Expect another correction soon: Rubin

Not quite a week into February and the markets are as unpredictable as ever. And according to noted CIBC economist Jeff Rubin, it’s likely we’ll see many more ups and downs in the coming months.

Rubin says the markets will likely drop another 5%, as North American banks continue with write-downs. “The tandem of falling U.S. housing prices and rising default rates should trigger as much as another $30 billion to $50 billion in asset write-downs…over the next quarter.”

The reason for more write-downs is the sub-prime mortgage mess, which, explains Rubin, is nowhere near finished. He says worldwide write-downs on U.S. sub-prime mortgages will likely peak at $265 billion — the industry has already bitten the bullet on $140 billion — over the next year.

He predicts that housing prices and defaults will keep on coming, despite Federal Reserve rate cuts and intervention from Washington aimed at sparing about 300,000 homes from mortgage resets. “As long as the falling house prices continue to generate significant negative home equity among sub-prime mortgage holders, default rates will continue to rise even if sub-prime mortgage rates do not,” says Rubin.

“A double-digit decline in housing prices will bring a concomitant increase in default rates, which will likely approach just under 30% by the fourth quarter.”

It’s not just the housing sector that’s in trouble. The Institute for Supply Management released a report Tuesday that says business activity in the non-manufacturing sector in the U.S. contracted in January for the first time in nearly five years.

The non-manufacturing index sits at 44.6%, its lowest since March 2003; the new orders index contracted to 43.5%, its lowest since October 2001; and the employment index dropped to 43.9%, its lowest since February 2002.

“Weakness in the economy coupled with increased costs have negatively affected business,” says Anthony Nieves, chair of the ISM. “Members have also indicated that they are experiencing inflationary pressures. The overall indication in January is that non-manufacturing has come to the end of a long-term period of growth.”

Only three industries reported growth in January, while 14 saw contraction. The three include utilities, professional, scientific and technical services, and educational services, while forestry, fishing and hunting, construction, and finance and insurance all took a negative hit last month.

While these results sound depressing, Rubin is upbeat about the year’s long-term outlook. He says that while the cuts and stimulus packages won’t help the housing sector, “they should go a long way in containing broad contagion effects to the rest of the economy.”

He adds that a 2.5% federal funds rate should help the U.S. economy and North American markets bounce back by the latter half of 2008.

Helping matters are the strength of overseas economies and the potential of triple-digit oil prices over the year. Rubin says this “should set the stage for a powerful second-half rally in the market that will see the TSX end the year at 14,500.”

Going further, he says energy and resources will push the TSX to 16,200 points by the end of 2009.

Still, Rubin’s not ignoring the short-term volatility. He’s cutting the weighting of stocks in his model portfolio by nine percentage points and putting that money into bonds. He’ll transfer the cash back into equities when the market rebounds in the second part of the year.

Sector-wise, Rubin says he’ll remain overweight in energy, gold and base metal stocks. “We continue to like the energy and commodity side of the market, which is largely detached from the problems of the U.S. housing market and even the more general outlook for the U.S. economy,” he says.

On the flipside, Rubin is reducing his weighting in banks and telecoms by a half-percentage point each, moving the funds into utilities instead.

Filed by Bryan Borzykowski, Advisor.ca, bryan.borzykowski@advisor.rogers.com

(02/05/08)

Bryan Borzykowski