Chris Kuflik - ScotiaMcLeod Montreal

Until this week, North American equity investors have been living in a utopia. Markets have, for most weeks only moved in one direction - up. In this holiday shortened week, the US markets, after reaching 2 year highs recently, have retreated. The TSX has been spared this decline, due in part to its high exposure to the oil and gold sectors. Will these gains continue or should we prepare for increased volatility and possibly declines?

The fundamental news for many North American equities has been good. The majority of companies have beaten analysts’ quarterly profit expectations. The increase in the supply of money, courtesy of the western world’s central bankers, has flooded the markets. Faced with low short term interest rates, falling long term bond prices and a rising stock market, investors have been moving into equities. Bullish sentiment, the percentage of investors who expect that the markets will continue to climb, has reached very high levels. Cash balances in mutual and pension funds are at lows similar to levels of last April. Any bad economic and geopolitical news was largely ignored until this week as the supply of new money to the institutions has been quickly put to work.  The utopia, while it may continue for a period of time, will be tested if not now, by the summer when the supply of fresh money for equities slows.

Equities – read the markets as a whole, have been overbought on a technical basis for approximately six months. You should note that strong markets can remain overbought for extended periods of time. This state of being overbought has and can continue until the supply of cash slows or stops. Don’t get me wrong. I’ll gladly take higher markets but I am concerned that mounting global pressures could cause a great deal of volatility.

The focus of geopolitical events this week has been on the uprising in the Middle East. Oil has spiked to levels not seen in over 2 years as Middle Eastern supply has come into question. Despite record inventory levels of oil in the US, WTI climbed to over $103 per barrel in sympathy with the rise in Brent prices. The fear is that the world economies will suffer with sustained high oil prices. 

The markets have largely ignored many of the problems that I have mentioned in past commentaries which seem to have been pushed off into the future. Some of these problems are resurfacing as new potential ones arise. In addition to debt troubles in periphery Europe, elections in some European countries have begun. In Germany, German Chancellor Angela Merkel's Christian Democrats (CDU) took a beating at Sunday's state elections in Hamburg, obtaining just 21.9 percent of the vote. While this does not cause the CDU to lose power, it has been suggested that this could force her to change or weaken her stance for Germany’s support of the European bailout fund later in March as this loss makes it more difficult to push through federal legislation in Germany. In addition there will be elections in Ireland in March where austerity measures are center stage.

Lastly, you should note that technically speaking, there have only been three times in the last hundred years when the stock market has doubled within two years in the US; once in 1932 and once in 1937. In both cases, the markets gave back substantially all of the gains that they achieved. I'm not predicting that this will happen this time, but it's worth noting that history has a cruel way of repeating itself. While I hope that this is not the case, we have taken precautions against this.

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Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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