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First Quarter 2011

May 9, 2011 • Print This Article

The Markets

The ability of equity markets to absorb a litany of bad news has been remarkable. The price of oil and precious metals responded to political, economic events and natural disasters by rallying to multi year highs. However, increases in the share price of companies drilling and extracting remained muted. There was no broad weakness in North American markets as might have been anticipated. It appears investors were focusing on the domestic economy and on corporate earnings, both of which appear to be growing above expectations. The Canadian dollar remains strong based on commodity strength. Canada remains in a good position as we face a great deal of attention on our resources and strong banking system.

Both the S&P 500 and TSX/S&P indexes advanced by over 5% (unadjusted for currency) over the quarter.

It has been a quarter of turbulence. The Mid East and Northern Africa have seen Tunisia and Egypt's governments fall, and civil war broke out in Libya. Protests also began in Yemen, Syria, and Bahrain. It is still unclear what the new "democracies" will look like, or even if they will be democracies. The relationships between the new governments and the western countries are still unclear. It is also uncertain whether the unrest can be contained or will inevitably spread to Saudi Arabia. The situation has had a clear impact on oil prices.

The earthquake and Tsunami hitting Japan and the resulting damage to the Fukushima Dai-ichi nuclear plant will have lasting ramifications. The shares of uranium producers immediately traded lower as the long term risks inherent in nuclear power were clearly demonstrated. The long term damage to Japans infrastructure will impact global manufacturing as many parts are sourced from Japan for a wide range of products from electronics to automobiles.

The European sovereign debt crisis continues. Bailout support for Greece, Ireland and recently Portugal, has caused major political rifts and could eventually cause a reassessment of the EU. In time, a debt restructuring is possible in Greece and Ireland.

A longer term concern for the global economy is inflation. With inflation running at 5.7% and GDP growth of almost 10%, China is attempting to slow its economy by raising interest rates and tightening lending standards. Loose fiscal policy in the United States, required to combat the recession, has resulted in a steady devaluation of the US Dollar. The combination of demand from a rapidly expanding China and US Dollar devaluation has resulted in the price of many commodities (energy, metals, food) being either at, or near, record levels.

Corporations have been able to mask the impact of higher input costs by increasing efficiency (lay offs, concessions, rehiring contract and part time workers instead of full time, closing union shops and opening non-union plants paying a fraction of the wages, etc.). This has lead to robust corporate profitability. However, wage and labour efficiency can only be pushed so far. Eventually companies will be forced to rehire and wage push inflation is a distinct possibility.

Anticipation of future inflationary pressure continues to impact the bond market which declined modestly in the quarter. This is the second consecutive quarter with lower bond prices.

Inflation, long kept at bay through cost cutting, may start to accelerate as companies have run out of ways to further trim budgets. Increased corporate input costs will eventually result in higher consumer prices. As inflation heads higher, governments will be under greater pressure to raise interest rates. In Canada, it is anticipated that the Bank of Canada will begin a series of interest rate increases later this year. Banks and other lenders have begun to increase borrowing rates on mortgages and other loans in anticipation.

Equity markets have been trading steadily higher. Predictions of continued GDP growth, higher corporate earnings and diminished potential of a double dip recession have offset a continuous stream of negativity from abroad. It is important to note that equities have climbed from the March 2008 lows without a substantial correction. Although corrections are unsettling they are essential for the overall health of the market. Corporate earnings cannot continue to grow exponentially and growth must in time slow down. As we move forward it is becoming more apparent that we are in the midst of a business cycle that is becoming less erratic and more conventional.

The obvious beneficiaries of the first quarter were oil and gas, agriculture and mining and it is likely that after some correctional activity, commodities will be an important part of a portfolio. Insurance companies should benefit from higher interest rates as they will get improved premium spreads. Banks should be able to pass on higher costs to consumers. Grocery chains and food processors might suffer from margin squeeze as they find it more difficult to pass on costs. Pipelines should be able to pass on costs but regulated power utilities may face some downward pressure. Bonds and debentures, especially those with longer durations, should decline in value as interest rates rise. Some interest sensitive utilities, some former Trusts and some REITS may come under pressure as well.

As always it is important to remember that a well balanced portfolio will be able to absorb corrections in asset classes. Dividends should continue to provide stable and predictable income going forward.

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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