Financial Planning, Investment Counselling, Tax and Accounting

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Market update

A global market mealtdown?

Global equity markets, including the Canadian stock market, have been broiled recently by significant market volatility.

In the last few months, even the most seasoned investment professional has learned new words such as collateralized debt obligations (CDOs), asset backed commercial paper (ABCP); credit default swaps (CDS) and sub-prime. And investors have now learned how this alphabet soup can cause queasiness as equity markets attempt to digest this concoction.

Mounting losses created a bad case of indigestion for global markets earlier in the month. The U.S. central bank quickly administered some soothing medicine in the form of a ¾% cut to the prime rate, followed by a fiscal stimulus package proposed by President Bush that included "direct and rapid income tax relief for the American people". This week, an additional ½% rate cut was announced and, as a result, markets now seem to be feeling a little better.

The big picture

While we cannot deny the fact that equity markets have experienced periods of market volatility recently, highlighted by what has happened over the past couple of weeks, taking a step back allows us to put the recent market turmoil into the perspective of the broader market cycle. By looking further back, we see that equity markets have in fact been strong for quite some time – a five year bull market that started 2003.

The Canadian perspective

Canada's economy has hit a wall and is unlikely to recover until the second half of this year due to a global slowdown and a crashing U.S. economy. Canada is likely to avoid a recession, even though the U.S. may actually dip into a mild slump.

"It may not necessarily feel fine, but we will get through fine" says Bank of Canada Governor David Dodge.

Canada's gross domestic product is forecast to advance about 1.8 per cent in 2008, well below the modest 2.3 per cent gain previously predicted. The central bank cut interest rates last Tuesday by a quarter-point for the second time in two months. In its first explanation of factors behind the move, it said Canada's economy slowed sharply at the end of last year and will all but stall in the first part of this year. "The major change is much weaker net exports," the bank said in its monetary policy update. "The outlook for Canadian exports has been marked down, reflecting the weaker U.S. economic outlook."

The United States is still digging out of its subprime mortgage mess, which has devastated housing activity, spiked borrowing costs, reduced household wealth and shaken the confidence of consumers. The global economy, which has sustained high resource prices that have helped drive activity in Western Canada, will also take a step back in 2008.

BMO economist Douglas Porter said the bank's tone suggests it feels "no real urgency" to keep up with the Federal Reserve in the race to the interest rate bottom. "Given their view that the economy will be perking back up by quarter two, the rate cut program could be done within the first half," he said.

As for the Canadian dollar, the central bank’s view is that loonie's current level at about 98 cents U.S. is about right.

So what should we do?

Undoubtedly these recent events have been unnerving, however the current situation is most certainly not a doomsday scenario. We do expect that the markets will continue to be volatile for the next several months. The U.S. is almost certainly into a mild recession, and this will spread somewhat to other parts of the globe. Canada, though not immune, should be OK.

We urge clients to focus on the longer-term view. Investment decisions should be driven by the asset allocation model and not by market turmoil. Markets can at times be very erratic, and their behaviour is often difficult to predict, particularly in the short term. However, the eventual outcome is quite certain – equity markets will recover from this period of volatility, and they will continue to rise over the long term.

In the meantime, we continue to keep a close eye on client portfolios. We are also monitoring market conditions, and we will follow up if in our opinion changes are warranted. In the interim, if you would like to meet to review your portfolio or discuss the current market conditions, please contact our office so that we can arrange for a review meeting.