Summary

  • The stock market in Canada started off 2011 with a gain of 1.0% in January, basically all of it coming on the final day of the month.  Larger stocks did better, a clear shift from the behaviour of the market over the past two years.
  • The Canadian bond market drifted lower in January, losing 0.4% as long-term bond yields increased, generating a 1.9% monthly loss for the Long-Term Composite.
  • Commodity markets were mixed to start the year.  Gold prices fell by 6% last month while Nickel moved up by over 10%.  Uranium was the star, though, rising another 15%.  Oil prices drifted lower initially but then rallied on the news from Egypt.
  • The Economic data continues to improve, particularly in the US where the recovery appears to be taking a stronger hold.  Overseas growth was strong, particularly in Asia, while some weak spots were noted in parts of Europe still. 
  • In terms of stock sectors, the Basic Materials sector was the biggest loser last month, falling 5.4% due to an 11.0% decline in the Gold sub-index.  Energy stocks had the most positive impact on the overall gains, moving up by 5.3% in January.
  • Our Stock Market Outlook is still bullish over the medium-term as economic growth is recovering, profits continue to improve, interest rates remain low and stock valuations are reasonable.  Stocks have had strong gains since the market lows last August and are always at risk of a short-term correction, particularly since investor sentiment levels have gotten somewhat bullish lately, as often seen at short-term market highs.  But we view that only as a short-term risk.  The overall fundamental outlook argues for higher stock prices over the next few years.  Corporate profits are within 10% of their prior peak and there’s no reason to think that stock prices won’t do the same.

Financial Markets: Monthly Review and Outlook

Stocks started off 2011 with tepid gains as investors were taking some profits after strong gains in the final few months of 2010 and due to fears about developing political problems in the Mideast, particularly Egypt.  The S&P/TSX Composite Index generated a total return of 1.0% in January, driven primarily by strength in the Energy sector, while being held back by sharp losses in Gold stocks. In terms of the Style Indices in Canada (compiled by RBC), the Momentum Index lead with a gain of 2.6% while the Value Index was up 1.9% and the Growth Index was up only 0.9%.  This is a continuation of the trend of the last two years.  In terms of market capitalization, though, the larger names have outperformed the small stocks so far this year, a clear reversal of what happened over the past two years.  But markets were exceptionally strong for the last four months of 2010 and may just be doing some churning at current levels until some more fundamental news on earnings or the economy takes centre stage again.

The fourth quarter earnings season is providing interest insights into current business conditions as well as the outlook, and in most cases the news continues to be quite good.   From the companies that have already released 4th quarter earnings, almost 75% in the US have beaten the expectations while over 78% of Canadian companies have achieved that feat.  That compares to a long-term average ‘beat percentage’ of around 65%.  On the revenue line, 74% of US companies have beaten the expectations while 71% of Canadian companies have beaten the expected revenue.  All of these numbers point to a strong outlook for 2011 as well as further fundamental support for current share prices.  Most companies are also making similar comments about their assessment of current conditions.  They generally see increased demand coming out of India and China with the momentum carrying into most of their business lines and geographies.  The one negative surprise has been some unexpected weakness in Europe, with major players like McDonalds, Dupont and Ford Motor all pointing to weakness in that region as the primary or only shortfall in their numbers.  In our view, the debt crisis in Europe is more about politics than economics. The entire outstanding debt of Ireland, Greece and Portugal amounts to around 620-billion Euros, or 6.8% of euro area GDP.  Financial bailout of these troubled nations is totally affordable if it gets to that stage.  Nevertheless, there has been intense political backlash, both within the crisis-stricken countries and outside of them, over how and under what conditions to best deal with the crisis.  The fallout does seem to be having an economic impact in at least the short-term though, according to the commentary from many companies active in that region.

In the U.S. stock market, blue-chip stocks kicked off the new year with their strongest January in 14 years, as a boom in corporate revenues and robust economic readings gave investors confidence that the U.S. economy has turned a corner. Helped by the Federal Reserve’s open monetary spigot, stocks continued a rally that began in December. Most of January was dominated by steady gains and few broad shocks, until protests erupted in Egypt last week.  January was a continuation of the trend we saw late last year as the economy is moving from recovery to expansion, and we’re seeing a move up in various measures of consumer and investor confidence.  The Dow’s 2.7% gain for the month is the blue-chip index’s strongest January since 1997 and the first positive January in four years. Apart from last Friday’s Egypt-related stumble, the Dow didn’t shed more than 40 points on any single day in January—good news for market watchers who believe a strong January bodes well for the rest of the year.  European markets were also strong last month with Germany up 2.4% and France gaining 5.3%.  The only area of weakness in January was in the emerging markets, with stocks falling 0.6% in China, 3.9% in Brazil and 4.1% in Mexico.

Oil prices surged to levels not seen since 2008 amid fears the anti-government unrest in Egypt could ripple across the Middle East, potentially disrupting global oil supplies.  Oil markets are also worried the chaos could paralyze the Suez Canal, a vital shipping lane, and the Suez-Mediterranean pipeline, which both run through Egypt bringing Middle East oil to Western markets.  Oil prices were already on the rise even before the turmoil in Egypt, increasing by $30 a barrel since the summer as the global economic recovery pushed up demand for crude. That has put pressure on the Organization of Petroleum Exporting Countries, which has faced mounting calls from oil-consuming countries to raise output.  OPEC Secretary-General Abdalla Salem El-Badri said the organization would open the spigots if the unrest in Egypt affected supply, though he said that was unlikely to happen. He stressed the market was well-supplied, with inventories full. OPEC says it has about six million barrels a day of spare capacity, which is equal to 7% of global demand, and that it can easily tap that if the world runs low on oil.

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