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October Market Commentary October 5th, 2010 By Kim Mailey, CFP

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I'm writing to share some thoughts on today's economic outlook, looking beyond the headlines.

Anyone following the old adage for stock markets of "sell in May and go away", clearly would have been disappointed with their decision for 2010.

Here's how markets performed in the last quarter and so far this year.

	Canada	US	Europe	Emerging Markets	World Stockmarket
July	+3.9%	+7.0%	+5.9%	+6.2%	+5.8%
August	+1.6%	(-4.4%)	(-2.1%)	(-1.4%)	(-3.3%)
September	+3.7%	+9.1%	+5.3%	+7.7%	+7.0%
July to September	+9.4%	+11.5%	+9.1%	+12.9%	+9.4%
2010 to Date	+5.6%	+4.0%	+2.3%	+8.2%	+2.0%
Source: MSCI index. All returns are in local currency

The importance of a balanced perspective

One of the keys to success for investors is maintaining emotional equilibrium, preventing the highs from being too high and the lows from being too low. Today, many Canadians are pessimistic about the American and global economies. This pessimism is amplified by the media coverage.

Some examples of forecasting and media attention

1. For example, in 2008, Fortune magazine wrote an article about Dr. Nouriel Roubini (aka Dr. Doom). The article said "In 2005 Roubini said home prices were riding a speculative wave that would soon sink the economy. Back then the professor was called a Cassandra. Now he's a sage". The New York Times wrote that he foresaw "homeowners defaulting on mortgages, trillions of dollars of mortgage-backed securities unraveling worldwide and the global financial system shuddering to a halt". In September 2006, he warned a skeptical IMF that: "The United States was likely to face a once-in-a-lifetime housing bust, an oil shock, sharply declining consumer confidence, and, ultimately, a deep recession". According to IMF economist Prakash Loungani, he was considered "a prophet" in 2007.

   As Roubini's descriptions of the current economic crisis have proven to be accurate, he is today a major figure in the U.S. and international debate about the economy

   Hot news: Nouriel Roubini now says there's a 40 per cent chance of a double-dip recession. Apparently, a 43 per cent chance is too high and a 38 per cent chance two low. The number is 40.

   How does he know and why should we care? Because he predicted the financial crisis before it happened.

   Dr. Roubini is a professor at New York University, but he also runs his own shop of economic consulting, so he has a very keen interest in keeping his name in the headlines. There's lots of money at stake, not to mention fame and glory.

   How do you keep your name in headlines? By reminding everyone you got it right and therefore, it's implied, you will get it right again and again. But that's not enough: You also have to design your comments to attract attention. Dr. Roubini is good at it, but he isn't alone.

2. Technical analyst Robert Prechter drew lots of eyeballs and gasps when he said last month that the Dow would fall below 1,000 (this a mere decade after James Glassman and Kevin Hassett's Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market made waves - remember that staggering piece of foresight?).

   It doesn't matter to Mr. Prechter that the earnings of the Dow companies - 30 of the biggest and brightest public companies in the world - would have to be ravaged like never before and trade at a price-earnings ratio that you could count on one thumb.

   Mr. Prechter said he was very long on cash.

   And he's probably more long today, since he charges $20 a month for his newsletter. It's not ridiculous to surmise that his subscriber list got a nice boost after he got all that attention with his bold and terrifying prediction.

   Mr. Prechter might not have any real ability to predict the stock market (he could make a billion dollars with very little down making that kind of an outlier bet without telling anyone). But he understands human psychology: Most investors, according to studies, prefer an extreme and unusual forecast to a moderate prediction. The idea is that the person making such a forecast is more credible; he must have done his homework to go out on a limb like that, right? In any case, it pays off.

3. David Rosenberg is a good writer on economics; he's clear, concise and convincing. He also enjoys some notoriety for having been right about the housing market. Part of his job is to attract attention to the firm he works for (he recently called the economic situation in the United States a "depression," and has said so in The Globe and Mail as well, which he also writes for). But besides that incentive, you have to wonder whether, having been rewarded for his bearishness, he's inclined to keep being a bear?

I wonder, if Dr. Roubini's conviction was so strong, how much money did he make shorting the housing catastrophe that he so spectacularly called? Not enough to stop working hard, clearly.

Lots of economists have gotten one call right and dined out on it for a long time. Few, in my experience at least, have gotten two big, bold calls right.

It’s easy to make a prediction; it’s a lot harder to do it with great conviction. Read The Big Short if you want to know who really saw the financial crisis coming; who called it and put their finances at risk. They're billionaires now.

Good pundits are valuable if they make you think, but always remember what their incentives are.

