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2011 First Half Review and Second Half Outlook July 5th, 2011 By Kim Mailey, CFP

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Welcome to the second half of 2011! The strong market returns in the first three months were, for the most part, taken away in the 2nd quarter. Investors seeking immediate and consistent returns are likely frustrated by the fact that year-to-date, 2011 has been without reward. However, just expanding the time horizon by 6 months paints an entirely different picture. The one year return to June 30th for North American and world markets ranged from 15% to 17%. Market growth is taking place but it seems to be one step back before we can take two steps forward.

	Canada (S&P/TSX Comp. Index)	US S & P 500 Index	World Markets (MSCI EAFE Index)
First Quarter 2011	+5.00%	+2.82%	+0.13%
Second Quarter 2011	-5.78%	-0.96%	-0.25%
Year-to-Date 2011	-1.06%	+1.83%	-0.12%
1 Year to June 30, 2011	+17.76%	+16.33%	+15.02%

* All returns are converted to Canadian Dollars

The Federal Reserve held its regularly scheduled policy meeting at the end of June and, to no one's surprise, elected to keep interest rates on hold. The accompanying statement and Fed Chairman Ben Bernanke's follow-on news conference made it clear that the central bank has downgraded its assessment of US economic growth. The Fed did, however, underscore that the factors causing the weakness were mostly temporary, in particular highlighting higher fuel and food prices and disruptions from the natural disasters in Japan earlier this year. Looking ahead, I am not expecting to see any near-term changes in the Fed's position. I think there is virtually no chance of additional quantitative easing measures (i.e., we will not see a QE3). Conversely, given a slow recovery and a subdued inflation outlook we are not expecting to see higher interest rates in the US until at least mid-2012.

An additional item that has garnered its share of recent headlines is the stalled debate in Washington over the debt ceiling. At present, Democrats and Republicans have been unable to move the debate forward, with Republicans remaining adamant in their stance that for every dollar the debt ceiling is raised, an equal amount of spending must be cut. The GOP is also insisting that any discussion of potential tax increases remain off the table. It really is not much of a surprise that the talks are getting bogged down. As we saw with the earlier debate over a potential government shutdown, there is a great deal of gamesmanship and political theater associated with these issues and, ultimately, we expect some sort of compromise to be reached. In our view, there is virtually no chance that the gridlock reaches a point that could cause an actual default on US Treasury debt. Even if Congress is unable to reach a short- or long-term agreement by the current deadline of August 2, the government would have a number of options. The Treasury department still has the flexibility to prioritize other spending to remain current on debt payments and policymakers could even elect to enact some sort of partial government shutdown rather than default.

As has been the case for many weeks now, conviction levels are low among investors, which have resulted in a modest, but prolonged, correction in stock prices. The macro environment of slow-but-positive growth, low inflation and easy monetary policy remains conducive to higher equity prices, but investors are unable or unwilling to look past near-term risks and as a result, the "risk on/risk off" trade remains dominant. The question, then, is what it will take to get the markets back on track. Corporate earnings have been strong, and we are approaching the beginning of the second-quarter earnings season, but expectations have drifted lower due to weakness in the financial sector. Clarity around the endgame of the European sovereign debt crisis would certainly help, but that does not appear to be forthcoming any time soon. Ultimately, we are expecting to see better news concerning the US economy and are calling for a reacceleration in growth in the second half of 2011. Should that happen, it should reassure investors that the global recovery will persist, which should help stock prices to again move higher.

ScotiaMcLeod has just updated its year end 2012 targets for the S&P/TSX Index and the S&P 500 Index.

	Current (June 30, 2011)	Target (Year-end 2012)	Target Return
S&P/TSX	13,301	14,750	10.9%
S&P 500	1,321	1,450	9.8%

This represents anticipated annualized returns in the 6% to 7% range which represents significantly better returns than are available through bonds and GICs, but lower returns than are historically provided in equities reflecting a slower growing economy as balance sheets recover.

For investors holding individual stock positions, ScotiaMcLeod's Portfolio Advisory Group is recommending lowering weightings in utilities and pipelines and REITS sectors, and increasing weightings in energy, materials, and insurance. Some of the specific buy recommendations are:

• Energy: Talisman Energy, Cdn. Natural Resources, Cenovis Energy, ARC Resources
  
• Materials: Garium, Teck Resources
  
• Insurance: Manulife, Sun Life
  
• Others: Dollarama, SNC Lavalin group, Canadian Pacific Railway, Finning International
  

In summary I believe that the correction we saw in the 2nd quarter has run its course. While markets may stay at this level for some time yet, I am expecting resumption in growth in the 2nd half of 2011. There are currently attractive opportunities and I would be happy to discuss recommendations suitable to your specific circumstances.