Here’s What We’re Thinking, November 29, 2011

The Investment Committee of the Portfolio Advisory Group meets weekly to formally discuss markets, sector allocation and investment recommendations. Below is a brief synopsis of our current market view.
Here’s What We’re Thinking

• Equity markets declined further last week on continued macro-economic concerns; news early in the week that the IMF (International Monetary Fund) had approved a new credit facility to fund short term liquidity shortfalls for “qualified” countries caused a brief bounce in stocks but the festering euro debt issues ultimately drove markets lower.
• German Chancellor Angela Merkel remains intransigent on the issue of creating euro-area bonds or using the ECB as the lender of last resort, thus prolonging discussions on finding a lasting resolution to the European debt crisis.
• Although we remain confident this euro-crisis will ultimately be resolved, time lines are uncertain and we expect stock market volatility to continue, resulting in equities trading in a narrow range for the foreseeable future.
• Some optimism has surfaced due to talks supportive of some form of “fiscal union” among eurozone members although there remains much skepticism on this subject.
• Part of last week’s declines were prompted by Chinese factory data indicating the manufacturing sector declined the most since March 2009, increasing concerns surrounding economic growth in one of the world’s most crucial regions.
• Yesterday global stock markets rebounded in a likely temporary relief rally supported by short-covering, thus merely returning stock prices back to prices seen a week prior.
• Stocks were also fueled yesterday by encouraging reports of Black Friday retail sales which increased 7% from last year, implying to some a positive Christmas selling season for retailers.
• As was the case during recent weeks of market declines, yesterday’s bounce was achieved on relatively light trading volumes, implying a continued lack of conviction by investors.
• Equity markets will likely be guided this week by some major U.S. economic data releases and the success, or not, of several scheduled European bond auctions: Italy held a successful auction yesterday, and more this morning, but at significant cost as 2022 bonds were sold at 7.56%, up from 6.06% when the same bond was sold only one month previously. Last week, Germany, the strongest credit in Europe, was unable to sell their desired allotment of new bonds at auction. Spain and France will also be issuing new bonds later this week.
• Yesterday debt rating agency Fitch reaffirmed the AAA rating on U.S. debt, but also changed their outlook to negative from stable.
• Today finance ministers from the eurozone meet in Brussels to discuss the merits of using the EFSF (European Financial Stability Facility) to insure a portion of certain sovereign bond issues with guarantees.
• In light of this macro back-drop, we expect this short term rally will be short lived and that Canadian and U.S. equity markets may extend the recent downward move; however, market technicals suggest investors be prepared to add equity exposure should we experience another 5%+ decline.
• Investors have been largely risk-averse during the recent period of market weakness and cash positions remain high among both institutional and retail investors. December 1 and 2 are big coupon payment and/or maturity dates for North American bond investors which could create a short term increase in buying as investors seek to replace low yielding fixed income investments with higher yielding equity alternatives.
• Many high quality dividend paying stocks at current levels do not offer much capital appreciation potential but will provide investors with the most downside protection if the market retreats; and the steady dividend income generated will remain an important component in portfolio total returns.
• Commodity cyclicals and industrial stocks offer the most upside potential in the event equities rally again, but they also will likely continue to exhibit the greatest volatility.
• For fixed income exposure, the current low rate environment offers little value in the mid to long end of the curve and we recommend investors remain short duration at this time. From a sector weighting perspective, investors should be underweight Canada’s and overweight provincials, municipals and corporates. The recent narrowing of high yield spreads leaves us at a point of indifference on these credits. With the Canadian dollar expected to outperform most major currencies over the coming year, we recommend Canadian investors remain in Canadian dollars for their fixed income holdings.
• For trading oriented investors we recommend selective profit taking as certain stocks have demonstrated significant outperformance recently.
• Gold’s multi-year rally has paused of late but technically looks very attractive. Both gold bullion and gold equities should perform well in the current environment.

For more information on how these ideas pertain to your investment portfolio, please contact Danielle or Bev.

Summarized by Steve Uzielli – Director, Portfolio Advisory Group

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