Where do we
go from here?
Stock
markets have traditionally been leading indicators. That is, the current
direction of the stock market has usually been a sign of things to come for the
economy in the subsequent six to eight months. Today, we’re getting mixed
signals and many investors aren’t sure what to make of them.
The North
American economies are displaying impressive strength. First quarter U.S.
economic growth was revised upward to an annualized figure of more than 6 per
cent. The Canadian economy added more than 60,000 jobs in June alone, bringing
the year-to-date total to about 300,000 new jobs added. Also, the housing
market remains strong in both nations. Looks pretty good.
Recall that
stock prices represent the consensus of the future expectations of all market
participants. If stock prices are going up, it’s because market participants
anticipate good times ahead. However, these days the stock market only seems to
fall in value on days ending with the letter ‘y’. Under normal conditions,
strong economic growth in the midst of falling stock prices would indicate one
of two possibilities.
Either the
economic figures are wrong and we’re about to witness a sharp reversal of
fortune; or the stock market is wrong. Since these aren’t normal conditions,
I’d guess the correct explanation lies behind door number three; which says
that the fraud and misleading accounting plaguing corporate America is unduly
punishing global stock prices.
Another
argument would state that stock prices remain relatively expensive so further
price weakness is warranted.
I recently
spoke with a couple of fund managers to get their views on this market.
Don Ferris,
Asset Mix Strategist with Mawer Investment Management, is bullish. He says the
figures don’t lie – and he expects relatively strong growth for the second
quarter of this year. If you don’t believe the numbers he suggests taking a cue
from the Bank of Canada’s chief, David Dodge. He’s been slowly raising interest
rates because he is seeing strong economic growth. Ferris has kept a steady mix
of 60 per cent stocks and 40 per cent bonds/cash but has been further
diversifying lately – i.e. Canadian stock exposure has been reduced in favour
of foreign stocks.
Irwin Michael,
owner and lead manager of ABC Funds, is also bullish. While he admits that
accounting fiascos have introduced even more uncertainty and frustration to his
task of finding undervalued companies, he expects the positive economic
momentum to continue without any serious interruption. He is using current
volatility to selectively pounce on individual stock opportunities as they
present themselves.
For a more
company-specific view, Vito Maida, respected fund manager and president of
Patient Capital Inc., says quality and value is a combination that continues to
prove elusive in this environment. His research reveals that many companies
continue to carry significant levels of debt; many intangible assets continue
to be overvalued; and cash flow growth is unimpressive.
Mr. Maida
is not alone in his view. Fund managers Gerry Coleman (CI’s Harbour funds) and
Larry Sarbit (AIC American Focussed) continue to stockpile cash as they
struggle to find attractively valued stocks. Further, more than three hundred
investment funds were sitting on at least 20 per cent in cash as of the end of
June.
It would be
fair to say that I’m cautiously optimistic. High stock valuations and broken
investor confidence are two big negatives against a quickly rebounding stock
market. On a brighter note, at some point stocks will stop falling because
they’ll be too attractively valued for investors to resist buying. Also, if the
economy continues its strong growth, it’s only a matter of time before stock
prices are propped up.
Regarding
investment portfolios, I continue to favour value stock pickers for the core.
For investors who would like to maintain some defensive positioning, a small
position in a precious metals fund or a larger than usual weighting in cash
should provide a cushion in the face of further weakness. Resist the urge to
make rash, emotionally driven decisions since they rarely yield much benefit.
In short,
expect this environment to worsen before it improves – but it will eventually
improve.
Dan Hallett, B.Comm., CFP, CFA is the Senior
Investment Analyst with Sterling Mutuals Inc. He can be reached at dhallett@sterlingmutuals.com Sterling Mutuals Inc. is registered as a
mutual fund dealer in Ontario, British Columbia, Alberta, and Manitoba.