material to the consumer, because of a competitive environment. However, if the prices will stay high, producer will eventually pass these higher costs on to the conumer. Just yesterday, McDonalds announced that it considers increasing the prices of Big Macs because of higher food prices.

The same will hold true over time for other commodity prices that producers will pass through to the consumer.

The CPI reflects only past price changes. What are other items that could cause inflation to rise in the future?

-       Sustained higher commodity prices that will be passed on the consumer

-       After the recovery of the recession unions will ask for higher wages, thereby  increasing production costs

-       Imported inflation. China as world manufacturer faces higher labour and raw material cost, that increase the cost of imported goods purchased in Canada.

-       Higher interest rates will lead to higher mortgage rates

Going forward the Canadian consumer will face several factors that could increase inflation over the next couple of years on an overall level. However, as we established, CPI data might not apply to your household, as you may not be an average Canadian household. Therefore your choices will affect your personal perceived inflation rate. Of course, you could create your own deflation, by only shopping at discount stores, selling your car, canned food instead of fresh food, using coupons and not buying the latest gadget. But is that fun?

Look out for inflation, possibly more than most expect, and review your investment portfolio.

Should you wish to discuss this further or would like to review your portfolio with us please call us at 416.572.2265.

Bernd Henseler                                                           Albrecht Weller

One particular feature of RRSP that could save you tax money during retirement is that a spouse can contribute to a spousal RSP.

-       How does it work? Instead of using your contribution room to pay into your own RRSP you pay into your spousal RSP and still deduct it from your earned income.

-       When can this be advantageous? If one spouse is in a higher tax bracket than the other and has already saved a higher amount in their RRSP. This will even out the RSP balances and gives more flexibility during retirement, while withdrawing money and paying taxes.

After you paid into your RRSP and still have extra money you should consider opening a Tax-Free Savings Account (TFSA). This was introduced in 2009 and allows every individual above 18 years to save up to $5,000 a year. The savings and any distributions or capital gains accumulate tax-free. The money can be accessed anytime and no taxes need to be paid. If you haven’t opened a TFSA account yet, you could use the accumulated unused contribution room for 2009 and 2010 plus this year contribution room and pay $15,000 into a TFSA.

Of course, should you want to save for your children or grand children education you should consider a Registered Education Savings Plan (RESP). The government is adding 20% to the first $2,500 in contributions to the beneficiaries RESP each year.

Another government sponsored savings plan was introduced recently for people with disabilities. With a Registered Disability Savings Plan (RDSP) the government gives up to $3,500 in grants to the beneficiary each year.

The following table compares the taxation of different income sources for an Ontario based tax payer. For example, if have a portfolio of 2 Million dollar and earn 4% in dividends from Canadian public companies you receive a before tax income of $80,000. This translates into an after tax income of $72,500 or a average tax rate of 9.38%. If you would earn the same $80,000 but from interest payments you receive after tax only $60,199 or an average tax rate of 24.75%.

We hope the brief tax ideas have been of interest and look forward to hearing from you if you have any questions. You can reach us at 416.572.2265 on our general number or Albrecht at 416.477.7216 and Bernd at 416.477.7217 directly.

We will have our portfolio review and capital market analysis and outlook within the next week.

You can also find this, past and future newsletters on our Blog at http://schwabencapital.wordpress.com .

If you have any questions, give us a call!

Albrecht Weller                                    Bernd Henseler                                        Martin Häfele

December 2010

Dear Friends and Clients,

It has been almost one year since we started operating as Schwaben Capital Group
Limited. As I had mentioned to many of my previous clients and friends, Martin
Häfele, a friend and client had joined me during the starting period of our
firm and I much appreciated and still appreciate his support and help. In
August of this year Bernd Henseler a former investment banking executive from
Deutsche Bank and Morgan Stanley joined us. This has allowed us to advance our
investment counseling and investment banking activities significantly.

As the year 2010 and our first year come to a close I would like to offer some of
my observations and commentaries to offer some perspective for my friends and
clients to reflect on over the holidays. We will have a more extensive
commentary with market performance and analysis as well as our portfolio
analysis in January 2011.

This year has been a fruitful year for many investors. While equity markets have
experienced more volatility and uncertainty than most investors would prefer,
the second half of the year and especially the last quarter have more clearly
defined a market trend. I believe the gains over the past 3 and 4 weeks in the
DOW and NASDAQ respectively are a clear affirmation of this. In Canada equities
have weathered this past downturn much better than the US due to 1.) a much
better banking position and 2.) of course the fact that the Canadian equity
markets has benefited from a strong resource sector. Company earnings have outpaced
expectations in both of the previous quarters. In fact in the last quarter
earnings outpaced earnings expectations in 77% of the earnings releases in the
US. While there are still many skeptics of equity markets, it has always been
my opinion that if earnings outpace expectations by a wide margin equities will
follow. In fact Oracle has released 47% higher revenues than last year this
past week. Although many skeptics still argue that the positive earnings that
the US has experienced were a function of the stimulus packages and may not be
a true recovery, it is my opinion that the stimulus packages in the US have
largely been effective however at the cost of possible significant pending
inflation. Some market observers believe that inflation is more a phenomenon of
the past, however I am very much of the opinion that the ballooning
quantitative easing and printing of money has been the direct cause of the gold
price appreciation and will be the cause of an impending inflationary period.
Even though Gold prices may appreciate further, I believe that with higher bond
yields, gold and other commodity price appreciations may be dampened. I also
feel that as soon as the economy in the US will pick up and the velocity of
money will increase, the US may face very significant inflationary pressures
and as such also higher interest rates. This will very likely not be welcome by
the US real estate market, which still shows difficulties. In fact, the $30
billion real estate support program will only stop approximately 800,000 foreclosures,
which only represent about 20 to 25% of the 3 to 4 million that was the target.
Higher interest rates may also have an adverse consumer impact in Canada as
Canadian consumer debt has reached the highest level in recorded history.

We have also done some number crunching to offer some perspective of equity
markets. Please see the table on the next page.

This is just a brief pre Christmas perspective. We should have more in January. We
will also publish this and future newsletters and other market commentaries also
on our blog. Please mark http://schwabencapital.wordpress.com/ our blog and follow us there as well. You can also visit our website at http://www.schwaben.ca for more information on our company, our team and the services we offer.

Until then – Merry Christmas – Happy Holidays and a Happy New Year.

With kind regards,

Albrecht, Martin and Bernd

Schwaben Capital Group manages assets for senior executives, high end entrepreneurs and high net worth families in excess of $1,000,000.

We gladly offer you random advise on investment strategy or overall market sentiment in order for you to evaluate our services.