Slowdown not leading to bear market

Recent market setbacks are nothing to get too worked up about, according to Paul Vaillancourt, senior vice-president and director of asset allocation strategy at Franklin Templeton Managed Investment Solutions. He says that the market is simply wringing out some excesses and that investors should not expect a long-term bear market.

“The markets are off 15%. That’s pretty close — typically a correction is anything above 10% [decline] and a bear market is 20%,” he says. “A typical bear market grinds its way through. You see a sell-off of about 20%, and it takes about nine months to a year to play out. Even if we are in a cyclical bear, which we don’t think we are, we’re two-thirds of the way done.”

Vaillancourt adds that the markets are currently pricing in “maximum pessimism, a crisis of confidence,” and that the U.S. slowdown will force the world into a “deep and lengthy” recession.

“What we think is going on is a cyclical correction, not a grinding bear market,” he explains. “This is a necessary re-pricing of risk. A freefall from these levels is not likely — this is an economic slowdown, not meltdown.”

There are four key factors that lead to sustained bear markets, says Vaillancourt, and none of them are currently present in his opinion. These include errors by policymakers, economic meltdowns, excessive asset valuations and real interest rates that are high and rising.

“We don’t think that no slowdown is looming — we’ve been talking about a slowdown in the U.S. for quite some time — it’s absolutely the case,” he says. “But again, we believe it’s more of a cyclical slowdown than a secular, multi-year event.”

Troubles in the U.S. housing market are having a logical knock-on effect on the U.S. financial sector, a re-pricing that Vaillancourt considers reasonable. But negative sentiment is dragging down stocks that do not deserve to take a hit, he says, pointing to companies like mining giant BHP Billiton and Canadian fertilizer producer Agrium.

“We’ve got to keep things in perspective,” he says. “This is a sell-off after five years of global expansion and double-digit market returns.”

Paul Taylor, chief investment officer at BMO Harris Private Banking, agrees that a big market drop and current re-pricing was due, but the fallout from the industry turmoil — especially the sub-prime debacle — won’t be as bad in Canada as it has been in the States.

“We believe there will be a meaningful slowing of Canada’s economy, given our commodity bias and the cyclical nature of Canadian equity,” he explains. “[But] we’re going into this slowing from a firmer footing than the U.S. market. We will inevitably be pulled into this downdraft of whatever slowing occurs, but generally our sense is we got into this with valuations that are not tremendously stretched. Whatever downside we do have, we do not believe this has the look and feel of a more prolonged sustained bear market.”

The Bank of Canada also says in its January Monetary Policy Report Update that Canada’s economy is relatively strong, even with some slowdown in the fourth quarter last year.

“Despite tighter credit conditions, domestic demand in Canada is expected to remain strong, supported by continued income growth associated with high commodity prices,” says the Bank.

The BoC projects that Canada’s economy will expand by 1.8% in 2008 and 2.8% in 2009. “This implies that the economy will move into excess supply in the second quarter of 2008, and then return to balance in early 2010.”

Still, the global slowdown means the Bank will probably cut rates again soon. “Further monetary stimulus is likely to be required in the near term to keep aggregate supply and demand in balance and to return inflation to target over the medium term,” the Bank says.

Even though Canada’s economic downturn isn’t as pronounced as America’s, Taylor says values in certain markets will be attractive in the coming months.

As for what areas look positive, the investment team at Fiduciary Trust think emerging markets — and Latin America in particular — will continue their climb, while the group is largely neutral on North American, European and even the Japanese markets.

Sector-wise, Taylor thinks gold and fertilizer stocks are poised to make significant gains. He says the latter is attractive because higher demand for renewable energy and increasing food prices around the world means fertilizer companies should do well.

As for gold, prices have doubled over the past couple of years, and with commodity prices looking strong, there is room for further growth.

Taylor also cites consumer staples as a place to invest. “Any setback we see in these staples, we argue, will have very limited downside regardless of the environment we find ourselves in going forward.”

In the short term, BMO Harris Private Banking is planning to move money “very selectively” from cash to Canadian equities. The company isn’t moving cash in “blanket fashion” to equities — it’s going to happen over the course of the next six months — but it is ready to start the process.

Filed by Bryan Borzykowski and Steven Lamb, Advisor.ca, bryan.borzykowski@advisor.rogers.com or steven.lamb@advisor.rogers.com

(01/24/08)

Steven Lamb and Bryan Borzykowski