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Third Quarter 2014

October 1, 2014 • Print This Article

The Markets

Last quarter we discussed a market that was climbing a wall of worry. Although the global situation has not changed dramatically in the quarter, investment sentiment has turned negative. Even a month ago, there were concerns that global growth was running away on the upside and that inflation could be a threat. The general consensus was that interest rates were going to rise sooner than originally anticipated. Accelerated global growth would provide increased demand for raw materials, especially oil, supporting relatively high commodity prices.
Instead, the growing consensus is that global growth may be decelerating.

  • European growth has stalled. Germany is at loggerheads with the rest of Europe over the need for quantitative easing to spur economic growth. The threat of deflation rather than inflation is a concern.
  • Slowing growth in Europe slows growth in China. China also has problems in Hong Kong with pro-democracy protestors leading up to elections.
  • The war in Iraq and Syria is expanding as more countries join the US led coalition against ISIS. However, it is unclear how air power will eliminate ISIS without boots on the ground. The intervention could expand further and continue for many years to come.
  • The ongoing tragedy of Ebola continues in West Africa. Although probably not a direct threat to developed countries, apart from isolated cases among travelers and healthcare workers, the fear of a widespread epidemic mirrors the panic over SARS.

Equity markets, which anticipated accelerating growth, have corrected to reflect the current economic environment. The price of oil and shares of companies dependent upon energy have been heavily sold. Increased production from shale deposits in the US and from Libya has not been met by increased demand. Normally it would have been expected that there would be a decrease in production from other OPEC producing countries. In fact, Saudi Arabia decided to maintain market share rather than maintain pricing by cutting production. Russia, squeezed by sanctions, produced a record volume of oil to buy US Dollars as the value of the Ruble fell.
However, the underpinnings for equity markets remain in place.

  • Economic growth continues in North America
  • Unemployment rates in North America continue to fall.
  • Corporate balance sheets are healthy.
  • Corporate earnings in North America continue to trend higher.
  • Investors are still demanding income in a very low interest rate environment which should be supportive of dividend paying equities.
  • A recognition of weakness in China and Europe and the resulting influx of funds to US Dollars as a safe haven has led to a rapidly escalating valuation for the US Dollar. The higher dollar depresses US inflation allowing the FED to delay raising rates.

Oil prices have reached a point where US shale oil and oil sands production become far less profitable. Saudi Arabia and other OPEC producers require higher prices to placate their people. Russia requires higher prices for their production to be profitable, so production cuts may occur to support prices.

The share price of oil companies, suppliers to oil companies and infrastructure plays in the oil patch have been hit hard. It should be kept in mind that many producers have hedged production out at much higher prices to meet divided and capex requirements. The increased value of the US Dollar has offset some of the decrease in commodity prices for Canadian producers. The differential between WTO and Canadian Select has decreased from over $40.00 per barrel to under $14.00 per barrel. Earnings for many Canadian producers could be little changed if the current pricing environment is not extended.


Early indications of third quarter earnings are positive with most companies reporting above consensus earnings. We are of the belief that equity markets are ultimately earnings driven. Changes in sentiment, driven by headlines, could roil markets, but as long as earnings momentum continues on the upside markets will ultimately respond positively. Investors still require sources of income. Yields on money market and investment grade bonds remain at very depressed levels. Dividend paying equities, we believe, will remain in demand by income dependent investors.

  • We maintain a negative bias on bonds. We feel that the long-term capital risk to bonds of higher interest rates does not justify the current interest rate being paid.
  • We maintain a position in equities favouring companies exhibiting superior earnings growth potential, good dividend yields and the ability to increase dividends over time. We believe the North American economy is becoming increasingly integrated and that Canada should benefit from growth in the United States.

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.

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