Making sense of the markets

By Kate McCaffery | March 16, 2005 | Last updated on March 16, 2005
4 min read

(March 16, 2005) The investment world is a rocky place these days — oil is up and doesn’t show signs of coming down much, commodities are also higher but will likely decline, credit is everywhere and there are even rumours across the pond that bankruptcy advisors are starting to hire extra staff.

Despite, or perhaps partly due to the bad news, Canada’s economy appears to be ticking along. Companies here have a lot of free cash flow and the credit default rate for Canadian corporations is historically low. Commodities continue to fuel the economy, and bond yields are low — a sign that the bond market doesn’t believe inflation is a problem. On top of that, recent economic reports show exporters seem able to stand on their own without the low Canadian dollar as a productivity crutch.

With all of that conflicting information, investors can be forgiven for being less than confident about where to go from here. Even professional market watchers aren’t entirely sure what to make of it all.

“There are a lot of inconsistencies out there right now,” agrees Mark Grammer, vice president of investments at Mackenzie Financial. “Inflation is benign and yet we’re seeing commodity prices skyrocketing. Credit is growing and you’re seeing the economy continuing to grow. There’s concern about the U.S. twin deficits, but actual growth in the economy remains very robust. You’re seeing a strong U.S. economy and a weak U.S. dollar. There’s a lot of volatility as well. That generally indicates that there is some concern about what is going on.”

Other strange signs of the times are the continued run of good performance in value stocks and persistent weak performance in growth sector stocks. Inflation is low and commodity prices are high, but inventories are growing. “Although inventory is going up right now, the expectation is for continued robust demand, particularly coming out of China, and for continued demand from the U.S.,” Grammer says. “There certainly seems to be a mismatch between supply and demand right now, but I think that’ll clarify itself in the next several months.”

In the next two quarters Grammer expects the inflation outlook will also be clearer. “If we are still in a benign inflation environment with prices of commodities going up, I would argue that it won’t be good for the stock market. It’ll mean that profit margins will be squeezed.” For example, if steel prices increase 15-20% the cost gets passed on to the end user ship builder or car company. “You might see further deterioration to profit margins in those kinds of companies. It would be negative for the stock market.” On the other hand, he says weakening commodity prices, a sign of global growth slowing down, would also depress markets.

The bond market is another area of concern for many investors. Roland Chalupka, vice president and portfolio manager with Franklin Templeton Investments’ private client group says he expects the bond market will continue to follow its present course of rising yields and depressed prices over the next year. “We don’t really see a shorter term big spike in interest rates again.” He says total returns from bonds will come in between 4.5% and 5% on the high side in the year to come. “For our portfolios, we’re tending to favour stocks over bonds for the next year or so.”

Grammer continues to remain overweight in Asian equities, but sounds a little wary of commodity and resource sectors. “I have to say I’m seeing some rationality out there, but there is also commentary coming out of people, particularly in the commodity areas, that this is the new paradigm. We all know what the new paradigm was like in technology, the new paradigm in Japan and the new paradigm in tulips. When I hear that word I get a bit nervous,” he says. “It doesn’t mean this is the beginning of the end for commodities though, because if we do have good global growth for the next few years then commodity prices could stay strong.”

Similarly with energy stocks, he says comparing the performance of many energy companies today to tech companies in 1999 reveals some striking similarities. “[Clients] shouldn’t be chasing anything because they think they missed it. If you were fortunate enough to be in the resource sector, that’s great for you, but I wouldn’t be mortgaging the house and putting it into resources right now, not after the run they’ve had. I would be careful about committing new money to the energy space right now.”

Until things begin to make more sense, both Grammer and Chalupka suggest it might be a good time to rebalance your client’s portfolios according to their original plans, and sit tight.

“Match your investment policy decisions with your own circumstances,” says Chalupka. “Meet with your advisor, stick with your plan. People who are looking for growth in this environment will tend towards equities. People who are looking for income will tend towards fixed income. That is a general rule that I think still applies.”

Filed by Kate McCaffery,


Kate McCaffery