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Where do markets go from here?

Friday, October 15, 2010


I have noticed that much of the sentiment lately has been decidedly pessimistic regarding the direction of stock markets. When I speak of the “stock markets,” I am referring to the North American indexes. I will touch on the three main areas of negativity before looking at some of the more positive elements.

The lost decade

The “lost decade” refers to the 10-year period from January 2000 to December 2010. (We’re close enough to December now that we can take an educated guess about the outcome in the next two months, and I’m reasonably sure there won’t be any big surprises.) During that period, an investment of $1,000 in the S&P 500 Composite Index would have declined to about $909. That hasn’t occurred since the Great Depression (1930-39, when a $1,000 investment dropped to $995).

This time, the timing has been awful, because the bulk of North American baby boomers are approaching retirement, and some investors have had to re-think retirement plans. They either need to work a few more years or have a more frugal retirement, neither of which is a terribly palatable option.

Your investment returns may have been more positive if you a) had bought on corrections, and/or b) had some natural resources/energy or some emerging market content in your portfolio.

The last decade has been a poor one, and there is no debating that fact now. What is important is to look at the historically long term to see what happened after the 1930-39 period. In fact, performance from then until 2000 – a period of 60 years – was very positive. Sometimes it pays to review the facts and take the long view. Excessive negativity kills opportunity.

The double dip and the U.S. economic recovery

It has become very fashionable to write (and talk) about the “double dip.” A double dip recession occurs when gross domestic product (GDP) contracts again after a quarter or two of positive growth following a recession. The pundits believe this may occur as the stimulus-driven infrastructure projects that helped pull the world out of the recession come to an end. They feel the economy may not be able to stand on its own without further stimulus. In addition, high levels of national debt, large federal deficits, and high debt servicing costs could weigh on economic growth.

The US economy has improved, but with consumers and government still carrying heavy debt loads, the recovery is likely to be muted. This might be the case for five years or more. The negative for Canada here is that the US has always been our number-one trading partner, and when its economy slows, ours does too.

A positive for Canada is that we have what the rest of the world wants – resources.

Further positive offsets here are that the emerging markets had very little asset-backed paper clogging up balance sheets, and have therefore led the way out of the recession. Their consumers have almost no debt, because those credit mechanisms (mortgages, car loans, and credit cards) haven’t yet been built into their economies. We take all those things for granted. Our grandparents didn’t. We have had credit explosion in only the last 40 to 60 years, which is relatively recent period of time.

China’s economy is growth at an annual rate of 9% to 10% and has recently overtaken Japan as the world’s second-largest economy. Only 10 years ago, very few people believed that China’s economy would be larger than Japan’s, but in compounded terms, Japan’s current GDP is lower than it was in 1990.

While it’s true that the U.S. and to a lesser degree other Western economies are struggling economically, the pace of growth in the emerging markets has led the way out of a recession for the first time ever. That’s very significant. This is the start of the passing of the torch from the industrialized nations to the emerging nations that I mentioned in my April article.

Sovereign debt

The eurozone narrowly avoided a financial crisis when European Union countries (mainly Germany) helped guarantee the debt of fiscally shaky peripheral nations like Greece, Portugal, Ireland, Italy, and Spain (known as the PIIGS). All have unsupportably high national debt levels and most are taking steps to rein in government spending so they won’t again be begging the EU (i.e., Germany) for another bailout in a few years’ time. I am hopeful that fiscal prudence and good governance will prevail and that sovereign debt problems will not become the next global economic disaster.

In conclusion, there are some negative economic forces at the moment, but when is the entire world ever running smoothly? Never. There are also quite a few positive events that are having a profound effect on the global economy and financial markets. The emerging markets’ thirst for resources has pushed most metals prices to record highs. For the moment, most of this power shift is an economic one. As time moves on, Brazil, India, China and other economically robust emerging nations will exert more political power too.

Remember to read between the lines and look for the positive information beyond the breathless and hyperbolic headlines of the day. Inevitably good news will be buried deep in the business section and hidden away in dry economic commentaries, because good news isn’t dramatic. Remember that even when markets move sideways, as some expect they will for the next three to five years, opportunities for prudent investment will still abound.

 

 

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