The second quarter of 2010 proved to be challenging with global concerns ruling the day. Investors focused on European debt, doubts about the Chinese economy being able to continue their pace of growth and heightened worries about the U.S. jobless recovery. All these issues brought into doubt the sustainability of the global recovery and many began wondering if we might not be headed for the dreaded double dip!

For the quarter, the SPTSX fell 5.51 % and ended the quarter at -2.54 % year to date. The fund was off 11.68 % resulting in a year to date return of 0.15 %.

Defensive sectors outperformed growth and large cap gold stocks attracted capital as the fear trade won the day.

As we all know, the market rallied sharply off its lows in 2009 posting a 35.05 % return for the year. An absolute market truism is; markets do not go up in a straight line. Was a pull back reasonable? Yes, by some measure, given the large gains of the previous year. On the other hand, do I believe that the global economy will double dip into a recession opening up the possibility of retracing 50 % of 2009 gains? (Something many pudants are talking about). No, I don’t.

European debt concerns are real but the potential impact on global markets from the PIGS debt crisis is 20 times smaller than the subprime crisis of 2007. The global economy is in much better shape to withstand the crisis as it is in a recovering phase verses entering a recessionary phase. Corporate balance sheets are better capitalized and individuals are increasing their savings. Furthermore, the weakness in the Euro will benefit the larger Northern European export led economies such as Germany on a go forward basis providing stimulus and making them more competitive.

The next major concern, weighing significantly on the material sectors is the severity of the Chinese slowdown. Authorities in China remain concerned about inflation especially property price inflation. The steps they have taken to slow price appreciation is having the desired outcome. The worry is, have they gone too far opening up the potential of a double dip? I don’t believe this is the case. If the economy was truly heading for a period of weakness the authorities would not be trying to cool it down. Furthermore, The Peoples Bank of China would not have ended the Yuan’s fixed rate to the dollar in June if authorities were worried about growth. China is lifting their foot off the accelerator not slamming on the breaks. This is after all a managed economy. The trade numbers suggest a very healthy economy. Imports and exports jumped almost 50 % on a year over year basis. Exports to the US are now back near their all time highs, as are their global imports.

With regards to a U.S. jobless recovery; Single economic releases are almost meaningless without some regard to trends. Numbers are regularly revised at later dates and rarely give an overview of economic growth. The trend that is clear is that the economy has gone from losing 600K – 800K jobs per month a year to net job growth over the last 5-6 months. Historically when an economy comes out of recession the initial GDP growth is high, as sales and earnings increase not only due to demand growth but also inventory replenishment. The economy then begins to slow to a more normalized rate. It is common for investors to worry about a double dip recession but this rarely occurs.

Valuations are compelling with P/E multiples at 12.4 x which is significantly less than the historic levels of 15.3 x. Stocks are significantly cheaper than the bonds. Corporate and high yield spreads have widened somewhat but not to any great degree and are not signalling that we are re-entering the recession. The yield curve is relatively steep. Fear is high and investors are focused solely on macro events and market technical’s with no regard to earnings, cash flow and fundamental valuations. Balance sheets are very healthy after repairing themselves from the 2008 credit crisis.

I believe this is a short term correction and that this market should be bought. I continue to favour companies with exposure to China and India, which explains the high base metal weight. I have trimmed the larger, slower growth gold names in favour of energy and other growth companies.