In 2000, world equity markets experienced incredible volatility with some of the largest market swings in history.
Through all the turbulence the Canadian equity market, represented by the TSE 300, was one of the top performing stock indices in the world. In Canada, the TSE 300 advanced 6.8 per cent and ended the year at 8,933.68.
In the United States, all the major indices had sub-par years. The Dow and S&P 500 had their worst year since 1981, with the Dow sliding 6.2 per cent to close the year at 10,786.85 and the S&P 500 dropping 10.1 per cent to end 2000 at 1,320.28.
These losses seem to pale in comparison to the high tech-weighted Nasdaq that suffered its worst annual loss since inception, plunging 39.3 per cent to end the year at 2,470.52.
Likewise, other major international stock exchanges had negative experiences in 2000 with the FTSE-100 (London) falling10.2 per cent, the CAC 40 (Paris) declining 0.5 per cent, the DAX (Frankfurt) sliding 7.5 per cent, the Nikkei (Tokyo) tumbling 27.2 per cent and the Hang Seng (Hong Kong) slumping 11.0 per cent.
Entering 2000, the U.S. Federal Reserve’s main goal was to execute a soft landing for the U.S economy. Through a series of six interest-rate hikes, U.S. Federal Reserve chairman Allan Greenspan has been successful in slowing the U.S. economy and deflating excessive valuations in the technology sector.
There is no doubt that the U.S expansion has finally lost some steam as real GDP grew at an annual rate of just under 2.5 per cent in the third quarter, less than half the pace of the previous year and the smallest gain since 1997. With 85 per cent of Canadian exports heading south of the border, an economic downturn in the United States will affect the Canadian economy.
In 2001, the success of North American equity markets will depend on the U.S. Federal Reserve’s ability to manipulate the U.S. economy and avoid a recession.
Wall Street’s most reputable strategists believe that the Federal Reserve will be successful in engineering a soft landing and that equity markets will have a respectable year. The 12 analysts that were interviewed have forecasted, on average, that the Dow will gain 12.6 per cent and that the S&P 500 will rise 18.1 per cent in 2001.
In Canada, ScotiaMcLeod’s Canadian portfolio analyst is projecting that the TSE 300 will advance by more than 20 per cent this year.
On Jan. 3, the Federal Reserve surprised the markets with a 50-basis-point reduction in overnight bank lending rates. This unexpected move suggests to me that Greenspan will take whatever steps are necessary to stimulate the economy and extend the longest economic expansion in U.S. history. In fact, there is speculation that Greenspan will cut interest rates by a further 50 basis points at the Federal Reserve’s regularly scheduled meeting at the end of January.
Although the Federal Reserve’s sudden action implies that the U.S. economy is in worse shape than originally anticipated, the equity markets reacted positively with one-day gains of 3.8 per cent on the TSE 300, 5.0 per cent on the S&P 500, 2.8 per cent on the Dow and 14.2 per cent on the Nasdaq.
Lower interest rates take time to work through the system. However, the end result is greater economic activity and improved corporate earnings.
Historically, a falling interest-rate environment has been viewed favourably by equity markets. In years when interest rates have declined, U.S. equity markets have experienced positive rates of returns more than 90 per cent of the time.
Quarterly earnings announcements will begin to accelerate this week. While the outlook for interest rates is positive, corporate earnings appear to be weak and guidance for the future is unclear.
In general, analysts are projecting earnings reports to remain depressed over the next three to six months before rebounding later in the year. Since equity markets are a discounting mechanism, the debate is whether or not the equity markets have already discounted all the bad news and are looking ahead to stronger profits later in the year.
Based on recent technical market trends, it appears that the majority of the bad news is priced into the market. For conservative investors it makes sense to wait for coming earnings announcements and clear signs of future earnings visibility prior to investing.
However, for investors who are willing to endure some short-term volatility, the outlook for the future is compelling. Sectors that I like include technology, telecommunication and interest-sensitive stocks such as financial services.
(Derek Ballendine is an investment executive with ScotiaMcLeod Inc. These views and ideas belong to Derek Ballendine and do not necessarily reflect the views and ideas of ScotiaMcLeod.)
