Chris Kuflik - ScotiaMcLeod Montreal

Global equity markets continue to lack any type of clear-cut, near term direction; and instead have presented investors with increasing volatility and losses. This has left many investors asking themselves the question, are we staring into the abyss? 

If you were to only look to the mainstream press, you would think that the answer to the above question would be a resounding yes, as the press focuses primarily on the negative news. This focus on the negative, has caused many investors in global equities to feel the pain via losses in equity values. Losses have been blamed on Europe’s debt crisis, concerns of a possible global recession, a slowing in China, and a lack of confidence in political leaders to fix those problems. Recently, while watching the 11 o’clock news on a major Canadian network, the first nine minutes of a thirty minute broadcast was devoted to reports on the global economy and markets. The primary twist of all of the stories was... you guessed it: the global meltdown (their words). No wonder investors are very concerned. I think I can speak for all of us when I say good riddance to the third quarter!

Unfortunately, there is also one more recent piece of negative news that is not in the mainstream press that you must be aware of. The Weekly Leading Index (WLI) growth indicator from the Economic Cycle Research Institute (ECRI) posted another week-over-week decline on September 23rd. This ERCI index is based upon dozens of specialized indices. This is important because the index is not based on someone’s opinion, but is based on hard data which is widely followed. This proprietary index declined from -6.7% to -7.2% last week. This prompted ECRI “to notify clients that the U.S. economy is indeed tipping into a new recession.”  You should note that this index did provide a false signal as recently as last summer when the number was more negative than the current reading, but the ERCI did not issue a recession call at that time. Their call is based in part upon sustained and rising unemployment in the US, the Eurozone debt issues and contraction, and a Chinese PMI number which indicates contraction. It is important to remember that the ERCI does excellent work, but it has not been infallible.

Since the ERCI issued this call, some important economic news and numbers have been reported. I am giving you these numbers, not to bore you, but to illustrate that the economy may not be as bad as the pundits are screaming. First in the US: Chicago PMI was 60.4% versus an estimate of 55%, Michigan Consumer Sentiment was 59.4% versus an estimate of 57%, GDP for the second quarter was revised upward from 1.2 % growth to 1.3% actual. Initial Jobless claims were 391,000 versus 419,000. The negative numbers were: a decline in durable orders to -0.1% versus an expectation of +0.1% and continuing unemployment claims which were higher by 14,000 versus expectations.

Of these numbers, the most important are the PMI. Recall that the PMI is “an index released monthly on the last business day of the month which indicates how vibrant regional manufacturing activity is.” An index value of 50 or higher indicates increasing business activity; below that indicates decreasing activity. The index breaks out readings for production, new orders, order backlog, inventories, prices paid, employment, and supplier deliveries. The PMI is a timely look at the strength of manufacturing industry in the Chicago Federal Reserve regions, which comprise Illinois, Iowa, Indiana, Michigan, and Wisconsin. The new orders and orders backlog indices are useful in predicting future production activity.

The Chicago PMI draws much of its influence from the fact that it is released one day before the ISM Index, which used to be called the NAPM index, and is produced by the Institute for Supply Management. The Chicago PMI Index is perceived by market traders to be a good leading indicator for the ISM, which typically affects the financial markets. Shortcomings of the PMI include the fact that it is only an opinion survey and relies on peoples’ perceptions, not data. It also doesn’t capture any technology improvements or increasing production efficiencies that might alter expectations and actual results” (source your dictionary.com).

I also believe Europe’s debt problems, while serious and painful, are solvable, and we may finally be seeing some progress on that right now. An expanded European Financial Stability Fund (ESFS), while still not yet unanimously adopted, is progressing. Assuming this comes to pass, we may be approaching a time that the markets actually pay more attention to something other than Europe for a while: namely corporate earnings which begin in the US on October 10^th.

A much anticipated Chinese PMI number was released Friday night. It was slightly better than expectations and marginally expansionary. The reading was the highest since May. New orders also increased. The most negative part of this report was that small and medium size Chinese firms continue to experience difficulty. This report should help to provide some marginal support to global investor confidence.

While global growth has waned, I believe that some degree of slower growth is now priced into equities. I have been encouraged that we have not yet seen a larger number of negative earnings preannouncements. The market is supposed to be forward looking. For this reason, investors will focus heavily on fourth-quarter guidance for clues as to the market’s direction.

As long as corporate results are reasonable and the crisis in Europe can be contained, I expect the market to at least find support near the low end of its recent trading range as valuations are compelling. Should we have positive developments, such as definitive progress on Europe’s debt, better economic data in the U.S. and around the world, and better-than-expected earnings guidance, we should see the markets move higher.

While we continue to hold large amounts of cash, I do not believe that we are staring into the abyss at this time. While the view of the market is currently clouded, the next few weeks will bring some clarity as to its direction. We are prepared to act with our shopping list of good dividend paying stocks should the skies begin to clear and will adhere to our stops if that is not the case. 

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

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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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