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Third Quarter 2011

January 18, 2012 • Print This Article

The Markets

All eyes are upon Europe as we seek some clarity to the sovereign debt issues. Global markets swing with risk on/risk off trading following every pronouncement and/or rumour. Markets are trading on sentiment and headlines, not fundamentals.

It is becoming increasingly apparent that Greece will face major restructuring. The issue surrounding lawmakers in Europe and the markets is what shape that restructuring will take and whether the rest of the peripheral countries will be adversely affected. The ripple effect of a Greek default could spread to the European and global banking system, as many international banks have holdings of Greek and peripheral country debt. In the event of disorderly default, banks will have to take huge write-downs. Governments are negotiating how to recapitalize the banks to prevent potential bank failures and a freeze up of credit similar to 2008.

The necessity of having 17 EU member countries pass legislation to allow for $8 billion keeping Greece afloat was delayed by the internal politics of Slovakia. The funds were required to buy time to allow for a comprehensive agreement to be drafted providing for a potential orderly Greek default. This could include a devaluation of Greek bond principal of up to 50% and a bank recapitalization fund (similar to TARP). The uncertainty of EU members passing a bill to provide up to 2 trillion Euros required to fund the banks and to support the peripheral countries through bond purchase programs is finding difficulty reaching consensus. Until a comprehensive plan is in place markets will remain volatile. Talks are underway at the time of writing. If a resolution is reached there could be a stabilization of equity markets. If there is no agreement, markets should continue to be volatile.

The economic woes of the Euro zone are impacting global trade. There are signs of weakness showing up in developing countries as trade growth is curtailed by tightened credit conditions. For example, growth in China has slowed to below 10% for the first time in several years. However, it should be noted that growth of over 9% is still robust by any measure. China should continue to consume an increasingly large proportion of the world's commodities as the population continues to urbanize and the middle class continues to grow. This should help to put a floor under commodity prices. In addition, the slowdown in growth has allowed inflation to abate to a 6% growth rate. With inflation trending lower the Chinese government should be able to deflate asset bubbles without triggering the hard landing of the economy feared by market watchers.

The growth slowdown in developing countries and uncertainty in Europe has lead to a decline in commodity prices, especially economically sensitive base metals such as copper. Declining commodity prices impact commodity dependant economies such as Canada. We believe that continued growth in the developing world even at lower levels should help offset weakness in commodity demand from Europe. We believe, barring a global recession, that there are tight supplies in many basic commodities, especially oil, and that any pullbacks in prices should be relatively short lived.

Lost in the geopolitical clutter, is the fact that the North American economy is growing and growth appears to be accelerating (albeit from very stagnant levels). Corporate profitability continues to remain robust as companies continue to extract concessions from labour. Efficiencies realized go directly to the bottom line.

Globalization has meant that components can and are being made in the lowest cost environments. The iPhone, for example, has components manufactured in Korea, Vietnam and Cambodia, assembly that takes place in China and development occurring primarily in the United States. Entry level jobs are lost and high skill/high pay jobs are retained. This process has helped polarize society especially in the United States. The inability of many young people to get the higher education required for the high skilled jobs that remain is fuelling the anger that has coalesced into the Occupy Movement. The belief is that jobs are being exported to enrich corporate coffers, enrich the wealthy shareholders at the expense of the average worker. The reality that Apple and many other companies could not compete globally if manufacturing was done locally is lost in the rhetoric.

It would appear that the S&P 500 and the TSX 300 are discounting a mild North American recession. Markets are currently in a broad trading range. Equity valuations swing from extreme to extreme based on news from Europe. If a rescue plan can be put in place focus will begin to return to fundamentals.

The Andras Group

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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