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March 1, 2016 INVESTMENT STRATEGY NOTES Nick Majendie, CA | Director, Wealth Management| ScotiaWealth Senior Portfolio Manager, with responsibility for advising the Anchor Managed Funds

More on central banks’ impact on the economy and financial markets

Stock market outlook negative rates was undertaken to weaken its In recent Anchor Notes, we have said that, in a world currency as was also the case with Switzerland. where central banks have been pursuing These moves have largely been successful. unprecedented levels of monetary ease, short term Bloomberg Business in an article initially published market forecasting is still more than normally on February 14 quotes Helge Pedersen, chief difficult. In a period of heightened uncertainty and economist at Nordea in Copenhagen as saying “We volatility, we have thus adopted a cautious and have learned that a negative interest rate is a tool defensive strategy in the early part of the year. that works to weaken one’s currency but it doesn’t work to stimulate lending.”3 In our last Anchor Note, we examined the impact of historically unusual central bank actions specifically We have discussed in recent Notes the odds of a U.S. on banks. In this Note, we examine how these recession this year, concluding that the ECRI actions are affecting financial markets more (Economic Cycle Research Institute) had been the generally. best prognosticator of recessions of any that we have followed over the last number of years and that The impact of central banks’ recent moves on the for the moment, the numbers were indicating very economy and financial markets slow growth but not yet a recession.4 The latest ECRI In our last Note, we stated: “Earlier this year, Weekly Leading Indicator (WLI) reading shows a Stephen Poloz, the Governor of the Bank of Canada negative number 3.4%5 (as of Feb 19, 2016), still said that the Bank was examining the use of negative short of the -10% number that is invariably the interest rates in Canada in possible response to precursor of a U.S. recession. economic weakness1 although most observers believe that the use of this measure is unlikely. Christine Lagarde, Managing Director of the Similarly, Janet Yellen in her recent testimony before International Monetary Fund, is quoted by Congress has talked of the Federal Reserve Board Bloomberg News on February 25 as saying at the G- studying the same subject.2 This comes on top of the 20 meeting in Shanghai that, even amid growing Bank of Japan in January following central banks in risks to the global economy, she still saw growth Denmark, the Eurozone, Sweden and Switzerland by despite threats from geopolitical risk, the credit moving to negative interest rates. cycle, capital outflows and falling commodity prices.

Denmark is the country with the longest history of 3Bloomberg Business (2016). Here’s Why ECB and BOJ Can’t Copy Danish Negative negative interest rates. The country’s initial move to Rate Success. http://www.bloomberg.com/news/articles/2016-02-14/here-s-why-ecb-and- boj-can-t-copy-danish-negative-rate-success Retrieved on Feb 14, 2016. 1 CBC News (2016). Business. http://www.cbc.ca/news/business/stephen-poloz-monetary- 4 Anchor Managed Funds (2016). The risks of a peaking in North American equity policy-1.3355704 Retrieved on Feb 12th, 2016 markets and a strategy to protect and prosper, December 15, 2015 issue. Retrieved on Feb 2 Board of Governors of the Federal Reserve System (2016). Speech Chair Janet L. 29, 2016 Yellen http://www.federalreserve.gov/newsevents/speech/yellen20151202a.html 5 ECRI Economic Cycle Research Institute. Featured ECRI Composite Indexes. Retrieved on Feb 12th, 2016 https://www.businesscycle.com/ Retrieved on Feb 29, 2016

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Her formal presentation said that: “Activity easing) and seven years of ZIRP (Zero Interest Rate weakened unexpectedly at the end of last year, Policy). These measures were designed to boost which has led us at the IMF to revise growth economic growth to a sufficient degree to allow a downward for this year and beyond. Growth in subsequent cycle of raising rates. This monetary advanced economies remains modest, and some strategy was originally designed to avoid the large emerging markets are showing signs of Japanese experience which saw repetitive periods of distress. On top of this, China’s necessary transition ZIRP (and now NIRP or Negative Interest Rate Policy). to a more balanced growth model has added to Clearly, that strategy is not working as U.S. economic market volatility. All this has unsettled financial growth continues to be weak. Thus, it is increasingly markets, which in turn depresses consumer and likely that the Fed will have to change tack yet again investor sentiment. In this fragile environment, we and there is increasing speculation as to a return to need urgent action not only to boost economic ZIRP and QE, if not even NIRP. In effect, the Fed’s potential, but also to boost confidence about the strategy has failed. recovery and near-term growth…Meanwhile, the effects of central bank monetary policies, even Similarly in terms of failed strategy, Japan’s Three innovative ones, are diminishing.”6 Arrows’s policy of fiscal stimulus, monetary easing and structural reforms under Abenomics has not Lagarde concluded that “We are still in an been working with two successive years of zero environment where there is growth around, and I growth including two recessions. This has resulted in can understand why quite a few players are now the Bank of Japan resorting desperately to NIRP, saying there is an overreaction of the markets and which so far has had the opposite effect of initially there is probably too much anxiety than is currently causing the yen to rise not fall. As we pointed out in warranted by what’s happening in the our last Note: “Despite the fact that it appears that fundamentals."7 Our reaction would be that Lagarde negative interest rates are having a negative rather is perhaps downplaying the fears of markets and than the desired positive effect, central bankers investors – particularly as it relates to the U.S. seem determined to double down on this doubtful economy. As underlined by the weak ECRI WLI, strategy. European Central Bank President Mario which have a lead time of eight to nine months, the Draghi has strongly indicated that the ECB will make market has started to realize that economic data a further deposit rate cut9 in March while observers surprises have been consistently on the negative believe that the Bank of Japan’s recent move was side recently and it has become more apparent that just the first in this direction”. We continue to the Fed’s plans for several rate hikes that were in believe that this makes it hard for banks to increase prospect for this year were likely on hold. And this is earnings when interest rates are low and will be in an environment that has also seen negative Q1 even more difficult when they are negative. S&P 500 earnings and continued negative revenue performance for the index.8 In addition, investors are starting to lose confidence in China’s leaders, who had been regarded as Doubts have also been growing at the continuing effective technocrats, to make a smooth transition efficacy of monetary policy. from an investment lead economy to a consumer driven economy. They have endeavoured to support After the 2008/9 Financial Crisis, the Federal Reserve this shift by increasing credit through the banks and Board undertook three rounds of QE (quantitative the shadow banking system.

6 International Monetary Fund (2016). G-20 Seminar on Structural Reforms. Alan Greenspan originated the Fed’s low interest http://www.imf.org/external/np/speeches/2016/022616.hth Retrieved on Feb 29, 2016 rate policy which ultimately led to the U.S. housing 7 Bloomberg Business (2016). IMF’s Lagarde still sees growth even amid growing global risks. http://www.bloomberg.com/news/articles/2016-02-26/imf-s-lagarde-still-sees- growth-even-amid-growing-global-risks Retrieved on Feb 26, 2016 9 The Guardian (2016). Stock Markets rally as Mario Draghi hints further stimulus on 8 Bloomberg Business (2016). http://www.bloomberg.com/quote/SPX:IND Retrieved on way. http://www.bloomberg.com/news/articles/2016-02-14/here-s-why-ecb-and-boj-can-t- Feb 29, 2016 copy-danish-negative-rate-success Retrieved on Feb 16, 2016

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crisis; then when, Ben Bernanke became Fed immediately sold the stock. We have a lot of Chairman, he started the ZIRP which under Janet confidence in David Garofalo, who has just become Yellen was further perpetuated (up to December the new CEO. We have interviewed him over a 2015). ZIRP was in place for 86 months and, as number of years when he was CEO of Hudbay pointed out above, has not succeeded in boosting Minerals Inc. and CFO of Agnico Eagle Mines Ltd. We economic growth and it is highly unlikely that a few believe that he will likely succeed in making more negative basis points on interest rates, if ever Goldcorp Inc.’s mines more efficient and results imposed by the Fed, would make any noticeable more reliable. But that will take time and investor difference either.10 sentiment is likely to remain negative for the next while. We are considering use of a replacement gold In sum, monetary policy in the Eurozone, the U.S. stock in the short term but are hopeful of being able and Japan has been a destabilizing influence on to reconsider Goldcorp Inc. as a gold vehicle down financial markets and combined with missteps by the road. Chinese officials have started to undermine investor confidence and, if this trend continues, it will have a In our last Anchor Note, we mentioned the potential negative impact on an earnings picture. for somewhat of a countertrend rally in North American markets. With this mind, we modestly That said, we still feel that financial markets are increased the equity segment in our Defensive somewhat oversold in the short term such that we Income portfolio from 25% to about one third. We may be able to see the recent rally developing did this by adding to five of the infrastructure stocks further over the next while. However, risks of a that we highlighted before Christmas in a Note. North American and global 2016 slowdown and These included BCE Inc., Enbridge Inc., Pembina possibly recession remain elevated. As we said in our Pipeline Corp., TransAlta Renewables Inc. and Telus last Note, “the former would be consistent with a Corp. We also added to Canadian Tire Corp. Ltd. and 20% to 30% correction, which we have already seen were much encouraged by its subsequent Q4 results. in Canada, while the latter would engender a Finally, we added modest positions in two banks, the considerably greater decline.” We remain Bank Of Nova Scotia11 and National Bank, both of defensively positioned in the interim as monitor the which we believed were selling at high single digit progress of U.S. and global economic direction. In multiples on forward EPS (earnings per share) and addition, the faltering faith in central banks and we thought could be due for a short term bounce if government officials has been a key reason, in our markets continued to rally. opinion, for the recovery in the gold price over the last few weeks and, unless those same officials can The WTI (West Texas Intermediate) oil price seems succeed in reversing the lack of investor confidence to have at least temporarily stabilized in the high in their efficacy, 2016 could well turn out to be a $20’s/low $30’s area.12 We think there is a year of surprising further strength in the price of reasonable prospect of a modest rally in oil and oil gold. stocks in Q2 with the end of the U.S. refinery maintenance season (anything more significant Portfolio changes would require a change of heart on production levels The strength of gold bullion and gold stocks has been by Saudi Arabia which seems unlikely). We decided a key reason for the positive performance of our therefore to moderately reduce our underweight oil Advantage Equity and Dividend Growth portfolios and gas exposure in our Advantage Equity, High year-to-date. However, as soon as we saw the Income, Balanced Income and Dividend Growth reserve and book value write-downs and the portfolios. In our Advantage Equity portfolio, we dividend cut by Goldcorp Inc. after Q4 results, we

