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December Market Update December 8, 2009

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Investors, fondly recalling the October 2007 high in the U.S. stock market, are undoubtedly anxious to see a full recovery of their capital. This is understandable. The promise of equities is clear - they offer the potential for growth as corporate profits increase over time in response to growing revenues and improved productivity. As illustrated below, $1.00 invested in U.S. large cap stocks on January 1, 1926 was worth $2,394 at the end of October 2009, after factoring in the reinvestment of dividends - this is a 9.72% average annual compounded rate of return.

It is this ascending graph which entices investors. “Stocks for the long-run” is the common mantra.

Unfortunately, this graph obscures a harsher reality. Over this almost 84-year history, U.S. large cap stocks experienced 105 periods where a “drawdown” occurred (i.e. where the value fell below its prior peak as measured at month-end) - about once every 10 months. And although the average decline from peak to trough was just -6.9%, there were eight periods where the decline was greater than -20%. The mother of all declines was the 83% plunge in the Great Depression followed by the recent 51% drawdown just experienced from October 2007 through February 2009. The average time from peak to trough was just three months, although this ranged from as little as a month to the 34 month decline at the outset of the Great Depression. Recoveries took longer - four months on average. The deeper the decline, the longer it took to recover.

Although global markets were falling into the abyss a year ago, I felt the market was inappropriately pricing apocalyptic scenarios. Indeed the worst of the global recession came in the first quarter of 2009 and economic activity has been improving since then. While the 2009 global economy was horrible, forward-looking equity markets managed to post solid performances, further illustrating how markets feed off anticipation, not what is written in the daily newspapers.

In the table below we look at the volatility experienced in the past 18 months.

	Previous Peak	March 9/09 Bottom	% Decline	Nov. 30/09 Level	Gain off Bottom
S&P/TSX Index	15,073 (6/18/08)	7,566	-50%	11,447	+51%
Dow Jones Ind. Avg.	14,165 (10/09/07)	6,547	-54%	10,345	+58%
S&P 500 Index	1,565 (10/09/07)	676	-57%	1,095	+62%
Canadian vs. US Dollar	$1.09 (11/06/07)	$0.77	-29%	$0.95	+23%

Things are improving south of our border. The US economy enjoyed a 2.8% growth rate in the 3rd quarter. The FOMC minutes from their November 3rd and 4th meeting revealed an encouraging economic environment for 2010, but still noted that they expect the recovery to be prolonged. Both existing home sales and new home sales rose by 10.1% and 6.2% respectively and were much better then expected, reassuring the fact that the economic environment is improving.

Many of the troubled American banks have, or are contemplating, paying back the money lent to them by the US Government. Bank of America has made arrangements to repay $45 billion 2_ years ahead of schedule, with the US tax payer making a healthy profit.

In early November Warren Buffet announced that his company Berkshire Hathaway plans to buy the balance of railway company Burlington Northern Santa Fe. By his own words, Buffett said he was going “all in” while betting on the strength of the economic recovery. My view, while constructive over the next 2 to 3 years, is slightly more subdued.

Entering 2010, I believe that equity markets will continue to reward investors, albeit at a more moderate pace than we have witnessed since March 9th. For 2010, earnings for the companies in the Canadian TSX index are forecast to improve by 25%, yet the market is expected to return 10%. Earnings for the US S&P 500 companies are forecast to improve by 36%. We believe the first _ of the year may be the most rewarding. Sometime in the second half of the year we expect the beginning of several small interest rate increases in both Canada and the US. By the end of 2011 prime rates are forecast to be 2% higher than they are now. The Canadian dollar is expected to trend towards par in the next year, and then in 2011 go as high as perhaps $1.05.

The investment success you enjoy in the next three to five years will be predicated primarily on one thing: asset allocation.

1. If you are going to require a lump sum from your investment portfolio in the next 12 months, take advantage of the market's recovery we have enjoyed since March and redeem the amount you will need in the next year. This will ensure that you won't sell investments at a lower price than today for an expense you knew you had.
   
2. Investments you are quite certain you won't require for a period of 3 to 5 year could be invested in a “pension-type” portfolio to enjoy the superior returns we believe will be delivered over this period when compared to interest bearing securities.
   

Here are some investment ideas that may be of interest to you:

• Do you have a bank account balance that is larger than necessary but you don't want to “lock” the funds in to a fixed-term. We can get you close to a 1% return on a fully CDIC insured high rate account with no fees to buy or sell.
  
• Do you have GICs at your local bank? You aren't sure that they are giving you the best rate? You don't like having envelopes come in from several institutions? At ScotiaMcLeod, I can purchase GICS from 17 different CDIC insured issuers. I can shop for the best rate for you with no fees to buy or sell and have it held with your other ScotiaMcLeod assets - one less envelope comes through your door!
  
• Do you require security of principal and tax efficient income from a portion of your savings? Retractable preferred shares provide both. I can recommend high quality retractable preferred shares maturing in the next 2 to 5 years that offer interest equivalent yields of 3% to 7%.
  
• Would you like to take a small portion of your growth portfolio and direct it toward one or more individual common shares that are high quality but out of favour? These opportunities have more risk, but also have more potential for reward. Some shares have not participated in the current rally and may offer the potential for higher long-term returns.
  
• Are you a healthy individual over 60, in a high marginal tax bracket, and have a desire for absolutely consistent yet tax efficient income for as long as you live with a full repayment of the principal upon your death? Consider having my insurance consultant, Paul Coridor, provide a quotation on an Insured Annuity.
  

Along with this market commentary, I have posted an article addressing year-end tax planning strategies. If you have triggered significant gains or losses in 2009 (perhaps from the sale of a cottage), I may be able to present a tax-smart strategy if we act quickly. Please call me on this issue or if you have questions about the other information I have provided.