Historically, September and October have been weak months for North American stock market indices. This year has been no exception with all of North America’s major indices posting negative returns.
From Sept. 1st to Oct. 13th, the TSE 300 fell 8.2 per cent, the Dow Jones Industrial Average (DJIA) dropped 9.1 per cent, the Standard & Poor 500 declined 9.5 per cent and the high-tech weighted Nasdaq tumbled 21.1 per cent.
The main events that have led to the sell-off include: negative earnings pre-announcements; higher oil prices; conflict in the Middle East and renewed signs of inflation.
While the aforementioned concerns are real, I believe most of the negative news is priced into the market. I would recommend that investors take advantage of the market weakness to establish positions in companies that are demonstrating solid earnings growth.
Corporate earnings announcements will begin to accelerate this week. So far, we have seen a number of negative earnings pre-announcements that have left investors on edge. As we enter the core of earnings season, I believe most of the negative news is behind us.
In my opinion, the majority of companies that are going to report disappointing results have already pre-announced them, with the remaining companies either meeting or exceeding earnings expectations.
To date, 69 companies have reported quarterly earnings from the S&P 500 index. On average, earnings have grown by an incredible 23 per cent compared to the same time last year. Research company First Call’s current forecast for third quarter earnings is for an increase of 15.9 per cent.
If actual third quarter earnings can continue to meet or surpass First Call’s prediction, I believe that investor sentiment will turn positive and money will re-enter the market. When the investment climate improves, there will be an abundance of cash to inject into the markets. In the U.S. alone, money market assets have grown by 22 per cent in the past year to $1.8 trillion US.
Last Thursday, West Texas Intermediate (WTI) crude oil closed at $36.06 per barrel. As long as oil prices can stabilize at $35 per barrel or lower, inflationary pressure should steady and the stock market should rebound.
Analysts are suggesting that oil prices will decline to the $25 – $30 per barrel level. In a recent statement, Saudi Arabian Oil Minister Ali al-Naimi said OPEC’s objective is to maintain an average selling price of $25 per barrel. If this is true, optimism for falling oil prices will improve.
However, the situation in the Middle East remains the wild card. If the Israeli-Palestinian violence accelerates, oil prices will rise sharply and all bets for a favourable rebound in the equity markets are off.
After numerous interest-rate hikes, economists believed that inflationary fears were behind us and the next move by the Federal Reserve would be to reduce interest rates. However, recent releases of strong retail sales data and higher than expected U.S. producer price index combined with a 30-year low in unemployment, has decreased the probability of an interest rate cut in the States.
This week, U.S. Federal Reserve Chairman Allan Greenspan will make two presentations that might give some indication as to the direction of U.S. interest rates. Any signs that interest rates have peaked will be viewed positively by equity markets.
Economists believe that the Canadian and U.S economies are slowing from extremely high growth rates to more sustainable levels. Last quarter’s GDP growth was an impressive 4.7 per cent in Canada and 5.6 per cent in the U.S.
Although ScotiaMcLeod is forecasting GDP growth to slow to 3.8 per cent in both Canada and the United States in 2001, it is still well above the 2.2 per cent average growth rate experienced in Canada and the 3.0 per cent growth rate achieved in the United States through the 1990s.
Just as importantly, corporate profitability remains strong in Canada and the United States. At the end of August, the return on equity stood at 11.2 per cent for the TSE 300 companies and 22.1 per cent for the S&P 500 companies. Even in an environment where economic growth is expected to slow down, return on equity is projected to continue to climb by 10 per cent to 15 per cent in 2001.
In the current environment of lower stock valuations, strong corporate profitability and stable economic growth, I believe North American equity markets are an attractive investment option.
For more conservative accounts I would wait for the crisis in the Middle East to subside or for further market weakness before entering the equity markets. In Canada, companies that I like include C-MAC Industries Inc., Toronto Dominion Bank, and BCE INC. In the United States, my favourite picks are Chase Manhattan Corp., Citigroup Inc., EMC Corp. and Kemet Corporation.
(Derek Ballendine is an investment executive with ScotiaMcLeod Inc. These views and ideas belong to Ballendine and do not necessarily reflect the views and ideas of ScotiaMcLeod.)
