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Market Commentary and Strategy February 2, 2010

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2010 has had a challenging start.

The terrible earthquake that shook Haiti has caused enormous loss of life, as well as an expensive and long-term rebuilding plan for that country. Scotiabank has 85 employees in Haiti and we are thankful they are all safe and accounted for. This is a very difficult time for them and their families. Our thoughts are with the people of Haiti who have been affected by this catastrophic event. Canada should hold its head high, claiming the highest per capita donations to aid in the relief effort.

Equities kicked off 2010 with January losses of 3.7% for the S&P 500 and 5.6% for the TSX. Even the high flying emerging markets saw the MSCI EM index decline by 6% in January. The declines were offset by gains in government bonds of 1.7% and corporate bonds of 2.2% in January.

The FOMC declared for the first time the U.S. economy is in “recovery" and took several steps to prepare investors for the removal of aggressive monetary stimulus. The FOMC upgraded its economic outlook, reaffirmed it will end liquidity backstops and implemented a $1.25 trillion program to buy mortgage-backed securities

As of January 29th, 221 companies in the S&P 500 have reported their fourth quarter financial results. Almost 80% of the companies that have reported their earnings so far announced positive earnings surprises over analysts’ expectations.

President Obama has put a sobering price tag on the financial crisis and the ensuing recession – a record-shattering $1.6 trillion (U.S.) deficit for 2010. He projects that 2010 will be a high watermark for the deficit – representing 10.6% of the country’s gross domestic product – the broadest measure of the economy. By 2014-15, the White House foresees both the debt and deficit declining to a more manageable 3.9% of the economy.

The U.S. Administration has proposed new rules regarding the size and activities of the large banks. Under the proposal, banks would be limited in their ability to take bank deposits, as well as operating a trading operation. The proposal to limit size/activities of banks combined with the recently proposed “bank tax" highlight the immense political scrutiny of the industry. I have posted the detailed research report from Credit Suisse outlining the details and expected impact on U.S. banks from this legislation:

Credit Suisse - Implications of the Bank Regulation Plan

I have also posted ScotiaMcLeod’s bank analyst Kevin Choquette’s research on the implication of this U.S. proposal on Canadian banks.

Scotia Capital - Canada's Dividend Culture - Caught in the Crossfire; Dividend Reset

STRATEGY:

I am not at all surprised to see the markets take a bit of a breather in January. I continue to expect that equities will outperform bonds, and bonds will outperform cash in 2010. It will be a transition year as the coordinated global government stimulus taps are turned off and the private sector takes over. Volatility is a given, but modest single digit returns are expected for the year and stronger growth is expected in 2011 and 2012.

Your asset allocation should reflect your needs.

SHORT TERM CASH:

• If you have lump sum cash requirements for the next twelve months that you have not set aside funds for, I would recommend you do so.

ON-GOING INCOME:

• We purchase GICs from 14 CDIC institutions. Let us shop for the best rate for you.
• Retractable Preferred Shares offer tax efficient dividend income along with a set maturity value and maturity date. There are a limited number of attractive issues trading in the market and selected new issues coming to market from time to time. Let us know if you have an interest in this area as interest equivalent returns are often twice that of a traditional GIC.
• Convertible Debentures are an instrument that offers the security of a fixed-income corporate bond with the upside of equity. With the support of ScotiaMcLeod research, I have indentified some attractive opportunities. I have posted An Introduction to Convertible Debentures at the following link:

  ScotiaMcleod - Introduction to Convertible Debentures

LONG-TERM GROWTH:

Please call me on any issues regarding this communication. I am grateful for my relationship with you and am most appreciative of referrals where you believe my services may be of benefit.