Market Outlook 1 May 2011 Monthly Briefing - Monthly Briefing •Risk of policy errors by central banks ishigh:forexample,the European Central Bank is raisingrates whilethe peripheral countries continue to strugglewithdebt problems; or China failsto engineerthe hoped - forsoft landing(negative). •Risk of contagionof social unrest in theMiddleEast/NorthAfrica(MENA) leadstosustainedhighoil prices. At over US$4.00per gallon at the pump, this acts tocurbdiscretionary spending by the American consumer (negative). • However,it isoftensaid that the cure forhigh pricesishigh prices, becauseit becomesa self - correcting mechanism.Highoil pricesresult in near - term demand destruction and longer term, substitution andadditional production (positive). •Further, high oil prices are unlikely to lead to higherinflation unlessthey translate into labourpricing power. Giventhehighunemployment ratein theU.S. andthewaninginfluenceof unions, wedonot seeinflationasa threat in the near term(positive). •Weareinthemidst of first quarter earnings season. Both the actual results but moreimportantly, theoutlookand forecast bymanagement teams for the balance of the year will set the tone for the marketnear term (positive or negative). Whileweremainlonger term positive andoptimistic, theoutlook for thenext 3to6months is less clear. Near term cautioniswarranted. Investorsshould remember to concentrate not only on The oldadage to“Sell in May andGo Away”hasoften been a profitable strategyforequityinvestors.But this year,we don’tthinkitwillbe so simple. Global dynamics, while always interesting, are currently in such astateof flux, that we believethenext few monthswill bemoreinteresting, and potentially more volatile, than normal. What aresomeof theissues we are monitoring? • U.S. employment is slowly recovering (positive for the equity markets). •Theoutlookfor homepricesinthe U.S. continues to be pretty bleak (negative). •Global growth is still expectedtobe robust(positive)butsupply chain disruptions fromthe Japan disasters will impact the near term(negative). •Sentiment indicators arebullishand investor complacency is prevalent (negative). •What happens toaliquiditydriven marketwhen Quantitative Easing 2 (QE2) ends in June? (negative). • Earnings momentum has peaked and earnings revisionshave turned down (negative). • Areequitiescheap orexpensive? Depends onwhoyouask! (positiveor negative). •Inflationappears tobecontainedin the developedworld(positive). • Inflationisnot contained insome emerging markets,likeBrazil,China andIndia(negative). • Bond yieldsare expected to rise only modestly (positive). « If I owe you apound, I have aprob- lem; but if I owe you a million, the problemis yours .» - John Maynard Keynes
Transcript
Market Outlook
1 May 2011 Monthly Briefing -
Monthly Briefing
• Risk of policy errors by central banks is high: for example, the European Central Bank is raising rates while the peripheral countries continue to struggle with debt problems; or China fails to engineer the hoped-for soft landing (negative). • Risk of contagion of social unrest in the Middle East/North Africa (MENA) leads to sustained high oil prices. At over US$4.00 per gallon at the pump, this acts to curb discretionary spending by the American consumer (negative). • However, it is often said that the cure for high prices is high prices, because it becomes a self-correcting mechanism. High oil prices result in near-term demand destruction and longer term, substitution and additional production (positive). • Further, high oil prices are unlikely to lead to higher inflation unless they translate into labour pricing power. Given the high unemployment rate in the U.S. and the waning influence of unions, we do not see inflation as a threat in the near term (positive). • We are in the midst of first quarter earnings season. Both the actual results but more importantly, the outlook and forecast by management teams for the balance of the year will set the tone for the market near term (positive or negative). While we remain longer term positive and optimistic, the outlook for the next 3 to 6 months is less clear. Near term caution is warranted. Investors should remember to concentrate not only on
The old adage to “Sell in May and Go Away” has often been a profitable strategy for equity investors. But this year, we don’t think it will be so simple. Global dynamics, while always interesting, are currently in such a state of flux, that we believe the next few months will be more interesting, and potentially more volatile, than normal. What are some of the issues we are monitoring? • U.S. employment is slowly recovering (positive for the equity markets). • The outlook for home prices in the U.S. continues to be pretty bleak (negative). • Global growth is still expected to be robust (positive) but supply chain disruptions from the Japan disasters will impact the near term (negative). • Sentiment indicators are bullish and investor complacency is prevalent (negative). • What happens to a liquidity driven market when Quantitative Easing 2 (QE2) ends in June? (negative). • Earnings momentum has peaked and earnings revisions have turned down (negative). • Are equities cheap or expensive? Depends on who you ask! (positive or negative). • Inflation appears to be contained in the developed world (positive). • Inflation is not contained in some emerging markets, like Brazil, China and India (negative). • Bond yields are expected to rise only modestly (positive).
«If I owe you a pound, I have a prob-lem; but if I owe you a million, the problem is yours.» - John Maynard Keynes
In April, there were some initial indications of what could be the beginning of a reversal between the relative performance of U.S. and Canadian stock markets. Since the end of March, the S&P 500 has outperformed the S&P/TSX Composite by 5%. The recent strength in the U.S. over Canada can be explained by several factors, including better relative earnings momentum, a weak U.S. dollar, better relative valuation, and a lower commodity weighting than the S&P/TSX. Q1/11 results in the U.S. were very strong, as the median positive surprise improved in the quarter. Q1 is traditionally a strong seasonal earnings quarter, but the renewed weakness in the U.S. dollar added support. U.S. interest rates have declined, making already attractive valuations more compelling than the bond market. There was a broadening out in sector performance, where more defensive sectors, which Canada lacks (such as consumer staples), had strong returns in the month. Meanwhile, Canadian Q1/11 results have so far been mixed, as the stronger Canadian dollar has negatively affected earnings. Also, there has been a very poor response to higher commodities prices from the resource stocks. This could be a signal
that stocks are discounting lower future commodity prices. Despite the stronger earnings, the equity portion of our portfolio is somewhat cautious entering the seasonally weak May-June period. Like last year, the positive effects of strong Q1 earnings will likely diminish and the market focus may turn to more macro factors. The sharp decline in U.S. interest rates is worrisome, as lower bond yields may be signaling slower growth from the U.S., perhaps as a consequence of near record high U.S gasoline prices. At the same time, inflationary pressures continue to build in Asian markets as growth moderates in China. Euro sovereign debt also remains a risk. Technically low trading volumes and what is considered to be an overly complacent equity market (i.e., low Volatility Index or VIX readings) suggest to remain cautious. As a result, the Portfolio has raised the cash position slightly over the past month and reduced some cyclical and high beta (high risk) exposure. Many Canadian stocks have already pulled back from their recent highs and are approaching what are considered good valuation or technical entry points. Over the next two months, there may be opportunities to buy during what will likely be a volatile period.
Portfolio Commentary
returns but on managing risk. Asset mix should be aligned to investment objec-tives and risk tolerance. In a world of
political, financial and economic risks, gold is a good offset. We expect the Spring and Summer to be interesting!
«Like last year, the positive effects of strong Q1 earnings will likely diminish and the market focus may turn to more macro factors.»
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