Chris Kuflik - ScotiaMcLeod Montreal

The financial media and jittery equity markets have caused many investors to become very confused. In the spring global economic problems caused sharp declines in most global indices. Since the first week of July, markets have rebounded sharply to recover many of this spring’s losses. The recovery has been led by better than expected earnings reports. Where should we go from here?

Fundamental and economic problems continue to build up onto the wall of worry for some equity investors. These problems are real, and have been placed on the ‘back burner’ while the earnings parade continues. Employment statistics, contracting credit, consumer confidence, and today durable goods orders – indicate that we are still in a very difficult economic situation. As a result it may be reasonable to expect that the broader markets and global economies will be slower for longer.

During this slow growth period, it will be imperative for investors to focus on those sectors and companies that are showing superior relative performance and providing some return of income from profits to investors. Relative strength is a valuable concept and tool that we use to identify investments. It is expressed as a ratio that can be applied to asset classes, sectors, or individual stocks.

The key behind the success of relative strength lies in the dispersion in returns of those items being compared. The greater the dispersion in the returns, the more likely relative strength is to be able to deliver superior performance over an index. So far this year, the difference between the best and worst performing sector in the US is 32.60%, the lowest it has been in the last twelve years. To put this in context, the average differential between the best and worst performing sector over that time period is more than 100 percentage points. In other words, it has been difficult this year to provide any substantial amount of outperformance without the help of risk controls and dividends or income from investments.

It is by no means far-fetched to say that we have been seeing a lack of strength among different sectors in domestic equities in 2010. A further representation of this is that currently we are only seeing 5 out of the total 32 Dow Jones sub-sectors ranking as having favored status. In Canada, 3 of 10 sectors are favored. However, we are beginning to notice a turnaround in this trend, as more sectors are improving.

Sector relative strength and favored status can produce some shocking results. An example of this can be found in the US. The real estate sector currently entered onto the favored list. This occurs despite the many problems and headwinds facing the sector that I have discussed in past commentaries. It should be noted that sector outperformance typically lasts between 3 and 18 months

I hope that you are enjoying the summer. I look forward to sharing the favored sectors with you and helping navigate these choppy markets whilst mitigating risk. Please call me at 514 287 2931 to discuss your portfolio. Please note that the Canadian markets will be closed this Monday.

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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