The debt overhang in Europe, the United States and Japan continues to grow. This was a major contributor to the global recession in 2008/2009, which was in effect a balance sheet recession rather than a normal cyclical adjustment to a period of above average growth. The ongoing deleveraging that has been required and will continue to be required means that there will be no "normal" cyclical recovery this time. As an example, the U.S. recovery is running about half the pace of previous recent recoveries. Clearly, the inability of the U.S. economy to return to pre-recession levels of economic output and employment means that to find a similar period of deleveraging one has to go back to pre Second World War experience. Thus, market forecasts based on the post World War II recoveries will be invalid and misleading. This Strategy Note will look at some of the longer term debt trends in the U.S., Europe and Japan and their implications for financial markets.

BNN speaks to Nick Majendie, Director and Senior Portfolio Manager, Majendie Wealth Management

Focus: Canadian Large Cap

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In our April 1 2012 Strategy Note, we discussed the unusual degree of uncertainty related to market forecasts at this time. As a result, we noted that in making a one year forecast in normal times, we would take a historical multiple range for the appropriate investment criterion (EPS, CFPS and Book Value) and apply it to consensus forecasts for those three metrics for the TSX and to EPS alone for the S and P 500. Thus, using the last two years’ average multiples for these metrics gave a potential upside at April 1 for the TSX of 12% (to 14,000), which with a dividend yield of 3% gave a total return of 15%. However, at this juncture, in view of the uncertainty, we said it would be more appropriate to take a more conservative approach. We said that, if there were a recession, analysts' consensus forward earnings forecasts tend to be about 20 to 30% too high. To take account of this recession risk, we, therefore, conservatively applied a 25% cut to those earnings, 20% to cash flow and 5% to book value targets but used recent (last two year) average multiples for those three metrics (roughly 15 times on EPS for the TSX, for example, as well as for the S and P 500). The adjusted next 12- month S&P TSX Earnings per Share (EPS), Cash Flow per Share and Book Value per Share on this basis come out respectively to $754, $1,349 and $7,075.