Summary

  • The stock market in Canada rose again in October, up 2.7%, as the rally since late August continued on optimism about earnings and continued easy monetary policy.
  • The Canadian bond market returned 0.2% last month as longer-term bond yields went up by around 10 basis points on higher expectations about growth and inflation.
  • Commodity markets were strong again last month with the CRB Commodities index rising 4.8%, driven higher by economically-sensitive materials such as lumber, silver, zinc, natural gas and uranium.
  • The Economic data remained positive, though not robust.  Growth in North America and Europe slipped back into the 2.0-2.5% annual range in the third quarter, enough to support corporate profit growth but not enough to generate strong employment gains.
  • In terms of stock sectors, Information Technology lead the charge with a 10.8% monthly gain as Research in Motion bounced back.  Basic Materials (excluding gold) were also strong as iron ore, coal, paper and fertilizer prices remained strong.
  • Our Stock Market Outlook has become somewhat more conservative in the short-term following sharp gains over the past two months and somewhat lofty expectations for more help from the US Federal Reserve in terms of ‘easy money’.  We are still bullish over the medium-term (up to 5 years) as economic growth is recovering, profits continue to improve, interest rates remain low and stock valuations are reasonable.

Financial Markets: Monthly Review and Outlook

Canadian stocks followed a strong September with further gains in October as investors prepare for potentially good market news from the US Federal Reserve meeting on November 3rd as well as the US mid-term elections on November 2nd.  Third quarter corporate earnings also came in ahead of expectations again.  For the month, the S&P/TSX Composite Index had a total return of 2.7%, with smaller stocks leading the way.  Although the heavyweight Financial and Energy sectors came in with modest gains for the month of 1.8% and 2.5%, respectively, the economically-sensitive groups such as Technology and Basic Materials were the big winners, supported by strong earnings as well as improved growth expectations.  Lagging the market were the defensive sectors such as Utilities and Telecom, each of which fell 0.8% on the month.  US stocks were also strong again last month as the S&P500 shot up another 3.7% while the ‘technology heavy’ Nasdaq index gained 5.9%.  Outside of North America, the big winner last month was the Chinese stock market where the Shanghai Composite index roared back by 12.2%, despite raising interest rates.  On the downside, the Japanese market was a laggard with a decline of 1.8% as third quarter growth was disappointing and a stronger Yen continued to be a headwind for the export sector of that economy.

Stocks have surprised to the upside since late August when investors were almost universally bearish, expecting that weak August markets would drift down further into the ‘traditionally soft’ September-October period.  Moreover, economic conditions seemed to be deteriorating further with the view that we might be headed for a ‘double-dip recession’ becoming more accepted and even expected.  But stocks always tend to confound the consensus opinion and have headed almost straight up since that time with most stock averages gaining 10-15% over the past two months.  One of the biggest drivers of the stock strength over the past two months was the optimism around the expected second round of Quantitative Easing (QE-2) by the US Federal Reserve. The initial round of easing of financial conditions that started during the financial crisis in 2008 consisted of taking short-term interest rates basically down to zero (0.25% Fed Funds rate) in order to boost economic growth.  But, after a strong rebound in growth in the second half of 2009, the economic data weakened again in the first half of 2010.  Since short-term interest rates can’t go any lower, Ben Bernanke and his colleagues at the US Federal Reserve were forced to look at other ways of stopping the US economy (and, by association, most of the global economy) from going down a ‘deflationary spiral’ similar to what Japan went through in the 1990’s.  QE-2 was proposed as a way of putting more liquidity into the financial system.  The mechanics of the program was for the US Fed to buy long-term US debt in substantial quantities over a period of time in order to push down longer-term interest rates, or at least keep them at their current low levels.  Rumours had the Fed buying as much as US$1 trillion of government debt over the next year, or about US$100 billion per month.  One of the unintended consequences of this proposed strategy was that it sent the US dollar into a brand new tailspin which saw the ‘trade weighted value’ of the US dollar (the “DXY”) drop by over 12% from its peak of over 88 in early June as global investors worried that the US would be issuing even more debt over the next few years to pay for all these expensive ‘rescue’ programs.  The flip side of this dollar weakness was commodity strength.  Copper, gold, oil and cyclical stock prices began surging higher as the US greenback kept deteriorating.  This lead to the paradoxical situation again where weak economic numbers (such as US payroll reports and confidence indicators) kept pushing stock prices higher since a weaker economic outlook increased the need and veracity on any QE-2 program once it began. Finally, after rising strictly on the basis of the prospects of QE-2 and extremely negative stock market sentiment indicators, the market started receiving support from third quarter earnings reports that have been once again coming in ahead of expectations.

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