You have to be a savvy consumer of media. It's easy to miss some of the good news beyond the headlines.

The Big Sky Conference: Looking past short term issues

That's why a conference that took place in mid September is important as it provided some offsetting perspective on the mid and long term positives for the United States and globally.

Speaking to 2000 business and political leaders at "The Big Sky Conference" in Montana, here are comments from Warren Buffett, Steve Ballmer of Microsoft and GE's Jeff Immelt.

Warren Buffett:
"I'm a huge bull on this country ... it's night and day from a year ago. I've seen sentiment turn sour in the last three months or so, generally in the media. I don't see that in our businesses. I see we're employing more people than a month ago, two months ago. The things that worked for the country through a century of two world wars, a depression and more - all while increasing the standard of living - will work again."

Steve Ballmer, Microsoft: "There soon will be more technological advancement and invention than there was during the Internet era and that will help drive business growth. I am very enthusiastic what the future holds. We will see new technologies that move beyond the Internet to tie together computers, phones, televisions and data centers to create amazing new products. And the pace of innovation will increase as technology makes workers more productive."

Jeff Immelt, GE:
"Angry political rhetoric is not helpful and headlines are too focused on finding negative indicators. Business at GE is improving. Signs across the world show growth improving as evidenced by a rise in GE's orders. GE is now finding it profitable to build manufacturing and service centers in the United States rather than overseas, because it is more competitive to do so."

The path ahead

Of note, these positive views are supported by recent research from McKinsey & Company, today's leading strategy consulting firm and the first place many Fortune 500 CEOs look to for advice.

McKinsey surveyed 2000 executives around the world in early September and found:

• Almost 60% said their country's economy is in recovery.
• Most expect profits to rise from last year.
• And nearly 40% expect to hire employees by the end of 2010.

It's not realistic to suggest there won't be challenges ahead, both for global economies and for stock markets. Given fragile market psychology, it's most likely that we will see continued choppy and volatile markets in the next twelve months.

At the same time, it's my job to look at a broad range of credible points of view, not just those who shout the loudest or take the most extreme positions ... and in doing that, I believe it's important to pay attention to the encouraging perspectives from business leaders on the front lines.

Given the likely rise in profits reflected in the comments from Warren Buffett, Steve Ballmer and Jeff Immelt and by the McKinsey research, I believe today's pessimism is overdone and I remain positive on the long-term outlook for the global economy.

I don't wear rose-colored glasses, and I am keenly aware of the employment and debt pressures that remain as impediments to stronger economic growth, but I still feel many of the positives are being overlooked.

Economy's strong points:

• Manufacturing remains well in expansion territory, with booming industrial production.
• Leading economic indicators turned back up for the second consecutive month.
• The savings rate is a healthy 6%.
• Commodity prices are surging, suggesting strong global growth and trade.
• Initial unemployment claims have moved back down.
• Home prices are up more than 3% from a year ago, and housing starts and pending home sales are tracking higher.
• Personal income and spending are both tracking higher.
• Retailers are beating sales forecasts, as consumer spending increased significantly in August.
• Construction spending surprised on the upside.
• Housing affordability is near all-time highs.

Stock market's strong points:

• Last month's gain was the second-strongest September for the S&P 500® index (historically, that's been a good sign for fourth-quarter performance).
• The majority of S&P 500 stocks are above their 200-day moving average.
• Market breadth is bullish.
• The market is entering its election-cycle sweet spot (typically from the midterm election through the third quarter of the pre-election year).
• Venture capital investment is up nearly 50% this year, while initial public offerings are in vogue again (young firms have accounted for 11% of private employment).
• Merger-and-acquisition (M&A) activity is booming again.

Bottom line: I remain on the side of the market and economy continuing to climb, albeit slowly, out of deep hole it fell into. I think the healing process is ongoing and that the United States, along with other developed economies, will experience soft patches within an admittedly mild recovery.

In the event the soft patch intensifies, the Fed will pull out all the stops to "reflate" the economy. Say what you will about prior monetary and fiscal stimulus, it did succeed in buying time for the private sector to deleverage and for the economy to gain a little traction.

The household sector is well on its way to a healthy deleveraging with debt-to-income having plunged, while the savings rate has surged. Corporate profits have been strong and M&A activity is heating up. In addition, segments of the global economy, notably the Asian and Latin American emerging markets, are on fire.

US stocks are not expensive and they're most certainly under-owned. Most individual investors are either pessimistic or indifferent about the stock market, suggesting the "wall of worry" - the contrarian nature of the market to perform best when pessimism is highest - is alive and well.

Thank you for the opportunity to work together. As always, should you have any questions on this note or any other matter, my team and I are always happy to take your calls.