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First Quarter 2014

March 1, 2014 • Print This Article

The Markets

Markets continued to advance in spite of reasons for investor concern in both Canada and the United States. Volatility increased over the quarter as markets became fixated by each new data point.

Positives:

It appears that economic recovery and growth in North America is becoming entrenched. Although GDP growth has moderated, inflation and interest rate pressure appears to be contained. Sabre rattling in Europe is constructive for energy prices. The inclement weather in the 1st quarter of 2014 drained natural gas inventories. The resulting higher pricing environment is supportive to oil and gas exploration and development companies. The cold weather also contained economic activity (housing, auto sales, consumer spending). GDP is predicted to have grown modestly during this period indicating a more robust underlying economy. It is anticipated demand and economic growth should pick up in the second quarter. Although unemployment is falling, there does not appear to be conditions consistent with wage push inflation. As more people find work, it should be supportive of housing prices and consumer spending.

There still appears to be considerable cash sitting on the sidelines in money market and short-term bond funds. Although there seems to have been some rotation away from fixed income into equities, there are many institutional and individual investors waiting for a correction to invest. This mindset has sidelined cash and could be the reason why the equity markets seem so well supported. Events, like the annexation of Crimea by Russia, should have created far more turmoil in equity markets.

Looking past the headlines, it appears that there is a firm base for equity valuations. Central banks may continue to reduce stimulus, tighten money supply and regulations. However, tightening is targeted, gradual and appears to be able to be absorbed with only brief market turbulence.

The low interest rate environment is gradually causing investors to look beyond bonds and money market funds in a search for yield. We believe that this rotation is still very tentative. The recent outperformance of utilities could be an early indication of this investment shift. Financial services are in a sweet spot with interest rates low enough to constrain default levels in a moderating housing price environment.

Concerns:

China, the growth engine that helped keep markets afloat during the dark days of the financial crisis, has an economy that appears to be cooling. Growth rates have been dropping toward 7% from over 10% a couple of years ago. China appears to be tightening its money supply and putting restrictions on lending practices to contain growth and to avoid a lending bubble and credit collapse. As previously stated, the Chinese economy is in transition to a consumer driven economy as the growing middle class becomes entrenched. The slowing Chinese economy could signal headwinds for commodity prices, especially base metals.

The incursion by Russia into the Ukraine is potentially destabilizing if it points to a resurgence of soviet style imperialism. Europe is dependent upon natural gas which flows through the Ukraine. Europe will likely not support meaningful sanctions and/or a military response for fear of having gas supplies interrupted. Any significant disruption of gas could possibly throw Europe back into recession. Russia is very codependent on gas sales. Any disruption would also have a devastating impact on the Russian economy, likely leading to a stalemate and de-escalation. Although equity valuations on both sides of the border appear reasonable, they are no longer depressed. In addition, there has not been a meaningful correction in several years. Second tier and concept stocks are attracting investor attention. There have been many high flying technology stocks that have used their inflated capital values to make acquisitions of companies that have little or no revenue. Each earnings announcement results in sharp market moves as bets are placed. The market is beginning to act as if it is top heavy and in need of a correction.

Strategy

The investment bias toward dividend paying equities remains in place. Interest rates remain artificially low. Central bankers on both sides of the Border have indicated that rates will remain low for an extended period. Funds sitting on the sidelines should continue to be attracted to equities in a search for yield. Although there appears to be some investor interest in lower cap equities, we anticipate a strong case can still be made for high dividend paying senior equity holdings.

Filed under: Uncategorized

The opinions, estimates and projections contained herein are those of the author as of the date hereof and are subject to change without notice and may not reflect those of Mackie Research Capital Corporation ("MRCC"). The information and opinions contained herein have been compiled and derived from sources believed to be reliable, but no representation or warranty, expressed or implied, is made as to their accuracy or completeness. Neither the author nor MRCC accepts liability whatsoever for any loss arising from any use of this report or its contents. Information may be available to MRCC which is not reflected herein. This report is not to be construed as an offer to sell or a solicitation for an offer to buy any securities. Member-Canadian Investor Protection Fund / member-fonds canadien de protection des ├ępargnants.

Mackie Research Capital Corporation (MRCC) makes no representations whatsoever about any other website which you may access through this one. When you access a non-MRCC website please understand that it is independent from MRCC and that MRCC has no control over the content on that website. The content, accuracy, opinions expressed, and other links provided by these resources are not investigated, verified, monitored, or endorsed by MRCC.

 

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