Market Outlook
July 2005 - A typical mid-cycle slowdown
Continued worries over oil prices, persistent unrest in Iraq, slowing economic growth and systematic tightening by the U.S. Federal Reserve (the "Fed") have collectively combined to hold back stocks so far this year. The MSCI World Index, the best available proxy for global equity markets, was down -0.4% in US$ during the first six months, which nonetheless translated into a positive +1.4% for Canadian investors as a result of the weakening of the C$ over the period.
The divergence between various geographical areas so far this year is worth mentioning. While U.S. equities, measured by the SP 500, have returned +1.0% in C$ (-0.8% in US$), a performance replicated by the rest of the world (EAFE is also up a meager +1.0% in C$, but down -0.9% in US$ terms), the Canadian stock market has been energized by rising oil prices as witnessed by the +8.1% TSX advance during the first half of 2005.
Slower growth with controlled inflation
Contrary to the 70s, when wage adjustments kept pace with rising oil prices and thus fuelling inflationary pressures, this time around, oil at $60/barrel constitutes a real �consumption tax�, while the emergence of �low-wage� countries, such as China and India, has completely changed �labor bargaining power�, allowing companies with �just in time� inventory management to shift production around the world to take advantage of this new reality -the U.S. automobile and textile industries are testament to this new reality. So, inflation is not an issue at this point in the cycle and will not be for the foreseeable future as the recent fall in bond yields around the world confirms. Over the past six months, 10-year bond yields have come down between 25 and 50 basis points, now standing at levels nobody would have dreamt of a year-ago - Canadian and U.S. bonds for example are now trading below 4%, while German and Japanese bond yields are 3.15% and 1.15% respectively.
What are the implications for financial markets?
Financial markets will remain under pressure until the Fed ceases raising interest rates, which is probably closer than widely expected, as the U.S. economy will most likely slow down over the coming quarters if oil prices remain at their current level. But the risks of the U.S. economy falling into recession are extremely low, and the second half of this year could well see a repeat of last year when equity prices rebounded strongly. Stay the course, ensure that your current asset allocation is in line with the strategic mix that is the most likely to allow you to achieve your investment goals. Finally, rebalance to ensure that your portfolio is well diversified and beware of market performances that are driven by a few sectors. |