11 The Bank of Nova Scotia is the parent company of Scotia Capital Inc., the portfolio 10 Newsmax Finance (2016). Why the Keynesian market wreckers are now coming for manager of the Anchor Managed Funds even your Ben Franklins. http://www.newsmax.com/Finance/DavidStockman/larry- 12 Bloomberg Business (2016). http://www.bloomberg.com/quote/CL1:COM Retrieved summers-currency-dollar-bills/2016/02/18/id/715009/ Retrieved on Feb 29, 2016 on Feb 29, 2016

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added to our holdings of ARC Resources Ltd, added to our holdings of Arc Energy Ltd. and Vermilion Energy Inc. and NuVista Energy Ltd. and Vermilion Energy Inc. bought a new position in Imperial Oil Ltd. In our High and Balanced Income portfolios, we added to our Due to Spring Break, our next Anchor Note will be Vermilion Energy holding and bought new positions published on April 1 2016. in Arc Energy Ltd and Imperial Oil Ltd. Finally, in our Dividend Growth portfolio, we bought new positions in Cenovus Energy Inc. and Imperial Oil Ltd. and

Nick Majendie, CA Director, Wealth Management, Senior Portfolio Manager, ScotiaWealth

PLEASE NOTE: IMPORTANT DISCLOSURES AND DISCLAIMERS ARE CONTAINED ON THE FOLLOWING PAGES.

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i The Bank of Nova Scotia is the parent company of Scotia Capital Inc. (“SCI”) and is therefore a related issuer of SCI. Scotia Managed Companies Administration Inc., a wholly-owned subsidiary of SCI, is the manager of the Anchor Managed Funds. ScotiaWealth, a division of SCI is the portfolio advisor to the Anchor Managed Funds. Nicholas L. Majendie, who is employed by ScotiaWealth, provides portfolio advice to the Funds.

This information reflects Mr. Majendie’s opinions as of the date of these notes. These opinions may change at any time and neither Mr. Majendie, ScotiaWealth nor their affiliates undertake to update the information or opinions. This information and opinion does not constitute investment advice or an offer to trade securities.

Anchor Managed Funds hold securities of the following issuers referred to in this note: ARC Resources Ltd., Bank of Nova Soctia, BCE Inc., Canadian Tire Corp. Ltd., Enbridge Inc., Imperial Oil Ltd., National Bank, Pembina Pipeline Corp., Telus Corp., and Vermilion Energy Inc.

Nick Majendie, who provides portfolio management advice to the Anchor Managed Funds, personally holds securities of the following issuers referred to in this note: ARC Resources Ltd., Bank of Nova Scotia, BCE Inc., Canadian Tire Corp. Ltd., Enbridge Inc., Imperial Oil Ltd., National Bank, NuVista Energy Ltd., Pembina Pipeline Corp., Telus Corp., and Vermilion Energy Inc.

Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

These Anchor Managed Funds are distributed under a Simplified Prospectus. The Simplified Prospectus, Fund Facts and Annual Information Form are available from ScotiaWealth or on www.sedar.com

This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaWealth, a division SCI, but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant CON’T ON NEXT PAGE

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particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice.

The statements in this newsletter may contain statements related to future financial performance of certain securities, indices or the Anchor Managed funds that may constitute forward-looking statements. These statements may be identified by words such as “expect”, “look forward to”, “anticipate”, “believe”, “seek”, “estimate”, “project”, “potential”, “predict”, or words of similar meaning. Such statements are based on the current expectations and certain assumptions of the author, and are, therefore, subject to certain risks and uncertainties. A variety of factors, many of which are beyond the author’s control, affect the performance of the securities and capital markets indices and therefore the performance of the Anchor funds and could cause the actual results, performance or achievements of the securities, indices or the Anchor funds to be materially different.