Our Library

August Review and Market Outlook Sept 6th, 2011 By Kim Mailey, CFP

Send to a Friend Back to Our Library

If you were in "summer" mode in the month of August and enjoying the great outdoors and not paying attention to the day-to-day gyrations, it would probably not surprise you to look at the month end return of a decline of just over 1% for the Canadian stock market given all of the troubles and uncertainty in the world.

Toronto's TSX Composite Index
August 2011	Year-to Date	One Year (9/10 - 8/11)
-1.37%	-5.02%	+7.18%

If you were glued to the daily news, you will likely remember your white knuckles as the market volatility was extreme! Six times during the month, the S&P 500 moved in excess of 4% in a single day. Using the Dow Jones Industrial Average as an example, the chart below highlights a few of these August 2011 days:

Dow Jones Industrial Average
	% Change	Historical Ranking1
August 8th	-5.55%	6th
August 9th	+3.98%	10th
August 10th	-4.62%	9th
August 11th	+3.95%	11th

^{1 This is the ranking of the largest one-day changes between a given day's close and the close of the previous trading day - not the largest changes during the trading day (i.e. intraday changes).}

The market sell-off since late July contradicts the upward trend in corporate earnings delivered during the most recent quarterly earnings reporting season in Canada and the U.S. Investor sentiment remains largely negative with continuing talk of economic recession; arguably equities are pricing-in a recession.

My view of the economy is that the United States remains an open question as to whether growth is modestly positive or if the US flirts with a recession. (Remember the technical definition of a recession is two consecutive quarters of negative growth - GDP.) I do not expect to see a period of economic weakness that is anything like what we saw in 2007 and 2008. Unlike then, the US financial system is much better capitalized, the housing market is no longer overvalued and there is some demand in the cyclical parts of the economy. Additionally, I would point out that while temporary factors from the first half of 2011 (including the spike in energy prices and the natural disasters in Japan) cannot completely explain the downturn in economic data, they are at least somewhat responsible. Whether or not the U.S. economy falls into technical recession, it has become increasingly clear that investors are facing a prolonged period of sluggish economic growth; what was at first seen as a "soft-patch" or mid-cycle slowdown has been extended.

At the same time, however, it is important to point out that there are several important catalysts that would normally be present at this point in the economic recovery cycle that are absent this time around. Chiefly, the Federal Reserve is not cutting interest rates and the government is not pumping up demand through stimulus measures. Additionally, there are several downside risks to the economic outlook. Domestically, the biggest of these is that policymakers tighten fiscal policy too aggressively, which could lead to a more intense and protracted slowdown. Outside of the United States, Europe's structural problems pose a significant risk, which perhaps represents the most serious concern facing the global economy.

European policymakers have yet to come to an agreement over how to address the ongoing sovereign debt crisis and in some ways appear to be dragging their feet. Neither Europe's political leaders nor the European Central Bank have provided an open-ended commitment that would limit contagion risk, let alone put an end to the crisis itself. As such, the situation in Europe remains a significant source of vulnerability for both the global economy and financial markets.

My investment bias still favours equities over other asset classes and there are several blue chip stocks that can now be bought with a dividend yield well in excess of that offered by GICs and government bonds. Scotia Capital Portfolio Strategist Vincent Delisle says: "forward P/Es look cheap, and we expect a modest rebound in valuations when pessimistic sentiment stabilizes."

I expect volatility to continue in the near-term, yet investors should be adding to positions on weakness, particularly in higher quality, dividend-paying, defensive stocks as our intermediate and longer term bias still favours equities over all other asset classes.

Income & Growth Opportunities:

The table illustrates the current opportunities in Canadian dividend paying yields:

TSX as of September 6, 2011
Number of Common Stocks Yielding over 5%	10
Number of Common Stocks Yielding 4% - 5%	7
Number of Common Stocks Yielding 3% - 4%	8
Number of Common Stocks Yielding 2% - 3%	9

Remember that 5 year GICs are paying less than 3% interest income. There are 25 opportunities to receive a 3% dividend yield which is taxed at about ½ the rate of interest income in a taxable account. Rather than renewing a maturing GIC into another "safe" GIC, we can discuss whether any of these opportunities are appropriate for your time horizon and risk tolerance.

Growth Opportunities:

The table below identifies several opportunities for expected growth in companies that ScotiaMcLeod follows. These include:

	Total 12 Month Return Potential2	Scotia Rating
Northern Dynasty Minerals	216%	1 Sector Outperform
Bombardier	69%	1 Sector Outperform
Canadian Natural Resources	49%	1 Sector Outperform
Finning International	44%	1 Sector Outperform
Chartwell Seniors Housing	34%	1 Sector Outperform
Thomson Reuters Corp	33%	1 Sector Outperform
Canadian Pacific Railway	29%	1 Sector Outperform
Royal Bank	26%	1 Sector Outperform
TD Bank	24%	1 Sector Outperform

^{2 Source: Bloomberg - TSX Consensus Earnings, Rating Targets - updated September 6, 2011}

I would be pleased to discuss these opportunities in greater detail with you

Summary

For investors, times like these underscore the importance of employing a time horizon that is appropriate to your objectives, implementing an appropriate asset allocation and maintaining a disciplined approach to portfolio rebalancing. Most of all, volatile times provide a reminder that your investment strategy should be driven by your needs, not by market movements. If short-term market movements cause you to panic, it may be time to reevaluate your investment strategy to ensure that it remains aligned with your goals and time horizon. We are here to listen to your concerns, please call us if you have any.