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June Review June 6th, 2011 By Kim Mailey, CFP

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May: OECD raises growth forecast
In its May report, the Organization for Economic Co-operation and Development (OECD) raised its 2011 outlook for the United States to 2.6% from 2.2% predicted in November, and revised the euro zone forecast to 2.0% from 1.7%. Japan's outlook was slashed to 0.9% from 1.7%, reflecting the economic fallout from March's devastating earthquake. Overall global growth was forecasted at 4.2% for 2011 and 4.6% in 2012.

Canada taps foreign markets for growth
Canadian exports are predicted to grow 12% this year and reach pre-recession levels next year as U.S. growth picks up, according to Export Development Canada. The gains are expected to be fuelled by higher commodity prices and a U.S. housing recovery that will boost Canada's long-struggling lumber business. Sales at Canadian-affiliated companies abroad hit $500-billion in 2010, surpassing Canadian exports of $450-billion, as Canadian companies increasingly tap into foreign markets by producing goods and services abroad.

Greece fights spiraling debt
Standard & Poor's cut Greece's debt rating to single-B, putting pressure on the EU and IMF to revamp the country's bailout. Greece will start selling state assets such as telecoms, ports and a water utility, and slash an additional €6-billion ($8.3-billion) this year, as borrowing costs surge, with record yields exceeding 17% for Greek 10-year bonds. The credit rating for Greece is now the same as Cuba.

U.S. GDP growth lower than expected
First-quarter GDP growth in the U.S. remained unchanged at 1.8% yesterday, while economists had expected a revision up to 2.2% from the Commerce Department. High gasoline and food prices were blamed for stalling consumer spending, which slowed to a pace of 2.2% annualized, compared to 4% in the previous quarter. At the same time, government spending fell at a 5.1% rate in the battle against budget deficits.

Microsoft buys Skype
Microsoft paid US$8.5-billion cash for Internet phone company Skype, marking the largest deal in Microsoft's history and beating out other suitors believed to include Google and Facebook.

Social networking firms go public
The first U.S. social-networking firm to go public, LinkedIn's IPO valued the company at more than US $3-billion. Shares more than doubled to $94 on the first day. Beijing-based Renren - dubbed the Chinese Facebook - launched a successful IPO, raising over US $700-million. The IPO for Yandex, "the Google of Russia," saw shares skyrocket 40%.

GM Volt in overdrive
GM is expanding production of the Chevrolet Volt to 60,000 a year, from 16,000, to meet tremendous consumer demand for the car, which can be recharged through a home electrical outlet. Chrysler is set to repay US $7.5-billion in bailout loans to the Canadian, Ontario and U.S. governments.

Crops in demand
The cost of coffee beans doubled in the past year, as global coffee consumption rose to record levels in 2010, driven by its growing popularity in Asia.

Kim's Commentary and Forecast:

Index	Month of May	Year to Date
TSX (Canada)	- 1.02%	+ 2.68%
S&P 500 (U.S.)	+ 0.76%	+ 4.20%
MSCI (World)	- 0.36%	+ 3.09%

As I wrote in my last update, I felt that the markets were poised to take a few months off to absorb the strong gains they had enjoyed since mid year 2010. To a large extent, the recently weaker tone in equity markets can be attributed to a broad slowdown in economic data that has been capturing the headlines of late. Some of the decline can be explained by seasonal factors (poor weather caused a disruption in growth in the first quarter) or factors that may prove to be temporary (the earthquake in Japan as well as the rise in energy prices having a negative impact on retail sales). At this juncture, it appears that the recovery or acceleration phase of the business cycle may be ending. I believe the economy is now shifting into an expansion mode, and the question will become how long that expansion will last.

From an earnings perspective, corporations have continued to grow their earnings at a pace faster than that of overall economic growth. At this point, nearly all of the S&P 500 companies have reported first-quarter earnings and the results have again been impressive. On average, companies exceeded earnings expectations by 6% and overall earnings are up 18% compared to year-ago levels. Strong corporate earnings should remain a meaningful tailwind for equity markets in the months ahead.

Outside of the United States, investors remain focused on the sovereign debt problems plaguing Europe. The International Monetary Fund has been advocating for a more comprehensive debt crisis plan and the European Union has recently taken some additional action, including calling for heightened austerity measures, increasing purchases of government bonds and providing banks with additional liquidity. The end game for the European debt crisis remains unknown, but will almost certainly require some combination of debt restructuring and debt forgiveness. It is doubtful that there will be additional monetary tightening by the European Central Bank at any point soon, but regardless of what happens, the potential for additional debt problems remains worrisome for investors.

At present, stock markets appear balanced between the positive forces of strong corporate earnings and low interest rates, offset by the negative forces of a growing list of downside risks. There are a number of headwinds investors must contend with. The most obvious, of course, is the slowdown in economic data, but investors are also wary regarding the eventual need for normalization in interest rates. Although I am not expecting the US Federal Reserve to raise rates any time soon, the pending end of the QE2 program is highlighting the fact that the Fed is moving away from its "emergency" stance of ultra-easy policy. In addition to a potentially more troublesome economic and rates backdrop, investors are also rightfully concerned about ongoing debt issues and the potential for renewed energy price spikes.

From my perspective, I acknowledge that all of these downside risks are real ones, but I am not among those who are calling for an end to the bull market. Rather, I believe that the long-term uptrend in stock prices will continue, but at a more challenged pace than what we saw over the last two years. Since the nadir of the bear market in March 2009, stock prices have doubled, and that is obviously not a pace that can continue indefinitely. With the economy continuing to grow at a now more modest pace, with inflationary pressures contained for now and with corporate earnings growing at an impressive pace, I believe that markets should be able to make additional gains in the latter months of this year and for some time to come. However, I also expect to see near-term risks cause markets to remain range-bound for the time being.

In summary, the global economy is moving from recovery to expansion, with the latter pointing to more moderate growth, not disappearing growth. Hence, earnings growth looks poised to continue well into 2012. The global equity recovery has looked fatigued since the start of 2011. Seasonal weakness in May is somewhat typical and the current "spring break" could eventually develop into a buying opportunity. To the extent equity markets retrench further, my inclination is to buy the weakness selectively as the underlying bull market trend remains positive; however, in the very short term there are likely no catalysts to move the markets substantially higher until the second quarter earnings season commences in early July.

PS My compliments to Scotiabank

Scotiabank, ScotiaMcLeod's parent company, celebrated several successes in the second quarter of 2011 and continued to be an engaged and caring global citizen.

• Scotiabank completed the acquisition of Dundee Wealth and achieved a significant milestone, surpassing $100 billion in assets under management.
• Scotiabank was recognized for excellence by The Great Place to Work® Institute in:
  • Canada (for the second consecutive year)
  • Mexico (for the eighth year in a row)
  • The Caribbean and Central America including the Dominican Republic, Puerto Rico, Costa Rica, El Salvador, Guatemala and Panama.
• Scotiabank was named to the Green 30 - a list of Canadian companies who best incorporate environmental stewardship into their business models and corporate cultures.
• Through Scotiabank's Bright Futures program, the Bank contributed $100,000 toward the earthquake relief efforts in Japan and made a $600,000 donation to endMS Research and Training Network to fund Canadian research into multiple sclerosis.