July: Canadian Investment Review


Many strategists are calling for a bullish trend in the second half of this year once we get through a few more tough economic reports in the weeks to come. Our “Silver lining” comes in the form of expected incoming data to begin surprising to the upside through July as we ‘climb the wall of worry’ and hope to see good stock market returns once again.

From a technical perspective, the immediate environment however continues to suggest caution until present uncertainties are resolved. The markets also remain in the seasonally volatile summer period that often leads to lower-lows in August through September, implying that equity benchmarks may remain below the year-to-date highs charted in April.

The June trading month proved to be a volatile end to the second quarter. Year-to-date the TSX is down only 142pts (1.1%) or flat if you incorporate dividends – the volatility makes it seem like the market is down more.

This year is characterized by a number of uncertain events both globally and in the U.S. They have contributed to the volatility, but one by one they are finally getting resolved. Global issues include:

  • – The Japan quake and the associated disruption. There was an all time record 15% drop in Japanese exports following the quake, which had a large effect on the entire global economy. Since then exports and demand are rebounding, which supports the argument for a second half (2011) rebound.
  • – The Greece situation needed a resolution, which has been achieved and the Greek Parliament recently survived a vote of no confidence and then passed a five-year austerity package.
  • – The debt crisis in Europe seems to be spreading with sudden concerns about Italy’s creditworthiness. The government debt of Europe’s 3rd largest economy (Italy) equals 120% of it’s GDP dwarfing the debt burdens of Greece, Portugal and Ireland. It seems that much will depend on these countries to grow more rapidly than they have in the past. The outlook remains bleak.
  • – The much anticipated Euro-zone banking stress tests revealed that 8 of 90 European banks failed. This news failed to provide much relief and considerable pessimism reigns and will do so at least until policy makers establish credibility and agree on a long-term strategy.
  • – New IMF head. France’s Finance Minister Christine Lagarde has been named the first woman to head the International Monetary Fund (IMF) after the abrupt resignation of Mr Strauss-Kahn after being arrested in New York for an alleged sexual assault. The process of unifying staff, economists and the restoring of confidence in the organisation is underway.
  • – The unresolved US Debt Ceiling. Negotiations continue in Washington with Obama now getting more actively involved. It will be politics as usual before a likely resolution prior to the drop-dead date of August 2nd.
  • – The end of the Federal Reserve’s second round of money-printing, or quantitative easing (QE2), with the Fed ending its $600 billion bond-buying program. It is likely that there will be a QE3 but it will be disguised as a different name … ‘Tax Repatriation Holiday’ would be as good a name as any.
  • – Monetary policy. We see the Fed leaving rates unchanged for the foreseeable future. The ongoing weakness in US employment growth rule out tightening of any form.
  • Canadian-Invesments-July-2011

So net net, we remain cautiously optimistic and expect positive economic news to gradually dominate as we move into the second half of the year. Should this trend emerge we will look to reinstate equity exposure to target weights. If not, we will implement further capital protection measures.

The second quarter earnings season is just beginning and we expect most of the softness has already been built in to equity prices. So far earnings have been reasonable; Alcoa profit more than doubled, Google net income surged 37% and J.P. Morgan Chase continues to deliver strong results although challenges in mortgage costs continue to weigh on the company. The next two weeks will be crucial.

Normally, the Bank of Canada would be tightening now, but if they did it would likely push the CAD even higher, putting pressure on an already weak manufacturing sector. As long as inflation data remain benign, we think the BoC will not increase interest rates in the short term.

Global Equity Markets: With growth in developed economies tracking below typical recoveries, China holds the key to stronger global growth. We believe the Chinese tightening cycle is coming to a close, growth is moderating, and inflation is peaking. Watch for improving loan growth as a signal of policy easing in China. This too should drive a second half rally in global emerging markets, led by Asia, and commodities.