We are happy to have our first article from Michael Gesualdi at TD Waterhouse, about the U.S. markets from a non-U.S. perspective.  Michael wanted to give us a broad view of the markets for his first offering, and his next article will start focusing in on particular factors affecting the markets. Pay close attention to his view on how other governments are being forced into enacting unwanted measures due to the US situation.  Also, please keep a look out next week when I discuss part I of a two part article concerning “When did Financial Freedom Get So Expensive?” -Dominic Mazzone   

GLOBAL MARKET REVIEW

By: Michael Gesualdi, TD Waterhouse Global Asset Management

 Central Banks Take Centre Stage
Last week the central banks in both the U.S. and Canada took centre stage, as the Bank of Canada made its last interest rate decision, followed by the release of its semi-annual Monetary Policy Report (MPR), and the markets were pondering what the Fed was going to do when it made its next interest rate decision this week. Well, we now know they have cut 25 basis points and have given the market a feeling that a pause is needed to keep inflationary measures in check.  For the Bank of Canada, the decision was a little easier as they are not all that far into their easing cycle, with only 100bps of interest rate relief delivered before last week’s additional 50bps rate cut.  But for the Fed, the decision is getting a little tougher, since the Fed has already delivered 300bps in rate cuts since September, and the markets are wondering when the easing cycle is going to end.  However, we think that both rate cutting cycles still have some distance to go, and expect to eventually see floors of 2.0% for the Bank of Canada’s overnight rate, and 1.0% for the U.S. Fed funds rate.

The real issue is a question of timing.  The effect that the US easing of rates has is that it is artificially inflating the Canadian Dollar, and we have seen the Canadian Dollar 10% above par in the last year. It is in my opinion that the Bank of Canada is easing rates to control the strength of the CDN dollar because Canada’s #1 trading partner, the US, has been moving away from Canadian imports and is increasing its domestic manufacturing instead. This has forced the bank of Canada to lower rates rather than keeping them steady or raising.  What a lot of U.S. investors are not aware of is that Canadian manufacturing and the auto sector mainly based in Eastern Canada, have been destroyed due to the weakness in US dollar and has forced many manufacturers to cut the labor force or shut their doors!  In my opinion, US housing needs to bottom so the Fed can move in the other direction and start raising rates to curb inflation and boost the strength in the US dollar. This in turn, will put the Canadian dollar back to where it belongs in the .85 to .90 range against the U.S. Dollar.

The U.S affecting the world abroad:

US Markets have been  rallying mainly due some positive earnings from Google, IBM, RIM, Apple and the agriculture plays; Monsanto, Mosaic. Commodities have driven the Canadian Market to positive returns year to date however it is important to put things into perspective.  9 Stocks have caused the Toronto Stock Exchange Composite Index (TSX) to reach its current levels of 14,000 plus. Without stellar performance from the likes of Potash Corp., RIM, EnCana, Suncor, Goldcorp, Agrium, Cognos, Canadian Natural Resources, Barrick and Kinross, the near-record TSX would in fact be trading approximately 1,000 points lower. The fact remains that the gains on the index are driven by only a few strong performers(mainly commodity plays), and gives weight to the theory of the rise of commodity based economies.

My thoughts on this are with the US Economy in a current economic contraction, it will at some point negatively affect prices of the Oil and Gas sector along with base and precious metals prices, and inadvertently the stocks associated with those commodities.

I do however think that over the next 6 to 12 months in this time of economic slowdown that this will present a tremendous buying opportunity. I would also like to point out that this is primarily due to the emerging middle classes in China and India. The Global Economy is at a crossroads with having to ease rates to bring calm to the US housing bust and the fear of a US Dollar collapse(this is a concern due to such heavy global investment in the U.S. economy). However, at the same time these other global economies are trying to keep their own inflation from running wild.  In my opinion the drop in US dollar is what is keeping the US economy from further slipping into a deeper recession. I say this because the US economy is seeing massive inflows from Sovereign Wealth Funds (I’ll cover the function of these in my next article) trying to bargain hunt in the US market, and also the weak dollar is increasing US exports. The big fear is that we don’t want a repeat of 1970’s stagflation when there was continuous upward inflation pressure and a stalling economy!

I would like to hear from readers on what topics you would like me to cover moving forward.  I plan to focus both on the Macro environment from a non-US perspective or even get specific on recommended asset classes and weightings.  Your input is greatly appreciated.