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Second Quarter 2009

July 27, 2009 • Print This Article

It looks like we may be entering a period of slow growth, not boom bust. We remain focused on Canadian dividend paying stocks.

Second quarter 2009

The Markets

In our last letter, two scenarios for recovery were presented: slow growth or boom/bust. At the time, there was concern that the stimulus being pumped into economies around the world would lead to rapid expansion, commodity supply squeeze, inflation, rising interest rates and eventual collapse into an extended recession. This appears to be increasingly unlikely.

It is still general consensus that the recovery will begin towards the end of 2009. However, it now appears that recovery will be muted, inflation will remain subdued and interest rates will remain at low levels. It is also apparent that unemployment levels will continue to rise long after GDP growth begins. It appears possible that we will enter into an extended "jobless recovery".

Government spending to date has gone primarily to bail out the financial service sector. Although stabilizing the credit market is a precursor to recovery, it seems that very little money allocated to infrastructure spending has actually been spent. Projects that should be "shovel ready" appear to be stuck in red tape. The situation is worse south of the border where stimulus, when it comes, will be funneled into hundreds of pork barrel projects that appear to be tailored more to enhance politician's re-election opportunities then to provide lasting economic benefit. It appears that it will not be until late 2010-2011 before funding really starts to flow. By that time, of course, the Recession should be over. We believe there is enough slack in the economy and unemployment rates should be high enough so the spending, when it finally occurs, should help extend the recovery without triggering excess inflation.

Global economic leadership appears to be shifting from the United States to the BRIC (Brazil, Russia, India, China) regions. There are increasing calls for the creation of a global basket currency to become the reserve currency rather then the US Dollar. While this appears to be little more then saber rattling at the moment, it does point to an erosion of US dominance in world affairs.

Second quarter earnings which begin to be reported on July 9th will reflect conditions that should be close to Bear Market bottom earnings. Analyst's consensus points to US corporate earnings falling 38% year over year. Comparing 1st and 2nd quarter earnings should show signs of stabilization.

Investors appear to be vacillating between hope for a "V" shaped recovery and fear of an extended economic bottoming process or worse, a second leg downward. We believe an extended bottoming process and modest recovery is the best case scenario. The financial system has been damaged and will take time to heal. If a "V" shaped recovery was to occur, we fear that, without sufficient healing time, imbalances would rapidly re-emerge, new bubbles would be created and governments, hamstrung by massive deficits, would have little choice but to watch as markets and economies decline.

Although equity markets, especially in Canada, appear to be correcting from recent gains, it appears unlikely that they will retest the March lows. Over the short term, rapid appreciation in commodity prices, due to economic recovery, appears to be unlikely. As the TSX is heavily weighted in commodities, the recent sell-off was more severe then in the US equity markets. Over the longer term, as the economy slowly recovers, commodity prices should rise as exploration and development, required to replace reserves, has not occurred. Over the long run, we believe that Canada and the Canadian equity markets should out-perform and the Canadian Dollar should appreciate vs. the US Dollar. However, volatility will remain at high levels as investors swing between hope and fear.


In a period where we anticipate that growth will be muted, inflation levels low and interest rates subdued, we believe that stock dividends will become critically important. We would not be surprised if equity markets become range bound for a time and yields of 4-6% will become important to prevent capital erosion.

Looking ahead, we believe that yield spreads will revert to more 'normal' levels. It is unusual, even after recent gains, for dividend yields on common shares and preferred shares of many financial service companies (for example: Bank of Montreal, CIBC, Manulife, Power Financial) to be higher then the yields on the companies underlying debentures. Assuming we are correct in our belief that rates in the bond market will be stable for some time and dividend rates are secure, equity valuations should rise.

We remain focused on Canadian dividend paying common shares. We are of the opinion that the relative strength of the Canadian financial system and the comparable fiscal responsibility of the Canadian government will, in time, allow the Canadian Dollar to out-perform the US Dollar. In a slow growth environment, currency fluctuations can distort returns. As a result, we remain underweight in US equities.

Filed under: Quarterly Reports

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.

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