Chris Kuflik - ScotiaMcLeod Montreal

Irrational exuberance was the term that the former chairman of the Federal Reserve Board, Alan Greenspan, used to describe the speculative fervour in financial markets in 1996. With the markets having regained the losses suffered in late 2008 and early 2009, should this term, once again be used to describe the current equity markets?

After a brief correction from February to mid March, equity markets have rebounded shrugging off negative news and it appears that they seem to only focus on the positive. While it is true that some economic indicators have been better than was expected, many of the global economic problems have not dissipated.

This week, it was reported than consumer confidence in the United States dropped from a reading of 72 in February to 63.4 in March. Recall that during the last economic expansion which ended in 2007, that this reading was around 98. This is important for several reasons. The US consumer makes up approximately 70% of Gross Domestic Product. If this is not just a one month ‘blip’, it could spell trouble for spending and the world’s largest economy in the coming months. Declines of this magnitude in consumer confidence usually occur in recessions or when the US economy is about to enter a recession. The only time in the last twenty years that a decline this great did not lead to a recession was after Hurricane Katrina.

The causes of this decline in consumer confidence are numerous. The decrease was principally attributed to the disaster in Japan, higher gasoline prices because of the unrest in the Middle East and higher food prices. Consumers are feeling the pinch of these higher commodity prices. Despite the better than forecasted employment numbers reported this week, wages are not keeping pace with the cost of living. In this environment, more of the average workers’ salary is being spent on food and energy. Corporations could also experience problems with rising commodity costs. Will they be able to pass along price increases and increase sales? Time will tell. We will look to the forward guidance that will be issued in corporate quarterly earnings reports which will begin in a few weeks.

In Canada, manufacturing helped our GDP grow by 2.8% in January. This was the best monthly performance since 2002. Manufacturing gains were reported to be broadly based. It has been suggested that some part of this gain was due to pent up demand as there were re-tooling and weather related shutdowns in the final two months of 2010. The greater concern to Canadian manufacturers, at this time is the rapid rise in the Canadian dollar versus the US dollar. This increase will make Canadian exports more expensive and could hurt sales and profitability in the future.

Lastly, investors need to keep in mind that the liquidity induced rally prompted by massive fiscal stimulus over the last few years may be in jeopardy when the central bankers slow or cease this stimulus at the end of this quarter. One only has to look to last spring to see the effect of the removal of the stimulus…a large correction occurred. On an interesting note, a recent survey of pension fund managers found that over one third of these managers felt that the US Federal Reserve Board would continue to inject liquidity into the economy via a third round of quantitative easing. 

While both Wall Street and I are happy with the recent good economic news, I question if and when the headwinds will cause problems for the equity markets. Barring any Black Swan events, I suspect that when we begin earnings season in a few weeks that we will have more clarity as to whether or not the markets are being irrationally exuberant at the present time. As such we will remain on high alert in the coming weeks and are prepared act quickly, should market conditions warrant it.

Please feel free to share this article with someone you feel could benefit from its contents.

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it  

Visit our website at www.chriskwealth.com

^® Registered trademark of The Bank of Nova Scotia, used by ScotiaMcLeod under license. ScotiaMcLeod is a division of Scotia Capital Inc. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund.

This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaMcLeod, a division of Scotia Capital Inc. ("SCI"), but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice.