Friday, October 14, 2011

2011 correction over?

A picture is worth a thousand words, the saying goes. Although if you look at the 5 year chart of the TSX index it looked like we were entering a bear market while the charts of the Dow Jones and S&P500 (see above) shows a mere correction. If you turned on the news lately, you would have been hit by a deluge of bad news and pessimism. But the economy has not gone into recession and every day there are ‘glimmers of hope’ that the North American economies are still doing better than ‘expected’ and that there is even growth. You’d think Europe is collapsing but even there anemic economic growth has been observed. In Asia, the growth is finally moderating. The ‘Doom and Gloomers’ are now fearing a complete collapse of the BRIC economies, but really, this is exactly what the Chinese government has been aiming for; moderate growth and less inflation. At 6.1%, mostly caused by rising food prices, the Chinese economy is still a bit high on inflation, but ‘core’ inflation excluding food and energy is a modest 2.9%.

I predicted early in the year a moderately performing Canadian stock market, an outperforming U.S. stock market and the recurrent problems of the European debt crisis. Although overall stock market performance was less than stellar up to now and I actually did recommend for older investors to sell off some of their riskier investments so that they may sleep at night, the overall prediction, surprisingly, still stands. In fact, the above chart of the S&P500 suggests that I may have been dead-on (talking about miracles).

The 3year S&P500 chart shows that we just went through a significant correction and trading volumes suggest that in September we actually may have hit a high volume ‘capitulation’ pattern. However, we have been nowhere near a repeat of the 2008-2009 bear market. Yes, commodities have been hard hit, but the diverse S&P500 index shows that the overall market is still in a bull market trend. Last year between May and September we experienced a significant correction and we were all talking about a double dip recession. This summer, a broader and deeper correction from August until today occurred based on similar worries as last year but the overall bull market trend is intact.

These days, European, Asian or North American stock markets are all strongly ‘correlated’ or interconnected. We have learned that although some country indexes have been harder hit than others, virtually none has escaped the poor stock market performance. So in terms of diversification, it is no longer effective to diversify one’s holdings amongst countries. Individual markets sectors though have performed widely divergent or ‘poorly correlated’. Dividend paying communication stocks and that of dividend paying utilities and consumer staples have outperformed commodity stocks during the correction; bonds have been stable (although going forward over the long term they are likely higher risk than stocks). Apart from its recent retrenchment, gold has been outright stellar.

So, these days, when building a diversified stock portfolio, it is better to diversify amongst market sectors rather than amongst countries. Since Canada’s stock market is predominantly commodity, communications, real estate and financial sector driven, we should also look south of the border to add stocks from the consumer staple, high tech and health care sectors. I stick with my earlier recommendation to buy Dow Jones ETFs in U.S. dollars (Dow Jones Spiders).

The 3 year S&P500 chart is still above its 200 week average showing an intact long term trend; while the 1 year graph below shows that we’re back trading above the 50 day average – something technical stock analysts consider ‘bullish’. Even better, today the S&P500 has broken or is about to break out above its short term market peaks signaling an approaching year-end rally. Whether the rally will be as powerful and long lasting as last years’ remains to be seen but for now it looks like the worst is over (I certainly hope so).

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