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May Review May 5th, 2011 By Kim Mailey, CFP

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Happy May!

Last month, the S&P credit agency sent shockwaves through the global financial system when it issued a warning on U.S. debt and changed its outlook on the U.S. sovereign credit rating from "stable" to "negative." This sent markets lower and the prices of commodities, such as oil, rocketing back above $110 per barrel and both gold and silver to new highs.

It should be clear the S&P announcement was just a warning, not a lowering of the U.S. debt rating, which was affirmed at AAA (the highest level possible). The fears quickly subsided and U.S. markets hit fresh three-year highs. Essentially there's only a one-third chance of a downgrade and anyone who's ever listened to the weather man knows that a 33 percent chance of rain means you probably don't need your umbrella!

However, the warning validates what we already know: The U.S. needs a plan to address its debt and budget issues - and fast. Due to the fact that future fiscal austerity measures will likely act as a drag on the economy, this could mean a third round of quantitative easing (QE3) heading into next year. I put a very low probability on a third round of balance sheet expansion occurring in 2011 unless U.S. economic growth weakens quite dramatically and/or inflation pressures abate significantly.

Where is the stock market heading? Is the cyclical bull market that started in early March 2009 close to exhaustion? These are the key questions on all investors' minds as financial markets remain caught between the easy money actions policies of central banks on the one hand, and a still tentative economic outlook on the other.

It is, therefore, no wonder that some legendary axioms are resorted to in a quest for direction. Besides the well known "buy low and sell high", few other axioms are more widely propagated than "sell in May and go away". In fact, a Google search revealed an astounding 12 million items featuring this phrase!

As equities have seen a particularly strong rally since August 2010, investors are justifiably questioning the market's next move. And they nervously wonder whether this May will not only herald longer days in the Northern Hemisphere, but also live up to its reputation as the advent of a corrective phase in the markets.

Looking at the recent past, the results are mixed in supporting the May to October period. The results are as follows:

• May 2009 - October 2009: +19.53%
• November 2009 - April 2010: +10.94%
• May 2010 - October 2010: +5.01%
• November 2010 - April 2011: +14.32%

I would suggest that the axiom "sell in May and go away" in itself is a rather doubtful basis for timing equity investments. However, it may serve a useful purpose as input, together with other factors, to otherwise rational decision making.

Returns Year-to-Date:

	Year to Date (Local Currency)	Year to Date (In Canadian $)
S&P/TSX (Canada)	+ 0.7%	+ 0.7%
Dow Jones (U.S.)	+ 9.8%	+ 5.8%
S&P 500 (U.S.)	+ 7.0%	+ 3.1%
FTSE (London)	+ 1.4%	+3.5%
MSCI (World)	n/a	+ 3.2%

Please find below an interesting video from the Wall Street Journal of two respected prognosticators debating "Are Stocks Overvalued?"

The Market Debate: Are Stocks Overvalued?

Rational decision making has me consider the fact that interest rates are expected to remain low for some time, and corporate profitability is healthy and improving. As of May 2nd 2011, 337 companies in the S&P 500 had reported first quarter financial results. So far, 72.0% of the companies that have reported their earnings have reported positive surprises over analyst's forecasts. Adjusted first quarter earnings for the S&P500 are U$23.33, which represents a 17% increase year over year. Based on expected 2011 S&P 500 earnings, the market is trading at a multiple of 14.5 times earnings. To me this indicates the market is not overpriced.

There are several uncertainties that investors are focused on in the short term:

• The U.S. debt situation and legislation that must be passed by the squabbling Republicans and Democrats.
• The Middle East conflicts
• The sovereign debt situation and likely bailouts required for Portugal and Greece.

Two recent events are the majority government in Canada which will provide greater certainty for investors and the Royal wedding, which had no impact on the markets but watching the pageantry was wonderful!

I continue to see us in a period of sideways movement over the next few months while these uncertainties are dealt with and the recent market gains are digested. There may be some contraction in markets but I believe it would be limited. Equities are expected to provide better returns than bonds in 2011 but likely be limited to single digit returns.

There are some very attractive opportunities in the market for both tax advantaged income and/or capital appreciation. If you have money getting little or no return in the bank or Canada Savings Bonds, please give me a call to discuss these opportunities in greater detail.